Dishonesty is a commonly cited reason for divorce. When that dishonesty extends to individual or business tax returns, a spouse may feel he or she is against a wall when a divorce is in the works. Should he or she report the dishonesty to the IRS? Who will be held financially responsible? Are there possible criminal repercussions?
The answer to those questions is this: it depends upon who knew what and when they knew it.
Spouses who were not involved in fraudulent tax reporting can request “innocent spouse relief” from the IRS. If you are granted status as an innocent spouse, you will not be held responsible for paying overdue taxes, interest and penalties for items that were improperly reported or omitted on your tax returns.
In order to qualify as an innocent spouse, you must:
- Have filed a joint return in which there was an understatement of taxes owed because of an error (unreported income or incorrect deductions) of your spouse or former spouse
- Establish that at the time you signed it you did not know and had no reason to believe there was an understatement of taxes
- Not have transferred property one to the other as part of a scheme to defraud the IRS or another creditor
- Make a case that it would be unfair to hold you financially accountable
If you knew that your former partner was committing tax fraud, you can both be held jointly and separately liable for any taxes owed as a result of underpayment. You can also be held accountable if you DID NOT know, but the IRS believes that a reasonable person in similar circumstances would have known of the errors, omissions or misstatements. How does the IRS determine that?
It will consider the nature of the errors, you and your former spouses’ financial position, your education and business knowledge, and the extent of your participation in the activities that resulted in the tax filing.
You will be asked whether the error or omission was a departure from past returns and whether you asked – or failed to ask – about the information when the return was signed.
Depending upon the answer to these questions, you may be considered an “innocent spouse” or you may qualify for partial relief if you had some, but not complete knowledge.
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