INNOCENT SPOUSE MUCH LITIGATED
One of the most litigated issues in Tax Court is an appeal from an IRS final determination that a spouse is not eligible for so-called “innocent spouse relief.” “Innocent Spouse” is a phrase commonly used to refer to a spouse or former spouse who seeks to avoid joint and several liability for taxes owing on a joint return he or she has filed. Actually, there are three distinct elective escape hatches for a spouse to avoid joint and several liability. The phrase “Innocent Spouse” when used by a tax lawyer is meant to apply to one such escape hatch under Section 6015(b) which can apply to both married and divorced spouses who did not know or have reason to know when signing the return of an item attributed to the other spouse giving rise to a tax due and whom it would be inequitable to hold liable. Another escape hatch found in Section 6015(c). This second escape hatch apportions the tax liability on the joint return to the two spouses as if separate returns had been filed. It applies only to divorced spouses, legally separated spouses or those not living in the same household for more than 12 months, lacking actual knowledge of an item in the return attributed to the other spouse Relief under Sections 6015(b) and (c) must be elected after the deficiency is asserted but not later than two years after the IRS commences collection activity against the electing spouse. This relief is available only for a deficiency and not with regard to unpaid taxes stated to be due on a filed return.
There is a third last resort escape hatch for a spouse to avoid joint and several liability on a joint return that includes liability for unpaid taxes. It is called “equitable relief.” Section 6015(f) requires the commissioner of IRS to establish procedures to determine when, “taking into account all the facts and circumstances, it is inequitable to hold the individual for any unpaid tax or any deficiency (or any portion of either).” Until July 25, 2011, IRS had insisted that equitable relief also had to be elected within two years of commencement of collection activity although the statute makes no reference to limiting the time for applying for equitable relief. The IRS now has reversed its course and states that equitable relief for deficiencies and unpaid taxes may be sought at any time within the running of the statute of limitations on collections (10 years from assessment). With regards to overpayments equitable relief may be sought during the period of limitations applicable to refund suits (generally 3 years from filing or two years from payment, whichever is later).
IRS had last updated its guidelines for equitable relief in Revenue Procedure 2003-61. These rules contained a three-tier analysis. First, a taxpayer had to overcome 7 thresh-hold conditions, which, if not met, disqualified the taxpayer from relief. Second, a taxpayer meeting the threshold tests and meeting three additional tests in the second tier of the analysis would ordinarily be granted relief. Third, a taxpayer not fitting into the group for whom relief would ordinarily be granted by IRS, could still qualify under a weighing of factors analysis. The Tax Court follows this factor weighing analysis finding for relief if the factors favoring relief exceed those against relief. The proposed Revenue Procedure (Un-numbered at this time, since IRS has solicited comments) formalizes the demise of the two-year request period and makes other significant changes to Rev. Proc. 2003-61, namely:
- The new Rev. Proc. retains the three-tier analysis of Rev Proc 2003-61, but the second is referred to as conditions under which IRS will grant “streamlined relief” as opposed the former Rev Proc which stated conditions under which IRS would ordinarily grant relief. It is not clear what “streamlined relief” means as the proposed Rev Proc does not expand on that term. It seems to refer to the speed within which IRS will act but no time frame is mentioned. Perhaps it is merely another way of expressing that IRS will ordinarily grant relief if the second tier conditions are fulfilled. IRS should explain this portion of the proposed Rev Proc.
