Innocent Spouse Relief in Tax Law

Generally, both spouses are responsible for paying any tax, interest, or penalties from their joint tax return. If you are going through a divorce and believe your current or soon to be former spouse should be solely responsible for an error or an underpayment of tax from your joint return, you may be eligible for innocent spouse relief. By filing a Request for Innocent Spouse Relief (IRS form 8857), you can ask the IRS to consider granting relief based on certain factors, including, but not limited to:

  • Your current financial situation
  • How involved you were with your family finances and preparing the tax returns
  • Whether you were (or are) a victim of domestic violence.

While your request is being considered, the IRS generally cannot collect any tax from you for the year(s) you request relief, but it does extend the amount of time the IRS has to collect any tax owed.

You must meet all of the following conditions in order to qualify for innocent spouse relief:

  • You filed a joint return which has an understatement of tax, due to unreported income or incorrect deduction, of your spouse (or former spouse).
  • You establish that at the time you signed the joint return you did not know, and had no reason to know, that there was an understatement of tax.
  • Taking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement of tax. According to the IRS, divorce, separation or desertion are examples of unfairness.
  • You and your spouse (or former spouse) have not transferred property to one another as part of a fraudulent scheme. A fraudulent scheme includes a scheme to defraud the IRS or another third party, such as an ex-spouse.

The IRS will make a determination within 6 months of the filing of a request for Innocent Spouse Relief. By law, the IRS must contact your spouse or former spouse concerning your request.

If you are going through a divorce and you are paying taxes for income that you were unaware of, you should speak with a lawyer to determine whether filing for innocent spouse relief is an option.

Categories: Divorce

About the Author

Rachel Castrejon opened her own law practice immediately after graduating from Loyola Law School and passing the California Bar exam in 1998. When she first opened her practice, she handled a variety of cases including wrongful termination, criminal appeals and family law matters. Ultimately, she chose to practice exclusively in the area of Family Law because she likes helping her clients through a very emotional process. Rachel’s goal is to help her clients through one of the most difficult times in their lives – the breakup of their family. Rachel understands the importance of achieving a resolution that is good for the entire family, particularly the children involved.

Learn more about Rachel

Disclaimer: The information and examples provided herein are based on the laws and regulations at the time of writing. Prior to deciding how to hold title in your property, you should consult with an accountant, probate attorney or family law attorney to determine the best way to hold your property for the purpose you want to accomplish.

Community Property with Right of Survivorship – Avoid Tax and Probate Fees

There are several ways to hold title jointly, such as tenancy in common, joint tenancy, community property or community property with right of survivorship.  There are advantages and disadvantages to each.

Community Property with Right of Survivorship

Holding title as community property with right of survivorship combines the benefits of joint tenancy and community property by allowing the transfer of the property to the surviving spouse without having to go through probate, the surviving spouse gets the total step-up in basis on the entire value of the property and neither spouse can transfer his or her interest to a third party. Married couples can title any asset, not just real property, as community property with rights of survivorship.

Community Property

For married couples, the property can be held as “community property” or “community property with right of survivorship.” There is a significant distinction between “community property” and “community property with right of survivorship.” When spouses hold property as community property, in the event of one spouse’s death, the surviving spouse gets a step-up in basis on the entire property as opposed to only the decedent’s share of the property. However, the surviving spouse must go through the cumbersome probate process and either spouse can dispose of his or her interest to another individual at time of death. This means that the tax basis on the property is assessed at the date of the deceased spouse’s death.
For Example: Susan and Bill purchased a house for $500,000 in 2000 and hold the title as community property. At the time that Bill passes away the house is worth $1 million.   Susan would have a tax basis of $1,000,000. If the house appreciates between the time of Bill’s death and when Susan sells the house, Susan will have a capital gain liability. For example, if Susan sells the house for $1,250,000 she will have a gain of $250,000. If she can claim the $250,000 exclusion of gain on the sale of a personal residence, she will not owe any tax ($250,000 gain – $250,000 exclusion = $0). If the property was not a personal residence, Susan would have to pay tax on the entire $250,000.

Tenants in Common

Holding property as “tenants in common” allows each spouse to own an undivided portion of the property.  Either spouse can sell, lease or will away his or her ownership percentage at any time.  The individual spouse’s interest is part of the individual’s estate and subject to probate or disposition under that individuals testamentary instrument (i.e. will or trust.) The heir of the individual’s estate will receive a step-up in basis on their inheritance. The step-up in basis means that the heirs’ tax basis in the inherited portion of the property will be the estimated fair market value at the deceased individual’s date of death, instead of the amount the deceased individual paid for the property., probate costs can be extremely costly and time consuming for your heirs.  Holding property as “tenants in common” is most common when two or more individuals who are not married to each other own property together.

In the event that you are married and want to hold property as tenants in common, you should discuss the ramifications with your spouse so there is a mutual understanding of the fact that either spouse’s interest can be encumbered or disposed of to a third party. It would be most helpful to have a written instrument that both spouses sign acknowledging their intent in holding the property as tenants in common.

Joint Tenancy

If spouses hold property as joint tenants, the surviving spouse automatically inherits the deceased spouse’s interest. Thus, the surviving spouse avoids the expensive and time-consuming probate process and neither of the spouse’s can encumber or give away his or her interest during his or her lifetime or on his or her death.

However, a big disadvantage to holding property in joint tenancy is that the surviving spouse only receives a step-up in basis on the inherited portion.

A simple illustration of the disadvantage: Susan and Bill purchased a house for $500,000 in 2000 and hold the title as joint tenants with equal interests. At the time Bill passes away the house is worth $1 million.   Susan would have a tax basis of $750,000 ($500,000/2 + $1,000,000/2.) If the house appreciates between the time of Bill’s death and when Susan sells the house, Susan will have a capital gain liability. For example, if Susan sells the house for $1,250,000 she will have a gain of $500,000. If she can claim the $250,000 exclusion of gain on the sale of a personal residence, she will have to pay tax on $250,000. If the property was not a personal residence, Susan would have to pay tax on the entire $500,000.

If you are holding property as a joint tenant, you may want to reconsider titling the property into another form so as to provide the most protection for the person who inherits the property.

Categories: Property Division

About the Author

Rachel Castrejon opened her own law practice immediately after graduating from Loyola Law School and passing the California Bar exam in 1998. When she first opened her practice, she handled a variety of cases including wrongful termination, criminal appeals and family law matters. Ultimately, she chose to practice exclusively in the area of Family Law because she likes helping her clients through a very emotional process. Rachel’s goal is to help her clients through one of the most difficult times in their lives – the breakup of their family. Rachel understands the importance of achieving a resolution that is good for the entire family, particularly the children involved.

Learn more about Rachel

Disclaimer: The information and examples provided herein are based on the laws and regulations at the time of writing. Prior to deciding how to hold title in your property, you should consult with an accountant, probate attorney or family law attorney to determine the best way to hold your property for the purpose you want to accomplish.