Tax Court: A Spouse's Liability for Tax Cheating

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When you get married, you usually vow to cherish and love your spouse until death you part, but nowhere do you say that you must share your federal income tax liability.

Fortunately, when circumstances permit, you may be able to avoid the obligation caused by a tax-cheating spouse, as evidenced by a new case, Jacobsen, TC Memo 2018-115, 7/25/18.

For starters, if you file a joint tax return with your spouse, you are “jointly and severally” liable for the tax payments. This means that the IRS can come after either one of you, or both for you, if you owe tax.

This includes back taxes, penalties and interest to boot. In fact, you might be held personally liable for a tax debt even if you were completely unaware of the situation.

Getting divorced won’t get you off the hook either. But there’s a loophole if you’re treated as an “innocent spouse” under IRS rules. To qualify:

  • You must have filed a joint return that has an understatement of tax that's solely attributable to your spouse's erroneous item.
  • You establish that you didn't know – or have reason to know -- that there was an understatement of tax when the return was filed
  • Taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax.

In the new case, the husband, a machine operator at a manufacturing plant in Wisconsin who moonlighted as a property inspector, was married to an accountant at a blood bank. The husband had little knowledge of tax and financial affairs and relied on his wife’s expertise in handling these matters.

However, in 2011 the wife was arrested for embezzling almost a half million dollars from her employer over the course of several years. During that time, the couple made no lavish expenditures – they didn’t pay off their mortgage, the husband continued to drive the same used car and certain home utilities were even shut off for lack of payment. The husband was completely unaware of his wife’s embezzlement scheme until her arrest.

Of course, embezzled funds and other proceeds from criminal activities are taxable. The wife failed to report any of this income for the tax years in question.

The husband continued to support his wife through the first couple of years of her incarceration before the couple became estranged. She eventually filed for divorce in 2014 and the divorce was finalized in 2015.

Finally, the Tax Court noted that the husband is a disabled veteran who suffers from posttraumatic stress disorder (PTSD). As a result of these events involving his wife, he experienced a mental breakdown.

Since he filed for innocent spouse relief, the husband has held down four jobs and moved three times. At the time of trial, he was employed at a food packaging company and was earning $69,000 per year

The Tax Court is sometimes accused of being heartless, but it showed some mercy in this case. Based on the facts and circumstances, including the husband’s lack of knowledge about the embezzlement and any financial gain, he was absolved of about $150,000 in back taxes, interest and penalties.

There are three main takeaways from this new case for your clients:

1. Although you share tax obligations with your spouse on a joint return, your responsibility may be alleviated if you didn’t know, or should have known, about a fraudulent tax return omission.

2. Keep apprised of your tax situation even if the other spouse is the one handling all your financial matters. The mere fact that you didn’t complete the return or provide any assistance isn’t enough to qualify for innocent spouse protection.

3. Don’t marry an accountant! (Just kidding.)

About Ken Berry

Ken Berry

Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a wide variety of newsletters, magazines, and other periodicals.           

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