This past June, the Seventh Circuit Court of Appeals in Cathy M. Lantz v. Commissioner (docket no. 09-3345, 6/8/2010) reversed the Tax Court and upheld the IRS’ position that innocent spouses seeking equitable relief under subsection (f) of IRC § 6015 are subject to the same two-year filing deadline that applies to the other two types of innocent spouse claims under sections 6015(b) and (c). Subsection (f) contains no reference to a filing deadline, and Tax Court decisions have held that there is none. Taxpayers—especially those in the Seventh Circuit—who may have sought to take advantage of the Tax Court’s holding in similar cases may now be looking to their CPA tax advisers to reassess their strategy. This article offers suggestions on preventing such problems and on alternative avenues of relief available to taxpayers, especially those who might have a valid innocent spouse claim except for a missed deadline.
INNOCENT SPOUSE CLAIMS
Spouses on a joint return are jointly and severally liable for the full amount of the tax due for the tax year. In a number of instances, one spouse (usually a financially unsophisticated person) neither knows, nor has reason to know, of inaccuracies on a return that was prepared by or under the direction of the other spouse. Under section 6015, the innocent spouse may be provided relief from liability for tax, penalties, interest and other amounts if the spouse files a timely Form 8857, Request for Innocent Spouse Relief. Section 6015(b) provides the requirements for tax relief for an innocent spouse in the most general case:
- A joint return was filed;
- There is an understatement of tax on the return that is due to an erroneous item of the other spouse;
- The innocent spouse signed the return and did not know, and had no reason to know, that the understated tax existed; and
- Taking into account all the facts and circumstances, it would be unfair to hold the spouse liable for a resulting tax deficiency.
If the innocent spouse knew, or had reason to know, upon signing the return that it reflected an understatement but not its amount, partial relief may be available for the amount he or she did not know about.
An alternate form of relief is available when spouses have divorced or separated after filing a joint return. While relief under section 6015(b) could be for the entire tax understatement and penalties and interest, separation-of-liability relief under section 6015(c) determines the liability of each spouse separately by allocating the income and deductions from the joint return to each spouse, in essence amending a joint return into separate ones. To qualify for this separation-of- liability relief, a spouse:
- Must have filed a joint return;
- At the time Form 8857 is filed, the innocent spouse is no longer married to or is legally separated from the other spouse, or they were not members of the same household during the prior 12 months;
- Relief will not apply to any portion of the tax understatement that is due to erroneous items about which the spouse had actual knowledge; and
- There was no transfer of property to the innocent spouse for the main purpose of avoiding tax or payment of tax.
A spouse who does not qualify for either innocent spouse relief or separation-of-liability relief might still qualify for “equitable relief” under section 6015(f) and be relieved of liability for understated or unpaid tax. To qualify for this relief, a spouse must have an unpaid amount of understated or underpaid tax, must not be eligible for relief under either of the two previously mentioned sections, and:
- After taking into account all of the facts and circumstances, it would be unfair to hold the spouse liable for the understated or underpaid tax;
- There was no transfer of any property to one another as part of a scheme to avoid tax or to defraud the IRS or another third party such as an ex-spouse, creditor or business partner; and
- The income tax liability from which relief is sought by one spouse is attributable to a tax item or omission of the other spouse (Revenue Procedure 2003-61).
Note that innocent spouse relief and separation-of-liability relief apply only to an understatement of tax, but equitable relief also applies to any underpayment of tax. Also note that although innocent spouse and equitable relief under sections 6015(b) and (f) can result in a refund, separation-of-liability relief under section 6015(c) does not result in a refund (see section 6015(g)(3)).
Taxpayers in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) should know that a determination under any of the provisions of section 6015 is made without regard to community property laws. Relief is also available under section 66 for taxpayers in community property states who have a similar problem: They are married but living apart from each other and filing separately, and they omit from gross income their share of community earned income. Like section 6015, section 66 has both “traditional” and equitable relief provisions (sections 66(a) and (c), respectively). Form 8857 is also used for this type of innocent spouse relief.
Both sections 6015(b) and (c) require requesting relief by filing Form 8857 within two years of the initiation of an IRS “collection activity” with respect to the innocent spouse. Treas. Reg. § 1.6015-5(b)(2) provides that collection activities include notice of an intent to levy (a section 6330 notice) offsetting one spouse’s separate overpayment against a joint liability, and certain other legal actions taken by the IRS. Although the equitable relief provisions of section 6015(f) contain no mention of a time limit for filing, in Treas. Reg. § 1.6015-5(b)(1) the IRS applied the same two-year limit to equitable relief under section 6015(f). The Tax Court has ruled in favor of several plaintiffs who argued that the omission of any stated time limit in the statute means Congress intended for there to be none, and that the regulation is invalid.
