Actual Knowledge: The One Defense the IRS Has Against Separation of Liability

Separation of liability under section 6015(c) is a powerful tool for divorced and separated spouses. It does not ask whether you should have known about your spouse's errors. It does not ask whether it would be fair to make you pay. It allocates the deficiency as if you had filed separately and caps your liability at your share.

The IRS has one main way to fight it: proving you actually knew about the item when you signed. This guide explains exactly what that means, because the line between actual knowledge and reason to know is where these cases are decided.

The statute

Internal Revenue Code section 6015(c)(3)(C) says that if the Secretary demonstrates that the individual making the election had actual knowledge, at the time the individual signed the return, of any item giving rise to a deficiency, or portion of one, that is not allocable to that individual, the election does not apply to that deficiency or portion. The same subparagraph says this rule does not apply where the individual with actual knowledge establishes that he or she signed the return under duress.

Three things in that sentence matter:

1. "The Secretary demonstrates." The IRS bears the burden.
2. "Actual knowledge." Not reason to know. Not should have known.
3. "Of any item." Knowledge of the item, not of the tax consequences.

The IRS must prove it

Treasury Regulation 1.6015-3(c)(2) says the IRS, having both the burden of production and the burden of persuasion, must establish by a preponderance of the evidence that the requesting spouse had actual knowledge of the erroneous item.

Compare that to the rest of section 6015(c), where section 6015(c)(2) puts the burden on you to prove the allocation. On actual knowledge, the burden flips. If the evidence is in equipoise, you win that issue.

What counts as actual knowledge

Omitted income

For omitted income, Treasury Regulation 1.6015-3(c)(2)(i)(A) says knowledge of the item includes knowledge of the receipt of the income. If you knew your spouse received a $5,000 dividend, you had actual knowledge of that item, whether or not you knew it was taxable and whether or not you knew it was left off the return. The regulation applies this even to income with no cash receipt, like reinvested dividends or a partnership distributive share shown on a Schedule K-1.

Deductions and credits

For an erroneous deduction or credit, the regulation says knowledge of the item means knowledge of the facts that made the item not allowable. For a fictitious or inflated deduction, the IRS must show you actually knew the expense was not incurred, or not incurred to that extent.

The regulation's medical expense examples are useful. If you knew your spouse had no medical expenses at all, an election as to a disallowed medical deduction is invalid. If you did not know whether your spouse had any, it is valid. If you knew there were some expenses but not the amount, the analysis turns on what you knew the real number could not have exceeded.

What does not count

The regulation draws several lines that protect requesting spouses.

Knowledge of the source is not enough. Under Treasury Regulation 1.6015-3(c)(2)(iii), knowing your spouse owned stock in a company is not actual knowledge that the company paid dividends that year.

Reason to know is not enough. The same paragraph says actual knowledge may not be inferred when the requesting spouse merely had reason to know of the item. The gambling example in the regulation shows how this works. The wife knew her husband gambled and kept a separate account, but did not know whether he had winnings. She had reason to know, but not actual knowledge, and her election to allocate the deficiency to him was valid.

Knowing the business exists is not knowing the income. In the regulation's plumbing example, a wife who knew her husband had a plumbing business but did not know whether it earned anything had no actual knowledge of the $30,000 of unreported income. If she knew he earned at least $8,000, her election was invalid only as to that $8,000.

What also does not save you

The regulation closes some doors too.

Not knowing the tax law. Under Treasury Regulation 1.6015-3(c)(2)(ii), actual knowledge of the proper tax treatment of an item is not relevant. In the regulation's self-employment tax example, a husband who knew his wife earned self-employment income but did not know self-employment tax had to be paid still had actual knowledge of the item.

Not reading the return. The same paragraph says your knowledge of how an item was treated on the return is not relevant. In the regulation's example, a wife who signed a blank return and never reviewed the finished one still had actual knowledge of a $100,000 dividend she knew her husband received.

Willful blindness. Treasury Regulation 1.6015-3(c)(2)(iv) says the IRS may rely on whether you made a deliberate effort to avoid learning about the item in order to shield yourself from liability.

Joint ownership. The same paragraph says joint ownership of the property that produced the item is a factor supporting actual knowledge. But in community property states, ownership arising solely by operation of community property law does not count. You must have been named on the ownership documents or otherwise asserted dominion and control.

Partial knowledge means partial loss

Actual knowledge is item by item and dollar by dollar. Treasury Regulation 1.6015-3(c)(2)(ii) says that if you had actual knowledge of only a portion of an erroneous item, relief is unavailable only for that portion. If you knew your spouse received $1,000 of dividends but not the additional $4,000, you lose relief on the $1,000 and keep it on the $4,000.

That is why I spend so much time with clients reconstructing what they knew, when, and how much. "I knew he did some side work" is a very different fact from "I knew he made about $20,000 on the side."

The abuse exception

Treasury Regulation 1.6015-3(c)(2)(v) provides that if you establish you were the victim of domestic abuse before the return was signed, and that, as a result of the prior abuse, you did not challenge the treatment of any items on the return for fear of your spouse's retaliation, the actual knowledge limitation does not apply.

The regulation adds that if you involuntarily executed the return, you may instead choose to establish that you signed under duress, which brings in Treasury Regulation 1.6013-4(d): a return signed under duress is not a joint return as to you. The guide to abuse and financial control covers how abuse is evaluated, and the guide to returns signed under duress covers the duress route.

Where the IRS gets its evidence

Often from your former spouse. Under Treasury Regulation 1.6015-6, the IRS must notify the nonrequesting spouse of your claim and give that person an opportunity to submit information, including information on the extent of your knowledge of the erroneous items. The guide to the nonrequesting spouse's rights explains that process.

So expect your ex to say you knew. Then remember who has the burden. An angry former spouse's say-so is evidence, but the IRS must still show actual knowledge by a preponderance of the evidence. Bank access records, separate accounts, a pattern of concealment, and your own credible account all matter.

A practical checklist

When I evaluate an actual knowledge issue, I work through the erroneous items one at a time and ask the same questions for each:

1. What exactly is the item: income received, a deduction claimed, a credit taken?
2. Whose item is it under the allocation rules?
3. What did the requesting spouse know about it on the day the return was signed, not later?
4. How do we know that? Statements, account access, emails, testimony.
5. If there was some knowledge, what is the most the requesting spouse could have known the amount to be?
6. Was the property jointly owned, and if so, was the requesting spouse named on the documents?
7. Is there evidence of abuse that kept the requesting spouse from challenging the return?

The answers usually show that the IRS's actual knowledge argument is strong on some items and weak on others. That is fine. Separation of liability is applied item by item, so winning most of the items can still eliminate most of the liability.