IRS 'innocent spouse' rules can be tough

When Valarie Stephenson tried to leave her husband in 2003, he put a gun to her head and threatened to kill her. She was so terrified that she remained in the marriage until 2007, when a friend — who noticed the bruises on her body — helped her escape to her mother's home in Phoenix. Stephenson then contacted an attorney and filed for divorce. After the divorce was finalized in 2008, Stephenson learned that she was liable for more than $66,000 in unpaid taxes stemming from a joint tax return filed in 1999. Stephenson asked the IRS for relief under the "innocent-spouse" rule. Taxpayers who are granted innocent-spouse status aren't responsible for a spouse's unpaid taxes, even if they signed a joint tax return. Stephenson said her former husband kept financial documents in a locked file cabinet, and threatened to hit her when she asked questions about documents he told her to sign.


While Stephenson seems like a textbook example of the type of individual the innocent-spouse rule is designed to help, the IRS said she was responsible for unpaid taxes related to a 1999 joint tax return. The reason: Stephenson failed to apply for relief within two years after receiving a collection notice from the IRS.
Stephenson appealed the decision in Tax Court and won. But the IRS' refusal to grant relief to Stephenson and others like her has ignited a firestorm of criticism from lawmakers, the IRS taxpayer advocate and legal aid attorneys. They argue that the deadline is particularly unfair to victims of domestic abuse, who are often kept in the dark about their spouse's finances for years.
Under the IRS interpretation of the rule, "You could be physically abused and locked up and not even have access to the (tax) records, but if you miss the limit, too bad for you," says Barton Bassett, a partner with the tax group for Morgan Lewis & Bockius.
The IRS says it's reviewing the innocent-spouse rules and plans to announce changes within the next few weeks. "We are seeing from our review so far that clearly our procedures need to be improved in this area," says IRS spokesman Terry Lemons.
The issue has generated rare bipartisan support in Congress. In April, Minnesota Rep.Michele Bachmann, a Republican presidential candidate and former federal tax attorney, introduced legislation in the House that would remove the time limit for innocent-spouse relief. Separately, House Democrats Pete Stark, of California, and Jim McDermott, of Washington, sent a letter to the IRS urging it to revoke the two-year rule. The letter was signed by 48 of their colleagues, including all Democrats on the House Ways and Means Committee, which has jurisdiction over tax issues. Senate Finance Committee Chairman Max Baucus, D-Mont., has also called on the IRS to evaluate the rule.
A tight deadline
Some taxpayers miss the filing deadline because their spouses hide the mail from them, which prevents them from seeing IRS notices, tax attorneys say. Others may not realize that a refund offset — which occurs when the IRS withholds a taxpayer's refund to cover unpaid taxes — will start the clock.
Other reasons taxpayers miss the deadline:
•Domestic abuse. Robert Nadler, an attorney for the Legal Aid Society of Middle Tennessee, is representing a woman who moved into a shelter for abused spouses after her husband fired a gun at her. He then showed up at her workplace and threatened to kill her and her children unless she moved back home. "That woman is not going to ask a question about whether some income has been reported," Nadler says. Her request for innocent-spouse status is pending before the IRS.
•Divorce. Divorce doesn't automatically relieve a taxpayer from liability for a joint tax return filed while the individual was still married, even if the divorce decree states otherwise, according to the IRS.
Taxpayers who were unaware of their ex-spouse's tax problems can seek innocent-spouse relief from the IRS. But often, tax attorneys say, divorced men and women don't learn of their ex's tax troubles until long after the deadline has passed.
•Fraud. Individuals who are convicted of criminal behavior often have problems with the IRS, too. If those taxpayers are incarcerated, their spouses may not learn about their unpaid taxes until it's too late to file for innocent-spouse relief.
Cathy Marie Lantz's husband, Richard Chentnik, a dentist, was arrested on charges of Medicare fraud in 2000. The IRS assessed the couple for $900,000 in additional taxes, interest and penalties. Chentnik told his wife he would file an innocent-spouse claim on her behalf, but died in a halfway house before submitting the application. By the time Lantz filed a claim, the two-year deadline had passed, and her application was denied.
The Tax Court overturned the IRS ruling, but the IRS appealed. While it agreed that the IRS' decision was harsh, an appeals court upheld the IRS decision.
•Death. In 2005, Joanne Payne's husband of 53 years died, leaving Payne with unpaid tax bills dating back to 2000. At the time of her husband's death, her attorneys say, she was emotionally distressed and had difficulty coping with routine financial matters.
Payne, who is in her 70s, paid some of the taxes due but still owes the IRS more than $4,000. The IRS denied her application for innocent-spouse relief because she missed the two-year deadline.
Bassett, one of the attorneys representing Payne, says she is in poor health, lives on a fixed income and is upside down on her mortgage. "She doesn't have any spare money," he says.
A high bar
Obtaining innocent-spouse relief is difficult, even for taxpayers who file on time. The IRS receives more than 50,000 innocent-spouse applications a year, and grants fewer than half of them. Last year, about 1,500 of the denials were related to the two-year deadline.
To obtain innocent-spouse relief, taxpayers must prove to the IRS that they didn't know, or have reason to know, that their spouse underpaid income taxes. The IRS will also consider factors such as the taxpayer's education and the couple's financial situation.
The IRS will reject a claim if it believes the taxpayer benefited from the tax avoidance. For example, a taxpayer who shared in unreported lottery winnings would probably be ineligible for innocent-spouse status, the IRS says.
Carol Joynt, 60, of Washington, D.C., knew she faced an uphill battle when her own lawyers said she wouldn't qualify for innocent-spouse relief.
Joynt's husband, Howard Joynt, was the owner of a popular bar and restaurant in Washington's Georgetown neighborhood when he died of pneumonia in 1997. After his death, Joynt learned that he owed the IRS $3 million.
Joynt says she didn't learn about her husband's tax problems earlier because his lawyers told him not to discuss his finances with her.
Joynt says those same attorneys told her the IRS wouldn't give her innocent-spouse relief because she didn't look like a woman who was unaware of her husband's financial affairs. After that, Joynt says, "I never again went to a lawyer's office wearing a suit."
Instead of giving in, she hired a new team of high-powered lawyers, led by Sheldon Cohen, a former IRS commissioner and author of the original innocent-spouse rules.
With their help, she was awarded innocent-spouse status in January 1998.
Joynt, who recently published a memoir, Innocent Spouse, says the two-year deadline wasn't an issue in her case. But she says she's spoken to many women who were unaware of their husbands' tax problems until they received a bill from the IRS. For women who have never been involved with their family's finances, she says, the two-year deadline is unrealistic.
"Almost daily, I have women come up to me and say, 'I'm just the way you were,'" Joynt says. "All ages, too."