|SPOUSES GUILTY UNTIL PROVEN INNOCENT TO IRS: 2/19/01|
By Leonard Wiener, U.S. News and World Report, 2/19/01; http://www.usnews.com/usnews/issue/010219/nycu/innocent.htm
Divorce may end wedlock, but the IRS often won't let you off so easily. Auditors can get you post-divorce even if it was your ex who didn't report income or claimed invalid deductions on a joint return. "You can say it's the other guy's debt, but the IRS may see you as easy prey," warns Marjorie O'Connell, a Washington, D.C., divorce attorney. That can be the case, for example, if your ex is broke, hard to find, lives far from the agent handling the case, or has hidden assets. "Or the IRS may figure your ex will give them a harder time than you," says O'Connell.
Recognizing the problem, Congress in 1998 broadened the rights of taxpayers to seek absolution from the Internal Revenue Service for a partner's misdeeds. The cases typically involve divorced or separated couples, though sometimes the protections apply to those still married. Yet lawyers and accountants say it can be a tough fight to get "innocent spouse" protection, most often sought by former wives. They say the IRS is often reluctant to ease up on claims despite a flood of requests, and a recent Tax Court decision could make matters worse.
The issue is especially timely this season as couples prepare to file joint returns. Most pay little mind to the fact that each spouse is responsible for anything and everything on the return. While cross-examining your partner can sour relations, the alternative of filing separately is often more expensive for married couples.
A taxing case. It took a federal judge to rescue Ellen H. from the IRS. A Florida woman who testified to extreme intimidation by her husband, she declined to discuss the details of the case and says she is trying to put the "difficult period" behind her. According to court testimony, during 38 years of marriage she mostly let her husband–an insurance executive and lawyer–handle the money while she raised four children. In 1995, she discovered that her retired husband had stopped paying tax on a $90,000 annual pension, arguing that it wasn't taxable because he was fired after a head injury. She says her husband–who, according to court documents, was becoming increasingly irrational and domineering–forced her to sign a letter to the IRS backing him.
The couple has divorced and he is in a nursing home, but the IRS argued that because Ellen knew about the unreported income, she is liable for back taxes and penalties. A judge last November disagreed, ruling that Ellen didn't appear to have benefited from the extra income, faced verbal and mental abuse, and feared her husband's volatility. The flawed returns she signed were judged "the product of duress."
Ellen was lucky. Many applicants who cannot prove such duress are turned down by the IRS and courts. They may be required to establish not only that they didn't know about the cheating but that it would be unreasonable to expect them to know. That's a pretty high hurdle. The Tax Court has been unmoved, for example, by claims of innocence when a couple's spending was far out of whack with reported income or when an educated professional played dumb about finances.
New headaches. Another worry is a recent court decision that could stifle a much ballyhooed approach to innocent-spouse relief. This provision, enacted in 1998, essentially allows divorced or separated spouses being audited to bear tax responsibility for only their share of past income or expenses. But in a surprise decision involving a Texas woman, the Tax Court ruled last summer that simply knowing about a tax-return entry, or income not reported by a spouse, can be enough to remove the cloak of innocence–even if the allegedly innocent spouse had no idea that the return was wrong.
In that case, the Texas woman knew that her husband received a $230,000 retirement distribution and used to it to pay off a mortgage, buy an SUV, and meet other expenses. But, she testified, when she asked him about the transactions before signing the return, her husband falsely assured her that it was legal to deduct the mortgage payment and thus skip tax on part of the retirement money. The ruling against the woman, now being appealed, could conceivably be twisted and used as a defense by a spouse who doesn't look at a return or is "intentionally ignorant," complains Ann Murphy, a former IRS attorney who teaches law at Gonzaga University in Spokane, Wash.
The cost of battling the IRS can be a barrier for some spouses. Attorney Howard Teller of Rockville, Md., recalls a supermarket employee whose ex-wife helped run a restaurant and showed him false W-2's to hide her income. The IRS tried to get $66,000 in back taxes from him. He won, but only after spending $7,000 in legal fees. So even if you trust your spouse, it's not a bad idea to check that joint return.