Tax
Court Loosens Innocent Spouse Rules
Sometimes
when a joint
return results in liabilities in the form of penalties, tax, and
interest, one spouse may be innocent. It used to be that an innocent
spouse had only two years to apply for relief in such cases. Now a
recent Tax Court decision loosens the restrictions in some
circumstances.
Each
Spouse Liable on
Joint Return
Under the
joint return
rules, each spouse is jointly and severally liable for the full amount
of tax, penalties, and interest arising from the return. [Code Sec.
6013(d)(3)] However, a joint filer can be relieved of all or part of a
tax liability if he or she qualifies for innocent spouse relief. [Code
Sec. 6015]
Unfortunately, in many cases, an innocent spouse may also be an unaware
spouse. He or she may have consistently allowed the other spouse to
handle family finances, including filing tax returns and dealing with
IRS correspondence. What’s more, this lack of awareness,
rather than bolstering an innocent spouse claim, can actually
disqualify an individual from innocent spouse relief.
IRS
Restrictions on
Relief
Under IRS
regulations,
to qualify for any type of innocent spouse relief, an individual must
file a request for innocent spouse relief no later than two years from
the date of the IRS’s first collection action against the
individual [Reg. Sec. 1.6015-5(b)(1)]. So, if a spouse does not become
aware of a tax problem until after the two-year deadline, the IRS
regulations bar any claim for relief.
Fortunately, in a new reported decision, the Tax Court concluded that
the IRS regulations aren’t quite fair. The Tax Court held
that the two-year time limit does apply to some types of innocent
spouse relief—but does not apply to requests for equitable
relief from a joint return liability.
Types of
Innocent Spouse
Relief
There are
three kinds of
innocent spouse relief:
Traditional
Innocent
Spouse Relief. An individual
will be relieved of liability for a tax understatement on a joint
return that is attributable to erroneous items of the other spouse if
the individual establishes that, in signing the return, he or she did
not know or have reason to know of the understatement and it would be
inequitable to hold the individual liable. [Code Sec. 6015(b)]
Separate Liability Relief.
Under this rule, an individual who is divorced or separated from the
spouse with whom a joint return was filed can limit liability to his or
her allocable share of a tax understatement shown of a joint return.
[Code Sec. 6015(c)]
Equitable Relief. If all else fails, an innocent spouse can ask the IRS
for equitable relief from a joint return liability. If under all the
facts and circumstances it would be inequitable to hold a spouse
liable, and relief isn’t available under the traditional
innocent spouse or separate liability rules, the IRS may relieve the
spouse of liability for an unpaid tax or understatement. [IRC
§6015(f)]
Both
traditional
innocent spouse relief and separate liability relief are limited to
liabilities resulting from understatements on a joint return; those
rules do not apply to a tax liability that was reported on a joint
return but was not paid. However, equitable relief may be granted by
the IRS for reported but unpaid liabilities.
The Code specifically provides that in the case of traditional innocent
spouse relief or separate liability relief, a spouse must request
relief no later than two years after the IRS began collection
activities against the spouse. [Code Sec. 6015(b)(1)(E), Code Sec. 6015
(c)(3)(B)] However the Code itself does not set any specific time limit
for requesting equitable innocent spouse relief. Instead, the IRS
regulations impose the same two-year time limit for requests for
equitable relief. [Reg. Sec. 1.6015-5(b)(1)]
Affect of
Tax Court
Decision: No Time Limit on Equitable Relief
The Tax
Court concluded
that the IRS went too far in applying the two-year time limit to all
innocent spouse requests. According to the Court, by imposing a time
limit on requests for traditional or separate liability relief but not
on requests for equitable relief, Congress unambiguously indicated that
the rules for equitable relief are intended to be broader and to apply
in situations where other types of relief are not available.
Consequently, the court held that the two-year limit does not apply to
requests for equitable relief. [Lantz, 132 T.C. No. 8]
Case in
Point
Denise
Mannella and her
husband, Anthony J. Mannella, filed joint federal income tax returns
for the years 1996 through 2000. However, they never paid the taxes due
for those years. On June 4, 2004, the IRS sent each of the
Manellas’ final notice of the tax liability and the
IRS’s intent to levy.
Denise Mannella claimed that the notice addressed to her was actually
received by her husband, who signed the certified mail receipts but
never delivered the notice to her or otherwise informed her of the
notice. In fact, she did not find out about the notice until more than
two years later. When she did become aware of the problem, she sought
legal advice and decided to seek relief from the joint tax liabilities.
The IRS
Argument
The IRS argued that Denise was ineligible for innocent spouse relief
because she did not request relief within two years of IRS's mailing
the notice of intent to levy. The Tax Court agreed with the IRS that
the two-year time limit barred Denise from claiming either traditional
innocent spouse relief or separate liability relief, noting that actual
receipt of an IRS notice is not required for it to trigger the two-year
time limit. However, the court held that, in light of its earlier
decision invalidating the IRS’s regulation, Denise was not
barred from requesting equitable innocent spouse relief. [Mannella, 132
T.C. No. 10]
New
Review Standard
The Tax Court has also eased the rules for individuals whose requests
for equitable innocent spouse relief are denied by the IRS. In the
past, the Tax Court has limited its review to determining whether the
IRS abused its discretion in denying relief. However, going forward the
court held that it will apply a de novo standard of review to equitable
innocent spouse cases. In other words, instead of simply determining
whether the IRS acted arbitrarily or capriciously in denying relief,
the court will examine the facts and make its own determination of
whether equitable relief should be granted.
Case in
Point
Suzanne L. Porter applied for relief from joint and several liability
for taxes related to a distribution her husband received from his IRA.
After reviewing the case, the Tax Court concluded that a number of
factors favored granting Porter equitable relief, including the facts
that Porter 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.
On the other hand, the court acknowledged that Porter had reason to
know of the IRA distribution because it appeared on the face of the
couple’s joint return. Moreover, the court noted that under
an abuse of discretion standard, it has upheld IRS's denial equitable
relief where a spouse knew or had reason to know of the item giving
rise to a deficiency or that a tax would not be paid. However, under
its new de novo review standard, the court concluded that the factors
favoring relief outweighed this one factor opposing relief. [Porter,
132 T.C. No. 11]
IRS
Response
The IRS
Chief Counsel
acknowledged the Tax Court’s rejection of the two-year time
limit on equitable innocent spouse claims, albeit half-heartedly. A
Chief Counsel notice directs IRS attorneys handling innocent spouse
cases not to file motions for summary judgment on the grounds that a
claim for equitable relief is time-barred. On the other hand, the
notice directs attorneys to continue to raise the two-year rule issue
whenever appropriate (for example, in the pre-trial memo, at trial, and
on brief), noting that IRS disagrees with the Tax Court decision. [CC
2009-012]
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