I.R.C. § 6402. Section 6402 gives the Service the ability to offset overpayments to satisfy certain unpaid debts. These debts include:

Creation of the Right to Offset for Debts. Past due debts owed to other federal agencies, past due child support and past due legally enforceable state income tax obligations become eligible for offset after receipt by the Secretary of the Treasury of a notification from the federal agency or the state. I.R.C. §§ 6402(c), 6402(d)(1) and (e)(1). Unpaid federal tax liabilities are eligible for section 6402 offset upon assessment. No preliminary notices are required before an offset can be made. Fulgoni v. United States, 23 Cl. Ct. 119, 91-1 U.S.T.C. ¶50,256, 67 A.F.T.R.2d ¶91-462 (1991).

How Offset Issues Arise. When spouses file joint income tax returns, each spouse has a separate interest in the jointly reported income and in any overpayment. Rev. Rul. 74-611, 1974-2 C.B. 399, amplified by, Rev. Rul. 85-70, 1985-1 C.B. 361. If both spouses are liable for a debt described in section 6402, the entire overpayment may be offset. Offset issues arise where spouses file joint returns and only one spouse owes a section 6402 debt. In this circumstance, an allocation must be made to determine the liable spouse's interest in the overpayment, the amount that can be offset for the liable spouse's debt, and the amount to be refunded to the nonliable spouse. Rev. Rul. 80-7, 1980-1 C.B. 296, amplified by Rev. Rul. 87-52, 1987-1 C.B. 347. Due to different property rights in income tax and withholding and other credits, there is a difference in the allocation process for community property states as opposed to the other states. Rev. Rul. 85-70, 1985-1 C.B. 361.

Injured Spouse Claims. If spouses file a joint income tax return and an obligation described in section 6402 is owed by one of the spouses, the Service will generally offset the entire overpayment. See Rev. Rul. 84-171, 1984-2 C.B. 310. If the spouse who does not owe the obligation (referred to as the "injured spouse") files a claim for his or her share of the overpayment (referred to as an "injured spouse claim"), the Service is required to refund his or her share of the overpayment. IRM 25.15.1.2.5; 31 C.F.R. §§ 285.2(f) and (g). An injured spouse obtains his or her portion of the overpayment by filing a Form 8379. IRM 25.15.1.2.5. An injured spouse claim can also be filed with an original return. As will be discussed below, in some circumstances the Service may have a common law right under state law to offset all or part of the injured spouse's community property share of the overpayment. These rights vary from state to state. Exhibit 25.18.5-1 contains examples of the application of injured spouse rules in various states and for various types of liabilities.

Injured Spouse v. Innocent Spouse. Injured spouse status and innocent spouse status are frequently confused with each other. Innocent spouse status relieves a spouse of the responsibility for paying taxes that may then be collected from the other spouse. Injured spouse status involves obtaining a refund of a spouse's interest in an overpayment that has been offset under I.R.C. § 6402.

Offsets for Debts Other Than Federal Taxes. If an injured spouse claim is filed by a spouse in a community property state, the Service needs to determine how much will be refunded. If the debt to which the offset was applied is not a federal tax liability, the Service determines what portion of the overpayment represents the injured spouse's share of the overpayment and refunds it.

Offsets for Federal Tax Debts. If the debt involved is a federal tax liability, the Service goes through a two-part procedure to determine how much will be refunded. Rev. Rul. 85-70, 1985-1 C.B. 361. In the first part, the Service determines each spouse's community property share of the overpayment. Rev. Rul. 85-70, 1985-1 C.B. 361. The Service will also determine if any portion of the overpayment represents the liable spouse's separate property. The liable spouse's community property and separate property share of the overpayment is the minimum amount that will be applied to the debt. The second part of the two-part process is to look to state law to determine if there is a common law right to setoff more than 50% of the community property portion of the overpayment. In a state where a creditor can reach an additional portion of community property to satisfy the separate liability of one of the spouses, the Service can exercise this right and claim a larger portion of the overpayment. Rev. Rul. 85-70, 1985-1 C.B. 361. As will be discussed below, no portion of the injured spouse's share of the community property overpayment can be reached for a section 6402 debt not relating to federal taxes, such as child support, state income taxes or other non-tax federal obligations (under sections 6402(c),(d) or (e)). The second part of the procedure only applies to claims for federal taxes (under section 6402(a)).