The IRS maintains that the same time limit found in sections 6015(b) and (c) nonetheless applies to section 6015(f), and the Seventh Circuit held the regulation to be valid. Similarly, although section 66(c) doesn’t mention a time limit for community property equitable relief claims, the IRS applies a two-year limit for them as well (Revenue Procedure 2003-61, section 4.01).
EFFECT OF THE LANTZ CASE
An innocent spouse might not be aware, or understand the significance, of an underpayment or IRS collection activity until after the two-year deadline for filing has passed. This is typically the result of being a truly innocent spouse (that is, one who is financially unsophisticated and relying on the other spouse to handle tax matters and deal with the IRS).
In the Tax Court proceedings of Cathy M. Lantz v. Commissioner (132 TC no. 8), Lantz’s individual tax refund was used to offset a joint tax liability from a previously filed joint return. Both she and her husband had received a notice from the IRS of an intent to levy on their property (a collection activity). Her husband told her he was handling the matter with the IRS, but he died in the interim, before filing a claim for innocent spouse relief for her. In 2006, after the IRS applied Lantz’s 2005 income tax refund against the outstanding joint liability, she filed for equitable innocent spouse relief. The IRS denied Lantz’s claim for equitable relief under section 6015(f), asserting its position, stated both in Revenue Procedure 2003-61 (2003-2 CB 296) and in Treas. Reg. § 1.6015-5(b), that the two-year filing limitation applies to a request for equitable relief under section 6015(f).
Lantz argued that the regulation limiting equitable relief to two years was invalid. The IRS conceded that, if not for the two-year deadline, Lantz would have been eligible for relief. The Tax Court held for the taxpayer, emphasizing that Congress explicitly included a two-year filing deadline in sections 6015(b) and (c) but not in subsection (f). Moreover, the court reasoned that, even if the statute was considered ambiguous, the two-year limit in the regulation was not a permissible interpretation of section 6015(f) because Congress intended the rule to be a last resort for those who do not qualify under sections 6015(b) or (c). Finally, the court noted that the equitable relief provision was intended to provide broader relief than either innocent spouse or separation-of-liability relief, and limiting equitable relief to the same two-year deadline would not provide such broader relief.
The taxpayer victory was short-lived. The IRS appealed, and the Seventh Circuit reversed the Tax Court (see “Tax Matters: Two-Year Limit on Equitable Relief Petitions Upheld,” JofA, Sept. 2010, page 68). The appeals court concluded that the IRS had a reasonable basis for limiting equitable relief requests to a two-year period, since without a limitation period the statute would allow taxpayers to file claims indefinitely. The court cited examples of other statutes where Congress did not provide a deadline for a substantive right and yet the courts borrowed a statute of limitations from another area of the law. The court reasoned that the equitable relief provision does in fact provide broader relief than that offered by the innocent spouse and separation-of-liability rules since it applies to unpaid tax, whereas the other two provisions only apply to understatements of tax. Further, the court noted that the wording of the statute states that relief “may” be granted and that authority to prescribe regulations was specifically delegated to the Treasury Department.
Thus, taxpayers in the Seventh Circuit (Illinois, Indiana and Wisconsin) seeking any type of relief under section 6015 will be required to file their claims within two years of the initiation of collection activities. The two-year filing requirement for claims of equitable innocent spouse relief under section 6015(f) is also currently on appeal from Tax Court decisions in the Third Circuit from Mannella v. Commissioner (132 TC 196 (2009)) and in the Second Circuit from Coulter v. Commissioner (Tax Court docket no. 1003-09). In Chief Counsel Notice CC-2010-011 (June 23, 2010), IRS attorneys were instructed to litigate cases related to requests for equitable relief under section 6015 filed after the two-year deadline, so the IRS is committed to pursuing this issue in the courts.
On Sept. 22, 2010, the Tax Court again held, in Audrey Marie Hall v. Commissioner, 135 TC no. 19, that the two-year filing limit for equitable relief was an invalid interpretation of section 6015(f). This case is appealable to the Sixth Circuit. For details, see “Tax Matters: Tax Court Again Strikes Down Innocent Spouse Filing Limit,” page 56 in this issue.
PREVENTION AND ALTERNATIVE AVENUES OF RELIEF
Based on the preceding discussion, claims for relief outside the two-year period in other circuits will be risky, expensive and time-consuming. It is therefore important to consider preventive measures and alternative avenues of relief other than section 6015 innocent spouse requests.
