Innocent Spouse/Injured Spouse/Equitable Relief
INTRODUCTION TO SPOUSAL RELIEF
Although many taxpayers enjoy substantial tax benefits from filing joint returns, those benefits may be outweighed when a tax deficiency or unpaid balance is asserted for a return. The general rule is that each spouse has joint and several liability. The IRS might also offset a current year joint refund to pay a separate obligation of one spouse. In community property states (like California), married individuals face the duty to pay taxes on ½ of a spouses income – even when they file a married filing separate return.
The law is complex, and the court cases are many dealing with the issue of spousal relief. I will provide a history of the law and a number of cases relevant to this topic, but the material is voluminous so be prepared for a long read! I would certainly not recommend that any taxpayer undertake the mission of seeking relief without being represented by a tax professional who has had actual experience (and success) in proposing relief for his or her client. I have represented clients in a number of these cases over the period of my tax practice and (so far) have had 100% success. But it is a lot of work, and occasionally, an appeal has to be filed if the preliminary determination is unfavorable for the client.
There are three separate categories to Innocent Spouse relief. They are:
(a) Innocent Spouse,
(b) Separation of Liability, and
(c) Equitable Relief.
The first two are only appropriate for understatement of tax on a return. That means that the tax liability as shown on the return was wrong. Typically, this error is discovered during an audit of the return.
On the occasion that there is underpayment of tax, only the Equitable Relief category is possible. Understatement and underpayment may both exist under Equitable Relief.
Please review the 2013 Chief Counsel Notice at the end of this page for important insight into the IRS litigation of these cases. Over the past years, there have been changes to the procedures. Depending upon the year of the liability and the year of filing for relief, different rules may apply.
Significant Change in the Rules for Innocent Spouse Relief
The IRS announced (2013) that it will extend help to more innocent spouses by eliminating the two-year time limit that now applies to certain relief requests.
After a thorough review:
The IRS will no longer apply the two-year limit to new equitable relief requests or requests currently being considered by the agency.
A taxpayer, whose equitable relief request was previously denied solely due to the two-year limit, may reapply using IRS Form 8857 Request for Innocent Spouse Relief, if the collection statute of limitations for the tax years involved has not expired.
IMPORTANT ANNOUNCEMENT – JANUARY 8, 2012
IRS Releases New Innocent Spouse Guidelines
IRS yesterday issued Notice 2012-8, which is a proposed revenue procedure that revises the threshold requirements for requesting equitable relief as well as the factors used by IRS in evaluating the requests. According to IRS’ press release, the factors have been revised to ensure that requests for innocent spouse relief are granted under section 6015(f) when facts and circumstances warrant and that, when appropriate, requests are granted in the initial stage of the administrative process. More specifically, the notice expands how IRS will take into account abuse and financial control by the nonrequesting spouse in determining whether equitable relief is warranted.
The new guidelines are effective immediately and will remain in place until the finalized Rev. Proc. is published. IRS will immediately begin using the new guidelines when evaluating equitable relief requests under section 6015(f). The link to the press release also includes the notice and the ubiquitous IRS YouTube video and podcast.
The following was released by the California Board of Equalization in October 2013 addressing changes in the Innocent Spouse Relief procedures:
BOE Chairman Jerome E. Horton Announces Important Changes to Innocent Spouse Relief
If your spouse owes income taxes, and you are an innocent spouse, you can request relief from that tax liability.
Board of Equalization Chairman Jerome E. Horton has called for state conformity with important changes to the Internal Revenue Service’s (IRS) Revenue Procedure 2013-34 governing Innocent Spouse Relief. The Franchise Tax Board (FTB) clarifies that in determining whether to grant a request for innocent spouse relief, FTB will rely on this new IRS procedure, which makes some important changes to the evaluation of this type of claim. Notably, there will now be a greater emphasis on the effect of abuse and financial control in the weight of the factors.
Horton said, “Where federal and California laws are the same, federal rulings dealing with the Internal Revenue Code (IRC) are persuasive authority in interpreting California statutes.”
Generally, to qualify for Innocent Spouse relief, you must meet all of these conditions:
- You must have filed a joint return which has an understatement of tax;
- The understatement of tax must be due to erroneous items of your spouse;
- You must establish that at the time you signed the joint return, you did not know, and had no reason to know, that there was an understatement of tax;
- Taking into account all of the facts and circumstances, it would be unfair to hold you liable for the understatement of tax; and
- You must request relief within two years after the date on which the IRS first began collection activity against you after July 22, 1998.
If you are making a request for relief under the innocent spouse rules, allow us to help you understand these new guidelines. Please visit the IRS’s website at www.irs.gov/pub/irs-pdf/p971.pdf. For more information on the new regulations contact the FTB at 1-800-852-5711.
Here is a link to a great YouTube video on this topic by Dennis Brager – a former IRS Counsel Attorney I worked with when I was in IRS Appeals. You can access the video here: The Power Point slides for this video are available here:
INNOCENT SPOUSE RELIEF
The IRS Restructuring Act of 1998 provided expanded spousal relief for taxpayers who have filed joint returns. IRC § 6015 provides three types of relief which depend upon whether the tax liability arose as a deficiency or as a filed joint return with a balance and upon the current marital status of the of the parties. For the first time parties may seek equitable relief from joint and several liability on joint returns even when the liability resulted from a return filed with a balance due. [IRS Publication 971]
The IRS Restructuring Act of 1998 generally makes innocent spouse relief easier to obtain. The Act eliminates all of the understatement thresholds of prior IRC § 6013 and requires only that the understatement of tax be attributable to an erroneous (and not just a grossly erroneous as in the past) item of the other spouse. An individual will be relieved of liability for tax (including interest, penalties and other amounts) for a tax year to the extent the liability is attributable to an understatement (understatement and tax deficiency are synonymous) described below:
- A joint return was filed for the tax year [IRC §6015(b)(1)(A)];
- There is an understatement of tax on the return that is attributable to an erroneous item by the other spouse [IRC §6015(b)(1)(B)];
- A taxpayer establishes that in signing the return he/she did not know and had no reason to know of the understatement; [IRC §6015(b)(1)(C);
- Taking into account all of the facts and circumstances, it would be inequitable to hold the taxpayer liable for the deficiency attributable to the understatement; [IRC §6015(b)(1)(D)].
Important Note: Concerning #5 (2-year rule), a 2004 Court case determined that the IRS failed to modify its standard notice(s) as required by the Act to alert taxpayers to their rights under Section 6015. Accordingly, the IRS modified their forms following the court decision, and is NOT enforcing the 2-year rule until 1/1/2007 (per my discussion with the Innocent Spouse Processing Center). Consequently, this 2-year rule will not apply for any innocent spouse claims filed through 12/31/2006. This is a link to the court case.
More recently, the IRS announced (see the beginning of this page) that it no longer is imposing the 2-year rule regardless of when the request for relief is filed!
If an individual who otherwise qualifies for innocent spouse relief fails to establish that he/she did not know or have reason to know of the understatement, but does establish that he/she did not know or have reason to know the extent of the understatement, that individual may be relieved of liability for tax, penalties and interest to the extent that liability is attributable to the portion of the understatement that he/she did not know or have reason to know. (Did you follow that?)
Example: If the husband and wife file a joint return and the IRS determines the deficiency for the year based on $15,000 of unreported income attributable to the husband. Wife shows she did not know or have reason to know of $5,000 of the under-reported income. If the wife otherwise qualifies for any spouse relief, she will be relieved of joint liability for the portion of the understatement attributable to the $5,000 of omitted income. She will still remain liable for the taxes due on the $10,000 of omitted income.
Election Of Separate Liability
The Act also provides a separate liability election for a taxpayer who, at the time of the election, is no longer married to including widowed, is legally separated from, or has been living apart for at least 12 months from the person with whom the taxpayer originally filed a joint return. [§3201] [IRC §6015(a)] The electing spouse must show that he or she did not know of the understatement by the other spouse.
The knowledge requirement is lower than for spouses who remain together where the electing spouse must show that she did not know or have reason to know in order to receive relief. A taxpayer may elect to have the liability for any deficiency limited to the portion of the deficiency that is attributable to items allocable to the taxpayer. The election is not available if the Secretary (IRS) demonstrates that assets were transferred between individuals filing a joint return as part of a fraudulent scheme of the individuals or if both individuals had actual knowledge of the understatement of tax.
Important Note Regarding Refund of Amounts Previously Paid: If you file for Innocent Spouse relief under the Separate Liability provision, any amounts previously paid (or levied) by the IRS on the liability to be relieved will generally NOT be refunded. By contrast, claim for relief under the “standard” Innocent Spouse Relief provision (6015(b)) can result in a full refund of all payments made against the liability to the extent the applying spouse is relieved of its payment.
MUST be Divorced, Separated or Living Apart
An individual is eligible to make the separate liability election only if at the time the election is filed he/she is no longer married to including widowed, or is legally separated from, the spouse from whom the joint return to which the election relates was filed; or he/she was not a member of the same household as the spouse with whom the joint return was filed at any time during the twelve month period ending at the date the election is filed [IRC §6015(c)(3)(A)(i)].
This provision allows additional relief when the IRS proposes a deficiency against a taxpayer who is no longer married or living with the person with whom he/she filed the joint return. The proponent may have had indication of a potential understatement but must have been without actual knowledge. If the understatement was not attributable to him/her, he/she may elect proportional liability. The provision does not apply to returns which were jointly filed showing a liability at the time of filing. It only applies to deficiencies as described in IRC §6662(d)(2)(a).
Expanded innocent spouse relief and the separate liability election must be elected no later than two years after the date on which the Secretary has begun collection activities with respect to the individual seeking the relief. The Act provides that the Tax Court has jurisdiction with respect to disputes about innocent spouse relief. However, please refer to the discussion above regarding the suspension of this 2-year requirement until 1/1/2007.
The IRS Restructuring Act further authorizes the Secretary to relieve an individual of liability if relief is not available under the expanded innocent spouse rules set forth above, if it would be inequitable to hold the individual liable for any unpaid tax or any deficiency. The expanded innocent spouse relief, separate liability election, and authority to provide equitable relief apply to liabilities for tax arising after the date of enactment, as well as any liability for tax arising on or before the date of enactment that remains unpaid on the date of enactment. A taxpayer who filed a joint balance due return may seek equitable relief.
IRS Notice 98-61 & Rev. Proc 2000-15
IRS Notice 98-61 1998-51 I.R.B. 13 and Rev. Proc 2000-15 provide interim guidance to taxpayers seeking equitable relief under section 6015(f) in three areas.
- First, Section 3.01 of the notice provides threshold conditions that must be satisfied in order for an individual to be considered for relief under section 6015(f).
