When a married couple files a joint tax return, “joint and several liability” will apply to any tax debts related to that return. This means that if the Internal Revenue Service (IRS) conducts a tax audit and determines that the couple owes taxes due to erroneous information on their joint tax return, the spouses will be equally liable for paying these tax debts. This can sometimes come as a surprise, especially if a couple has gotten divorced since filing the joint tax return in question. Even if a divorce decree addressed tax issues and states that one spouse will be responsible for paying joint tax debts, the IRS can still pursue repayment from both spouses. However in some cases, a person may receive innocent spouse relief if they were not responsible for the tax debts.

Innocent Spouse Relief Eligibility Requirements

Innocent spouse relief may be available in situations where individual income taxes or self-employment taxes are owed to the IRS based on incorrect information on a couple’s joint tax return. To be eligible for innocent spouse relief, a person must be able to show that errors on a tax return were solely attributable to their current or former spouse. They will need to verify that when they signed the joint tax return, they did not know or could not reasonably have known about the errors.

A person may receive innocent spouse relief based on errors on a tax return related to unreported or misreported income or claiming of improper tax deductions, credits, or property basis. For example, if a person’s ex-spouse was a business owner, and they did not report all income earned through their business in a certain year, while also claiming tax deductions for business expenses without actually paying for those expenses, a tax audit may determine that taxes are owed. If the other spouse was not involved in the business and had no knowledge of the business’s finances, they may be eligible to receive innocent spouse relief, and the other spouse will be solely responsible for paying the tax debts.

Taxes are a reality that most U.S. citizens and residents need to deal with, and understanding the various tax laws that apply to a person or business can often be a complicated matter. If a taxpayer makes mistakes or oversights when filing tax returns or other tax documents, they could face penalties from the Internal Revenue Service (IRS). Being contacted by the IRS may cause taxpayers to worry that they will be subject to these types of penalties. However, not every piece of communication from the IRS will result in penalties, and taxpayers will want to understand the different types of notices that the IRS may send and their options for responding and addressing or correcting tax issues.

IRS Letters and Notices

Communications from the IRS can generally be grouped into one of the following categories:

• Soft letters - In some cases, the IRS may identify potential issues that may affect certain taxpayers and send notice reminding the taxpayer of the actions they can take to ensure that they are in compliance with tax laws and avoid potential penalties. In some cases, the IRS may request that a taxpayer provide certain types of information or file amended tax returns. In recent years, the IRS has sent soft letters related to issues such as reporting virtual currency transactions or filing the proper forms related to foreign accounts or investments.

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The IRS pays close attention to taxpayers’ income and financial transactions, and there are a variety of reasons it may conduct tax audits. In recent years, virtual currencies such as Bitcoin have been a growing concern for the IRS, and many cryptocurrency owners have received notices regarding their requirements for reporting transactions involving these currencies. This scrutiny is likely to increase in the future as the use of virtual currencies becomes more widespread. In fact, the IRS released a draft of the 1040 tax form for 2020, and one of the first questions that is included on this form is “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” This indicates that those who own or trade cryptocurrency may face audits if they do not meet their requirements for reporting transactions and paying applicable taxes.

Tax Issues Related to Virtual Currency

Even though cryptocurrencies may be used similarly to currency issued by the United States or other countries, they are not recognized as legal tender. Instead, virtual currencies are considered property, and taxes may apply to transactions involving these currencies. If a person receives virtual currency in exchange for performing services, either as an employee or an independent contractor, this will be considered taxable income.

When virtual currency is sold or exchanged for other property, a taxpayer will be required to report gains or losses on a federal income tax return. These gains or losses are calculated by comparing the taxpayer’s basis in the virtual currency, or the fair market value of the currency at the time it was acquired, with the amount received in exchange for the virtual currency. Capital gains taxes may apply to gains made when selling virtual currency, and a taxpayer may be able to deduct losses in these transactions.

U.S. taxpayers are required to report foreign financial accounts and other offshore assets and investments, and taxes may apply to income earned from foreign sources. In the past, the IRS allowed taxpayers who had not met these requirements to become compliant through the Offshore Voluntary Disclosure Program (OVDP). This program is no longer available, and it has left some taxpayers unsure about how to report their foreign assets and pay any taxes owed while minimizing the potential penalties that may apply. 

One issue that the IRS has identified as an area of concern involves taxpayers who applied for pre-clearance with the OVDP but did not complete this program. Specifically, some taxpayers may have been denied access to the program, or they may have voluntarily withdrawn their requests. The IRS’s Large Business & International (LB&I) division will be investigating these taxpayers, and tax audits may be performed in cases involving continued noncompliance.

Options for Compliance With Foreign Tax Reporting Requirements

In some cases, taxpayers who were unable to become compliant through the OVDP may be eligible for the Streamlined Domestic Offshore Procedures (SDOP) or Streamlined Foreign Offshore Procedures (SFOP) programs. A person will qualify for this program if he or she can show that his or her noncompliance was non-willful, meaning that the taxpayer did not know about or did not understand the requirements for reporting foreign assets and income. These taxpayers will be required to comply with tax return requirements for the past 3 years, Foreign Bank and Financial Account Reports (FBAR) requirements for the past 6 years, and other required information. They must provide information about the balances of unreported foreign accounts for the past 6 years, and they must pay all outstanding taxes and interest. In most cases, a 5% penalty will apply to the taxpayer’s highest aggregate foreign account value, although this penalty may be waived in certain cases.

The U.S. tax code is very complex, and taxpayers are required to file a wide variety of forms correctly when completing their tax returns. This is especially true for those who own foreign assets or earn income from foreign sources. Failure to meet these requirements can result in tax audits, and taxpayers may face hefty penalties for their failure to comply with their tax requirements. 

The Large Business & International (LB&I) division of the Internal Revenue Service maintains a number of “campaigns” meant to address ongoing concerns about misreporting of assets and income and noncompliance with tax obligations. One notable campaign addresses “loose filing” of Form 5471, (Information Return of U.S. Persons with Respect to Certain Foreign Corporations).

Requirements for Filing Form 5471

Form 5471 is used to evaluate the extent of a taxpayer’s foreign assets while also tracking the profits earned by a foreign corporation and any changes in a company’s structure or ownership that may affect the taxes it pays. There are several categories of filers that are required to submit Form 5471, including shareholders of specified foreign corporations (SFCs) or controlled foreign corporations (CFCs), officers or directors of foreign corporations in which a U.S. person has at least 10% ownership stake, or a U.S. person who had control (more than 50% of stock or voting power) of a foreign corporation during the relevant tax accounting period.