Certainly, clients would be well advised to try to avoid the time limit problem in the first place. Tax advisers should work hard at building the type of relationship with their clients that whenever clients have that hint or feeling that all is not right, they seek advice promptly. This will not only avoid the two-year time limit problem but also will allow the tax adviser to dispel some common taxpayer misconceptions. For example, some taxpayers believe a provision in a divorce agreement that specifies which spouse will pay any tax deficiencies will be effective against IRS collection efforts. It will not be, and innocent spouses in that circumstance can only hope they can win an indemnification lawsuit against the other spouse at less cost than the amount of taxes and penalties at issue.
File a separate return instead of a joint return. If a spouse suspects a tax problem, filing a separate return eliminates the joint and several liability associated with a joint return. Convincing a taxpayer to file separately frequently requires great tact on the part of the tax adviser, because the taxpayer may already be emotionally unsettled. If a joint return has already been filed, it is still possible to change to a separate return, but the time frame is short. Treas. Reg. § 1.6013-1(a)(1) allows changing to a separate return if the time for filing returns for the tax year has not yet expired. Under Treas. Reg. § 1.6013-1(d)(5) if an executor or administrator has been appointed after a joint return was filed, he or she has one year after the due date for filing (plus extensions) to disaffirm the joint return and file a separate return. For purposes of self-employment taxes, spouses subject to community property laws may be able to allocate non-partnership income from a trade or business, related deductions and resulting self-employment tax liability between them (section 1402(a)(5)(A)).
Take advantage of the CDP hearing. As part of collection due process, the IRS is required to provide proper notice to taxpayers of their right to a hearing under section 6320 for a tax lien and under section 6330 before a levy. The taxpayer must request the hearing within 30 days of the date of the notice. The CDP hearing is important because the process should generally be less costly than litigation, and it provides an alternative whereby a taxpayer can challenge a tax liability or work out alternative collection arrangements.
A defect in the taxpayer notification procedure, such as sending the notice to the wrong address, requires the IRS to send a substitute notice, and another 30-day request period must be allowed (Treas. Reg. § 301.6320-1). If, after filing a joint return, the spouses separated and have different addresses, and if the IRS was notified, the IRS must send a copy of the notice to each spouse (section 6212(b)(2)). Thus, good practice dictates filing a Form 8822, Change of Address, promptly.
If the two-year time limit was missed and none of the methods above are useful, two more general-purpose opportunities are available.
Extension of time to file a claim for relief. Taxpayers who missed the two-year deadline might apply for an extension of time to file their claim for relief. In the Lantz Tax Court decision, Judge James S. Halpern noted in a dissenting opinion the possible applicability of a request for an extension of time to file a regulatory election under Treas. Reg. § 301.9100-3 (“9100 relief”). The regulations provide that 9100 relief applies to “regulatory” elections, as distinguished from “statutory” elections. Statutory elections are those elections whose due dates are prescribed by statute. Thus, if granted, 9100 relief would bring the taxpayer back under the scope of section 6015(f) but not subsections (b) or (c).
The 9100 relief is available when a taxpayer can establish to the satisfaction of the IRS that the taxpayer acted reasonably and in good faith and that the grant of relief will not prejudice the interests of the government. Treas. Reg. § 301.9100-3(b)(1)(iii) appears to be directly applicable to an innocent spouse since it explicitly recognizes as acting in good faith a taxpayer who “failed to make the election because, after exercising reasonable diligence (taking into account the taxpayer’s experience and the complexity of the return or issue), the taxpayer was unaware of the necessity for the election.” By contrast, Treas. Reg. § 301.9100-3(b)(3)(iii) specifically states that taxpayers have not acted in good faith if facts have changed since the due date for the election and their request for an extension is the result of hindsight.
The documents to support 9100 relief could be extensive. The specific list of documents and information required to support a 9100 request is presented in Treas. Reg. §§ 301.9100-3(e)(2)–(4) and includes affidavits and certain other information. Since Treas. Reg. § 301.9100-3(e)(5) states that a 9100 request is a request for a letter ruling, all of the documents and information to support any type of ruling request are also required, along with a user fee of at least $625 (see “Applying for a Private Letter Ruling,” JofA, Jan. 2010, page 21). The first revenue procedure issued each year is from the IRS associate chief counsel’s office specifying the procedures to be followed and the documents to be included for every ruling request. For example, section 7 of Revenue Procedure 2010-1 specifies a long list of documents and information that must accompany a ruling request.
Practitioners might face a legal problem with the 9100 approach, however, when helping an innocent spouse who missed the two-year deadline to claim relief. In the Lantz Tax Court case, the majority noted in footnote 10 that both of the parties to the litigation agreed that the effort to obtain 9100 relief would be fruitless for a taxpayer seeking section 6015(f) relief more than two years after the initial collection activity. The majority agreed with the parties and asserted that the IRS’ interpretation of its own regulations was entitled to deference. Moreover, the majority said, the complex procedures required to secure an extension were “daunting to the point of impracticability.” Judge Halpern, in his dissent, said the majority had overstated the difficulties and legal impediments to seeking 9100 relief. From the reported case, we cannot determine why Lantz took the position that 9100 relief was not available to her; maybe it was a strategic litigation decision she and her attorneys made to focus only on obtaining direct section 6015(f) relief.