Separate Tax Formula. The injured spouse's share of the overpayment is the amount of that spouse's interest in the overpayment, computed in accordance with the separate tax formula, which is as follows:

See Rev. Rul. 85-70, 1985-1 C.B. 361; Rev. Rul. 80-7, 1980-1 C.B. 296, amplified by Rev. Rul. 87-52, 1987-1 C.B. 347,incorporating by reference Treas. Reg. § 20.2053-6(f). As the formula shows, it is necessary to calculate each spouse's separate tax liability.

Injured Spouse's Separate Tax. To determine the injured spouse's separate tax liability for purposes of the separate tax formula, each spouse's tax liability must be determined as if they filed separate returns. Rev. Rul. 80-7, 1980-1 C.B. 296, amplified by Rev. Rul. 87-52, 1987-1 C.B. 347, incorporating by reference Treas. Reg. § 20.2053-6(f). This requires an allocation of income and deductions between the spouses.

Allocating Credits. After determining each spouse's share of the tax under the separate tax formula, it is necessary to allocate and apply the credits (e.g., withholding, estimated tax and earned income tax credits) to each spouse's tax liability to determine his or her share of the overpayment. Under no circumstances can an injured spouse be refunded more than the joint overpayment. Thus, for example, it is possible under this formula for the liable spouse to not have sufficient credits to cover his or her share of the tax liability, and for the injured spouse's share of the credits (when applied to his or her liability) to exceed the joint refund. In this circumstance, the injured spouse is entitled to a refund only to the extent of the overpayment on the joint return. See Rev. Rul. 85-70, 1985-1 C.B. 361.

State Community Property Law Presumptions. State community property laws create a presumption that property received by spouses is community property. Therefore, in allocating income the Service will assume that the items on the return are community property unless the taxpayers prove otherwise or the law provides that particular items of income, deductions or credits are the separate property of one of the spouses. See Rev. Rul. 85-70, 1985-1 C.B. 361.

Generally. As previously discussed, to do the calculation based on the separate tax formula, the income, deductions and other tax items must be allocated between the spouses and separate tax liabilities must be determined. With respect to spouses in community property states, there are special rules that apply to income and deductions. These rules are more fully set forth earlier in IRM 25.18.1, but some common issues that arise are discussed in this section.

Allocating Income. As previously discussed, state community property laws presume that property acquired by spouses is community property. However, the Service will not treat an item as community property if it is clear from the face of the return that federal or other law requires that the item be treated as separate property. See discussion below for examples of items treated as separate property income by law. If items are community property income, each spouse is considered to be the recipient of half of the item. In an injured spouse allocation, items of community property income should be allocated 50% to each spouse.

Deductions. Deductions associated with income are generally characterized in the same manner as the income. Therefore, for example, if Schedule C income is treated as community property and allocated to both spouses, any Schedule C deductions are also treated as community property and split. Deductions that are not related to income (e.g., medical, charitable contributions, property taxes, state taxes) are split, unless it is established that they were paid with separate property, in which case they would be deductible by the spouse whose separate property was used to pay them. Powell v. Commissioner, T.C. Memo. 1967-32; see also Hunt v. Commissioner, 47 B.T.A. 829 (1942); Bishop v. Commissioner, 152 F.2d 389 (9th Cir. 1945); Commissioner v. Newcombe, 203 F.2d 128 (9th Cir. 1953); Keeter v. United States, 97-2 U.S.T.C. ¶50,940, 80 A.F.T.R.2d ¶97-5640 (E.D. Cal. 1997). These rules apply to allocations of deductions for injured spouse calculations.

Effect When All Items Are Community Property. When all items on the return are community property, each spouse will be entitled to half of the overpayment. This happens frequently where all of the income on the return is from wages.

In spite of the state community property law presumption, some items of income, deduction or tax may be separate property. This usually occurs because the spouses have provided proof that the items are separate property or because federal law dictates that the items are separate property. When this happens, the affected items should be allocated to the spouse who owns them. Common circumstances where items are separate property include the following:

Wage Withholding. Withholding credits from community property income are community property and are allocated 50% to each spouse. Treas. Reg. §1.31-1(a); Gilmore v. United States, 290 F.2d 942 (Ct.Cl. 1961), rev'd on other grounds, 372 U.S. 39 (1963). If it is established that the underlying wages are not community property, the withholding should be characterized consistently with the wages.

