Separation of Liability: How Section 6015(c) Splits a Joint Deficiency

If your marriage is over, or you have been living apart for a year, the tax code gives you a tool that does not care whether it would be fair to make you pay. Separation of liability under Internal Revenue Code section 6015(c) simply asks how the IRS's adjustments would have landed if you and your spouse had filed separately, and then caps your liability at your share. For a lot of divorced spouses, it is the strongest option on the table.

Who can elect separation of liability

Section 6015(c)(3)(A)(i) limits the election to an individual who, at the time the election is filed:

• Is no longer married to the person with whom the joint return was filed, or is legally separated from that person; or
• Was not a member of the same household as that person at any time during the 12-month period ending on the date the election is filed.

Treasury Regulation 1.6015-3(a) adds that a widowed spouse is also eligible. Divorce and legal separation are determined under section 7703, as of the date the election is filed, per Treasury Regulation 1.6015-3(b)(1) and (b)(2).

The household test is stricter than it sounds

Living in different places is not always enough. Treasury Regulation 1.6015-3(b)(3) says spouses are still members of the same household during a temporary absence if it is reasonable to assume the absent spouse will return and the household is maintained in anticipation of that return. The regulation lists incarceration, illness, business, vacation, military service and education as examples of temporary absences.

It also says that spouses who live in two separate dwellings are still members of the same household if they are not estranged. So a couple with a city apartment and a lake house is not separated for tax purposes just because they sleep in different places. Estrangement is the key word.

And timing matters. The 12 months are measured backward from the date you file the election. If you moved out ten months ago, waiting two more months before filing could make you eligible. But do not let that waiting game blow your two-year deadline.

What the election does

Section 6015(c)(1) says your liability for any deficiency on the joint return shall not exceed the portion properly allocable to you under section 6015(d). The election does not erase the deficiency. It divides it.

Treasury Regulation 1.6015-3(d)(1)(ii) makes an important point: only the requesting spouse receives relief. A spouse who does not also elect remains liable for the entire deficiency. And even if both spouses elect, some portion may not be allocable, and both remain jointly and severally liable for that portion.

How the IRS allocates items

The core rule is in section 6015(d)(3)(A). Items giving rise to the deficiency are allocated as if the spouses had filed separate returns. Treasury Regulation 1.6015-3(d)(2) fills in the details:

• Erroneous income items go to the spouse who was the source of the income. Wages go to the spouse who performed the services. Business or investment income goes to the spouse who owned the business or investment.
• Erroneous deductions related to a business or investment go to the spouse who owned it.
• Items from jointly owned property are generally split 50 percent to each spouse, absent clear and convincing evidence supporting a different split.
• Deductions unrelated to a business or investment are generally split 50 percent to each spouse unless the evidence shows otherwise.

Community property law does not control. Section 6015(a) says any determination under section 6015 is made without regard to community property laws, and Treasury Regulation 1.6015-1(f) confirms that an erroneous item is attributed to the individual whose activities gave rise to it.

The proportionate formula

Under section 6015(d)(1) and Treasury Regulation 1.6015-3(d)(4), your share of the deficiency equals the deficiency multiplied by the ratio of the net erroneous items allocable to you over the net amount of all erroneous items.

The regulation's own example: a $54,000 deficiency arises from $120,000 of erroneous items, $80,000 allocable to the wife and $40,000 to the husband. The wife's liability is capped at two-thirds of $54,000, or $36,000. The IRS can collect up to $36,000 from her and up to $54,000 from him, but not more than $54,000 in total.

Some items skip the formula. Section 6015(d)(2) and Treasury Regulation 1.6015-3(d)(4)(ii) treat disallowed credits and taxes other than regular income tax and alternative minimum tax, such as self-employment tax, as separate treatment items assigned directly to the spouse they belong to. Accuracy-related and fraud penalties under sections 6662 and 6663 go to the spouse whose item generated the penalty, per Treasury Regulation 1.6015-3(d)(4)(iv)(B).

The benefit exception

There is one rule that catches higher-earning spouses off guard. Under section 6015(d)(3)(B), an item otherwise allocable to your spouse gets allocated to you to the extent it gave you a tax benefit on the joint return.

The classic example in Treasury Regulation 1.6015-3(d)(5): the husband reported $4,000 of business income and deducted $20,000 of expenses, creating a $16,000 loss that offset the wife's wages. When all $20,000 was disallowed, only $4,000 was allocated to him. The other $16,000 was allocated to her, because it was her wage income those deductions sheltered.

The limits on the election

Actual knowledge

Under section 6015(c)(3)(C), if the IRS demonstrates that you had actual knowledge, when you signed the return, of an item giving rise to a deficiency allocable to your spouse, the election does not apply to that item. This is the most litigated part of 6015(c), and it is narrower than people fear: the IRS bears the burden and must prove actual knowledge, not reason to know. There is also an abuse exception. The guide to the actual knowledge rule covers it in depth.

Disqualified asset transfers

Under section 6015(c)(4), your allocated share increases by the value of any disqualified asset your spouse transferred to you. A disqualified asset is property transferred with the principal purpose of avoiding tax or payment of tax. Transfers made after the date one year before the first letter of proposed deficiency is sent are presumed to have that purpose.

But here is the important exception for divorcing spouses. Section 6015(c)(4)(B)(ii)(II) says the presumption does not apply to a transfer made under a decree of divorce or separate maintenance or a written instrument incident to such a decree. Property you received in the divorce settlement is not presumed to be a tax dodge.

Fraudulent schemes

Under section 6015(c)(3)(A)(ii), if the IRS shows that assets were transferred between the spouses as part of a fraudulent scheme, the election is invalid for either spouse.

No refunds

Section 6015(g)(3) bars any credit or refund resulting from a 6015(c) election, and Treasury Regulation 1.6015-3(c)(1) says relief is only available for unpaid liabilities resulting from understatements. If you have already paid, you need 6015(b) or 6015(f) to get money back.

The burden of proof

Section 6015(c)(2) puts the burden on you to establish the portion of the deficiency allocable to you, except for actual knowledge and the fraudulent scheme rule, where the IRS carries the burden. In practice, that means you need records showing whose business it was, whose account the money landed in, and whose name was on the brokerage statement. Treasury Regulation 1.6015-3(d)(3) says the same thing in more words.

Timing

Section 6015(c)(3)(B) lets you elect at any time after a deficiency is asserted, but no later than two years after the IRS begins collection activities against you. Treasury Regulation 1.6015-5(b)(3) confirms that a request may be made before collection starts, including in connection with an audit or examination of the joint return. So you can, and often should, raise 6015(c) during the audit itself.

What this means for a divorce

If you are divorcing and an audit is open or likely, separation of liability belongs in the conversation with your family law attorney. Your divorce decree cannot bind the IRS. The guide to why a divorce decree does not bind the IRS explains why. But the decree can document who owned what, and that documentation is exactly what a 6015(c) allocation runs on.