Posted by: Garcia & Cuadra, PA | October 3, 2012

Current Innocent Spouse Provisions (Part III)

Whether a spouse has actual knowledge of an erroneous item at the time the return was signed depends upon all of the facts and circumstances.    Regarding omitted items, actual knowledge of the item includes knowledge of the receipt of the income.  If, for example, a spouse knows of the receipt of a sum of money that is not reported on the joint return, but does not know of the source, the spouse has actual knowledge of the item giving rise to the deficiency.   In determining whether a requesting spouse has actual knowledge or reason to know of an understatement of tax attributable to an erroneous item, courts have employed different approaches.  In cases involving omitted income, courts have asked whether the spouse has actual knowledge of (or reason to know of) the underlying transaction that produced the income (the “knowledge-of-the-transaction test”).  In cases involving erroneous deductions, the courts have used either the knowledge of the transaction test or an alternative test that asks whether a reasonably prudent taxpayer at the time of the signing the return could be expected to know that it contained the erroneous item.

When considering when it is inequitable to hold the requesting spouse jointly and severally liable for an understatement on a return, all of the facts and circumstances must be examined.  One important factor is whether the requesting spouse significantly benefited (either directly or indirectly) from the understatement. A significant benefit is any benefit in excess of normal support.  A direct or indirect benefit may include a transfer of property or rights to property, even if the transfer occurs several years after the understatement.  Other significant factors bearing on inequity include:  (1) whether the requesting spouse has been deserted by the non requesting spouse; (2) whether the spouses have been divorced or separated; and (3) whether the requesting spouse received benefit on the return from the understatement.  Additional guidelines for this determination include:  (1) whether the requesting spouse would suffer economic hardship if relief is not granted; (2) whether the requesting spouse has a legal obligation to pay the outstanding tax liability pursuant to a divorce decree or instrument; (3) whether the requesting spouse has made a good faith effort to comply with the income tax laws in taxable years subsequent to the year to which the request for relief relates; (4) whether the non requesting spouse abused the requesting spouse; and (5) whether the requesting spouse was in poor mental or physical health on the date she signed the return or at the time of the request for relief.

(More to follow on this topic on our next blog)

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