Relief by Separation of Liability

Under this type of relief, you allocate (divide) the understatement of tax (plus interest and penalties) on your joint return between you and your spouse (or former spouse). The understatement of tax allocated to you is generally the amount you are responsible for. See How To Figure Your Separation of Liability, later.

You can request this type of relief whether or not you request innocent spouse relief.

To request relief by separation of liability, you must have filed a joint return and meet either of the following requirements at the time you file Form 8857.

• You are no longer married to, or are legally separated from, the spouse with whom you filed the joint return for which you are requesting relief. (Under this rule, you are no longer married if you are widowed.)
• You were not a member of the same household as the spouse with whom you filed the joint return at any time during the 12-month period ending on the date you file Form 8857.

Burden of proof. You have the burden of proof in establishing the basis for separating your liability.

Invalid request. Even if you meet the requirements discussed previously, a request for separation of liability will not be granted in the following situations.

1. The IRS proves that you and your spouse transferred assets as part of a fraudulent scheme.
2. The IRS proves that at the time you signed your joint return, you had actual knowledge of any items giving rise to the deficiency that were allocable to your spouse.
3. Your spouse (or former spouse) transferred property to you to avoid tax or the payment of tax. See Transfers of property to avoid tax, later.

In situations (2) and (3), a request will be denied only for the part of the deficiency due to the incorrect items about which you had actual knowledge, or to the extent of the value of the property transferred. If you establish that you signed your joint return under duress, then it is not a joint return, and you are not liable for amounts from that return. However, you may be required to file a separate return for that tax year.

Example. Bill and Karen Green filed a joint return showing Karen's wages of $50,000 and Bill's self-employment income of $10,000. The IRS audited their return and found that Bill did not report $20,000 of self-employment income. The additional income resulted in a $6,000 understatement of tax, plus interest and penalties. After obtaining a legal separation from Bill, Karen filed Form 8857 to request relief by separation of liability. The IRS proved that Karen actually knew about the $20,000 of additional income at the time she signed the joint return. Bill is liable for all of the understatement of tax, interest, and penalties because all of it was due to his unreported income. Karen is also liable for the understatement of tax, interest, and penalties due to the $20,000 of unreported income because she actually knew of the item. The IRS can collect the entire deficiency from either Karen or Bill.

Transfers of property to avoid tax. If your spouse transfers property to you for the main purpose of avoiding tax or payment of tax, the tax liability allocated to you will be increased by the value of the property transferred. A transfer will be presumed to have as its main purpose the avoidance of tax or payment of tax if the transfer is made after the date that is 1 year before the date on which the IRS sent its first letter of proposed deficiency allowing you an opportunity for a meeting in the IRS Appeals Office. This presumption will not apply if the transfer was made under a divorce decree, separate maintenance agreement, or a written instrument incident to such an agreement. The presumption will also not apply if you establish that the transfer did not have as its main purpose the avoidance of tax or payment of tax.

How To Figure Your Separation of Liability

The IRS will figure your separation of liability and figure any related interest and penalties after you file a completed Form 8857 with the required attachment. You are not required to figure these amounts. But if you wish, you can figure your separation of liability yourself by using Worksheet 1 and instructions that follow. However, if you filed Form 8814 to report your child's tax liability on your joint return, do not include that liability when figuring your separation of liability. Allocate it as appropriate between you and your spouse. Also do not include household employment taxes that are reported on Form 1040.

Instructions for Completing Worksheet 1

Use the following instructions to complete Worksheet 1.

Worksheet for Figuring Your Separation of Liability.

Line 1. When allocating income and deductions taken into account in computing the understatement of tax, allocate them in the same manner you would have allocated them if you and your spouse had filed separate returns.

Allocate wages and salaries to the spouse who performed the services and received the Form W�2. You generally allocate business and investment income (including capital gains) according to which spouse owned the business or investment that produced the income. Income from a jointly owned business or investment should be allocated equally between you and your spouse unless there is evidence that shows a different allocation is appropriate.

Allocate business deductions according to the ownership of the business. Allocate personal deductions (such as itemized deductions for mortgage interest and taxes) equally between you and your spouse unless there is evidence that shows a different allocation is appropriate, or the IRS establishes that you had actual knowledge of the joint items.

Items that are limited or not allowed on separate returns. If a deduction would not be allowed if you had filed a separate return, figure the deduction as you would on a joint return and allocate that amount between you and your spouse.

A similar rule applies to income and deductions (such as taxable social security benefits and the IRA deduction) that are subject to special limits on a separate return. Figure these items as you would on a joint return and allocate them between you and your spouse.