Estimated Tax Payments. Where spouses make estimated tax payments and subsequently file a joint return with an overpayment subject to a section 6402 offset, the estimated tax payments should be allocated in proportion to the spouses' separate tax liabilities. The formula for this is as follows:

Rev. Rul. 80-7, 1980-1 C.B. 296, amplified by Rev. Rul. 87-52, 1987-1 C.B. 347, incorporating by reference Treas. Reg. § 1.6015(b)-1(b). This formula only applies as a presumption. Ownership of estimated tax payments in the context of a joint return is determined by their source. Elam v. United States, 112 F.3d 1036 (9th Cir. 1997); Gens v. United States, 673 F.2d 366 (Ct. Cl. 1981), cert. denied, 459 U.S. 906 (1982). Therefore, if the spouses establish that the source of the payment was community property, the payment should be split evenly. If they establish that it is the separate property of one of the spouses, it should be allocated to that spouse.

Taxes and Credits. Some taxes and credits are allocated to spouses without regard to community property. These items are exceptions to the community property presumption and are not split. These include the earned income tax credit and self-employment tax.

Earned Income Tax Credit. Under I.R.C. § 32(c)(2)(B)(i), the amount of earned income for purposes of the earned income tax credit is calculated without regard to community property laws. If only one spouse has earned income, the credit is allocated to that spouse. If, however, both spouses have earned income and are eligible for the credit, each spouse’s share must be determined. Rev. Rul. 80-7, 1980-1 C.B. 296, amplified by Rev. Rul. 87-52, 1987-1 C.B. 347. Under section 32(b), the credit is phased out as certain income levels are reached. Therefore, for purposes of determining each spouse's contribution toward an overpayment, the credit cannot be allocated on a dollar-for-dollar basis. The allocated amount is arrived at by using the earned income tax credit tables to determine the hypothetical separate earned income tax credit that would have been available to each spouse if that spouse had filed a separate return (and if the earned income tax credit were available on a separate return) and then using the following formula:

See Rev. Rul. 87-52, 1987-1 C.B. 347. For purposes of determining the hypothetical separate credit, each spouse should use the same number of qualifying children as were used to determine the actual joint credit. In addition, because the earned income tax credit is determined without regard to community property laws, it cannot be characterized as community property for purposes of the allocation. This would mean that the injured spouse's share of earned income tax credit would not be available for set-off, since it is the injured spouse's separate property.

Self-Employment Tax. The self-employment tax with respect to self-employment income (net income from a trade or business, other than a partnership) is allocated to the spouse who has management and control over the trade or business. Treas. Reg. § 1.1402(a)-8(a); Heidig v. Commissioner, T.C. Memo. 1986-411; Tolotti v. Commissioner, T.C. Memo. 1987-13. Management and control means actual management and control, not management and control imputed from husband to wife under community property laws. Treas. Reg. § 1.1402(a)-8. Therefore, the self-employment tax is allocated to the spouse actually carrying on the trade or business. For purposes of the injured spouse calculation, self-employment tax should be allocated in accordance with this rule. Similarly, the self-employment tax attributable to a partnership that is a trade or business is allocated to the spouse who is the partner, even if part of the income is otherwise attributable to the other spouse for income tax purposes. Treas. Reg. § 1.1402(a)-8(b).

Generally. After an injured spouse claim is filed in a community property state, the Service must first determine each spouse's community property share of the overpayment and any separate property. Rev. Rul. 85-70, 1985-1 C.B. 361. This will usually be 50% of the overpayment.

Offsets for Debts Other Than Federal Taxes. As discussed previously, if the section 6402 debt is for a liability other than federal taxes, then the offset is limited to the liable spouse's share of the community property portion of the overpayment and any part of the refund that is the liable spouse's separate property. Oatman v. Secretary of the Treasury, 34 F.3d 787 (9th Cir. 1994). The Service follows this position in all community property states. Therefore, in offsets not involving federal tax debts, the Service will refund the injured spouse's community property share of the overpayment and any part of the refund that is the injured spouse's separate property.

Offsets for Federal Tax Debts. If the liability is for federal taxes, however, the amount allocable to the liable spouse's share of the overpayment is the minimum amount that will be applied to the debt. If the applicable state law allows a creditor to reach an additional portion of community property to satisfy the separate liability of one of the spouses, the Service can exercise this right and claim a larger portion of the overpayment. Rev. Rul. 85-70, 1985-1 C.B. 361.

As discussed previously, some state community property laws allow private creditors to reach more than half of community property to satisfy the separate liability of one of the spouses. In the case of an offset for the separate federal tax debt of one of the spouses, the Service can rely on these state law remedies to offset more than half of the community property interest in an overpayment. These rules are complex and care must be taken in applying them, however. Often it is necessary to know when the spouses were married. Here is a brief summary of the rules in each of the community property states. These rules are also summarized in Exhibit 25.18.5-1 to this section.