Regardless of the reason, how this issue might be resolved if separately litigated by a taxpayer who does not take such a legal position is still an open question. A different taxpayer litigating just the 9100 issue might obtain better results, and this may be a promising opportunity for a taxpayer seeking relief in the Lantz environment. However, until this tactic is fully litigated, its usefulness in this context will remain undetermined.
Release of levy. If the IRS has levied on the taxpayer’s property, another alternative avenue of relief would be to seek a release of the levy and return of the property under section 6343. This alternative was mentioned in the Seventh Circuit Lantz opinion because that court thought that it might be applicable to Lantz.
The release-of-levy rules instruct the IRS to release a levy and return property to taxpayers when the levy creates an economic hardship due to the taxpayer’s financial condition (section 6343(a)(1)(D)). Under Treas. Reg. §§ 301.6343-1(b)(4)(i) and (ii), such economic hardship would be evident when the levy would prevent taxpayers from being able to pay their reasonable basic living expenses. The IRS will consider a host of factors in making its determination of how much taxpayers need for their basic expenses, including:
- The taxpayer’s age, employment history, ability to earn, number of dependents and status as a dependent of someone else;
- The amount reasonably necessary for food, clothing, housing, medical expenses, transportation, current tax payments, alimony, child support and child care;
- The cost of living where the taxpayer lives;
- The amount of property exempt from levy that is available to pay the taxpayer’s expenses;
- Any extraordinary circumstances, such as special education expenses; and
- Any other factor that the taxpayer claims bears on economic hardship and brings to the IRS’ attention.
Release of a levy and return of property presents a useful opportunity for relief in the right circumstances, because there is no statutory time limit for obtaining relief. Moreover, even taxpayers who have not filed timely tax returns are entitled to this relief (see, for example, Kathleen A. Vinatieri v. Commissioner, 133 TC no. 16).
THE ROAD AHEAD
Taxpayers and their advisers should carefully watch for the outcome of the Second and Third circuit appeals decisions, and for a possible appeal in the Sixth Circuit. These outcomes will determine the applicability of the two-year filing period for equitable relief under section 6015(f) in those circuits unless the U.S. Supreme Court decides a case on the issue or Congress amends section 6015 to clarify the issue. In the meantime, taxpayers seeking relief from joint and several tax liabilities would do well to pursue alternative relief through one of the avenues identified in this article or by other means.
Taxpayers may seek relief under IRC § 6015(b) from joint and several liability for a tax deficiency arising from a joint return, where the requesting spouse did not know, and had no reason to know, of an understatement and, taking into account all the facts and circumstances, it would be unfair to hold that spouse liable for the understatement.
In addition, section 6015(c) allows divorced and separated spouses in certain instances to seek relief from an understatement on a prior joint return. Spouses who do not qualify for either of those provisions may seek equitable relief under section 6015(f). In all these forms of innocent spouse relief, the requesting spouse must properly apply for relief within two years of when the IRS begins collection activity. The deadline for 6015(f) relief is set by regulation, while that for the other two provisions is contained within the statute.
In the U.S. Tax Court, taxpayers have successfully challenged the time limit with respect to section 6015(f) relief; however, the Seventh Circuit Court of Appeals recently upheld the IRS’ authority to impose the deadline. Tax advisers can explore with their clients at least two alternative avenues of relief: requests for an extension of time to file a regulatory election under Treas. Reg. § 301.9100-3 and requests for a release of levy and return of property under section 6343.
Tax advisers can also educate their married individual tax clients about joint and several liability and, where appropriate, suggest filing separate rather than joint returns.
Donald L. Rosenberg (firstname.lastname@example.org) is a professor of accounting at Towson University in Towson, Md., and Allen Finley Schuldenfrei (email@example.com) maintains a law practice in Baltimore.
To comment on this article or to suggest an idea for another article, contact Paul Bonner, senior editor, at firstname.lastname@example.org or 919-402-4434.
- “Tax Matters: Two-Year Limit on Equitable Relief Petitions Upheld,” JofA, Sept. 2010, page 68
- “Seventh Circuit Upholds Limitation Period for Seeking Equitable Innocent Spouse Relief,” AICPA Tax Insider, July 15, 2010,
- “Applying for a Private Letter Ruling,” JofA, Jan. 2010, page 21
- “Tax Practice & Procedures: Innocent Spouse Relief,” The Tax Adviser, April 2007, page 237
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