Example. Charles and Mary filed a joint return for 1998. Charles received social security benefits in 1998, but none of them were taxable because his and Mary's total income was less than the base amount ($32,000) for joint returns. Several months after filing their return, Charles and Mary received a notice from the IRS for additional tax because they did not report some interest and dividend income. The notice also showed that half of Charles' social security benefits were taxable because the additional interest and dividend income increased their total income so that it was more than the $32,000 base amount. If Charles had filed a separate return, 85% of his social security benefits would have been taxable. When figuring his separation of liability, Charles allocates only half of his social security benefits. This is true even though 85% of his benefits would have been taxable if he and Mary had filed separate returns.

Items allocable to one spouse that benefit the other spouse. An item that is otherwise allocable to one spouse must be allocated to the other spouse to the extent the item created a tax benefit on the return for the other spouse. This does not relieve the first spouse of liability. Rather, both spouses will be jointly and severally liable for the item to the extent of the benefit received.

Example. Your joint return shows $50,000 of wages allocable to you and $15,000 of self-employment income allocable to your spouse. The IRS audited your return and disallowed a $20,000 business deduction allocable to your spouse. Only $15,000 of the disallowed deduction offset your spouse's self-employment income. The remaining $5,000 must be allocated to you because that amount offset your income.

Lines 5 and 6. Enter the part of the understatement of tax that is due to the disallowance of a credit or to the increase in any tax other than the income tax or alternative minimum tax. Allocate credits and other taxes in the same manner you would have allocated them if you and your spouse had filed separate returns.

Example. You reported $750 in self-employment tax on your return. All of this tax is allocable to you. The IRS audited your return and determined that your self-employment tax should have been $1,100. On line 6, you enter the $350 increase in self-employment tax ($1,100 - $750).

Credits that are not allowed on separate returns. If a credit would not be allowed if you had filed a separate return, figure the credit as you would on a joint return and allocate it between you and your spouse. Examples of credits that are generally not allowed on a separate return are the child and dependent care credit, the credit for the elderly, the adoption credit, the Hope and lifetime learning credits, and the earned income credit.

Example. You claimed a credit of $860 for child and dependent care expenses on your tax return. The IRS audited your return and allowed you only $500. The remaining $360 was disallowed. Even though none of the credit would have been allowed on separate returns, you are entitled to a $500 credit for purposes of figuring your separation of liability. You allocate the $360 disallowance (rather than the full $860) between you and your spouse (or former spouse) on lines 5 and 6 of Worksheet 1.

Credits allocable to one spouse that benefit the other spouse. A credit that is otherwise allocable to one spouse must be allocated to the other spouse to the extent the item created a tax benefit on the return for the other spouse. This does not relieve the first spouse of the liability. Rather, both spouses will be jointly and severally liable for the item to the extent of the benefit received.

Example. Tom and Donna filed a joint return that showed $30,000 of wages attributable to Tom and a $1,000 lifetime learning credit attributable to Donna. The lifetime learning credit was for Donna's graduate tuition expenses. Since Donna had no income, the entire credit offset $1,000 of Tom's income tax on the return. Tom received the tax benefit on the return from the entire credit. The IRS audited their return and disallowed $400 of the credit. Tom and Donna remain jointly and severally liable for the $400 deficiency. It was Donna's item and Tom received a $400 tax benefit.

Worksheet 1 Example

Cindy and Clarence Brown filed a joint return for 1997. They divorced in 1998. On July 27, 1999, the IRS issued a Notice of Deficiency to the Browns relating to their 1997 return. There were four items listed on the notice.

1. $2,378 is nonemployee compensation that Clarence got for some consulting work and did not report.
2. $336 is self-employment tax related to the $2,378 nonemployee compensation.
3. $168 is the deduction for half of the self-employment tax.
4. $500 is interest income from Cindy's bank account.

Cindy decides to file Form 8857 (not illustrated) to request relief under separation of liability. She allocates the items between her and Clarence as follows and attaches this allocation to Form 8857.

Although not required, Cindy uses Worksheet 1 to determine the understatement of tax that is allocable to her. She fills out the worksheet (shown on page 8) as follows.

Line 1. Cindy enters the interest income from her bank account.

Line 2. The net amount of income and deductions taken into account in computing the understatement of tax is $2,710. This is the sum of the nonemployee compensation, $2,378, and interest income, $500, minus the deduction for one-half of self-employment tax, $168.

Line 3. Cindy divides line 1 by line 2 to get .185.

Line 4. Cindy enters the $743 understatement of tax. This is shown on the Notice of Deficiency.

Line 5. Cindy enters Clarence's self-employment tax of $336.

Line 6. Cindy enters -0- because there are no credits or other taxes to be allocated to her.

Lines 7-10. Cindy completes lines 7 through 10. Line 10 shows that she is responsible for $75 of the understatement of tax. Clarence is responsible for the remaining amount ($668).

Filled-in Worksheet for Figuring Your Separation of Liability.

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