DON’T LET A CHEATIN’ SPOUSE STICK YOU WITH THE TAX BILL

Your marriage broke up amid a thousand accusations. Now you’re staring at a letter from IRS that adds insult to injury — a bill your “ex” has decided not to pay. Congress made it easier to claim you didn’t know the tax problems your spouse was creating. But to get off the hook, make sure you really didn’t know anything.

It used to be that, if your spouse ran off and left you with a ton of tax problems that you never knew about, you were financial toast.

The Internal Revenue Service could come after you for any money owed while you were married to the oaf and make you pay. The U.S. Supreme Court held in 1999, for example, that New Yorker Elizabeth Cockrell was liable for a $650,000 tax bill generated in the early 1980s by her former husband, a tax-shelter promoter and commodities trader.

Congress tried to remedy the problem in a 1998 tax bill. It allowed spouses who had no clue they faced a tax bill to seek relief. Relief is often granted, if not in all cases. The facts have to be just right, and you should be prepared for the process to take time.

Joint Return, Joint Problem

The tax concept at play is called “joint and several liability.” It means that if you’re married and file a joint tax return, husband and wife are both responsible for any taxes due. The liability extends even after a divorce.

It is a strict concept, one the IRS defends strenuously and which the courts are rarely willing to let up on. In a Texas case, for example, a wife knew her husband had used a big retirement distribution to pay off a mortgage and buy a sport-utility vehicle. And she knew the distribution was taxable. She was held liable even though he had told her, fraudulently, that there was no tax problem.

It was in the context of disputes like these that Congress enacted innocent spouse relief. After passage of the 1998 law, the IRS was hit with far more claims than the 3,000 it originally expected. In fact, the agency received 45,000 in the first year alone. Since then, filings have come in at a rate of 600 to 1,000 a week. Through fiscal 2004, there have been 317,349 innocent spouse claims filed since the innocent spouse relief law was passed.

Under the 1998 law, you can ask the IRS for relief as an “innocent spouse.” You can qualify as an “innocent spouse” and be relieved from some or all liability from a deficiency on a joint return if:

The item at issue need not be grossly erroneous, nor does the understatement have to be substantial in order to qualify for innocent spouse treatment.

Innocent spouse relief may be provided on an apportioned basis. In that case, you may even be relieved of liability for a portion of the deficiency if you knew or had reason to know of other understatements of tax on your joint return.

You apply using Form 8857. You must apply within two years from the date the IRS begins collection actions.

There’s a special provision if you, at the time of the application, are no longer married to your joint filer — or are legally separated, or have lived apart from him or her for at least 12 months.

In any of those cases, you can elect to limit your liability to the portion of the deficiency that’s attributable directly to you. In simple terms, the IRS computes your returns as if you filed separately and applies your percentage of the total tax due to the actual deficiency.

Assume the deficiency is $1,000 on a disallowed deduction. And had you filed separately, you’d have owed a total tax of $4,000 and your spouse a total tax of $6,000. The IRS can only go after you for 40% of the additional tax that’s owed, or $400.

But There’s a Catch

If you and your spouse fraudulently transfer assets between you, neither spouse is eligible for relief.

If the IRS proves that the electing spouse had actual knowledge of the item on the return that’s found to be incorrect, then the election doesn’t apply, either. But, the burden of proof here is on the IRS to establish actual knowledge.

Even if you don’t qualify for innocent spouse relief or separation of liability, you may be eligible for “equitable” relief. To get equitable relief, it must be unfair to hold you liable for the underpayment or understatement of tax, taking into account all of the facts and circumstances.

If the IRS rejects your election as an innocent spouse, you can petition the Tax Court for judicial review. In that case, your spouse must be notified by the IRS and has 60 days to intervene and contest your petition.