FEBRUARY 2012 Compliance Matters

Convincing the Internal Revenue Service to grant a request for innocent spouse relief has traditionally been an uphill battle for thousands of people, primarily women, who claimed they lacked control over family finances, and should not be punished for the misdeeds of their marital partners. Advocates have argued that many of these spouses, who are also spousal abuse victims, should not be penalized yet again.

Last year, the IRS announced important changes to its innocent spouse relief guidelines that effectively qualified more people. In December 2011, the agency said that it would consider additional factors when deciding whether to grant innocent spouse relief. The agency also provided further guidance regarding innocent spouse defenses, and proposed a procedure that the agency began using immediately to evaluate requests for equitable relief. In addition to qualifying more people for relief, the goal of the changes is also to streamline the process of evaluating requests. It remains to be seen whether the new guidelines will significantly reduce the numbers of egregious cases of women for whom previous law and guidelines proved ineffective. However, the new rules are a big step forward.

The new rules address equitable relief, one of three types of innocent spouse relief that could be granted under the law. Under the new IRS guidelines, abuse or lack of financial control may mitigate other factors that might weigh against granting equitable relief under current law. If the non-requesting spouse abused the requesting spouse or maintained control of family finances by restricting access to financial information, this factor will weigh heavily in favor of relief. This holds true even if the requesting spouse knew or had reason to know about misstatements on joint tax returns.

The agency also established new guidance on the potential impact of economic hardship on the agency decisions. Previously, a lack of economic hardship weighed against granting equitable innocent spouse relief. Today, while economic hardship can effectively help a case, having experienced no financial distress will not count against the spouse requesting relief.

Under Traditional Innocent Spouse Defense, a joint return is filed, and there is a tax understatement based on incorrect information by the applicant’s spouse or former spouse. Either the person requesting relief did not know of the misstatement or have reason to know at the time the document was signed.

Separation of Liability applies when the applicant is no longer married to or is separated from the spouse, and the two are estranged and have been living in separate households for the 12 months ending on the date the return was filed. Under separation of liability, you separate or divide the understatement of tax (plus interest and penalties) on your joint return between you and your spouse. The understatement of tax allocated to you is generally the amount of income and deductions attributable to your earnings and assets.

Community property laws are not a factor in determining whether an item belongs to the spouse or requesting spouse for the purpose of requesting relief from liability. Community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Anyone requesting relief based on community property laws must file the necessary form no later than 6 months before the expiration of the period of limitations on assessment (including extensions) against a spouse or former spouse for the tax year for which she or he is requesting relief. If you do not qualify for relief under these guidelines, you may apply for equitable relief.

If a requesting spouse does not qualify for relief under the traditional innocent spouse defense or separation of liability, she or he may qualify for equitable relief. Equitable relief addresses mitigating factors including abuse that could justify an IRS decision not to hold the requesting spouse liable for underpaid balances for an amount on a signed return.

Stanley Foodman, CEO, Foodman CPAs & Advisors is a recognized forensic accounting and litigation support practitioner, specializing in international tax. A pioneer in the field, he has served as an expert witness and forensic accountant for some of the nation’s most complex, high-profile economic crime cases. Mr. Foodman is a former auxiliary special agent for the Florida Department of Law Enforcement with specialization in economic crime – money laundering, bank fraud, public corruption and discovery of hidden assets. He serves on the advisory board of the International Association for Asset Recovery (IAAR).

Foodman CPAs & Advisors is a full service accounting and litigation support firm, specializing in forensic accounting and international tax. One of the top 25 accounting firms in South Florida, Foodman represents clients locally, nationally and internationally.