Certified Specialist In Taxation Law
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Certified Specialist In Taxation Law |
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INNOCENT SPOUSE RELIEF News Release IR-1999-06: New versions of the IRS form and publication for innocent spouse relief were issued and incorporate changes made by the IRS Restructuring and Reform Act of 1998. Taxpayers should use the revised Form 8857, Request for Innocent Spouse Relief, when seeking relief. Details on the new provision are in the revised Publication 971, Innocent Spouse Relief. Code Section 6015. Spouses filing joint returns are generally open to joint and several liability for any tax, interest, or penalty arising from their return. Code Section 6013(d)(3) entry on the return was inaccurate, it may be inequitable to hold that spouse liable for a tax deficiency arising from the mistake. The innocent spouse rules are designed to provide relief in these situations for the unsuspecting spouse. The IRS Restructuring and Reform Act of 1998, Pub. L. 105-206, amended the innocent spouse rules, effective for any tax liability arising after July 22, 1998, or arising before, but remaining unpaid as of, July 22, 1998. The 1998 Act removed the prior innocent spouse rules found in former Code Section 6013(e) and added new innocent taxpayer rules found in (a) JOINT RETURNS Generally, the innocent spouse provisions are necessary only when a joint return is filed, since joint and several liability does not exist where spouses file separate returns or no return at all. Whether a joint return has been filed is a question of the parties' intent. Since an involuntary signature indicates a lack of intent to file a joint return, a spouse that does not voluntarily sign a joint return will be relieved of liability. Consequently, a spouse that signs a joint return under duress is relieved of liability for any deficiencies arising under the return. Signatures on joint returns have also been considered involuntary when ordered by a divorce court (Anderson v. Commissioner, T.C. Memo. 1984-82) or supplied in compliance with a critically ill spouse's wishes. Hickey v. Commissioner, T.C. Memo. 1955-149. Failure on the part of one spouse to sign a joint return does not necessarily mean that such a return is not intended. A rebuttable presumption exists that a joint return was filed where one spouse files a purported joint return and the other spouse fails to object to the return or fails to file a separate return. Consequently, if a husband signs his wife's name to a purported joint return, the burden of proof is on the wife to show that she had not authorized the signature and that she had not intended to file a joint return. A history of filing joint returns and the inclusion of income and deductions for both spouses also provide evidence that a joint return was intended. Evans v. Commissioner, T.C. Memo. 1982-700. Additionally, failure to sign a return due to spite, anger, recalcitrance, or other factors unrelated to the return will not preclude the return from qualifying as a joint return. (b) CURRENT INNOCENT SPOUSE RELIEF PROVISIONS The IRS Restructuring and Reform Act of 1998 added Code Section 6015, which contains relief provisions applicable to all joint filers and also contains special provisions for taxpayers who filed jointly but who are divorced, legally separated, or not living together when relief is sought. Code Section 6015 provides three liability limitation mechanisms with respect to a joint income tax return: (1) innocent spouse relief, in modified form, is available under Code Section 6015(b), (2) a new elective liability allocation mechanism may be available under Code Section 6015(f) if it would be inequitable to hold the taxpayer liable. COMPLIANCE TIP: Taxpayers should use Form 8857, Request for Innocent Spouse Relief, when seeking any of the three types of relief available under Code Section 6015. Another feature of Code Section 6015 is important to residents of community property states who file a joint return. 6015(a) without regard to community property laws. Accordingly, a spouse is treated as if his income, deductions, credits, etc., are attributable only to him under Code Section 6015, regardless of the effect of community property laws. The Code Section 6015 provisions are effective for any tax liability arising after July 22, 1998, or arising before but remaining unpaid as of July 22, 1998. The 1998 Act removed the prior innocent spouse rules found in former Code Section 6013(e). Where practicable, the IRS must separately send any notice relating to a joint return (e.g., notices of deficiency) to each spouse filing the joint return. Pub. L. 105-206, Section 3201(d). (b)(1) Relief applicable to all joint filers The 1998 legislation generally makes innocent spouse status easier to obtain. A joint filer may seek relief from joint and several liability as an innocent spouse under Code Section 6015(b) if: (1) there is an understatement of tax attributable to erroneous items of one spouse filing the return; (2) the other spouse establishes that in signing the return she did not know (and had no reason to know) that there was such an understatement; (3) it would be inequitable to hold the innocent spouse liable for the deficiency, taking into account all facts and circumstances; and (4) the innocent spouse elects to apply Code Section 6015(b) within two years from the date collection activities begin. If all of the conditions are satisfied, the innocent spouse is relieved of liability for tax (including interest, penalties, and other amounts) to the extent the liability is attributable to such an understatement. Code Section 6015(b) eliminates the understatement thresholds that were present in prior law Code Section 6013(e). In addition, Code Section 6015(b) requires only that the understatement of tax be attributable to an erroneous item (not a grossly erroneous item, as under prior law) of the other spouse. As to whether a taxpayer claiming relief under Code Section 6015(b) "did not know, and had no reason to know," that there was an understatement, courts will examine the circumstances that faced the innocent taxpayer and the likelihood that a reasonable person in the same position would infer that an inaccurate return had been filed. If a taxpayer knew (or had reason to know) about an understatement, but did not know (and had no reason to know) the extent of such understatement, then she will still be relieved of liability on that portion of the understatement of which she had no knowledge (or reason to know). Code Section 6015(b)(2). Special procedural rules apply when an individual petitions the Tax Court for innocent spouse relief. These rules cover, inter alia, filing deadlines, restrictions on the collection of assessments, and notice requirements. Code Section 6015(e). (b)(2) Taxpayers divorced, legally separated, or not living together An additional method of avoiding tax liability is available for innocent taxpayers filing a joint return who are either divorced, legally separated, or not living together. Code Section 6015(c). Under this alternative procedure, an innocent taxpayer may elect to be liable for only that portion of the deficiency allocable to her (i.e., as if each spouse had filed a separate return for the relevant year). An election to seek relief under Code Section 6015(c) can be made within two years from the date collection activities begin by an individual who: (1) at the time the election is filed, is no longer married to, or is legally separated from, the other joint filer; or (2) was not a member of the same household as the other joint filer at any time during the twelve-month period ending on the date the election is filed. Code Section 6015(c)(3)(A)(i). Elections can be invalidated if assets are transferred between the joint filers as part of a fraudulent scheme (Code Section 6015(c)(3)(A)(ii) ) or if it is shown that the individual seeking relief had actual knowledge of any item giving rise to a deficiency not allocable to her (unless she signs the return under duress). Special procedural rules apply when an individual petitions the Tax Court for innocent spouse relief. These rules cover, inter alia, filing deadlines, restrictions on the collection of assessments, and notice requirements. Code Section 6015(e). The alternative procedure for an innocent taxpayer who is separated or divorced from her spouse allows the taxpayer to elect liability for only that portion of the deficiency allocable to her. Generally, the portion of a deficiency allocable to an innocent taxpayer bears the same ratio to such deficiency as (1) the net amount of items taken into account in computing the deficiency that would have been allocated to the innocent taxpayer if separate returns had been filed, bears to (2) the net amount of all items taken into account in computing the deficiency. The burden of proof for establishing the portion of any deficiency allocable to an innocent taxpayer generally rests with the taxpayer electing treatment under Code Section 6015(c). EXAMPLE 1: Brian and Mary, who are legally separated, filed a joint return. Several deductions claimed on the return are disallowed, resulting in a deficiency of $4,000. Mary, however, is unaware of the nature of these deductions. If Brian and Mary had filed separate returns, only 25 percent of the total amount of items used to compute the deficiency would have been allocated to Mary. Therefore, Mary would be liable for only $1,000 (25 percent of the deficiency) if she makes an election under Code Section 6015(c)(3). Brian would be liable for the remaining $3,000. The general formula for allocating deficiencies under (1) If a deficiency (or portion thereof) is attributable to the disallowance of a credit, or to any tax (other than a tax imposed by Code Section 1 or Code Section 55 ) required to be included with the joint return, it will not be apportioned ( Section 6015(d)(2) ); (2) items otherwise allocable to one taxpayer will also be allocable to the other to the extent the item provides a tax benefit to the other taxpayer (Code Section 6015(d)(3)(B) ); (3) fraud on the part of one or both individuals may result in alternative allocations (Code Section 6015(d)(3)(C) ); (4) a child's liability, if included on a joint return, is disregarded in computing the separate liability of either taxpayer and allocated appropriately between the two taxpayers. 