Injured Spouse or Innocent Spouse

Marriage is not a business, but there is business in marriage. Taxes have an impact on marriage. Outstanding tax debt definitely impacts a marriage.  I recommend any couple contemplating marriage to swap credit reports and IRS account transcripts. Anywho, married couples have two options for filing - Married Filing Jointly or Married Filing Separately. Each has its pros and cons. 

Married Filing Jointly

For married couples, filing jointly is usually the best way to go. The couple gets access to all the tax credits, and normally has a lower tax liability than filing separately. The downside of Married Filing Jointly is that each spouse is responsible for a tax liability, even if one spouse created it. The responsibility is attached to the tax year. It doesn’t matter if the couple divorces. Each person remains responsible for the tax debt until it is paid. For example: You were married in 2019 and filed jointly, but the tax bill was never paid. You got a divorce in 2021. Both spouses are still responsible for the tax debt for tax year 2019, even though you are no longer married. 

Let’s assume that your spouse owes back taxes. When you and your spouse file your taxes, you’re due a refund. Yay! Then a few weeks later, you check the status of your refund to find that it had been applied to your spouse’s past tax debt.

Married Filing Separately

The benefit of filing separately is that each spouse is responsible for their own tax bill. While that is a great benefit, the cumulative tax bill is generally higher. Married Filing Separate couples are not eligible for certain tax credits: earned income credit or American Opportunity Credit for example. The only thing really gained from filing separately is that neither spouse is responsible for the other spouse’s tax liability. 

Married Filing Jointly Injured Spouse

If a spouse owes a tax debt that was in place prior to the marriage, the current spouse won’t be held liable for the debt; HOWEVER any refund due to the couple will be applied to the owing spouse’s tax debt. The Injured Spouse provision in the tax code allows married couples to take advantage of filing jointly without having to be financially responsible for past tax debt. Here’s how it works:

Jack and Sue were recently married. Jack discovered that Sue owed back child support. When Jack and Sue prepared their tax return, they were due a refund of $1500. Since Jack did not want to be responsible for paying Sue’s back child support, Jack filed the Injured Spouse Form 8379 with the tax return. Jack will receive his portion of the refund back. Sue’s portion of the tax refund will get held and applied to back child support.

What is Innocent Spouse Relief?

An Innocent Spouse claim is related to a tax bill. Essentially, one spouse is saying, “yes, there is a tax bill, but I should not be responsible to pay it.” It can be a real challenge to prove an innocent spouse claim. 

Since a joint return requires both signatures, it would be difficult to prove that one spouse didn’t know about the tax bill or only one spouse should be responsible. The first question anyone will ask is: If you were not responsible for the tax liability or believed the return to be incorrect, why did you sign the return?
There are cases of domestic and financial abuse, in which one spouse controls access to the finances, to include taxes. Innocent spouse claims are filed on Form 8857, separate from the tax return. 

The issue with an innocent spouse claim is that Spouse 1 is arguing that Spouse 2 created the tax bill and Spouse 1 shouldn’t be held responsible to pay it. Spouse 2 is claiming that Spouse 1 should be responsible to pay the tax bill as well.

The IRS looks at different variables such as your age, educational level, and the type of job you have, or if there was documented abuse involved.  If the IRS determines that you were intelligent enough that you should have known about the tax bill, and abuse can’t be proven,  then an innocent spouse claim will probably get denied. 

Facts and circumstances will determine the success of the Injured Spouse or Innocent Spouse claim. Please note: The IRS also does not follow divorce decrees. If your divorce decree says your spouse is supposed to pay the tax bill, and they don't,  you're still responsible in the eyes of the IRS.

If you require assistance with either of these claims, reach out to us to schedule a call.

How long do you have to claim a Refund?

I was watching a video, and the creator erroneously claimed that you have three years to file your taxes. I reviewed the comments and watched all of the people cyber high-fiving at this false information. It was painful. I’m here to set the record straight. 

When do you have to file? 

You are required to file your tax return generally by April 15th every year. If you cannot file your return, you must request an extension of time to file, which provides an additional 6 months to file your return. Filing the extension is requesting additional time to file your paperwork. It does not extend the payment deadline. There are no penalties for late filing when there is a refund. But this blog post isn’t about a tax bill, it’s about a refund. 

Refund Statute Expiration Date

As I stated, the inspiration for this post came from a YouTube video. You are required to file your return on time every year (to include extension). If you don’t, you have three years to claim a refund. If you file an extension, the deadline is the extended due date. What does this look like?

