Is the Tax Court Becoming a Divorce Court?

EXECUTIVE SUMMARY

THE IRS WORKLOAD IS INCREASING AS A RESULT OF MORE innocent spouse claims. A 1998 change in the law is also bringing more work to the Tax Court, which is considering a wide range of domestic issues that previously were the purview of the divorce courts. THE 1998 INNOCENT SPOUSE LAW MAKES IT EASIER for an innocent spouse who files a joint return to avoid responsibility for the total tax on the return. IRC section 6015 provides for Tax Court jurisdiction in innocent spouse cases, although the IRS disagrees with the extent of this jurisdiction. A JOINT RETURN IS TYPICALLY REQUIRED to be eligible for innocent spouse relief. Sections 6015(b) and 6015(c) specifically require it. In Raymond , the Tax Court found that a joint return was required for all 6015 claims, even though section 6015(f) does not explicitly require one. Wenner suggests to CPAs the Tax Court is willing to consider section 6015(f) equity claims without accompanying 6015(b) and 6015(c) elections. FOLLOWING TAX COURT ACTION IN BUTLER AND in Fernandez , the IRS acquiesced in the latter case and said it would not object to Tax Court review of IRS equitable relief decisions under section 6015(f). CPAs HAVE AN INCREASING NUMBER OF WAYS to help clients get relief under section 6015. The Tax Court can review section 6015 claims as part of collection due-process procedures under 6320 involving tax lien notices and 6330 involving tax levies. THE TAX COURT’S MEDIATION ROLE IN INNOCENT SPOUSE claims is likely to grow more if the IRS considers refund claim cases and as practitioners become more familiar with the requirements.

LARRY A. COZORT, JD, PhD, is associate professor of accounting at Tennessee State University in Nashville. His e-mail address is cozort@yahoo.com .

he IRS is experiencing a dramatic workload increase as more and more taxpayers claim innocent spouse relief to avoid liability on a joint tax return. For 1999 to 2001, it received a staggering 152,942 relief requests, and in 2001, the average claim processing time was 363 days. The increase in claims has also resulted in more litigation. In fact, Tax Court cases interpreting the 1998 innocent spouse law revision have expanded the court’s jurisdiction. The court now considers a wide range of domestic issues that typically were within the purview of divorce courts. To help CPAs better advise spouses seeking relief, this article reviews the innocent spouse rules and some of the many Tax Court cases that have resulted.

THE INNOCENT SPOUSE LAW
The 1998 Internal Revenue Service and Reform Act made it easier for an innocent spouse who signed a joint return to avoid responsibility for the total tax due. The law covers federal income and self-employment taxes including penalties, additions to tax and interest. Employment taxes on household employees are not eligible.

Because the IRS was swamped by relief requests even before it took any action to collect a tax, the agency now accepts requests only after a taxpayer receives notice of an audit or other notification of a potential liability. A taxpayer must file a relief request no later than two years after collection begins. If the IRS denies the request, the taxpayer has 90 days to petition the Tax Court.

IRC section 6015(b), innocent spouse relief. Provides that a spouse will be relieved of an understated tax liability on a joint return (but not a tax underpayment) when he or she did not know or have reason to know of the understatement and it would be inequitable to hold the spouse responsible. An understatement occurs when income is omitted or expenses are overstated, resulting in a reported tax that is less than actually owed. An underpayment occurs when the reported tax is not paid in full.

IRC section 6015(c), separation of liability. Applies to taxpayers who file a joint return but who are no longer married, are legally separated or not living together for at least 12 months. The section allows the IRS to allocate the liability between the spouses as if they had filed separate returns in cases of a tax understatement (but not for a tax underpayment). The taxpayer must not have had actual knowledge of the item creating the underpayment. Equitable considerations do not apply.

IRC section 6015(e). Provides for Tax Court jurisdiction over section 6015 claims; however, the interpretation of the provision is the subject of disagreement, as discussed below.

IRC section 6015(e)(4). Provides that the spouse not making a section 6015 election—the nonrequesting party—can join in a Tax Court proceeding.

IRC section 6015(f), equitable relief. Provides that someone can be relieved of tax liability if the facts indicate such relief would be an equitable (fair) result. This section applies to both tax understatements and underpayments.
For more information see “ How Innocent Spouses Spell Relief, ” JofA , Mar.00, page 63.

A taxpayer is eligible for section 6015(f) relief only if sections 6015(b) and 6015(c) do not apply. Under IRS regulations, if a taxpayer asks for equitable relief under section 6015(f) without electing sections 6015(b) or 6015(c), the IRS cannot automatically grant it under those sections. The IRS rejected the suggestion that a section 6015(f) election should trigger the other two provisions because sections 6015(b) or 6015(c) suspend the statute of limitation; a section 6015(f) request does not. However, if the IRS determines the requesting party may be eligible for sections 6015(b) or 6015(c) relief, it will contact the taxpayer to see if he or she wants to elect the additional provision. Under IRS regulations the amended claim will relate back to the original one for purposes of determining its timeliness.

The IRS rejects about 40% of all claims for innocent spouse relief because the requesting party is ineligible. Innocent spouse relief is designed for cases where the taxpayer underpaid or understated tax. With few exceptions it is not for cases where the taxpayer paid in full. Of the IRS rejections in 1999 to 2001, 19% were because there was no tax underpayment or understatement—the tax had been paid in full. In 7% of the requests, the requesting party confused “injured spouse” status with innocent spouse status and asked for injured spouse relief. (See the exhibit on page 38 for other statistics.)