- Second, Section 3.02 of the notice sets forth the circumstances in which relief under section 6015(f) will ordinarily be granted in the situation where an individual did not know, and had no reason to know, that funds intended for the payment of tax were instead taken by the spouse for the spouse’s benefit.
- Third, for all other requests for relief under section 6015(f), and all requests for relief under section 66(c), Section 3.03 of the notice provides a partial list of factors to be considered in determining whether it would be inequitable to hold an individual liable for a deficiency or unpaid liability.
Eligibility to Be Considered for Equitable Relief
All the following threshold conditions must be satisfied before the Service will consider a request for equitable relief under S 6015(f). In addition, with the exception of conditions (1) and (2), all of the following threshold conditions must be satisfied before the Service will consider a claim for equitable relief under S 66(c). The threshold conditions are as follows:
(1) The requesting spouse filed a joint return for the taxable year for which relief is sought;
(2) Relief is not available to the requesting spouse under S 6015(b) or 6015(c);
(3) The requesting spouse applies for relief no later than two years after the date of the Service’s first collection activity after July 22, 1998, with respect to the requesting spouse; (Again, this will not be in effect until 1/1/2007)
(4) Except as provided in the next sentence, the liability remains unpaid. A requesting spouse is eligible to be considered for relief in the form of a refund of liabilities for: (a) amounts paid on or after July 22, 1998, and on or before April 15, 1999; and (b) installment payments, made after July 22, 1998, pursuant to an installment agreement entered into with the Service and with respect to which an individual is not in default, that are made after the claim for relief is requested;
(5) No assets were transferred between the spouses filing the joint return as part of a fraudulent scheme by such spouses;
(6) There were no disqualified assets transferred to the requesting spouse by the non-requesting spouse. If there were disqualified assets transferred to the requesting spouse by the non-requesting spouse, relief will be available only to the extent that the liability exceeds the value of such disqualified assets. For this purpose, the term “disqualified asset” has the meaning given such term by S 6015(c)(4)(B); and
(7) The requesting spouse did not file the return with fraudulent intent.
A requesting spouse satisfying all the applicable threshold conditions set forth above may be relieved of all or part of the liability under S 6015(f) or 66(c), if, taking into account all the facts and circumstances, the Service determines that it would be inequitable to hold the requesting spouse liable for such liability.
Circumstances under Which Equitable Relief Will Ordinarily Be Granted
In cases where a liability reported on a joint return is unpaid, equitable relief under § 6015(f) will ordinarily be granted (subject to the limitations of paragraph (2) below) in cases where all of the following elements are satisfied:
(a) At the time relief is requested, the requesting spouse is no longer married to, or is legally separated from, the non-requesting spouse, or has not been a member of the same household as the non-requesting spouse at any time during the 12-month period ending on the date relief was requested;
(b) At the time the return was signed, the requesting spouse had no knowledge or reason to know that the tax would not be paid. The requesting spouse must establish that it was reasonable for the requesting spouse to believe that the non-requesting spouse would pay the reported liability. If a requesting spouse would otherwise qualify for relief under this section, except for the fact that the requesting spouse had no knowledge or reason to know of only a portion of the unpaid liability, then the requesting spouse may be granted relief only to the extent that the liability is attributable to such portion; and
(c) The requesting spouse will suffer economic hardship if relief is not granted. For purposes of this section, the determination of whether a requesting spouse will suffer economic hardship will be made by the Commissioner or the Commissioner’s delegate, and will be based on rules similar to those provided in § 301.6343-1(b)(4) of the Regulations on Procedure and Administration.
2.110 Relief under this section is subject to the following limitations:
(a) If the return is or has been adjusted to reflect an understatement of tax, relief will be available only to the extent of the liability shown on the return prior to any such adjustment; and
(b) Relief will only be available to the extent that the unpaid liability is allocable to the non-requesting spouse.
Factors for Determining Whether to Grant Equitable Relief.
Rev. Proc 2000-15, 2000-5 I.R.B. 447, 2000 WL 42026 applies to married individuals filing separate returns in community property states who request relief under section 66(c), and individuals who meet the threshold conditions of the notice but who do not qualify for relief under the notice.
Individuals may qualify for relief from tax liability for a taxable year under section 6015(f) or 66(c) if, taking into account all the facts and circumstances, it is inequitable to hold the individual liable for the unpaid liability or deficiency. The following are partial lists of the positive and negative factors that will be taken into account in determining whether to grant equitable relief under section 6015(f) or 66(c). The list is not intended to be exhaustive.
(1) Factors weighing in favor of relief:
The factors weighing in favor of relief include, but are not limited to, the following:
(a) Marital status. The requesting spouse is separated (whether legally separated or living apart) or divorced from the non-requesting spouse.
(b) Economic hardship. The requesting spouse would suffer economic hardship (within the meaning of section 4.02(1)(c) of this revenue procedure) if relief from the liability is not granted.
(c) Abuse. The requesting spouse was abused by the non-requesting spouse, but such abuse did not amount to duress.
(d) No knowledge or reason to know. In the case of a liability that was properly reported but not paid, the requesting spouse did not know and had no reason to know that the liability would not be paid. In the case of a liability that arose from a deficiency, the requesting spouse did not know and had no reason to know of the items giving rise to the deficiency.
(e) Non-requesting spouse’s legal obligation. The non-requesting spouse has a legal obligation pursuant to a divorce decree or agreement to pay the outstanding liability. This will not be a factor weighing in favor of relief if the requesting spouse knew or had reason to know, at the time the divorce decree or agreement was entered into, that the non-requesting spouse would not pay the liability.
(f) Attributable to non-requesting spouse. The liability for which relief is sought is solely attributable to the non-requesting spouse.
(2) Factors weighing against relief:
The factors weighing against relief include, but are not limited to, the following:
(a) Attributable to the requesting spouse. The unpaid liability or item giving rise to the deficiency is attributable to the requesting spouse.
(b) Knowledge, or reason to know. A requesting spouse knew or had reason to know of the item giving rise to a deficiency or that the reported liability would be unpaid at the time the return was signed. This is an extremely strong factor weighing against relief. Nonetheless, when the factors in favor of equitable relief are unusually strong, it may be appropriate to grant relief under S 6015(f) in limited situations where a requesting spouse knew or had reason to know that the liability would not be paid, and in very limited situations where the requesting spouse knew or had reason to know of an item giving rise to a deficiency.
(c) Significant benefit. The requesting spouse has significantly benefitted (beyond normal support) from the unpaid liability or items giving rise to the deficiency. See S 1.6013-5(b).
(d) Lack of economic hardship. The requesting spouse will not experience economic hardship (within the meaning of section 4.02(1)(c) of this revenue procedure) if relief from the liability is not granted.
(e) Noncompliance with federal income tax laws. The requesting spouse has not made a good faith effort to comply with federal income tax laws in the tax years following the tax year or years to which the request for relief relates.
(f) Requesting spouse’s legal obligation. The requesting spouse has a legal obligation pursuant to a divorce decree or agreement to pay the liability.
A credit or refund can be obtained under the innocent spouse rules and, under certain circumstances, under IRS’s authority to grant equitable relief to a spouse (amounts paid from 7-22-98 TO 4-15-99). However, the separate liability election may not be used to create a refund or to direct a refund to a particular spouse.
Tax Court Has Jurisdiction to Review Denial of Equitable Innocent
Spouse Relief in “Stand-Alone” Petition
Fernandez v. Commissioner, 114 T.C. No. 21; 2000 U.S. Tax Ct. LEXIS 27 (Tax Ct. May 10, 2000).
In a case in which the taxpayer’s application was made directly through section 6015, rather than as part of a section 6213 deficiency proceeding, the Tax Court held it had jurisdiction to review a denial of equitable innocent spouse relief, assuming the taxpayer made an election under subsections (b) and/or (c).
In March 1999, Diane Fernandez submitted a request for relief from joint and several liability for tax year 1988, pursuant to section 6015 (b), (c), and (f). The Service denied the request on the ground that she had actual and constructive knowledge of the capital gains and the tax underpayment. Additionally, the determination letter advised that Fernandez received a significant financial benefit when she received sales proceeds of more than $19,000. After Fernandez filed a petition with the Tax Court, the Service moved to dismiss. It argued the Tax Court had no jurisdiction to review a denial of subsection (f) relief.
Relying on Butler v. Commissioner, 114 T.C. No. 19; 2000 U.S. Tax Ct. LEXIS 25 (2000), the Tax Court said it did. Initially, the court looked to the prefatory language in 6015(e)(1)(“in the case of an individual who elects to have subsection (b) or (c) apply”) and determined the language did not confine the court’s jurisdiction to review of subsection (b) or (c) elections. Instead, it merely sets forth the procedural requirements necessary to obtain Tax Court jurisdiction for all seeking innocent spouse relief. The court concluded that “before an individual may petition this Court for review of innocent spouse relief, including relief under subsection (f), such individual must make an election under subsections (b) and/or (c).” Statutory authority for its jurisdiction over subsection (f) could be found in 6015(e)(1)(A) which states: “the individual may petition the Tax Court (and the Tax Court shall have jurisdiction) to determine the appropriate relief available to the individual under this section.” The court interpreted “under this section” to include all subsections of 6015. As did Butler, the court held that the legislative history makes it clear Congress did not intend to limit its review of 6015.
Previously in Butler, the Tax Court had held that a taxpayer can seek review of a denial of 6015(f) relief in a section 6213 deficiency proceeding, if he or she applies for relief under subsection (b) or (c). Fernandez is noteworthy because of its stance concerning “stand-alone” requests for relief.
Distinction Between Should Have Known and Actually Knew Gives Rise to 6015(c) Relief.
Charlton v. Commissioner, 114 T.C. No. 22; 2000 U.S. Tax Ct. LEXIS 29 (May 16, 2000).
A former husband was entitled to section (f) equitable relief where he knew of his wife’s self-employment income, but did not actually know of the amount of the omitted income.
In connection with a 1994 joint income tax return, the IRS determined a $15,000 deficiency arising from denial of deductions related to rental cabins and reallocation of self-employment income from a physician transcription service which the wife, Sarah Hawthorne, operated. Hawthorne and ex-husband, Fredie Charlton, who divorced in 1995, separately asserted that they qualified for innocent spouse relief. The Tax Court consolidated the petitions.
Citing Butler v. Commissioner, 114 T.C. No. 19 (2000), the Tax Court rebuffed the government’s contention that it lacked jurisdiction to decide whether Hawthorne was entitled to equitable relief pursuant to section 6015(f). Because Hawthorne and the IRS suspended any activity relating to her claim while Charlton’s case is pending, the court indicated she could file a motion to seek Tax Court review if her application is denied. Meanwhile, the court would delay entry of decision.