Let’s assume you have not filed your 2021 tax return. The original due date for filing the 2021 tax return was Monday, April 18, 2022. One had to file the return or request an extension. Assuming you are due a refund on your 2021 tax return, the FINAL deadline to file your return to request a refund is April 15, 2025. If you file an extension, then the FINAL deadline would be October 15, 2025. 

What happens if you don’t file within 3 years?

Let’s look at an actual example. A taxpayer filed his 2017 tax return late, and was due a refund. The original filing deadline for tax year 2017 was April 17, 2018.  The taxpayer did not file an extension. The FINAL deadline for requesting the refund was May 17, 2021. Note: The normal deadline of April 15, 2021 was extended a month for Covid relief. The taxpayer did not file the return until November 30, 2021. 

Once the Refund Statute expires (RSED), the IRS gets to keep your money. That’s it! Your refund becomes property of the Department of Treasury. There are generally no take-backs on this rule,  unless there are extenuating circumstances. You have to be able to prove those circumstances. Even if you have past tax debt, you still do not get access to the refund to reduce the tax debt. This taxpayer 'donated' $3,141 to the Department of Treasury. 

Here’s an example. This taxpayer had several unfiled years, and owed taxes for tax year 2015. They would have been due a refund for the 2017 tax return, which was filed in November 2021.  The Refund Statute expired in May 2021, so the 2017 refund was NOT be applied to the 2015 tax debt. 

I know what you may be thinking. If you OWE the government, they have 10 years to collect and there are penalties and interest! Yes, you are correct! You, however, only have 3 years to claim a refund. 

If you learn nothing else from this post, file on time, even if you think you’re going to owe. If you have unfiled tax returns, reach out to us! We’re here to help!

The #1 Way to Avoid an Audit

Someone asked me, “LuSundra, what is the number one tip you would give to help a business owner avoid an audit?”
My answer: Don’t invite one.

The IRS decides to audit.

The decision to audit lies strictly with the IRS. There really is nothing you can do to avoid an audit. No tax professional can ever tell you that you will or won’t get audited. We don’t make that decision. 

Are there red flags that may trigger an audit? Yes! 

However, you can also file a perfect tax return and still get audited. That’s just the nature of filing taxes. That’s why I always recommend preparing your return as if you knew that the IRS was going to show up tomorrow. Tomorrow may come one day. 

Red flags that can trigger an audit

There are some things that can trigger an audit. The sad thing is that these audit triggers are common knowledge, yet people seem to keep doing them and expect to NOT get audited. Talk about the definition of insanity! Anywho, here are a few audit triggers that send an engraved invitation to the IRS to audit you. 

Excessive business losses:

The most publicized fraudulent activity is with Schedule C business losses. If you have losses 3 out of 5 years, you might get audited. (In my best ‘You might be a redneck’ voice). 

Does having business losses automatically mean you will get audited? No. 

However, if you have years of business losses, and those losses consistently produce a large refund, that’s going to make the IRS pause and dig a little deeper. How can one stay in business if you’re consistently losing large amounts of money. 

All round numbers:

As tax professionals, we see it all the time. If all your income and expenses are even rounded numbers, you might get audited!

Income - $25,000

Utilities - $1,000

Advertising - $5,000

Commissions and fees - $7,000

Really?? All your income and expenses were these nice round numbers? No change? Have you ever seen a utility bill that was rounded to the nearest $10? 

All those round numbers tell the IRS that you are making up the numbers versus providing actual expenses. 

Cash Heavy Businesses: 

Businesses like barber shops, hair salons, car washes, vending machines, etc. are cash heavy businesses. Cash, for the most part, isn’t traceable, which tempts people to under-report their income. It also leads to the round figure reporting, discussed in the previous paragraph. Listen, don’t let the smooth taste fool you. The IRS has a Criminal Investigative division. Your audit may start out as the IRS requesting receipts or invoices to prove the information on your tax return. If you can’t provide what they ask for, the auditor will make an adjustment on your return. Make no mistake, a ‘simple’ audit can turn into a criminal investigation. 

Excessive Itemized Deductions:

The Tax Cuts and Jobs Act of 2017 removed the majority of itemized deductions and limited others. There are very few people who itemize their deductions these days. When taxpayers have excessive tax deductions, that may cause the IRS to pause and take a look. For example, if a taxpayer takes an excessive amount of mortgage interest deduction or has a disproportionately high amount of charitable deductions, an audit will be invited, because the numbers don’t make sense.

If you received an audit notice, reach out to us! We're here to help!