I often am asked by someone going through a divorce whether they should prepare their tax return using the Married-filing-joint method (MFJ) or Married-filing-separate (MFS) method. My first response is that MFJ is usually the method which results in the least amount of tax paid by the couple. However, often there are other, higher priorities than just paying lower taxes.
In a community property state like Texas, spouses must share community income, deductions, etc… However IRC Section 66 overturns local community property laws, but in order to avail oneself of IRC Section 66 you must meet five tests:
- The couple must be married sometime during the year.
- The couple must have lived apart the entire year.
- The couple must not file a joint return.
- One or both have earned income that is community.
- None of the income was transferred between the spouses during the year.
IRC Section 66(b) provides that the IRS can ignore community property laws in the event that one spouse fails to notify the other spouse of either community income or deductions prior to filing the tax return.
Innocent Spouse Relief
Another provision to protect individuals from the application of community property laws is IRC Section 66(c). It provides relief to an innocent spouse if that individual did not know or have any reason to know of the community income. This is known as “Innocent Spouse Relief.”
To qualify for Innocent Spouse Relief, all the following requirements must be met.
- The jointly filed return has an understatement of tax due to erroneous items of your spouse, such as unreported income or incorrect deductions.
- It can be established that at the time you signed the return you did not know and had no reason to know that there was an understatement of tax.
- Taking all the facts and circumstances into account, it would be unfair to hold you accountable for the understatement of tax.
Steve Walker is a CPA with over 30 years accounting, tax, valuation, and forensic accounting experience. Prior to returning to practice in 2004, for twelve years Mr. Walker was employed by one of the country’s largest family law firms where he was involved with client cases dealing with characterization, valuation, tax, and financial issues while also serving as part of the firm’s management team as Executive Director. His practice focuses exclusively on family law matters and forensic accounting with an emphasis on characterization and tracing of separate property. Contact him here for more information.