With respect to Charlton, the court held that he did not qualify for relief pursuant to section 6015(b). Though Charlton asserted that he did not know and had no reason to know of the $22,000 understatement of the transcription service’s income, the court observed that he had prepared the income tax return based on summary information his wife provided to him, and that he had “unfettered access” to the service’s financial records which were maintained in their home.
Nonelecting Spouse Entitled to Challenge Grant of Innocent Spouse Relief to Former Wife
Corson v. Commissioner, 114 T.C. No. 24; 2000 U.S. Tax Ct. LEXIS 30 (May 18, 2000).
The Tax Court allowed one former spouse to challenge the other electing spouse’s claim for relief under section 6015 where both spouses were before the court in the same deficiency case. Under present law, Tax Court jurisdiction to review innocent spouse claims arise either as an affirmative defense in a 6213(a) deficiency proceeding or as review of administrative determination regarding relief (or failure to rule) in a “stand alone” matter. Because Judith’s claim was raised as an amendment to the couple’s petition for deficiency redetermination, the court considered her claim within the framework of deficiency jurisdiction.
Nonelecting Ex-Spouse May Intervene in Deficiency Case Where Other Spouse is Claiming 6015 Relief
King v. Commissioner, 115 T.C. No. 8; 2000 U.S. Tax Ct. LEXIS 52 (Aug. 10, 2000).
The Tax Court held nonelecting spouses are allowed to intervene in any proceeding in which the other spouse is claiming section 6015 relief.
“Item Giving Rise to Deficiency” in Omitted Income Case Disputed
Cheshire v. Commissioner, 115 T.C. No. 16; 2000 U.S. Tax Ct. LEXIS 61 (Aug. 30, 2000).
In a split decision, the Tax Court held that in omitted income cases, section 6015(c)(3)(C) does not require actual knowledge on the part of the electing spouse as to whether the entry on the return is or is not correct. Pointing to legislative history, three judges dissented.
Kathryn was also not entitled to section 6015(c) relief. Here, the parties disputed whether she had actual knowledge, at the time the joint return was signed, of “any item giving rise to the deficiency (or portion thereof).” With respect to the knowledge component of the analysis, the court held that “the statute mandates only a showing that the electing spouse knew of the item on the return that gave rise to the deficiency,” but not that knowledge of the tax consequences arising from the item or that the item reported on the return is incorrect. Further, the knowledge standard is an “actual and clear awareness (as opposed to reason to know)” of the item’s existence. To the extent that legislative history arguably suggests otherwise, the court stressed that nowhere does the statutory language “explicitly state or reasonably imply that relief is denied only where the electing spouse has actual knowledge that the item giving rise to the deficiency … is incorrectly reported on the return.”
Turning to the meaning of the word “item,” the court held that “in omitted income situations ‘item’ refers to the item of income that should have been reported on the return.” This definition is consistent with that used in other sections of the Code. Additionally, the court was troubled that acceptance of an ignorance of the tax consequences (aka law) defense would lead to “potentially any spouse who is not a certified public accountant or tax attorney would be allowed to escape paying income tax.”
The petitioner was entitled to section 6015(f) relief with respect to a portion of the accuracy-related penalty. The court was satisfied that she believed that the portion of retirement distribution proceeds used to pay off the mortgage on the family residence would be nontaxable. Further, she acted in good faith inasmuch as she trusted and relied upon her husband when it came to the preparation of the tax returns, she asked him about the potential tax ramifications, had no reason to doubt the truthfulness of his statements, and in fact believed him. The court concluded that “[under these circumstances, we do not believe petitioner had an obligation to inquire further.” Accordingly, she was entitled to relief as to the omitted retirement distribution proceeds, but not as to the omitted interest income.
There were two concurrences. Judge Chiechi concurred in the result only. In his concurrence, Judge Thornton construed the majority opinion to reject the Service’s argument that actual knowledge of an “item” means actual knowledge merely of the event or transaction giving rise to the deficiency. Five of the majority judges joined in this concurrence.
There were two dissenting opinions. The first, authored by Judge Parr, stressed that 6015 is a remedial statute intended to provide broader relief than that provided by section 6013(e). Though agreeing that it was not inequitable to hold the petitioner liable for the deficiency pursuant to section (f), Judge Parr was troubled that the majority construed both the term “understatement” in 6015(b) and the word “item” in 6015(c) as synonymous with “transaction.”
In a lengthy dissent, Judge Colvin (joined by Judges Marvel and Parr) protested that the majority’s construction of 6015(c)(3)(C) “squarely conflicts” with the legislative history of 6015(c). Unlike the majority, he found the phrase “item giving rise to a deficiency” to be ambiguous because it could refer to a transaction or activity or to knowledge that an entry on a tax return was incorrect. Because of the sweeping changes to the innocent spouse provisions in 1998, Judge Colvin advocated caution in applying interpretations of the prior law to section 6015(c). Under his reading of legislative history (including four separate items for support), “Congress intended ‘actual knowledge’ to be knowledge that the return is incorrect.” Consequently, the majority disregarded this requirement inasmuch as it held with respect to section (f) relief that the petitioner thought the reporting of the distributions on her tax return was correct.
Finally, the dissent disparages the majority’s treatment of prior authority. First, reliance on Wiksell v. Commissioner, 215 F.3d 1335 (9th Cir. 2000)(unpub.), was inappropriate inasmuch as that opinion does not discuss whether the actual knowledge of any item giving rise to a deficiency refers to incorrect reporting. Second, the majority’s failure to reconcile Charlton v. Commissioner (see above) with Cheshire will “inevitably cause confusion because, both here and in Charlton, we found that the putative innocent spouse knew of the activity which gave rise to the deficiency.” If the majority intends to promulgate a new standard such that knowledge of an income-producing transaction does not cause a putative innocent spouse to fail to qualify for the separate liability election unless the putative innocent spouse knew the amount of income involved, then it should so state.
Form 8857, Form 12510 & Publication 971
A taxpayer seeking innocent spouse relief should file Form 8857 and Form 12510 with the IRS. If the taxpayer is the subject of an on-going audit you should raise the innocent spouse issue as soon as possible with the examining officer. Review IRS Publication 971 prior to raising an innocent spouse defense. A representative must be aware of potential conflicts of interest which will arise when they represent both parties.
Notice to Putative Guilty Spouse
When an innocent spouse claim is filed for one taxpayer, the IRS will notify the other spouse filing the joint return. They will send that spouse a letter and ask if he/she will verify the statements of the taxpayer seeking innocent spouse status.
The Tax Court
To get Tax Court review of a deficiency, a taxpayer must file a petition with the Tax Court at Washington, D.C., in response to a notice of deficiency (90-day letter, from IRS, within 90 days (150 days if the notice is addressed to a person outside the U.S.) after the notice is mailed (i.e., postmarked). For 90-day letters mailed after Dec. 31, ’98, a petition is treated as timely if it’s filed with the Tax Court on or before the last date specified by IRS in the 90-day letter for filing it. ( IRC § 6213(a)) The Tax Court’s jurisdiction generally is limited to the review (without a jury) of deficiencies asserted by IRS (and not paid when the 90-day letter is issued). It can order payment of a refund if it determines the taxpayer overpaid. ( IRC §6512(b)) But it can’t grant equitable relief. The Tax Court has jurisdiction to order a refund of any amount collected while IRS was prohibited from collecting a deficiency by levy or court proceeding but only if a timely petition for a re-determination of the deficiency has been filed and only with respect to the deficiency at issue. ( IRC § 6213(a))
Notice and Intervention
If the IRS denies an innocent spouse claim he/she may file a Tax Court petition pursuant IRC §§ 6320(c) and 6330(d), added by §3401 of the Internal Revenue Service Restructuring and Reform Act of 1998, but the statutes provide that upon judicial review of determinations made by IRS appeals, notice must be given the putative “guilty spouse” as follows:
(a) Notice: The Commissioner shall serve notice of the filing of the petition on the other individual filing the joint return.
(b) Intervention: If the other individual filing the joint return desires to intervene, then such individual shall file a notice of intervention with the Court not later than 60 days after service of the notice by the Commissioner of the filing of the petition, unless the Court directs otherwise, and attach to the notice of intervention a copy of such notice of filing. All new matters of claim or defense in a notice of intervention shall be deemed denied.”
Injured Spouse–a person filing a joint return with an overpayment of taxes which is offset by the spouse’s taxes, non-tax debt such as a student loan or back child-support. A claim may be filed to protect the injured spouse’s share of the joint overpayment.
NOTE: At the end of this page is an excerpt from the IRS addressing INJURED SPOUSE important tips.
A taxpayer who:
(a) files a joint return with a spouse who has a past-due tax obligation or support obligation and
(b) has income, prepaid credits from withholding, estimated tax payments, or refundable credits such as the earned income credit, can recover his portion of a joint overpayment applied against the past-due child support owed by the other spouse.
The taxpayer uses Form 8379—not Form 1040X —to file this injured spouse claim. If the joint return hasn’t yet been filed, he should attach Form 8379 to the joint return and write “Injured Spouse” in the upper left corner of the return. If the joint return has already been filed, he should mail Form 8379 by itself to the Internal Revenue Service Center where the joint return was filed. If the non-debtor spouse takes appropriate action and secures his or her proper share of a tax refund from which the offset was made, IRS must request that the Treasury Department’s Financial Management Service (FMS) deduct that amount from amounts payable to HHS or the state.
Offsets To Non-tax Federal Agency Debts
If a taxpayer filing a joint return with the debtor owing a past-due legally enforceable debt to a federal agency takes appropriate action to secure his or her proper share of a tax refund against which an offset was made, IRS must pay that person his or her share of the refund and request that the Treasury Department’s Financial Management Service (FMS) deduct that amount from amounts later payable to the creditor agency. FMS and the creditor agency must adjust their debtor records accordingly. IRS must pay that person his or her share of the refund. IRS must deduct the amount of the payment from amounts that are derived from later reductions in refunds and are payable to the appropriate trust fund.
Community Property States
In a community property state (Texas), IRS was entitled to offset half of the refund due on a joint return against a debt owed by the husband to a federal agency, even though all of the refund was related to the wife’s personal earnings, the husband’s debt was incurred before the marriage, and then applicable Texas law provided that a spouse’s personal earnings were under her “sole management, control…” and that community property under one spouse’s sole management, control, etc. wasn’t subject to any liabilities incurred by the other spouse before the marriage. State law exemptions of this sort don’t prevent the federal offset.
