IRC 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, past due legally enforceable state income tax, and past due unemployment compensation obligations become eligible for offset after receipt by the Secretary of the Treasury of a notification from the federal agency or the state. See IRC 6402(c), IRC 6402(d)(1) and IRC 6402(e)(1). Unpaid federal tax liabilities are eligible for IRC 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. See 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 IRC 6402, the entire overpayment may be offset. Offset issues arise where spouses file joint returns and only one spouse owes an IRC 6402 debt. The general practice of the Service is to offset the entire debt. See Rev. Rul. 84-171, 1984-2 C.B. 310. However, under well-settled law, where spouses file joint returns and report a refund or overpayment, the spouses have separate interests in the joint overpayment. See Rev. Rul. 80-7, 1980-1 C.B. 296, amplified byRev. Rul. 87-52, 1987-1 C.B. 347. The spouse who is not liable for the debt (referred to as the “injured spouse”) may file a claim for his or her portion of the refund (referred to as an “injured spouse claim”). 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 injured spouse. See Rev. Rul. 80-7. Injured spouse issues can arise in all U.S. jurisdictions. However, 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. See Rev. Rul. 85-70.

Injured Spouse Claims. If spouses file a joint income tax return and an obligation described in IRC 6402 is owed by one of the spouses, the Service will generally offset the entire overpayment. See Rev. Rul. 84-171. If the injured spouse files a claim for his or her share of the overpayment, the Service is required to refund the portion of the overpayment to which the injured spouse is legally entitled. See IRM 25.15.1.2.5, Relief from Joint and Several Liability-Injured Spouse Claims; 31 CFR 285.2(f) and (g). An injured spouse obtains his or her portion of the overpayment by filing a Form 8379, Injured Spouse Allocation. See 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 the right under IRC 6402 to offset all or part of the community property portion of the overpayment. The interest a liable spouse has in the community property portion of the overpayment varies 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.

Amount Retained and Amount Refunded. As discussed above, if spouses file a joint return and one of them owes an IRC 6402 debt, the Service will offset the entire overpayment, and only refund the injured spouse’s share of the refund if an injured spouse claim is filed. However, if the injured spouse files a claim with the joint return and the claim is allowed, the Service will refund the injured spouse’s share of the overpayment. For purposes of IRM 25.18.5, the amount of the overpayment the Service keeps after an injured spouse claim is filed in either situation is referred to as the "amount retained." The injured spouse’s portion of the overpayment that is refunded after the injured spouse claim is filed is referred to as the "amount refunded."

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 are owed jointly and severally with the other spouse. See IRC 66 and IRC 6015. Injured spouse status involves obtaining a refund of a spouse's interest in an overpayment that has been offset under IRC 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 to the injured spouse. See Rev. Rul. 85-70. In the first part, the Service determines each spouse's community property share of the overpayment. 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 the Service will retain if an injured spouse claim is filed and the claim is allowed. The second part of the two-part process is to look to state law to determine if there is a right to retain more than 50% of the community property portion of the overpayment. In a state where a creditor under state law can reach more than 50% of community property to satisfy the separate liability of one of the spouses, the portion above 50% belongs to the liable spouse because state law gives him/her a property interest in that additional portion of the community property. The Service may apply his/her greater than 50% share of community property portion of the overpayment to the separate tax liability. See Rev. Rul. 85-70. As will be discussed below, if an injured spouse claim is filed, no portion of the injured spouse's share of the community property portion of the overpayment can be retained for an IRC 6402 debt not relating to federal taxes, such as child support, state income taxes or unemployment compensation (under IRC 6402(c), (d), (e), or (f)). The second part of the procedure only applies to claims for federal taxes (under IRC 6402(a)).

Injured Spouse’s Share of the Overpayment. The injured spouse’s share of the overpayment is computed by subtracting that spouse's share of the joint liability, determined in accordance with the separate tax formula, from that spouse's contribution of credits toward the joint liability. The amount credited cannot exceed the amount of the joint overpayment.

Separate Tax Formula. Under the separate tax formula, a spouse's share of the joint liability is computed using the separate tax formula, as follows:

See Rev. Rul. 85-70; Rev. Rul. 80-7, amplified byRev. Rul. 87-52, 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 Liability. 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, amplified by Rev. Rul. 87-52; Treas. Reg. 1.6654-2(e)(5)(ii)(B). 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 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.

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.

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, Basic Principles of Community Property Law, 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; 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.