6015(d)(5). If property is transferred to the innocent taxpayer by the other joint filer in an effort to avoid taxation, then the portion of the deficiency for which the innocent taxpayer is liable is increased by an amount equal to the value of such property. deficiency that would have been allocated to an innocent taxpayer if separate returns had been filed, limitations on separate returns for deductions and credits are disregarded. Code Section 6015(d)(4). Even if there is not a known deficiency at the time, an eligible taxpayer may want to consider electing the proportional liability option found in Code Section 6015(c) immediately following her divorce or separation. This may protect the taxpayer if notice of collection activities is not received within the two-year election period found in Code Section 6015(c)(3)(B). (b)(3) Equitable relief Equitable relief may be available under Code Section 6015(f) if relief is not obtainable under either Code Section 6015(b) (general election of innocent spouse relief) or Code Section 6015(c) (relief for separated or divorced spouses). Code Section 6015(f) innocent spouse relief is available if it would be inequitable to hold the spouse liable under the facts and circumstances. Pursuant to the interim guidelines established in Notice 98-61 equitable relief under Code Section 6015(f) only if: (1) She made a joint return for the taxable year for which relief is sought; (2) relief is not available under the general provisions of Sections 6015(b) or 6015(c) ; (3) she applies for relief no later than two years after the IRS's first collection activity against her after July 22, 1998; (4) the liability generally remains unpaid at the time relief is requested; (5) no assets were transferred between the joint filers as part of a fraudulent scheme; (6) there were no disqualified assets transferred to the requesting spouse by the non-requesting spouse; (7) she did not file the joint return with fraudulent intent. A spouse satisfying all the above threshold conditions may then be relieved of tax liability under Code Section 6015(f) if, taking into account all the facts and circumstances, it is inequitable to hold her liable for all or part of the liability. Equitable relief will ordinarily be granted to a spouse requesting relief under Code Section 6015(f) (to the extent that the unpaid liability is attributable to the non-requesting spouse) where: (1) the liability reported on a joint return for such year was unpaid at the time the return was filed; (2) 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 at no time during the previous twelve months been a member of the same household as the non-requesting spouse; (3) at the time the return was filed, the requesting spouse did not know, and had no reason to know, that the tax would not be paid; and (4) the requesting spouse would suffer undue hardship if relief were not granted. Notice 98-61, 1998-51 I.R.B. 13. If, however, a joint return is 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. Notice 98-61, 1998- 51 I.R.B.13. The IRS also provides partial lists of the positive and negative factors that it will take into account in determining whether to grant equitable relief for individuals who meet the threshold conditions described above but who do not meet the requirements listed for when relief is ordinarily granted. in favor of relief: (1) Separation (whether legally separated or living apart) or divorce of requesting and non-requesting spouse; (2) hardship for requesting spouse if the relief is not granted; (3) abuse (not amounting to duress) by non-requesting spouse against requesting spouse; and (4) a legal obligation of the non-requesting spouse (pursuant to a divorce decree or agreement) to pay the tax liability. Notice 98-61, 1998-51 I.R.B. 13. The following factors are among those that will be weighed against relief: (1) if any unpaid liability or item giving rise to a deficiency is attributable to the requesting spouse; (2) knowledge, or reason to know, of an unpaid liability or deficiency by the requesting spouse; (3) a significant benefit (beyond normal support) from the unpaid liability or items giving rise to the deficiency exists for the requesting spouse; and (4) a legal obligation of the requesting spouse (pursuant to a divorce decree or agreement) to pay the tax liability. Notice 98-61, 1998-51 I.R.B. 13. (c) FORMER INNOCENT SPOUSE RELIEF PROVISIONS The IRS Restructuring and Reform Act of 1998, Pub. L. 105-206, amended the innocent spouse rules, effective for any tax liability arising after July 22, 1998, or arising before but remaining unpaid as of July 22, 1998. The 1998 Act removed the prior innocent spouse rules found in former Code Section 6013(e) and added new innocent taxpayer rules found in (c)(1) Test for Innocent Spouse Relief Under pre-1988 Act Code Section 6013(e), a spouse without knowledge of a false statement (the "innocent spouse") generally is liable for any tax deficiencies, including interest and penalties. However, relief may be available to an innocent spouse if there is a "substantial understatement" of tax attributable to "grossly erroneous items." Pre-1998 Act Code Section 6013(e)(1)(B). A "substantial understatement" of tax is an understatement that exceeds $500. Pre-1998 Act Code Section 6013(e)(3). "Grossly erroneous items" include omissions from gross income and claims for a deduction, credit, or basis for which there is no basis in fact or law. Pre-1998 Act Code Section 6013(e)(2)(B). Relief will not be provided under the pre-1998 Act rules unless the "innocent" spouse did not know, and had no reason to know, of the substantial understatement at the time the return was signed, and only if it would be inequitable to hold him or her liable, taking into account all facts and circumstances. Pre-1998 Act Code Sections 6013(e)(1)(C) and 6013(e)(1)(D). While the Code no longer requires a consideration of whether the innocent spouse benefited from the erroneous items, that factor continues to be taken into account. (c)(2) Percentage of AGI For relief to be available under the pre-1998 Act rules (other than for a liability attributable to an omission of an item from gross income (pre- 1998 Act Code Section 