Award Of Fees
A refund due the taxpayer and her ex-husband (H) was applied to a past due child support obligation of H. Taxpayer filed an Injured Spouse Claim (Form 8379) requesting her portion of the refund. IRS denied taxpayer’s request. The taxpayer was awarded fees because IRS’s actions, after the suit was filed, were “substantially unjustified” because they unnecessarily increased taxpayer’s litigation costs by focusing on issues of jurisdiction and venue rather than examining the merits of the taxpayer’s substantive position.
IRC § 66 – TREATMENT OF COMMUNITY INCOME
Community Property and Community Income
Federal income tax law recognizes the principle of community income in community property states, under which community income is treated as going half to each spouse even if one spouse earns all the community income and the couple files separate returns. Under specified conditions, however, the Code relieves a “separated,” or “innocent” spouse from the above 50-50 allocation rule by allocating all the community income to the earner-spouse. IRS may also disallow the benefits of community property laws to certain spouses.
The laws of the taxpayer’s state (or country) of domicile (generally referred to as “local law,” determine whether two individuals are married and thus subject to a state’s or country’s community property laws. Local law also determines whether a taxpayer has community property or community income. However, while local law determines a person’s rights to income or property, federal tax law determines the tax on those rights. Federal taxes are affected by community property laws only if married taxpayers file separate returns while living in a community property state.
California Community Property
Income of married taxpayers domiciled in California is generally taxed as community income—i.e., one half to each spouse when filing separate returns. However, income from separate property, income from property in non-community property jurisdictions treated by California as separate property, income that the spouses previously agreed would be treated as income from separate property, and income after divorce or legal separation is taxed as separate income from the spouse’s separate property.
A wife domiciled in California has a vested interest in community property. For tax purposes, community property income is divided equally between husband and wife. This is true even if the community income is derived from illegal sources (e.g., drug trafficking) by one spouse without the knowledge of the other. Otherwise allowable deductions paid out of community income are generally deductible one-half by each spouse.
Earnings Included as Community Income.
Under then applicable California law, there was a statutory presumption that a husband’s earnings were community property. Clear and satisfactory proof was required to contradict this presumption. That proof included persuasive evidence of the existence of an agreement between a husband and wife changing the status of the earnings from community property to separate property.
The tax advantage in filing separate returns, where it exists, is seldom large. Many tax cases on community status in recent years involve separate returns of husband and wife living apart rather than united couples filing separately for a tax benefit. In one case, married taxpayers who had always filed joint returns tried unsuccessfully to take advantage of the community property laws. The issue involved cancellation of debt (COD) income that passed through from a partnership interest that was community property. Taxpayers excluded most of the COD income under the insolvency exception, Sec. 108, but maintained that the wife shouldn’t have to reduce her allocated portion of an NOL carryover by any of the excluded income because COD income wasn’t considered “income” under local (TX) community property law. The Tax Court rejected the argument, pointing out that federal law defines what is “income” for federal tax purposes.
- 66 Treatment of Community Income
The IRS may disallow the benefits of any community property law to any taxpayer with respect to any income if the taxpayer acted as if solely entitled to the income and failed to notify the taxpayer’s spouse before the due date (including extensions) for filing the return for the taxable year in which the income was derived of the nature and amount of the income.
- 66 Standards
A married individual who doesn’t file a joint return, and omits from his or her gross income his or her share of community income (determined under the allocation rules of IRC § 879(a), is relieved from income tax liability on the omitted income if both of these two requirements are met:
(1) The individual must establish lack of knowledge or reason to know of the omitted item,
(2) Under all the facts and circumstances it would be inequitable to include the item of community income in the individual’s gross income. In this case, the item will be included only in the other spouse’s gross income (and not in the gross income of the individual).
Benefit From Income
In determining whether it would be inequitable to include the item in the gross income of the spouse lacking knowledge, the determination may include whether that spouse benefited from the untaxed income, and whether the defense was promptly raised to prevent the statute of limitations from running on the other spouse. Congress is concerned about the inequity of taxing an individual on community earned income of the other spouse where the individual received no benefit from the earnings.
Example Of Benefitting From Income
A taxpayer benefited from the income that was paid to and/or earned by her spouse during the years at issue where at least a portion of that income was used to pay at least some of the couple’s living expenses for those years. These living expenses included expenses for groceries, gasoline, maintenance of the trailer house where they lived, utilities, and meals at restaurants, as well as expenses attributable to their respective children, and taxpayer’s parents, who lived with them at various periods during the years at issue. Thus, the Tax Court, affirmed by the Ninth Circuit, concluded it would not be inequitable for the taxpayer to include one-half of that income in her gross income.
Proving Lack Of Benefit
Where a California housewife didn’t benefit from her former husband’s income beyond normal support, the Tax Court determined that it would be inequitable to include unreported community income in her gross income to the extent that she lacked knowledge of her husband’s income.
When she lived with her former husband, she rented her dwellings, drove an old car, and had no credit cards. She took nothing away from the marriage except an older, used car. Moreover, 16 years passed between the time that she and her former husband separated and the time that she received a notice of deficiency from IRS about his earnings, of which she knew little or nothing even at the earlier date.
Knowledge Of Amount
A taxpayer’s knowledge of an item of community income must be determined with reference to her knowledge of the particular income-producing activity. The exact amount of the item isn’t determinative. Thus, a claim that the innocent spouse didn’t know the specific amount of the unreported community income was irrelevant in meeting the above two requirements.
No Reason to Know
The “no reason to know” prerequisite wasn’t met where the taxpayer-wife actively participated (as a bookkeeper) in her husband’s businesses that generated the unreported community income. The requirement also wasn’t satisfied where a music teacher knew and participated in her husband’s real estate activities. Her participation consisted of acting as a nominee on her husband’s behalf in various real estate transactions, attending real estate closings, and signing various documents. The couple’s move from a moderate residence to a home costing more than $300,000 should have made the wife aware of the improvement of their living conditions and therefore the income from the community real estate.
Lack of Knowledge
The lack of knowledge requirement also wasn’t met where the taxpayer-wife knew that the husband was a full-time employee, or was engaged in income-producing business activities. Thus, where a taxpayer/wife knew about her husband’s income from his steel business, the requirement wasn’t met.
Contrary to her testimony that she believed that the business was having financial difficulties, the wife knew that her husband, whose sole source of income was his steel business, was able to make $2,000 a month child support payments to her and mortgage payments on her property during the entire year in issue.
However, where the taxpayer-wife believed that her husband was only in a legitimate occupation but the husband’s unreported community income was derived from illegal activities (such as narcotic trafficking or embezzlement), the Tax Court won’t attribute knowledge of the illegal activity or a portion of the income from the illegal activity to the taxpayer-wife without evidence that either the marital community or the taxpayer-wife benefited from the unreported community income. The same rule was applied to relieve a taxpayer-wife from tax liability on unreported interest income from secret certificate of deposits of her husband.
Income of Separated Spouses Under Community Property Laws.
Separated couples treat their income according to the statutes of their state, unless they meet the conditions of spouses living apart all year, In some states, income earned after separation continues to be community income before a decree of divorce.
In other states, it’s separate income. Depending upon the state, a decree of separate maintenance may not dissolve community interest. On the other hand, the court in the state issuing the decree may terminate the marital community and divide the property between the spouses.
Separation Agreement vs. Separation
A separation agreement dividing the community property between the spouses and providing that this property along with future accumulations and the earnings of each spouse is to be separate property might, in some states, end the marital community. In other states, the marital community will end when the husband and wife permanently separate, even without a formal agreement Even if a taxpayer cannot qualify under § 66, he/she might qualify for innocent spouse protection.
Denial of Community Property Law Benefits to Certain Spouses
If a spouse acts as if he or she is solely entitled to the community income and fails to notify the other spouse of the nature and amount of the income before the return due date (including extensions), IRS may deny any benefit of community property laws to such spouse. In other words, IRS may charge the spouse with the tax on his or her entire income. The Tax Court applied this rule to attribute to (and thus tax) a husband the entire community investment income where the wife wasn’t notified of her share of such income and the husband treated the entire investment income as his own.
However, the rule didn’t apply where taxpayer hand-delivered to his wife (from whom he was separated) various tax documents, including his Forms W-2 and 1099, before the due date of her return. And the Tax Court refused to permit IRS to disallow the benefits of the (Arizona) community property laws to a married taxpayer who didn’t act as if she were solely entitled to her wage income, and didn’t fail to notify her husband of that income, and where IRS was unable to offer any persuasive reason for disregarding those community property laws. Thus, taxpayer, who didn’t file a joint return (but whose return as filed reflected “a fanciful approach to her Federal income tax responsibilities,” including a negative number for wages) was taxed on only one-half of her actual wages, not the entire wages that IRS asserted in its deficiency notice.
The Tax Court also rejected IRS’s attempt to disallow the benefits of Arizona community property laws to another taxpayer who lived separate from his wife, but who had provided substantial income for the benefit of the marital community and had done so despite the fact that he wasn’t under a court order compelling him to. It didn’t matter that the amounts he sent to his wife had fluctuated; the fluctuations were due to the changing employment situations of the taxpayer and his wife.
IRC § 66(b) Only Available To IRS
IRC § 66(b) (footnote 42) can be used only by IRS in order to disallow the benefits of community property laws to a taxpayer under certain prescribed conditions. By its plain language, it’s not a relief provision that can be used by a taxpayer to avoid his or her liability for tax on community income paid to and/or earned by the taxpayer’s spouse.
IRC § 66(b) doesn’t afford an “innocent spouse” remedy; a taxpayer can’t rely on it to claim innocent spouse relief. Where a taxpayer argued that because IRS had previously determined deficiencies and assessed tax against her spouse with respect to income earned by and/or paid to the spouse, IRC § 66(b) relieved her from including any part of that income, the Ninth Circuit affirmed the Tax Court’s decision that her argument was misdirected.
Theft loss deduction for appropriated spouse’s community income share.
Where a spouse—usually the wife—has no control over her husband’s community income and the husband appropriates his wife’s share of the community income, may the wife take a theft loss deduction for the share she never received but nevertheless was required to report on her separate return? The Tax Court and the Fifth Circuit say “yes” but the wife must first prove that her share was stolen (i.e., that the husband was a thief). This wasn’t proven in a case arising under the then Louisiana law where the husband was deemed “head and master” of the marital partnership, and in a case arising under the then Texas law.
Because of the current Code relief provisions: one for spouses living apart; the other for “innocent spouses”, the much harder-to-prove theft loss deduction issue is little used. However, in appropriate cases it is still available.
New Revenue Procedure released in 2003!!!!!!