Same-sex marriage. On June 26, 2015, in Obergefell v. Hodges, 135 S.Ct. 2584 (2015), the Supreme Court held that:

As a result, same-sex married couples receive the same state and federal benefits and burdens as opposite-sex married couples. Therefore, same-sex married couples who domicile in a community property state are subject to community property rules in the same manner as opposite-sex married couples.

Registered Domestic Partners. Under the laws of California, Nevada, and Washington, same-sex and opposite-sex registered domestic partners are subject to state community property laws in the same manner as married couples. Cal. Fam. Code § 297.5(a); Nev. Rev. Stat. § 122A.200; Wash. Rev. Code § 26.16.030. However, since registered domestic partners are not married, they cannot file joint federal income tax returns. If a registered domestic partner in California, Nevada or Washington files their individual federal income tax return reporting an overpayment, the overpayment is available to satisfy the separate tax debt of the other registered domestic partner in the same manner it would be available to satisfy a separate debt of a married individual in those states. See IRM 25.18.5.14. Thus, all or part of the overpayment may be offset and applied to the other registered partner’s debt.

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. See 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 an IRC 6402 offset, the estimated tax payments should be allocated in proportion to the spouses' separate tax liabilities. The formula for this is as follows:

See Rev. Rul. 80-7, amplified by Rev. Rul. 87-52, incorporating by reference then 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 IRC 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. See Rev. Rul. 80-7, amplified byRev. Rul. 87-52. Under IRC 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:

SeeRev. Rul. 87-52. 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. See 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. See 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. See Treas. Reg. 1.1402(a)-8(b).

Generally. To determine how much to refund 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. See Rev. Rul. 85-70. Since the payments are frequently all community property, this will usually be 50% of the overpayment.

Offsets for Debts Other Than Federal Taxes. If the IRC 6402 debt is for a liability other than federal taxes, then other federal law applies and the amount of the community property portion of the overpayment that may be retained, if a claim is filed, is limited to the liable spouse's share of the community property, without regard for the state-law rule giving the liable spouse an interest in the community property above 50%, and any portion 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 liable spouse’s property interest in the community property portion of the overpayment is not altered by any right that a creditor may have under state law to reach the nonliable spouse's share of the joint refund. In the context of IRC 6402(c), (d), (e), and (f), the IRS is not a creditor of the liable spouse because the debt being collected is not a tax debt. Instead, the IRS is acting as a conduit. 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 retained to apply 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 retain a larger portion of the overpayment. See Rev. Rul. 85-70.

State law defines property. IRC 6321 provides the Service with a statutory lien or claim attaching all a taxpayer’s property or rights to property for the amount of the federal tax debt. As discussed previously, some state community property laws define the property reachable by creditors to include more than half of community property for satisfaction of the separate liability of one of the spouses. In the case of an offset, relating to the separate statutory lien for the federal tax debt of one of the spouses, these state laws give the liable spouse a property interest in more than one half of the community property. The Service can rely on these state property laws for attachment of the Service’s statutory lien to and retention of more than half of the community property interest in an overpayment. These rules are complex and care must be taken in applying them. It is often necessary to know when the spouses were married. Service personnel working these claims often do not have this information, therefore they should assume that the liabilities were incurred during marriage unless the taxpayer establishes otherwise. 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.

Because of complexities in Texas community property law, it is important to discuss with Counsel how to handle injured spouse claims involving federal tax offsets in Texas.

Where there are liabilities for unpaid federal taxes and other liabilities described in IRC 6402, the offset should first be applied to the federal tax liabilities. See IRC 6402(f)(2); 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. If an injured spouse claim is filed, the Service cannot offset more than 50% of a community property overpayment to satisfy a child support obligation, a debt to another federal agency, a state income tax liability, or unemployment compensation liability pursuant to IRC 6402 If unpaid federal tax liabilities exceed 50% of the portion of the overpayment that is community property and there are other liabilities not involving federal taxes, the Service can only apply the overpayment to the extent of the federal tax debt. Any excess cannot be applied to the other obligations, but should be refunded. This is because offset under IRC 6402 for the payment of non-tax obligations may not exceed 50% of the community property. 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 community property portion of the joint overpayment, then the Service can retain the full amount of the tax debt. Then, the Service can retain the difference between the tax offset and 50% of the overpayment and apply this amount to the liable spouse’s other IRC 6402 debt. In this case, the remaining 50% of the joint overpayment must be refunded to the injured spouse. The priority of offset between IRC 6402 obligations after federal taxes is as follows: past due child support; debts owed to federal agencies, state income tax obligations; and unemployment compensation liabilities. See IRC 6402(f)(2). Priority between multiple debts owed to federal agencies is determined by the order in which the debts accrued. See IRC 6402(d)(2). Priority between multiple debts owed to a state or states will be determined by the order in which the debts accrued. See IRC 6402(e)(3) and IRC 6402(f)(2).

