Volume 25 Issue 3 --May/June 2013
Many tax practitioners are familiar with the concept of innocent spouse relief, where one spouse seeks relief from a joint tax liability with his or her spouse. Not so many practitioners are familiar with the concept of injured spouse relief, which involves refunds on joint returns where one, but not both, of the joint return filers is subject to a legally enforceable claim for which a refund offset is permitted under IRC § 6402.
Despite the similarity in the terminology, “injured spouse” relief and “innocent spouse” relief are entirely separate and distinct concepts.
Under IRC § 6402, the IRS has the right to reduce tax refunds by the amount of certain debts that a taxpayer owes. These debts include past due debts owed to other federal agencies, past due child support, and past due legally enforceable state income tax obligations.
But what happens if the refund is from a joint return and only one spouse is subject to these debts?
Suppose for example, that Bob and Mary file a joint return and are entitled to a substantial refund. Bob, however, has a legally enforceable past due child support obligation growing out of his first marriage to Wilma.
Under procedures set forth in regulations under Title 31 of the Code of Federal Regulations, 31 CFR § 285.2, Bob’s past due child support obligation can become an offset against Bob and Mary’s tax refund. But only Bob is liable for the child support. What about Mary’s interest in the refund?
If the obligation giving rise to the tax refund offset is joint, then the entire refund is subject to offset. If the debt is not joint but is only enforceable against one spouse (Bob here), then the other spouse (Mary here) is called the “injured spouse” by the IRS because she does not owe the obligation that created the offset. In that case, Mary as the injured spouse can file a claim for her share of the refund, not reduced by the offset attributable to the other spouse’s obligation.
The IRS has long ruled that when spouses file joint income tax returns, each spouse has a separate interest in the jointly reported income and in any overpayment or refund. Hence, the injured spouse is entitled to receive his or her share of the refund even if the liable spouse’s entire refund is offset.
Stating this principle is much simpler than applying it.
First, the injured spouse must file a claim to his or her share of the refund. Form 8379 is used for that purpose.
In general, it is necessary to determine the liable spouse's interest in the overpayment, the amount that can be offset for the liable spouse's debt, and the amount to be refunded to the nonliable (injured) spouse. The allocation process involves several steps and varies with the type of claim giving rise to the offset and state law.
The injured spouse’s share of the overpayment is computed by subtracting that spouse’s share of the joint liability from that spouse’s contribution of credits toward the joint liability.
Each spouse’s share of the tax liability is determined as if they had filed separate returns, with the income and deductions allocated between the two spouses. Next the credits generating the overpayment (such as withholding, estimated tax payments, and other credits) must be allocated to each spouse’s separate tax liability.
Suppose that the joint refund is $1,500 and that Mary’s share of the credits is $7,000 while her separate tax liability is $6,000. Mary’s refund would be $1,000 ($7,000—$6,000), and Bob’s share of the refund would be subject to offset.
Under no circumstances can an injured spouse be refunded more than the amount of the joint overpayment. For example, if Mary’s share of the credits in the foregoing example, was $8,000, her refund would still be limited to $1,500 — the amount of the overpayment on the joint return — not the $2,000 difference between her share of the credits and her separate tax liability.
In common law states, income and deductions are allocated according to the legal owner of the item under state law. In community property states, income and deductions related to community property are split, but income and deduction items relating to separate property will not be.
Sections of the Internal Revenue Manual 18.104.22.168 et seq. contain a number of detailed rules for allocating various income, deduction, and credit items in community property states. Indeed there are special rules for tax offsets in Texas and in other community property states that allow creditors to reach more than half the community property to satisfy the debts of one spouse.
If you have questions about injured spouse relief please call the Tax & Business Professionals.
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