Revenue Procedure 2003-61 provides further guidance for a taxpayer seeking equitable relief as an “innocent spouse”. See: innocent_spouse_revproc.pdf
2007 IRS Notice – revised form
Revised Innocent Spouse Form Now Available
2004 Court Case
In a 2004 Tax Court case, a taxpayer’s spouse was permitted to offer evidence in his spouse’s claim for innocent spouse relief.
Spouse can intervene to support other spouse’s innocent spouse claim
Diana Van Arsdalen, (2004) 123 TC No. 7
The Tax Court has held that neither Code Sec. 6015 , nor its own Rule 325, precludes a spouse who isn’t seeking innocent spouse relief from intervening in a proceeding before the Court for the purpose of supporting his spouse’s or former spouse’s claim for innocent spouse relief.
Code Sec. 6015 provides relief from joint liability under certain circumstances for tax arising after July 22, ’98, and for any liability for tax arising on or before July 22, ’98, but remaining unpaid as of that date. Code Sec. 6015(f) confers discretion on IRS to grant equitable relief for taxpayers who don’t qualify for relief under Code Sec. 6015(b) (regular relief) or Code Sec. 6015(c) (relief for separated and divorced individuals). Numerous requirements must be met to qualify for relief.
In this case, Diana Von Arsdalen filed joint Federal income tax returns with her then husband, Stanley David Murray, for the tax years ’92 to ’96. On Oct. 23, 2003, IRS issued to her a notice of determination denying her claim for relief from joint and several liability for ’92 to ’96. This notice denied her all three types of innocent spouse relief—regular, separate and equitable. After that, on Jan. 21, 2004, Diana filed with the Tax Court a petition for determination of relief from joint and several liability on a joint return challenging IRS’s notice of determination dated Oct. 23, 2003.
On Mar. 8, 2004, IRS filed with the Tax Court a notice of filing petition and right to intervene (the notice). The notice stated that IRS had informed Mr. Murray of the filing of the petition and of his right to intervene in the case for the sole purpose of challenging Diana’s entitlement to relief from joint and several liability.
One week later, Diana filed with the Tax Court a Motion to strike the notice on the ground that IRS misinterpreted Tax Court Rule 325(b) insofar as the notice stated that Mr. Murray would be permitted to intervene in the case for the sole purpose of challenging her entitlement to relief from joint and several liability.
Mr. Murray later informed the Tax Court that he wanted to intervene for the sole purpose of offering evidence in support of Diana’s right and entitlement to equitable relief and wouldn’t be offering any evidence to challenge her right to equitable relief.
IRS opposed the motion to strike.
Tax Court allows intervention to support spouse. The Tax Court concluded that justice requires that the spouse not seeking relief be permitted to intervene in administrative and judicial proceedings under Code Sec. 6015 for the purpose of submitting any information, be it favorable or antithetical, that is relevant to the determination whether the other spouse is entitled to relief from joint and several liability. Thus, it agreed to Diana’s motion and to file Mr. Murray’s notice of intervention.
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Here is another excerpt from a 2004 Innocent Spouse Case:
IRS didn’t abuse its discretion in denying attorney/nurse Code Sec. 6015(f) equitable relief from joint liability: although taxpayer showed that asset transfers from husband pursuant to prenuptial agreement weren’t “disqualified” or part of fraudulent or tax avoidance scheme, and although she further refuted IRS’s fraudulent filing argument, relief denial was supported by other factors including her failure to prove economic hardship; failure to show lack of knowledge or reason to know of non-payment for 1 year’s reported liability and of omitted income and erroneous deductions giving rise to other years’ understatements; failure to show those items were attributable only to husband; and failure to show lack of significant benefit. (Maureen Monsour v. Commissioner, (2004) TC Memo 2004-190 , 2004 )
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Here is a 2008 case involving Section 6015(f) relief:
Innocent spouse relief granted despite ex-husband’s objection
Bishop, TC Summary Opinion 2008-33
The Tax Court agreed with the IRS and, over the objection of the taxpayer’s ex-husband, held that the taxpayer was entitled to equitable relief under Section 6015(f) from her husband’s tax underpayments.
The taxpayer married in 1982, and the couple had two children. The husband was previously a revenue agent who conducted income tax audits for the IRS. However, in 1995, he pled guilty to the charge of bribing a public official and was sentenced to 28 months in prison. He was released from prison in 1997 and rejoined his family. Thereafter, he began working as an auditor for a state agency. The taxpayer was employed as a claims processor for a health insurance company. The couple separated in 2003 and were divorced in 2004.
Before and after 2000, the taxpayer and her husband began to live beyond their means, incurring substantial expenses and debts. The husband was domineering; he controlled the couple’s financial matters and prepared their federal income tax returns. During the years at issue (2000-2002), he decreased his tax withholding by increasing his exemptions and advised the taxpayer to do the same. These actions resulted in underpayments of tax for the years 2000-2002 and the failure to pay unpaid tax liabilities after they were assessed.
The taxpayer did not sign the joint federal income tax returns for 2000 and 2001, and her husband did not disclose or discuss the return’s contents. However, she gave her Forms W-2 to the husband for those years, and they were attached to the returns. Not until late 2002 or early 2003 did the taxpayer become aware that the husband had made no payments on the unpaid taxes for 2000 and 2001 ($2,532 and $4,685, respectively).
The taxpayer did sign the couple’s joint federal tax return for 2002. The total underpayment for that year was $6,105. The taxpayer subsequently corrected her withholding and entered into an installment agreement with the IRS to pay the balance of her tax due for 2003. At the time of the trial, she was current in paying her federal income tax.
Some time after the couple divorced, the taxpayer filed a request with the IRS for relief from joint and several liability under Section 6015(f) with respect to her unpaid federal income tax liability. Although the IRS initially determined that the taxpayer was not entitled to relief, on review, it changed its mind and concluded that she was entitled to relief. The ex-husband, however, objected, asserting that the taxpayer should pay her share of the taxes, which meant that the Tax Court had to determine whether the taxpayer was entitled to relief under Section 6015(f) for the relevant years.
In renderings its opinion, the court pointed out that because the taxpayer was seeking relief from underpayments of tax, rather than understatements of tax, relief was not available to her under Sections 6015(b) and (c), and her only avenue for relief was Section 6015(f)’s equitable relief. Under section 4.02(1) of Rev. Proc. 2003-61, 2003-2 CB 296, however, Section 6015(f) equitable relief will ordinarily be granted if each of the following elements is satisfied:
(1) On the date of the request for relief, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse, or has not been a member of the same household at any time during the 12-month period ending on the date of the relief request.
(2) On the date the requesting spouse signed the joint return, he or she had no knowledge or reason to know that the nonrequesting spouse would not pay the income tax liability.
(3) The requesting spouse will suffer economic hardship if the Service does not grant relief.
The court said that the taxpayer was divorced from the husband and would suffer economic hardship if relief was not granted. Also, she may not have been aware of the tax liabilities on the 2000 and 2001 returns because she did not sign them or discuss them and did not actually know that there were unpaid taxes until late 2002. The court, however, believed that the taxpayer should have had reason to know that the tax liabilities might exist because of the couple’s mounting debts and severe financial situation. The court pointed out that she knew there were unpaid taxes for 2002 because she signed the return for that year and confronted her husband about the unpaid taxes for all three years. Additionally, the taxpayer knew about the tax liabilities when she joined the husband as a party in a chapter 13 bankruptcy proceeding in February 2003. Therefore, the court concluded that the taxpayer did not satisfy the knowledge element of Rev. Proc. 2003-61, section 4.02, and did not qualify for equitable relief under that section.
Luckily for the taxpayer, this did not end the inquiry. If a spouse fails to qualify for relief under section 4.02 of Rev. Proc. 2003-61, the IRS may still grant relief under section 4.03 of that Procedure. Section 4.03 lists factors that the Service will take into account in determining whether to grant equitable relief under Section 6015(f). No single factor is determinative, all factors are to be considered and weighed appropriately, and the list of factors is not exclusive.
(1) Marital status. The taxpayer and her husband separated in 2003 and divorced in 2004. (Factor weighed in favor of granting relief.)
(2) Economic hardship. The taxpayer’s monthly income barely covered her monthly expenses. She was raising two children and had not received child support from her husband since 2004. In addition, when the husband was in prison, the taxpayer incurred considerable debt in order to support the family, which she was paying off. Therefore, the taxpayer would suffer economic hardship if relief was not granted. (Factor weighed in favor of granting relief.)
(3) Knowledge or reason to know. As mentioned above, the taxpayer had reason to know that her husband was not going to pay the tax liabilities. (Factor weighed against granting relief.)
(4) Nonrequesting spouse’s legal obligation. The divorce decree did not contain a provision as to which spouse had a legal obligation to pay the outstanding tax liabilities. (Factor was neutral.)
(5) Significant benefit. The taxpayer did not receive significant benefit beyond normal support from the unpaid tax liabilities. (Factor was neutral.)
(6) Compliance with income tax laws. Tax compliance is a factor considered only against granting relief. The IRS did not contend that the taxpayer did not make a good faith effort to comply with her federal income tax obligations in years subsequent to 2002. (Factor did not apply.)
(7) Abuse. While the taxpayer was not physically abused by the husband, she suffered mental and emotional abuse at his hands. He yelled and threatened her, he accessed her bank account to pay pornography sites, and he had an affair, which led to the divorce. The taxpayer also feared he would retaliate against their children. (Factor weighed in favor of granting relief.)
The court found three factors in favor of relief, one against, and the rest neutral. Accordingly, it concluded that it would be inequitable to hold the taxpayer liable for the underpayments of tax, and she was entitled to relief under Section 6015(f).
In a 2009 case, the Court changes its standard of review that may provide more opportunity for spouses pursuing relief:
Tax Court now uses de novo standard to review denial of equitable innocent spouse relief
Porter (2009), 132 TC No. 11
A divided Tax Court has held that a de novo standard of review now is the appropriate review standard required in determining if a taxpayer-spouse is entitled to Code Sec. 6015(f) equitable innocent spouse relief. Applying this standard, the Court concluded that the taxpayer was entitled to equitable relief.
Background. Each spouse is jointly and severally liable for the tax, interest, and penalties (other than the civil fraud penalty) arising from a joint return. Code Sec. 6015(f) allows relief to a requesting spouse if, among other conditions, taking into account all the facts and circumstances, it is inequitable to hold the individual liable.
Suzanne L. Porter (also known as Suzanne L. Holman) applied for relief from joint and several liability for additional tax under Code Sec. 72(t), related to a distribution her husband received from his individual retirement account (IRA). IRS denied Porter’s application for relief, and she petitioned the Tax Court for a determination of whether she was entitled to Code Sec. 6015(f) relief.
