Innocent Spouse Defense in Bankruptcy

As a general rule, any debt owed by a person is the responsibility of that specific person. Usually, you are only responsible for debt that is in your name. However, there are exceptions to this general rule. In certain circumstances, a person can be held responsible for their spouse’s debt.

Whether you can be held responsible for the debt of your spouse depends on a few different factors including:

• The state where you live (for example, common law versus community property states);
• If it is joint debt (for example, a credit card that was in both of your names);
• If you are a cosigner (for example, cosigning a loan); and
• If you are still married or divorced (for example, if you divorce, a court may say who is responsible for debt). In some instances there are creditors rights upon divorce.

A person can sometimes be responsible for their spouse’s debt that involves bankruptcy and taxes There are two major situations when an individual can be held responsible for their spouses debt:

• In a common property state, any money, property or other assets owned together by both spouses is called community property. Community property belongs to both spouses. It can be used to pay the debt of one of the spouses. Community property states follow a different set of rules called community property laws. Some examples of community property states include: California, Washington, New Mexico, Texas, Nevada, etc.
• If spouses file their taxes together, any tax debt is the responsibility of both spouses.

The Impact of Filing Joint Tax Returns

When filing taxes, many married couples submit a joint income tax return to the Internal Revenue Service (“IRS”). In many cases, filing taxes together is the best financial option if you are married. A joint tax return can have many positive benefits. However, it is important to remember that the decision to file joint taxes may sometimes have certain consequences.

Filing a joint tax return will make each spouse responsible for the other person’s tax debts. Tax debt means you owe the IRS additional money. This can happen if you do not report income, take the wrong deductions, claim credits that do not apply, etc. If spouses file their taxes together, they are jointly and severally responsible for any debts. This means that both spouses are equally responsible for any tax debt. It does not matter if the debt is only one person’s fault. Joint and several liability means that both people share responsibility. The IRS can try to collect the whole debt from one person. They can also hold them responsible together.

The Innocent Spouse Defense

The innocent spouse rule is a defense that is used to help protect innocent people from unfair responsibilities. Congress created this rule to provide innocent spouse relief. The purpose of this rule is to prevent unfair consequences that could result from joint and several liability for taxes and bankruptcy. The innocent spouse rule can release or free a spouse from responsibility for tax debt or bankruptcy.

To use the innocent spouse defense and receive innocent spouse relief you must establish five elements. The five required elements you must prove include:

• You filed joint income tax returns with the IRS for the relevant years;
• The tax returns have a significant understatement of taxes owed because of errors made by a not innocent spouse;
  • Errors can include: not telling the IRS about income, using deductions that do not apply, claiming credits that you do not qualify for, etc.
• The innocent spouse who signed the tax return did not know and had no reason to know about the errors that were made;
• It is inequitable, or against justice and fairness, to hold the innocent spouse responsible; and
• The defense is used within 2 years, starting from when the IRS begins to try collecting the debt.

When Can the Defense Apply in Bankruptcy Proceedings?

Sometimes the innocent spouse defense can arise in a bankruptcy filing. Most commonly, this can happen if taxes are owed and put into collection. One or both of the spouses may start a bankruptcy proceeding to get rid of tax debt.

Example: A married couple, John and Jane, files a joint tax return. Jane always does the taxes and handles all the finances. Jane submits a return to the IRS but lies about the money he made from his business. John did not know about the money or that Jane lied. John signs the tax return thinking it is correct. The IRS finds out that the tax return is incorrect and decides that they owe $100,000. John and Jane cannot pay the tax debt. The IRS tries to collect the debt and it goes into collection. The couple decides to file for bankruptcy. The innocent spouse rule may apply.

A recent court decision found that the innocent spouse defense can be used in bankruptcy court, not just tax court. However, there may be requirements before you can use the defense in bankruptcy court. You may have to file a form with the IRS before using the defense in bankruptcy court. Since the law on this topic can be complicated, it is a good idea to talk to an attorney if you want to try to use this rule in bankruptcy court.

In general, the courts have looked at various situations to figure out when the innocent spouse defense can be used in bankruptcy proceedings. The courts have looked at the following scenarios:

• When both spouses owed debt in a bankruptcy proceeding, a court has the power to determine if the innocent spouse rule can be used.
• When an innocent spouse is in bankruptcy and the other spouse is not, the court has the power to decide if the innocent spouse rule can be used.
• When the innocent spouse is not part of the bankruptcy proceeding, the court does not have the power to apply the rule.

How Does the Court Determine Whether the Defense Succeed?

If a court has the power to look at the innocent spouse defense, it will look at the specifics of the case. Whether the defense will succeed will likely depend on two factors:

• The circumstances surrounding the substantial understatement of taxes owed. This means that the court will look at the specific facts involving the taxes filed and what severe error was made on the taxes. The court will look at any important facts related to the filing.
• Whether the innocent spouse meets the lack of knowledge requirement. The court will look at what the person knew, was unaware of, and what they should have known.

Making a decision about the innocent spouse defense is often very difficult for the court. In general, the courts have come to different decisions depending on the circumstances. It is important to remember that the court will make a determination based on the specific facts in your case.

What Happens If the Defense Succeeds?

If a spouse is successful in using the innocent spouse defense, a court can provide relief. This means that the innocent spouse can be cleared of all or part responsibility for the debt.

The court can decide to grant relief in full or in apportionment. Relief in full means that the innocent spouse is not responsible for any of the debt. Relief in apportionment means that the innocent spouse is only responsible for a part or portion of the debt. Apportionment is the process of figuring out who is responsible for certain debts and dividing that debt.

What If I Am No Longer Married?

If you are no longer married, you can still use the innocent spouse defense. You are considered no longer married if you are:

• Divorced;
• Widowed;
• Legally separated; or
• Have lived apart from your spouse for 12 months or longer;

The law says that an innocent spouse who is no longer married can still use the innocent spouse defense to lower or completely eliminate their responsibility for debt.

Do I Need an Attorney?

The rules of the innocent spouse defense may be different depending on the state you are in. It is highly recommended that you contact an experienced bankruptcy lawyers in your area. Figuring out how to deal with debt and the possibility of bankruptcy can seem overwhelming.

A skilled and knowledgeable attorney can help you understand all your options and guide you through the process. If you are facing bankruptcy or debt because of your spouse, you may be able to use the innocent spouse defense. An attorney can review your specific circumstances and tell you about any possible defenses. They can also determine whether you are able to lower or completely eliminate your responsibility for debt.