Where there are liabilities for unpaid federal taxes and other liabilities described in I.R.C. § 6402, the offset should first be made against the federal tax liabilities. I.R.C. § 6402(e)(3); Treas. Reg. § 301.6402-5(d)(1 ). If there is any amount left over after this application, it would then be applied to the other liabilities. The Service cannot offset more than 50% of a joint community property overpayment to satisfy a section 6402 liability involving child support, a debt to another federal agency, or a state income tax liability. If unpaid federal tax liabilities exceed 50% of the overpayment and there are other liabilities not involving federal taxes, the Service can only offset the overpayment to the extent of the federal tax debt. Any excess cannot be applied to the other obligations. This is because the Service will have already taken the maximum amount (50%) of the refund and applied it to the tax obligation. If the tax debt is less than 50% of the joint overpayment, then the Service can offset the full amount of the tax debt. In addition, the Service can offset the liable spouse's other debt by the difference between the tax offset and 50% of the overpayment. In this case, the remaining 50% of the joint overpayment must be refunded to the injured spouse. The priority of offset between section 6402 obligations after federal taxes is as follows: past due child support; debts owed to federal agencies; and state income tax obligations. I.R.C. § 6402(e)(3). Priority between multiple debts owed to federal agencies is determined by the order in which the debts accrued. I.R.C. § 6402(d)(2).

The Service may legally offset a spouse's overpayment to satisfy an unpaid tax liability of the other spouse, even though the overpayment was reported on a separate return. Eaves v. United States, 433 F.2d 1296 (10th Cir. 1970). These types of offsets are not covered by section 6402. This is permissible as being similar to a levy or offset on community property. Assuming that the nonliable spouse who filed the return reported his or her portion of the community income correctly, an offset is only permissible to the extent that state law allows creditors to go against the nonliable spouse's half of community property for an obligation of the liable spouse. This is because in filing a separate return, the spouse who is not liable has already made the allocation, and the reported overpayment would represent his or her share of the overpayment. The examiner should verify that the income was reported properly under community property principles.

Debts Not Involving Federal Taxes

A husband and wife are married and domicile in Louisiana. The husband owes $25,000 for an unpaid federal student loan from before his marriage. For 2000, the husband and wife file a joint return. The husband earned $40,000 in wages and had withholding of $4,000. The wife earned $50,000 and had withholding of $8,000. They report a tax liability of $9,000 and a refund of $3,000. The Service offsets the entire refund. The wife files an injured spouse claim. The Service should refund $1,500 (half of the overpayment), calculated as follows:

Earned Income Tax Credit Allocation

The husband and wife are married and domicile in Wisconsin. The husband owes back child support of $17,000 from a previous marriage. For 2000, the husband has wages of $8,000 and withholding of $900. The wife has wages of $13,000 and withholding of $600. They have two dependent children who lived with them. They file a joint return and report an earned income tax credit of $2,133 and a tax liability of $366. They report an overpayment of $3,267. The entire amount is offset by the Service for the child support claim. If the wife files an injured spouse claim, the Service should refund $1,727 to the wife, calculated as follows:

Federal Tax Claims and Common Law Right of Offset

A husband and wife live in California. The husband owes $18,000 in employment taxes from 1998, before the marriage. For 2000, the husband and wife file a joint return. The husband earned $50,000 in wages and had withholding of $8,000. The wife earned $35,000 and had withholding of $7,000. They file a joint return and report a tax liability of $14,481 and a refund of $519. The Service offsets the entire refund. The wife files an injured spouse claim. The injured spouse claim should be denied. Although based on the facts submitted the wife has a half interest in the overpayment since it is entirely community property, under California law a private creditor may attach both halves of community property to satisfy a premarital debt of one of the spouses. Accordingly, the Service can offset the entire refund of $519.

Order of Application

A husband and wife live in California. Husband owes $1,500 in premarital taxes and $3,000 for child support from a previous marriage. All items reported on the return are community property. For 2000, the husband received wages of $35,000 and had withholding of $6,000. The wife received wages of $13,000 and had withholding of $3,000. They file a joint return and report a joint tax liability of $5,261 and an overpayment of $3,739. If the Service offsets the entire overpayment and the wife files an injured spouse claim, the wife should receive a refund of $1,869.50 and the overpayment should be applied as follows:

1. Allocation of Taxes and Credits

2. Application of Offset to Overpayment