De novo standard of review. The Tax Court concluded that in determining whether a taxpayer, such as Porter, was entitled to equitable relief under Code Sec. 6015(f), the Court must apply a de novo standard of review, rather than an abuse of discretion standard as it had previously done. While the Court noted that it had always applied a de novo scope and standard of review in determining whether relief was warranted under Code Sec. 6015(b) (innocent spouse relief) or Code Sec. 6015(c) (separate liability relief), it had not done so for Code Sec. 6015(f) relief cases.
In 2006, Congress amended Code Sec. 6015(e)(1) in the Tax Relief and Health Care Act of 2006 (P.L. 109-432) to confirm the Tax Court’s jurisdiction to determine the appropriate relief available under Code Sec. 6015(f). Given Congress’s direction that the Tax Court determine the appropriate relief available under Code Sec. 6015(b), Code Sec. 6015(c), and Code Sec. 6015(f), the Court now concluded that there was no longer any reason to apply a different standard of review for Code Sec. 6015(f) relief cases. Accordingly, in cases brought under Code Sec. 6015(f), the Court now applies a de novo standard of review as well as a de novo scope of review.
Equitable relief. Applying that standard, the Court concluded that Porter was entitled to Code Sec. 6015(f) equitable relief. The factors favoring relief outweighed the factor opposing relief—that Porter had reason to know of her husband’s IRA distribution. Accordingly, the Court found that Porter had met her burden of proving by the preponderance of the evidence that it would be inequitable to hold her liable for the Code Sec. 72(t) additional tax on her husband’s IRA distribution.
The Court found that the factors favoring relief were that she and her husband were divorced, that she would suffer hardship if relief were not granted, that she didn’t receive a significant benefit beyond normal support from the IRA distribution, and that she diligently complied with income tax laws in later years. That she had reason to know of the distribution because it appeared on the face of their return favored not granting her relief.
Under an abuse of discretion standard, the Court noted that it has upheld IRS’s denial of Code Sec. 6015(f) equitable relief where the taxpayer knew or had reason to know of the item giving rise to the deficiency or that the tax would not be paid. However, the Court was no longer restricted to determining whether IRS’s determination was an abuse of discretion. Under a de novo standard of review, the Court took into account all the facts and circumstances to determine whether it was inequitable to hold the requesting spouse liable for the unpaid tax or deficiency. The Court recognized that Porter had reason to know of the IRA distribution because she signed the return and didn’t inquire into its contents. But, this factor was tempered by the fact that she regularly inquired into her husband’s finances during the preceding year and he refused to answer or answered evasively.
Split court. In addition to the majority opinion, the Tax Court decision included two concurring opinions and a strong dissenting opinion in which six judges joined.
Here is a 2009 Tax Court case where the taxpayer lost. An important factor considered by the Court was that the taxpayer would not suffer economic hardship if held liable for the tax on the unreported unemployment compensation income:
IRS’s refusal to grant taxpayer Code Sec. 6015(f) relief from joint liabilities arising from her and ex-husband’s failure to include his unemployment compensation in gross income was upheld: relief denial was supported by facts that taxpayer knew of unemployment compensation and that she didn’t show she’d suffer economic hardship if held liable. Claim that she only knew of income’s existence but not that it was supposed to be reported was considered irrelevant. Also, facts that she didn’t significantly benefit from income omission and had stayed compliant with her later year tax obligations didn’t outweigh foregoing relief-negative factors. (Stephanie R. Hardin v. Commissioner, (2009) TC Memo 2009-115 , 2009 TC Memo ¶2009-115 )
This is an excerpt from a 2011 Appellate Court decision concerning the 2-year period within which relief must be requested:
Here is an excerpt from a 2011 case where the husband was granted innocent spouse relief:
INJURED SPOUSE RELIEF
Seven Facts about Injured Spouse Relief
If you file a joint return and all or part of your refund is applied against your spouses’ past-due federal tax, state income tax, child or spousal support or federal nontax debt, such as a student loan, you may be entitled to injured spouse relief.
Here are seven facts the IRS wants you to know about claiming injured spouse relief:
For more information about the Injured Spouse and Innocent Spouse Relief, visit www.IRS.gov.
Chief Counsel Notice 2013-011
In a Chief Counsel Notice (CCN), IRS has provided guidance to Chief Counsel attorneys regarding the handling and litigation of innocent spouse relief cases. The CCN reflects IRS’s recent Action on Decision (AOD) on the Tax Court’s standard and scope of review in Code Sec. 6015(f) cases, and also includes detailed instructions on how to handle innocent spouse claims that make their way to the Court before IRS has issued its own determination.
Where its conditions are met, Code Sec. 6015 provides relief from joint and several liability on a joint return to certain innocent spouses, including equitable relief under Code Sec. 6015(f) where other relief provided by Code Sec. 6015 is not available. Code Sec. 6015(e)(1) gives the Tax Court jurisdiction to “determine the relief available“ to one who files a timely petition requesting equitable relief. IRS argued in these cases that the scope of the Tax Court’s review was limited to determining whether IRS abused its discretion in denying equitable relief, and should be confined to matters contained in the administrative record.
The Tax Court, in Porter, (2008) 130 TC 115, and Porter, (2009) 132 TC 203, and more recently in Wilson, TC Memo 2010-134, rejected IRS’s positions. The Tax Court, and the Ninth Circuit in affirming Wilson (Wilson v. Com., (CA 9 1/15/2013) 111 AFTR 2d 2013-522), held that the Tax Court’s review is de novo regarding both the scope of its review (allowing the relief-seeking spouse to introduce evidence beyond the administrative record) and the standard of review (allowing the Court to determine the taxpayer’s relief regardless of IRS’s determination of the matter). Thus, the Tax Court shouldn’t be limited to evidence developed in the administrative record, but may look to other facts. Nor is the Tax Court’s ability to grant relief dependent on a finding that the IRS abused its discretion in denying relief.
In Action On Decision (AOD) 2013-007,06/04/2013, IRS acquiesced in the Wilson case and will no longer argue that the Tax Court can grant relief only where it finds IRS has abused its discretion based solely on evidence in the administrative record. (See Weekly Alert ¶ 10 06/13/2013 for more details)
In light of the AOD, IRS has provided new guidance on the standard and scope of review that the Tax Court applies when reviewing Code Sec. 6015(f) requests for relief from joint and several liability, as well as on litigating cases that involve claims for relief under Code Sec. 6015.
In all Code Sec. 6015(f) cases, under the Porter decisions, the standard and scope of review is de novo. However, even though Chief Counsel attorneys are no longer required to preserve the standard and scope of review issues for appeal, the CCN nonetheless advises them to continue to work with petitioners to stipulate to evidence in the administrative record that is relevant to the Court’s determination regarding Code Sec. 6015 relief.
The CCN noted that, although the Tax Court makes the final determination regarding entitlement to relief under Code Sec. 6015(b), Code Sec. 6015(c), or Code Sec. 6015(f), it is still appropriate for IRS to have the first opportunity to make a determination. If IRS hasn’t has made a determination regarding a petitioner’s entitlement to Code Sec. 6015 relief before the petitioner filed a petition, the trial attorney must request a determination from the Cincinnati Centralized Innocent Spouse Operations (CCISO) unit. This can occur if the taxpayer filed a request for relief with IRS but received no determination within six months, or if a taxpayer raises Code Sec. 6015 relief for the first time in a petition from a Notice of Deficiency.
The trial attorney should share CCISO’s determination with petitioner. If CCISO denied relief, the petitioner may request that Appeals consider the denial, and the trial attorney should refer the case to Appeals under normal procedures if there is sufficient time before the trial. If there is not time, but the parties agree that Appeals’ review would facilitate settlement, they should jointly request a continuance. The trial attorney should prepare to defend CCISO’s denial of relief at trial but may also settle or concede the case.
If the nonrequesting spouse has not intervened or is not a joint petitioner, the trial attorney should generally follow CCISO’s determination that the petitioner is entitled to relief and settle the case. In the rare circumstance that the trial attorney and his or her manager believe that CCISO’s determination shouldn’t be followed, the matter must be coordinated with the appropriate branches of the Procedure and Administration Division. If Appeals determines that the petitioner is entitled to relief, the trial attorney should follow that determination and settle the case.
If the nonrequesting spouse is a joint petitioner or an intervener in the case, IRS can’t provide Code Sec. 6015 relief or settle with the requesting spouse unless the nonrequesting spouse agrees and is a party to the settlement. (Corson, (2000) 114 TC 354) However, if the nonrequesting spouse is not a joint petitioner or an intervener, IRS may settle with the requesting spouse. Thus, in cases in which the nonrequesting spouse is a party, the trial attorney should only treat the determination by CCISO or Appeals to grant relief as a recommendation unless the nonrequesting spouse agrees that the petitioner is entitled to relief.
If the nonrequesting spouse does not agree that the petitioner is entitled to relief, the trial attorney should decide whether granting relief is appropriate considering CCISO’s or Appeals’ determination, the evidence in the administrative file, discoverable evidence, statements and documents submitted by the nonrequesting spouse, and evidence that may be adduced at trial. If the trial attorney agrees that the petitioner is entitled to relief, the trial attorney should enter into a stipulation of settled issues with the petitioner with the understanding that the case will still need to proceed to trial on the innocent spouse issue. If the trial attorney agrees with the nonrequesting spouse that the petitioner is not entitled to relief, the trial attorney should prepare to defend CCISO’s denial of relief at trial.
RECENT TAX COURT CASES
Wife denied innocent spouse receive because (a) the husband was not deceptive and (b) the wife failed to ask questions
Arobo, TC Memo 2016-66
Tax Court has held that where a couple filed jointly, the husband had always been the primary financial provider, and their lifestyle hadn’t changed from earlier years when the couple reported significant business income on their returns, the wife did not qualify for innocent spouse relief with respect to their returns that showed either losses from, or didn’t even report activity from, the husband’s business. The principal reason for this holding was that she failed to establish that she didn’t have reason to know there was an understatement on those returns.
Married taxpayers who elect to file a joint Federal income tax return are jointly and severally liable for the tax reported or reportable on the tax return. However, Internal Revenue Code Section 6015 discusses several circumstances when a spouse may be granted relief from the liability.
(a) Code Sec. 6015(a)(1) provides that a spouse who has made a joint return may elect to seek relief from joint and several liability under Code Sec. 6015(b).
(b) Code Sec. 6015(b)(1) provides that a taxpayer will be relieved of liability for an understatement of tax if:
(A) a joint return was made for the tax year in question;
(B) there is an understatement of tax attributable to erroneous items of the non-requesting spouse;
(C) the requesting spouse “establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement”;
(D) taking into account all the facts and circumstances, it would be inequitable to hold the requesting spouse liable for the deficiency attributable to the understatement; and
(E) the requesting spouse elects to invoke Code Sec. 6015(b) within two years after the date IRS has begun collection actions with respect to the requesting spouse.
