Are you considered an innocent spouse for tax purposes? What is an innocent spouse and is there a protection for innocent spouses?

Most couples file joint income tax returns as a married couple. This means generally that both parties are responsible for what is on the return, as well as what income should be reflected on the return, but is not. Sometimes the division of labor between husband and wife is such that one of the parties handles the tax return. Sometimes that person places the returns in front of the non-preparing spouse and that spouse signs the returns, not knowing or checking the information in the returns for accuracy. Worse still are cases where the preparing spouse signs both names to the returns and the non-preparing spouse has no clue that the return was ever prepared, filed or what was in the return.

As a result, if the preparing spouse prepares the returns and substantially underreports the income earned, both parties are responsible for the additional tax, interest and penalties that ensue because of the action of the one spouse. Sometimes the unreported income is a result of fraud, gambling, drugs or other illicit activities. The non-preparing spouse may claim that he or she did not have any knowledge of the underreporting and they may genuinely not have any knowledge, but still may be held responsible by the IRS.

There is a procedure to request “innocent spouse” relief from the IRS, which involves filing an IRS Form 8857, which form needs to be filed within two years from the date that the IRS files a levy notice for the tax owed. A person who needs to use this form and request this relief should go to a qualified professional, as certain documents should be attached to the form. The IRS has denied about 2,000 of the 50,000 taxpayers that apply for relief each year, just for filing for this relief after the two year period has elapsed.

While the federal lawmakers are pushing for rule changes for the innocent spouse rule, it is important if the usual non-preparing spouse suspects their partner of failing to include income or making up expenses, that non-preparing spouse should file a separate return. That way that spouse will not be liable for the tax mess created by the other spouse.

Another thing that people may not know is that the IRS can legally disregard a divorce decree. Even if that decree holds you harmless or states that the other party is responsible for the IRS problems, the IRS does not have to follow that provision. That just means that if the IRS comes after you for the entire amount and your former spouse has any assets, you may go after him or her to recover the amount pursuant to that section of the decree. At that point, though, that former spouse probably has no assets to recover or even to pay the IRS their due.

Sometimes an abusive relationship keeps one spouse from taking action or filing a separate return. If this happens, it is recommended that spouse keep a diary or other record to support their fears, which may come in handy later.

Although the IRS will allow the innocent spouse rule to protect some spouses, it is always a better route not to have to trust that they will. If in doubt, file a separate return.

About two years ago, an new law was enacted which provided for the formation of Low-Profit Limited Liability Companies, referred to as L3C’s. These entities are organized to do good for a charitable purpose, but are still formed to be for-profit entities. Since these are organized as a for-profit entity, these organizations can attract the capital that is necessary for their purposes without relying on grants or other charitable contributions.

These are vehicles which can offer more flexible, leveraged solutions to complex problems in our society. For instance, if a private foundation wanted to operate a training program for residents in an economically depressed neighborhood, the L3C could open a laundry in that neighborhood, the private foundation could do the training. A normal for-profit company might be unwilling to take the entire risk, so a private foundation can do a joint venture with the L3C to further the charitable purposes of the private foundation.

L3C’s are intended to make it possible for both the tax-exempt private foundation and for profit entities to invest in a way that significantly furthers one or more charitable or educational purposes. Both tax-exempt and for-profit companies can invest in and be members of an L3C. As with a regular LLC, the L3C can be managed by one or more of its members or by an outside manager.

A big advantage for a private foundation is that the investment in the L3C is intended to qualify as a program related investment under the Internal Revenue Code, although the IRS has failed to either recognize the L3C entity or provide a procedure for determining if the investment in an L3C is considered program related. Once the IRS formally recognizes these vehicles, it will be easier to use the L3C. Until then, a private foundation will have to file to obtain a private letter ruling for each program related investment made by a private foundation, which can be time consuming and costly.

This new entity may offer new options for achieving a charitable purpose in the future to help solve many of the problems in our society.

by Lawrence J. Gregory

My wife and I are part of very large group whom I like to call the Emerging or Newly Established Individuals. We are of a group that does not yet need the advanced estate and tax planning of our Baby Boomer parents, but we are established enough to need a basic plan. The Emerging or Newly Established Individual is someone who has recently made significant life decisions with regards to their financial stability and growth. For instance, my wife and I have begun gearing up to finally sell our condo, purchase a single family home, and start a family. Emerging or Newly Established Individuals have generally done any of the following in the past few years:

1. Bought a condo or house
2. Recently got married
3. Recently had children
4. Have a 401(k), IRA, pension, or a life insurance policy.

If you are a member of this group, you are no doubt on the slow and steady climb up the hill of financial responsibility, and are likely burdened with student loans, mortgage payments, condo assessments, the new cost of raising a child, college savings and retirement savings. As a result, developing a quality estate plan tends to be placed on the back burner at the most critical time. I have found that most estate planning by this group is either never timely completed, or is assumed that a discount document provider such as LegalZoom will be sufficient. At this juncture in your life, it has now become critical that you at least have a basic estate plan to properly direct your final wishes for you and your family. A failure to plan for your estate could have unintended consequences, such as the need to open a costly guardianship estate with the court for your minor children, or incurring unnecessary probate costs.

A basic estate plan consisting of a testamentary will, living will, power of attorney for property, and power of attorney for health care is generally sufficient for this group. These documents cover the most critical aspects of the Emerging or Newly Established Individual’s estate, including:

1. To whom your property will go upon your death
2. Who will be the guardian of your minor children
3. Who will be able to make health and property decisions upon your incapacity.

However, if you own real estate or any other large investments, a living trust may also be beneficial to help reduce any probate costs and possible future estate taxes.

While the basic estate plan will cover the needs of most Emerging and Newly Established Individuals, this does not imply that one can feel safe ordering forms from a self-service company like LegalZoom. These companies sell you preprinted fill-in forms without any customization to your specific situation. While this method may be less expensive (and sometimes not) than consulting an attorney, you are ultimately responsible for its contents and correctness. Even LegalZoom’s disclaimer says “The law is a personal matter, and no general information or legal tool like the kind LegalZoom provides can fit every circumstance.” I would not risk such an important document to a website that knows nothing about your personal circumstance. An attorney is still the only way to be confident that your estate planning documents reflect your true wishes.

As an Emerging or Newly Established Individual, you owe it to yourself and your family to develop an estate plan that addresses your wishes regarding everything you have worked so hard to achieve.