- The Rev Proc reiterates IRS’s long held position that returns filed under duress are not joint returns and that a spouse who signs a return under duress need not apply for “innocent spouse” relief since no joint return is deemed filed by IRS. The original Rev. Proc. and proposed replacement distinguish between abuse as a factor in deciding whether equitable relief is appropriate and duress as a condition vitiating a purported joint return filing. In fact, the two may be indistinguishable. If a spouse is afraid to question items in the return, it is hard to conceive that spouse feeling able to refuse to sign. Treas. Reg. 1.6013-4(d) does not define duress. IRS should reconsider whether an abused spouse can be a willing joint filer. If IRS wishes to retain this imaginary demarking line, then at least provide some criteria it will use to determine, based on abuse alone, that no voluntary joint filing was made. IRS might, for example, treat cases in which a police report was filed or where restraining orders were sought as per seduress. A non-abused spouse may feel intimidated by the other spouse’s knowledge, professional standing, or handling of household finances, and not inquire; but, an abused spouse afraid to ask a question is also afraid to refuse to sign and that is duress. One should not need a gun pointed at one’s head at the time of signing the return to be found to have signed under duress. A pattern of abuse is duress. The Rev Proc makes the presence of “abuse” or “control over household finances” an overriding positive factor that will vitiate other negative factors that otherwise weigh against granting relief such as:
- “Knowledge or reason to know.”
- “Actual knowledge.”
- Deficiency or underpayment attributed in full to items of requesting spouse.
- The proposed Rev Proc adds a new exception to one of the threshold conditions: The tax liability need not be attributable to a return item of the non-requesting spouse when the non-requesting spouse’s fraud gave rise the understatement of tax or deficiency.
- The proposed Rev Proc clarifies that the factors in the weighing analysis should be applied qualitatively and not quantitatively. Thus, a taxpayer can qualify even if the majority of factors weigh against granting relief, if, the totality of the facts and circumstances indicate that equity demands relief be granted. In this analysis no one factor controls. Further, that “actual knowledge” will no longer be weighed more heavily than other factors. It states, “The degree of importance of each factor varies depending on the circumstances of the requesting spouse and the factual context surrounding the marriage. The factors are designed as guides.”
- The Rev Proc continues to consider economic hardship as a factor but attempts to objectify this part of the analysis by tying economic hardship to objective criteria. Also, it states that a lack of finding of hardship is neutral and does not disfavor granting of relief. This writer believes that economic hardship should not be a favorable factor for determining if a spouse should receive equitable relief. Including this factor muddles up two distinctly different issues:
- Should the spouse equitably be held jointly and severally liable based on his or her knowledge of the return information, participation in the return preparation process and contribution of items of income? And,
- Is the spouse otherwise liable, able to pay?
- Economic hardship should be considered by collection in deciding whether to temporarily close a collection case as “currently not collectible.” In deciding whether to grant equitable relief, however, perhaps lack of economic hardship should be a negative factor. The presence of economic hardship should be a neutral factor. Economic hardship can change to economic prosperity. That is why “currently not collectible” is the more appropriate relief measure for a spouse in dour financial straits. This could be considered at the same time the spouse is applying for equitable relief. Presently, the IRS continues to consider economic hardship and this aspect of the process is favorable to taxpayers.
- The Rev Proc clarifies that the fact that the requesting spouse is subsequently compliant with all Federal income tax laws is a factor that may weigh in favor of relief (i.e., files all required returns and pays taxes due).
- The Rev Proc states that in underpayment cases, IRS will consider if the requesting spouse knew or had reason to know that the non-requesting spouse could not or would not pay the tax liability within a reasonably prompt time after filing the joint return.
- The Rev Proc broadens the availability of refunds beyond cases in involving payments made by the requesting spouse under an installment agreement.
- The Rev Proc clarifies whether either spouse has a legal obligation (by virtue of the divorce decree or separation agreement) to pay the liability will be considered not just whether the non-requesting spouse had such an obligation.
IRS has requested comments but the Rev Proc will be applied by IRS until it is finalized. A Taxpayer can elect to have Rev Proc 2003-61 continue to apply to his or her request of equitable relief by so stating in the application for relief. There is much to consider in the 25 pages of this proposed Rev Proc and I am sure there will be a great deal of comment and discussion which may result in the final Rev Proc differing is some respects from the proposal. The Tax Court, however, has refused to consider the new factors under the proposed Rev. Proc. because the proposed Rev. Proc. is not final and the period for comment has not expired. The Court continues to review the factors in Rev. Proc. 2003-61 in deciding petitions for review of denials for equitable relief. For example, see Yosinsky v. Commissioner, T.C. Memo 2012-95 (July 12, 2012).
© 2012 by Robert S. Steinberg, Esquire
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