(c) Code Sec. 6015(f) provides for equitable innocent spouse relief under procedures prescribed by IRS if:
(1) taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency and
(2) relief is not available to the requesting spouse under Code Sec. 6015(b) or Code Sec. 6015(c). The requesting spouse has the burden of proving that he/she is entitled to relief. (Alt, (2002) 119 TC 306119 TC 306)
In 2013, the IRS issued Rev Proc 2013-34 that sets forth a 3-step procedure to be followed in evaluating requests for this equitable relief:
(1) section 4.01 lists seven threshold conditions which must be met;
(2) section 4.02 lists circumstances in which IRS will make streamlined relief determinations; and
(3) section 4.03 sets forth nonexclusive factors that IRS will consider in determining whether equitable relief should be granted because it would be inequitable to hold a requesting spouse jointly and severally liable. The section 4.03 factors include:
(a) marital status (i.e., do the spouses remain together?);
(b) economic hardship;
(c) knowledge or reason to know of the requesting spouse;
(d) legal obligation arising from a divorce decree or other binding agreement;
(e) significant benefit gained by the requesting spouse;
(f) compliance with income tax laws; and
(g) mental or physical health at the time of filing the request for relief. No single factor is determinative.
The taxpayers filed joint returns for the years 2004 through 2007. Mr. Arobo was the family’s primary financial provider. Mrs. Arobo had a college degree and earned roughly $20,000 per year during those years. Mr. Arobo was the sole owner of a mortgage origination company during the years involved. It ceased doing business in 2008. Mrs. Arobo was not involved in the operation of the company.
Mrs. Arobo paid the household bills. Mr. Arobo regularly gave Mrs. Arobo checks drawn on his individual account or on one of the company’s accounts to pay household expenses.
The taxpayers’ Federal income tax returns for the tax years of 2004 through 2007 were all late-filed. Mr. Arobo was responsible for the preparation and filing of the taxpayers’ income tax returns. Mrs. Arobo did not review the returns; rather, she “entrusted her husband and just signed them.” She testified that she learned that Mr. Arobo had failed to file their 2004, 2005, 2006, and 2007 tax returns only when they were contacted by IRS.
The 2004 and 2005 income tax returns each reported on the first page, on line 12, a business loss; they also reported negative adjusted gross income. The 2006 and 2007 income tax returns reported adjusted gross income of $52,163 and $32,049, respectively; no business income or loss was reported on, and no Schedule C, Profit or Loss From Business, was attached to, either the 2006 return or the 2007 tax return.
The Arobos came to a settlement with IRS with respect to their unpaid tax liabilities. Mr. Arobo testified that he had recently found employment, which he anticipated would provide him with funds to pay the taxpayers’ outstanding income tax liabilities.
The Court held that Mrs. Arobo didn’t meet the requirements of either Code Sec. 6015(b)(1) or Code Sec. 6015(f) innocent spouse relief.
Code Sec. 6015(b)(1) relief. IRS conceded that Mrs. Arobo satisfied the requirements of Code Sec. 6015(b)(1)(A), Code Sec. 6015(b)(1)(B) and Code Sec. 6015(b)(1)(E), but argued that she did not meet the requirements of Code Sec. 6015(b)(1)(C) (whether the requesting spouse established that she did not know, and had no reason to know, there was an understatement in income tax). And, the Court agreed.
The Court said that an individual has reason to know of an understatement if a reasonably prudent taxpayer in her position at the time she signed the return could be expected to know that the return contained the understatement. Consequently, the requesting spouse has a “duty of inquiry” with respect to the income tax return filed. The duty of inquiry is subjective, focusing on the individual seeking relief. Citing Hayman, (CA 2 1993) 71 AFTR 2d 93-176371 AFTR 2d 93-1763, the Court said that the factors to be considered in making this determination are: (1) the requesting spouse’s level of education; (2) the requesting spouse’s involvement in the family’s business and financial affairs; (3) the presence of expenditures that appear lavish or unusual when compared to the family’s past levels of income, standard of living, and spending patterns; and (4) the culpable spouse’s evasiveness and deceit concerning the couple’s finances.
The returns for 2005, 2006, and 2007 were filed only after the 2004 return was under IRS examination. As a result, a reasonably prudent person in the position of Mrs. Arobo should have been diligent, vigilant, and circumspect, and therefore she should have carefully reviewed the 2005, 2006, and 2007 tax returns for accuracy. Even a cursory review of each year’s tax return would have revealed that Mr. Arobo’s mortgage origination business had reported (on line 12 of the first page of each return) substantial losses for 2004 and 2005 and that no business income or loss was reported for 2006 and 2007.
Mrs. Arobo was responsible for paying the family’s bills. Had she reviewed the tax returns, she would have seen that the returns reported no net business income for four years and yet the family’s standard of living had not diminished. There was no indication that Mr. Arobo was deceitful or evasive with respect to the family’s finances.
Code Sec. 6015(f) relief. The Court then looked to the factors in Rev Proc 2013-34 and concluded that they pointed to Mrs. Arobo not qualifying for equitable relief.
IRS conceded that Mrs. Arobo met the threshold requirements of Rev Proc 2013-34, Sec. 4.01, and Mrs. Arobo conceded that she did not qualify for the streamlined procedures of section 4.02. So, the Court looked at the nonexclusive factors of section 4.03.
The parties agreed that factors (a) marital status, (f) tax compliance, and (g) mental/physical health were neutral and that the legal obligation factor was inapplicable. Accordingly, the Court limited its inquiry to factors (b) economic hardship; (c) knowledge or reason to know; and (e) significant benefit.
Rev Proc 2013-34, Sec. 4.03(2)(b), provides that an economic hardship “exists if satisfaction of the tax liability in whole or in part will cause the requesting spouse to be unable to pay reasonable basic living expenses.” The revenue procedure provides that factor (b) weighs in favor of relief where the requesting spouse would suffer economic hardship if relief were denied and is neutral where the requesting spouse would not suffer such hardship if relief were denied.
Mrs. Arobo stated on Form 8857 (Request for Innocent Spouse Relief) that her monthly income in 2015 was $3,420 and that her monthly expenses were $3,360; thus, her monthly expenses do not exceed her monthly income. Moreover, Mr. Arobo testified that he expected to be able to pay the taxpayers’ liability. Consequently, Mrs. Arobo did not prove she would suffer economic hardship if she was denied relief. The Court found factor (b) to be neutral.
As to knowledge or reason to know, the Court said that the analysis is essentially that same as that in Code Sec. 6015(b)(1)(C) (see above) and concluded that this factor weighed against relief.
Rev Proc 2013-34 provides that the significant benefit factor will weigh in favor of relief if the nonrequesting spouse significantly benefited from the unpaid tax or understatement and the requesting spouse had little or no benefit or the nonrequesting spouse enjoyed the benefit to the requesting spouse’s detriment.
The taxpayers testified that they used their income to maintain their lifestyle. If Mr. Arobo’s mortgage origination business had suffered the losses reported or had no income, the taxpayers’ standard of living would have been significantly decreased. Thus, Mrs. Arobo, as well as Mr. Arobo, received the benefit of paying no tax on hundreds of thousands of dollars. So, this factor also weighed against granting her relief.
No innocent spouse relief for wife who knew husband received Form 1099 income
Lessard, TC Summary Opinion 2017-95
The Tax Court has held that, where a married couple filed a joint return, then later divorced, the wife was not entitled to innocent spouse relief with respect to two sources of income earned by the husband for which the wife was aware he had received 1099 forms. The typical scenario is that married taxpayers who file a joint federal income tax return are jointly and severally liable for the tax reported or reportable on the tax return. (Code Sec. 6013(d)(3))
However, Code Sec. 6015 provides that a spouse who has made a joint return may elect to seek relief from joint and several liability under one of three relief provisions.
Code Sec. 6015(b)(1) provides that a taxpayer will be relieved of liability for an understatement of tax if:
- A joint return was made for the tax year in question;
- There is an understatement of tax attributable to erroneous items of the nonrequesting spouse;
- The requesting spouse “establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement”;
- Taking into account all the facts and circumstances, it would be inequitable to hold the requesting spouse liable for the deficiency attributable to the understatement; and
- The requesting spouse elects to invoke Code Sec. 6015(b) within two years after the date IRS has begun collection actions with respect to the requesting spouse.
An election under Code Sec. 6015(c) treats former spouses that filed a joint return as if they had filed separate returns, and each spouse’s liability is limited to that portion of the deficiency properly allocable to that spouse. (Code Sec. 6015(c)(1), Code Sec. 6015(d)(3)) Such an allocation is not permitted, however, if IRS demonstrates that the individual electing relief had actual knowledge, at the time the return was signed, of any item giving rise to a deficiency (or portion thereof) which is not allocable to that individual. (Code Sec. 6015(c)(3)(C))
Code Sec. 6015(f) provides for equitable innocent spouse relief under procedures prescribed by IRS if:
- Taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency and
- Relief is not available to the requesting spouse under Code Sec. 6015(b) or Code Sec. 6015(c).
The requesting spouse has the burden of proving that he/she is entitled to relief. (Alt, (2002) 119 TC 306)
Rev Proc 2013-34, 2013-43 IRB 399, sets forth the following for use in evaluating requests for this equitable relief:
- Section 4.01 lists seven threshold conditions which must be met (e.g., joint return was filed for relevant year and no assets were transferred between the spouses as part of a fraudulent scheme by the spouses);
- Section 4.03 sets forth the following nonexclusive factors that IRS will consider in determining whether equitable relief should be granted because it would be inequitable to hold a requesting spouse jointly and severally liable:
- Marital status (i.e., do the spouses remain together?);
- Economic hardship;
- Knowledge or reason to know of the requesting spouse;
- Legal obligation arising from a divorce decree or other binding agreement;
- Significant benefit gained by the requesting spouse;
- Compliance with income tax laws; and
- Mental or physical health at the time of filing the request for relief. No single factor is determinative.
In this case, the requesting taxpayer, Mindy Lessard (Mindy), was married to Mr. Tomko in 2013. The couple filed a joint 2013 tax return. They were divorced in 2014. The IRS mailed a Notice of Deficiency (referred to as a 90-day letter) to the taxpayers. According to the NOD, the tax arose due to their failure to report the following two sources of income:
- Cancellation of debt income in the total amount of $19,741 and
- $20,502 of withdrawals from Mr. Tomko’s retirement plan.