The Service may legally offset under IRC 6402 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). 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 gives the liable spouse a property interest in the overpayment reported on the nonliable spouse’s separate return. The portion of the overpayment that is separate property is not subject to offset because the liable spouse has no property interest. The portion of the overpayment that is community property may be retained to the extent state law permits collection against the nonliable spouse’s half of community property for an obligation of the liable spouse. Presumably, in filing a separate return, the non-liable spouse has already made the allocation, and the reported overpayment would represent his or her share of the overpayment but for state law giving the liable spouse a property interest in it. However, the examiner should verify that the income was reported properly under community property principles.

Debts Not Involving Federal Taxes

Husband and wife are married and domicile in Louisiana. Husband owes $25,000 for an unpaid federal student loan from before his marriage. For 2010, husband and wife file a joint return. Husband earned $40,000 in wages and had withholding of $4,000. 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. Wife files an injured spouse claim.

The Service should refund $1,500 (half of the overpayment), calculated as follows:

Earned Income Tax Credit Allocation

Husband and wife are married and domicile in Wisconsin. Husband owes back child support of $17,000 from a previous marriage. For 2010, husband has wages of $8,000 and withholding of $900. 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 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 wife files an injured spouse claim, the Service should refund $1,727 her, calculated as follows:

Federal Tax Claims and Section 6402 Offset.

Husband and wife live in California. Husband owes $18,000 in employment taxes from 2008, before the marriage. For 2010, husband and wife file a joint return. Husband earned $50,000 in wages and had withholding of $8,000. 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. Wife files an injured spouse claim. The injured spouse claim should be denied. Although normally the wife might have a half-interest in the overpayment since it is entirely community property, the liable spouse has a property interest in the all of the refund. Under California law all of the community property is liable for a premarital debt of one of the spouses. Accordingly, the Service can offset the entire refund of $519.

Order of Application

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 2010, husband received wages of $35,000 and had withholding of $6,000. 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 wife files an injured spouse claim, wife should receive a refund of $1,869.50 and the overpayment should be applied as follows:

(i) Allocation of Taxes and Credits

(ii) Application of Offset to Overpayment

Offsetting Refunds in Texas to Apply to Federal Income Tax Liabilities.

Husband and wife are married and domicile in Texas. Husband owes a separate tax liability from a prior year of $12,000. Husband and wife file a joint federal income tax return for 2013. The return reports a total tax liability of $7,923 and a total overpayment of $487. Husband received wages of $65,305, with $7,906 withheld for income taxes. Wife received wages of $9,262, with $464 withheld for income taxes. Husband received a premature withdrawal from an IRA in the amount of $120, incurring a tax under IRC 72(t) of $12 (which is included in the income tax liability). The spouses claimed the standard deduction. They also claimed two exemptions on the return. In addition, they claimed a telephone excise tax refund of $40.

The first step is to calculate each spouse’s separate tax liability. This would be done as follows:

Next the separate tax formula should be applied as follows:

$3,947.53/$7,913.06 X $7,911.00 = $3,946.50 (wife’s share of the joint liability)

$3,965.53/$7,913.06 X $7,911.00 = $3,964.50 (husband’s share of the joint liability)

Therefore, each spouse’s share of the income tax liability would be as follows:

Next the payments should be characterized and applied as follows:

The entire portion that represents husband’s overpayment can be retained. The next issue is to determine how much of wife’s overpayment can be retained. Under Texas law, the Service can offset 100% of the portion of the refund that is husband’s SMCP and 100% of that portion that is JMCP. In addition, the Service can retain 50% of the portion that is wife’s SMCP, which it has already done by retaining the husband’s portion of the overpayment. The Service cannot retain any part of the refund that is wife’s separate property. Therefore, the Service can retain any portion of wife’s refund that is either JMCP or husband’s community property interest in the wife’s SMCP. If we assume that the tax payments were applied proportionately to the tax liability, the amount of the refund that is JMCP or husband’s SMCP would be calculated as follows:

or

$258.50 X ($3,953 + $20)/$4,205) = $244.24

Consequently the amount wife can retain is equal to her portion of her overpayment minus the amount that can be retained.

or

$258.50 - $244.24 = $14.26