6013(e)(4)(E))), the additional liability (including interest and penalties) must exceed a certain percentage of the innocent spouse's adjusted gross income (AGI) for the "pre-adjustment year," the most recent taxable year of the "innocent" spouse ending before the deficiency notice is mailed. For example, if the deficiency notice is mailed in March 1996, the most recent taxable year would be 1995. Pre-1998 Act Code Section 6013(e)(4)(C). If the pre-adjustment year AGI is $20,000 or less, the liability attributable to the substantial understatement must exceed 10 percent of AGI. Pre-1998 Act Code Section 6013(e)(4)(A). If the pre-adjustment year AGI is more than $20,000, the liability attributable to the substantial understatement must exceed 25 percent of AGI. Pre-1998 Act Code Section 6013(e)(4)(B). If the "innocent" spouse is married to a new spouse at the close of the pre-adjustment year, the innocent spouse's AGI will include the income of the new spouse for purposes of this determination, regardless of whether they file a joint return. Pre-1998 Act Code Section 6013(e)(4)(D). Community property laws are not taken into account, except for gross income from property. Pre-1998 Act Code Section 6013(e)(5). EXAMPLE 2: In 1994, a phony deduction is claimed on Arnie and Barb's joint return, but Barb is unaware of the nature of the deduction. In 1995, Arnie and Barb are divorced. In 1996, Barb has AGI of $15,000. In 1997, a deficiency notice is mailed to Barb with respect to the fraudulent deduction taken in 1994. Arnie has died, disappeared, or is insolvent. The pre-1998 Act innocent spouse rules only apply if the additional tax liability (including interest and penalties) attributable to the phony deduction exceeds $1,500 (10% X pre- adjustment year AGI of $15,000). Thus, the pre-1998 Act innocent spouse rules will not apply if the additional tax liability is only $1,200, but they will apply if the additional tax liability is $1,800 (provided the other requirements associated with the innocent spouse rules are met). EXAMPLE 3: Assume the same facts as Example 2, except that for 1996, the pre-adjustment year, Barb has AGI of $36,000 instead of $15,000. Unless the additional tax liability for 1994 (including interest and penalties) exceeds $9,000 (25 percent X AGI of $36,000), the innocent spouse rules are not applicable. Thus, the innocent spouse rules will not apply if the additional tax liability is only $7,500, but they will apply if the additional tax liability is $9,500 (provided the other requirements associated with the innocent spouse rules are met). EXAMPLE 4: Assume the same facts as Example 2, except that instead of claiming a phony deduction, Arnie omitted an item from gross income. As long as the additional tax liability for 1994 exceeds $500, the innocent spouse rules apply. In this situation, AGI is not a factor for an omission of an item from gross income. (c)(3) Knew or should have known A taxpayer claiming innocent spouse relief under the pre-1998 Act rules must establish that he did not know, and had no reason to know, that there was a substantial understatement at the time the return was signed. Pre- 1998 Act Code Section 6013(e)(1)(C). The test for constructive knowledge has been variously stated, but it appears that the primary requirements are the circumstances that faced the innocent spouse and the likelihood that a reasonable person in the same position would infer that omissions or erroneous deductions had been made. Some factors that the courts have considered to be significant in determining whether an individual had reason to know of omissions of income or erroneous deductions include unusual or lavish expenditures, Mysse v. Commissioner participation in the couple's business affairs or bookkeeping, Sonneborn v. Commissioner forthright about the couple's income, the omitted income or claimed deduction. A spouse is not relieved of joint and several liability under the pre-1998 Act rules where her assertion of lack of knowledge was predicated on her ignorance of the legal tax consequences of transactions in which the facts were in her possession or were reasonably within her reach. (c)(4) No basis in law or fact Any claim for a deduction, credit, or basis must have "no basis in fact or in law" for relief to be available to the innocent spouse under the pre- 1998 Act rules. Pre-1998 Act Code Section 6013(e)(2)(B). This standard is not used elsewhere in the Code. It was explained in the Committee reports by reference to a "phony deduction." H.R. Rep. 432, 98th Cong., 2d Sess. 1502 (1984). Innocent spouse relief has been denied, however, where the deductions had no basis in law or fact. The position on taken by the Tax Court is that the disallowance of the deduction in itself does not satisfy the standard. For example, in Douglas v. Commissioner substantiate the full amount of her deceased husband's deductions for alimony and employee business expenses that had been disallowed. The Tax Court held that the widow was not entitled to innocent spouse relief because she failed to show that the disallowed deductions had "no basis in fact or law." The standards set forth by the court were that a deduction has no basis in fact when the expense for which the deduction is made was never in fact made, and a deduction has no basis in law when the expense, even if made, does not qualify as a deductible expense under well-settled legal principles or when no substantial legal argument can be made to support the deductibility.
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