The cancellation of debt income was attributable to both taxpayers in differing amounts. $14,936 of the cancellation of indebtedness income was attributable to Mr. Tomko and the remaining $4,805 was attributable to Mindy. Mindy said that she was not aware of the credit card accounts until she received the Forms 1099-C, Cancellation of Debt, at the end of 2013.
On Nov. 7, 2013, Mindy, at a bank and in the presence of a notary, signed a spousal waiver permitting Mr. Tomko to withdraw money from his retirement account at any time without her further consent. She was not aware of any withdrawals, however, until after the receipt of Forms 1099-R at the beginning of 2014.
Mr. Tomko presented Mindy with their 2013 joint income tax return on the night of Apr. 14, 2014, one day before the return was due. Mindy generally looked it over and noted that it reflected a refund. She did not specifically determine whether the retirement and cancellation of indebtedness income was included on the return. Mindy signed the 2013 joint return, prepared by Mr. Tomko as she had no specialized tax knowledge and she trusted him. Mr. Tomko had handled the tax returns and financial matters in earlier years because of his banking and finance background.
The Tax Court held that Mindy did not qualify for relief under any of the relief provisions for the following reasons.
The Court held that Mindy did not qualify for Code Section 6015(b) relief as she did not meet condition (D) or condition (E) as described in the paragraph that begins “Code Sec. 6015(b)(1) provides that…”, above.
As to whether Mindy knew or had reason to know of the understatement, by her execution of a spousal waiver permitting Mr. Tomko to withdraw funds from his retirement accounts in November of 2013, she was made aware of his potentially withdrawing the funds. Subsequently, Mindy received and was aware of the Forms 1099-R before the time the 2013 joint income tax return was prepared and filed. Mindy admitted that she looked over the return before filing although she relied on Mr. Tomko’s expertise in preparing it. Her signing the return without properly reviewing it does not excuse her from “knowing or having reason to know” of the misstatement on the return.
Whether it is inequitable to hold a spouse liable for a deficiency is determined by “taking into account all the facts and circumstances”. (Code Sec. 6015(b)(1)(D)) The Court said that the most often cited material factors to be considered are:
- Whether there has been a significant benefit to the spouse claiming relief and
- Whether the failure to report the correct tax liability on the joint return results from concealment, overreaching, or any other wrongdoing on the part of the other spouse.
The Court said that the record in this case did not reveal any concealment, overreaching, or other wrongdoing on the part of Mr. Tomko. Mindy and Mr. Tomko lived together throughout 2013 and did not become divorced until June of 2014. Until that time, they shared household expenses, and each contributed some income to pay those expenses. Mr. Tomko used the withdrawals from his retirement account for usual living expenses, and Mindy benefited from those expenditures. Thus, the Court said, it was not inequitable to hold Mindy liable for the deficiency in tax for the 2013 year.
The Court held that this Code section 6015(c) didn’t apply because Mindy failed the knowledge requirement in Code Sec. 6015(c)(3)(C).
The Court said that the knowledge requirement of Code Sec. 6015(c)(3)(C) does not require the electing spouse to know the tax consequences arising from the item giving rise to the deficiency or that the item reported on the return is incorrect. Rather, the statute mandates only a showing that the electing spouse actually knew of the item on the return that gave rise to the deficiency (or portion thereof).
When Mindy signed the 2013 joint return, she was aware of the amounts, the sources, and the date of receipt of the retirement distributions, and she was also aware of the cancellation of debt income attributable to herself and Mr. Tomko. She became aware because of her receipt of the Forms 1099-C and 1099-R. Although Mindy denied that she knew that Mr. Tomko was going to withdraw retirement income at the time that she signed the spousal waiver, she was aware of the Forms 1099-R reflecting a total of $20,502 of retirement income withdrawn during 2013 when she signed the 2013 joint return. Her failure to fully understand the tax consequences of those items did not provide a basis for relief.
Mindy was also not entitled to equitable relief under Code Sec. 6015(f).
One of the threshold conditions under Rev Proc 2013-34, Sec. 4.01 is that the income tax liability from which the requesting spouse seeks relief is attributable to an item of the nonrequesting spouse’s income. The Court found that Mindy’s unreported $4,805 cancellation of debt income precluded her meeting the seventh threshold condition and that therefore the portion of the deficiency attributable to the $4,805 cancellation of debt income did not qualify for relief under Code Sec. 6015(f). It found that Mindy did meet the threshold conditions with respect to the $14,936 of cancellation of debt income attributable to Mr. Tomko and the $20,502 in withdrawals from Mr. Tomko’s retirement account.
The Court then did a detailed analysis of the Rev Proc 2013-34, Sec. 4.03 factors, with the following results:
- Marital Status. Mindy was divorced and living apart from Mr. Tomko when she filed her request for “innocent spouse” relief. This factor weighed in favor of granting relief.
- Economic Hardship. In general, economic hardship exists where payment of the tax liability would cause the taxpayer to be unable to pay reasonable basic living expenses. Mindy showed that there was outstanding debt at the time of her divorce from Mr. Tomko, but there was no showing of economic hardship. Accordingly, this factor did not weigh in favor of granting relief.
- Knowledge or Reason To Know. The fact that Mindy did not understand the tax return and/or that the disputed items of income (the retirement withdrawals and the cancellation of debt income) were either misstated or not reported on the return was of no import. As explained above regarding Code Sec. 6015(b) relief, Mindy’s signing of the return without properly reviewing it did not excuse her from “knowing or having reason to know” of the misstatement on the return. Consequently, this factor did not weigh in favor of granting relief.
- Nonrequesting Spouse’s Legal Obligation. Where a divorce decree or other court order gives the nonrequesting spouse a legal obligation to pay the liability, this fact can weigh in favor of granting relief to the requesting spouse. No divorce decree or separation order imposed such a liability on Mr. Tomko, and this factor therefore did not weigh in favor of granting relief.
- Significant Benefit. There was no evidence that the proceeds of Mr. Tomko’s canceled debt were received or used in 2013, so as to that item, this factor was neutral. As to the retirement withdrawals, they were made during the period under consideration. Mindy and Mr. Tomko both financially contributed to the payment of the household expenses during 2013 and before their divorce in June 2014. There was, however, no indication of a “significant benefit” (beyond normal support) from the unpaid income tax liability or items giving rise to the liability. Therefore, this factor weighed moderately in favor of relief.
- Compliance With Federal Tax Laws. IRS agreed that Mindy was in compliance with Federal income tax laws for the tax years following the tax year to which the request for relief related. Accordingly, this factor weighed in favor of relief.
- Mental or Physical Health. There was no evidence of mental or physical health problems, and this factor was deemed neutral.
Spouse who knew taxes weren’t paid still got equitable innocent spouse relief
Grady, TC Summary Opinion 2021-29
Code Sec. 6015 provides that a spouse who has made a joint return may elect to seek relief from joint and several liability. Code Sec. 6015(f) provides for equitable innocent spouse relief under procedures prescribed by IRS if, taking into account “all the facts and circumstances,” it is inequitable to hold the individual liable for any unpaid tax or any deficiency.
The Tax Court has held that, both for a tax year with respect to which a wife didn’t know her joint return taxes weren’t being paid by her husband, and for several years with respect to which she did know her joint return taxes weren’t being paid, the wife was entitled to equitable innocent spouse relief.
The IRS’s guidelines for determining whether to grant section 6015(f) relief are found in Rev Proc 2013-34, 2013-43 IRB 397. If certain threshold conditions are met, then the IRS will relieve the requesting spouse of liability if either
- Three additional conditions for so-called “streamlined” relief are met, or
- Relief is justified upon consideration of multiple equitable factors.
The requesting spouse is eligible for streamlined relief under Rev Proc 2013-34, sec. 4.02, only in cases in which that spouse establishes that:
- On the date the IRS makes its determination, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse;
- The requesting spouse will suffer economic hardship if relief is not granted; and
- On the date the joint return was filed, the requesting spouse did not know or have reason to know the nonrequesting spouse would not or could not pay the underpayment.
The multiple factor test looks at, but is not limited to:
- Marital status,
- Economic hardship,
- Knowledge or reason to know of understatement or underpayment,
- Legal obligations to pay the tax,
- Significant benefits reaped from the understatement,
- Subsequent compliance with income tax laws, and
- Mental or physical health.
A single factor is not determinative. (Rev Proc 2013-34, sec. 4.03(2))
In this case, Ms. Gans was married to Mr. Dickey for the years at issue, 2006-2011. Mr. Dickey took charge of filing and paying taxes due with the couple’s joint tax returns. However, for each of the years at issue, he either filed late or didn’t file at all. Mr. Dickey repeatedly told Ms. Gans that he would file their tax returns and pay their tax debts, and she should not worry about it. He set up multiple installment agreements for the couple’s Federal income tax liabilities. He made intermittent payments between September 2008 and June 2015, but none after that. Although Ms. Gans had access to the couple’s joint bank accounts, she did not check them to see whether Mr. Dickey made the required installment agreement payments.
The couple divorced in 2015. Thereafter, Ms. Gans moved in with her parents. Later, she married Mr. Gans.
Wife qualified for streamlined relief for 2006. In concluding that Ms. Gans qualified for streamlined relief in 2006, the Court noted:
Ms. Gans was no longer married to Mr. Dickey when the IRS issued its final determination.
Ms. Gans would suffer economic hardship if relief was not granted. A requesting spouse will suffer economic hardship if payment of part or all of the tax liability “will cause the requesting spouse to be unable to pay reasonable basic living expenses.” The determination as to what constitutes a reasonable amount for basic living expenses may vary with the circumstances of the individual taxpayer but will not include the maintenance of an affluent or luxurious lifestyle. (Rev Proc 2013-34, sec. 4.03(2)(b))
Ms. Gans testified that she was employed and had earned $14,190.52 in 2018 at the time of the trial. The Court has taken judicial notice that the poverty level for one person in 2018 was $12,140. She did not own a car or a house. Rather, she lived with her elderly and sick parents and then her new husband, Mr. Gans, who owned the house she lived in and the cars she used.
Ms. Gans did not have reason to know that Mr. Dickey would not pay the 2006 joint Federal income tax liability. When the couple filed their 2006 joint Federal tax return, Mr. Dickey requested an installment agreement within 30 days after the return was filed that would apply to the 2006 tax liability. Therefore, when Ms. Gans signed the 2006 joint Federal income tax return, she did not know or have reason to know that the underpayment would not be paid.
Wife qualified under multiple equitable factor relief for the other years. As to the other tax years in question, the Court held that each of the factors weighed in favor of relief other than the knew-or-had-reason-to-know factor. For example, the Court looked to the same factors noted above in determining that the wife met the economic hardship test. And the Court noted that the “significant benefits” test weighed in her favor—she did not receive a significant benefit from the failure to pay the outstanding tax liabilities.