The innocent spouse rules exist because joint returns make each spouse liable for the whole tax, and sometimes that is unfair. But "innocent" has a specific meaning in the Code, and it does not mean "trusting." Cheshire v. Commissioner is the case I point to when someone tells me, "I signed it, but I had no idea it was wrong."
The Facts
Kathryn Cheshire married David Cheshire in 1970. He retired from Southwestern Bell effective January 1, 1992, and received retirement distributions in 1992 totaling $229,924. Of that, $42,183 was rolled over into a qualified account and was not taxable. He deposited $184,377 into the couple's joint checking account, which earned $1,168 in interest that year. Kathryn knew about the distributions and the interest.
The couple used $99,425 of the money to pay off their home mortgage and $20,189 to buy a 1992 Ford Explorer. Other funds went to start-up capital for David's new business, paying off loans on a family truck and their daughter's car, family expenses and a college fund. Kathryn knew about all of it.
David prepared their joint 1992 return. It reported $199,771.05 in retirement distributions but claimed only $56,150.12 as taxable. Before signing, Kathryn asked about the tax consequences. David told her a CPA had advised that retirement proceeds used to pay off a mortgage were nontaxable. She accepted that and signed. In fact, David had not consulted the CPA, and the distributions that were not rolled over were taxable.
The couple separated in July 1993 and divorced about seventeen months later. The divorce decree gave Kathryn the marital home free and clear and the Ford Explorer. The IRS determined the Cheshires had understated taxable distributions by $131,591 and underreported interest, and imposed an accuracy-related penalty under IRC § 6662(a).
Kathryn sought innocent spouse relief under all three subsections of § 6015. Before trial the IRS conceded relief on some smaller distributions. The Tax Court denied relief on the rest, and she appealed.
The Issue
When a spouse knows all the facts of a transaction but is mistaken about how it is taxed, does she qualify for innocent spouse relief under § 6015(b), (c) or (f)?
The Holding
No. Chief Judge King wrote for the Fifth Circuit, which affirmed. "Ignorance of the law cannot establish an innocent spouse defense to tax liability." Kathryn had reason to know of the understatement under § 6015(b), had actual knowledge of the item under § 6015(c), and the denial of equitable relief under § 6015(f) was not an abuse of discretion.
The Reasoning
Section 6015(b): reason to know
Section 6015(b)(1)(C) requires the requesting spouse to establish that in signing the return she "did not know, and had no reason to know" of the understatement. Courts apply a knowledge-of-the-transaction test in omitted income cases. In erroneous deduction cases, the Fifth Circuit asks whether the spouse knew or had reason to know the deduction would cause an understatement. The court did not decide which category this case fit, because Kathryn lost under both. She knew the amount of the distributions, where they were deposited, the interest they earned and how the money was spent. Her only defense was a mistaken belief about the law.
A circuit split on the test, not the result
The opinion explains that circuits disagree about the knowledge test for erroneous deduction cases. The Ninth Circuit adopted a test asking whether a reasonably prudent taxpayer in the spouse's position could be expected to know the return contained a substantial understatement, and the Fifth Circuit had adopted that approach in an earlier case. The court noted that the Second, Seventh, Eighth and Eleventh Circuits had also followed the Ninth Circuit. Even under that more forgiving test, the Fifth Circuit said, a spouse who knows virtually all the facts and is mistaken only about the law has reason to know as a matter of law. The test you face can depend on where you live, but in a case like this one the answer comes out the same.
Section 6015(c): actual knowledge of the "item"
Section 6015(c) lets a divorced or separated spouse limit liability to her own share, but it is unavailable if the IRS proves she had "actual knowledge" of "any item giving rise to a deficiency" when she signed. Kathryn argued "item" meant the incorrect tax reporting. The court disagreed. Looking at how "item" is used elsewhere in § 6015 and the Code, it held that "item" means "an item of income, deduction, or credit." She knew the distributions existed. That was enough, even though she did not know they were taxable.
Section 6015(f): significant benefit
For equitable relief, the court reviewed the IRS's denial for abuse of discretion. It said the most important factor in its circuit was whether the requesting spouse "significantly benefitted" from the understatement. Kathryn received the house, whose mortgage had been paid off with $99,425 of untaxed distributions, and the car bought with distribution money. Denying relief was not an abuse of discretion. The Tax Court had granted her equitable relief from the part of the accuracy penalty tied to the retirement distributions, and that ruling was not appealed.
What It Means for Taxpayers Today
Knowing the facts is the trap
If you knew about the income, knew where it went and spent it together, you will have a hard time claiming you had no reason to know about a tax understatement. Being told by your spouse that "the accountant said it was fine" does not change that, especially when no accountant was ever consulted.
The standard of review has changed
The § 6015(f) part of Cheshire was decided under an abuse of discretion standard. That is no longer the law. The Tax Court moved to de novo review in Porter v. Commissioner, and Congress wrote de novo review into the statute in the Taxpayer First Act of 2019. IRC § 6015(e)(7) now says the Tax Court reviews determinations de novo, based on the administrative record and any newly discovered or previously unavailable evidence. Benefit from the understatement remains a significant fact, but a requesting spouse now gets a fresh look in the Tax Court rather than deference to the IRS.
Build your record at the IRS stage
Because § 6015(e)(7) limits the Tax Court mostly to the administrative record, the evidence you submit with Form 8857 and during the IRS's review matters more than ever. Document what you knew, what you did not know, who handled the finances, any abuse or intimidation, and what you received in the divorce.
Divorce decrees do not bind the IRS
Kathryn got the house in the divorce. That did not protect her from the IRS; it hurt her, because it showed she benefited from the unreported income. A divorce decree can allocate responsibility between spouses, but it does not change joint and several liability to the government. Our article on innocent spouse relief and our piece on tax problems after divorce walk through the practical side.
Partial relief is still relief
Notice that Kathryn won some relief: the IRS conceded part of the distributions, and the Tax Court relieved her of part of the penalty. Innocent spouse claims are rarely all or nothing. Claim everything you are entitled to and let the facts sort it out.
The Bottom Line
Cheshire is the clearest statement of a hard rule. Innocent spouse relief protects spouses who did not know the facts. It does not protect spouses who knew the facts and trusted someone else about the law. If you were in the room when the money came in and went out, start from the assumption that the knowledge requirement is your biggest obstacle, and build your case around everything else.