CPAs should distinguish the innocent spouse provisions of section 6015 from injured spouse claims arising when the IRS offsets a refund on a joint tax return to collect tax one spouse owes. An injured spouse may seek relief by filing Form 8379, Injured Spouse Claim and Allocation, while using Form 8857, Innocent Spouse Relief, to seek section 6015 relief.

The IRS Web site, www.irs.gov , can help CPAs determine whether innocent spouse relief is available. Click on “Individuals,” then on “Innocent Spouses” to review relevant information, including the recently revised Publication 971, Innocent Spouse Relief, and an interactive link titled “Explore if you are an eligible innocent spouse.”

COMPARING THE PROVISIONS
The IRS and the courts can grant section 6015(b) innocent spouse relief and section 6015(f) equitable relief only when all facts and circumstances indicate relief would be equitable. An equitable remedy requires the court to reach a “fair” result after considering all of the facts. Section 6015(c) separate liability relief does not involve equitable considerations.

Frequently, taxpayers are forced to file separate returns because their spouse is not available to sign a joint return. These taxpayers then ask the IRS for innocent spouse relief. This is the most common reason the IRS denies a relief request—no joint return had been filed. In Raymond (119 TC No. 11), Ms. Raymond filed a separate return including income for which she claimed no responsibility. She did not pay any tax but rather used this mechanism to resolve her responsibility for the reported income under the innocent spouse provisions. While sections 6015(b) and 6015(c) specifically require a joint return, section 6015(f) does not; however, the Raymond court found a joint return was required for all 6015 claims and refused to consider the merits of Ms. Raymond’s relief request.

IRS regulations interpret section 6015(b) as requiring that the requesting party have no reason to know of the understatement at the time the return is filed and section 6015(c) as requiring that party to have no actual knowledge of the item that created the understatement. Thus, the regulations impose a different standard on the requesting party under section 6015(b) when contrasted with section 6015(c). “Reason to know” is easier to prove than actual knowledge but knowledge of the item causing the understatement is easier to prove than knowledge of the return misstatement. Court decisions reached before the July 2002 IRS regulations interpreting section 6015 contain a different interpretation of reason to know.

NEW TAX COURT JURISDICTION
The Tax Court has only the jurisdiction Congress authorized. In each case the court must determine whether it has jurisdiction as a threshold question. For example, in IRC section 6213, Congress gave the Tax Court jurisdiction over tax deficiency proceedings—where the IRS determines a taxpayer has understated taxable income. The Tax Court considers all facts and circumstances related to a deficiency, including a taxpayer’s innocent spouse claim. In response to the number of innocent spouse cases it was hearing, the Tax Court issued new procedures (see www.ustaxcourt.gov/rules/New.pdf .)

The Tax Court decided the 1998 innocent spouse legislation expanded its jurisdiction. In Butler (114 TC 276) the IRS issued a deficiency notice to a married couple. The husband had received a substantial settlement for damages relating to his nursery business; however, he omitted the damages as income in the couple’s joint tax return. The wife asserted innocent spouse status under section 6015(b) and the court denied relief. The IRS previously had denied section 6015(b) relief and refused equitable relief under section 6015(f). It argued the Tax Court did not have jurisdiction to consider an IRS denial of a section 6015(f) claim because section 6015(e) specifically prohibits such jurisdiction.

The Tax Court found the 1998 act’s legislative history strongly supported its jurisdiction over 6015(f) equitable claims. In addition the court noted a strong presumption that an administrative agency’s actions were subject to judicial review. Such review is exempted only when a statute specifically prohibits it or the law permits the action within the agency’s discretion. The Tax Court found no such restrictions. However, the IRS argued the Tax Court had no standards for adjudicating an equitable relief remedy. The court noted that section 6015(e) required it to consider all facts and circumstances, a common judicial standard. Thus, the Tax Court concluded it had jurisdiction over section 6015(f) equitable relief claims when the case arose under a section 6213 deficiency proceeding.

Fernandez (114 TC 324) involved a “standalone” action—meaning the IRS had not made a section 6213 deficiency determination. A couple omitted capital gains from the sale of a house from a joint return. The wife requested relief under sections 6015(b), 6015(c) or 6015(f). The IRS denied her request. Because there was no deficiency determination—it was a standalone action—the Tax Court had no jurisdiction under the section 6213 deficiency provisions. As a result section 6015 was the only basis for jurisdiction.

As it had in Butler , the IRS argued the Tax Court had no jurisdiction based on its interpretation of section 6015(e). In this case the Tax Court ruled it had jurisdiction over 6015(f) complaints based on a clear reading of section 6015(e). It said the statute required the taxpayer to make an affirmative election for relief under sections 6015(b) or 6015(c) before the court could consider a section 6015(f) claim. Fernandez suggests to CPAs that even if section 6015(b) or 6015(c) relief is not appropriate, such as for tax underpayments, IRS denial of relief under these provisions will trigger Tax Court jurisdiction under section 6015(f).

Following Butler and Fernandez , the IRS acquiesced (AOD CC-2000-06) in Fernandez and said it would not object to Tax Court review of IRS decisions under section 6015(f). More recently, the IRS again acquiesced in Beck (TC Memo 2001-198) where the Tax Court determined it had jurisdiction over IRC section 66(c) community income cases using an equitable remedy similar to section 6015(f). Under section 66(c), an innocent spouse may get equitable relief from income tax liability on unreported community income—income from a couple’s community property.

AVENUES TO 6015 RELIEF
CPAs have an increasing number of ways to help clients get help under section 6015. In addition to section 6015 standalone actions and section 6213(a) deficiency proceedings, the Tax Court can review section 6015 claims as part of collection due-process procedures under section 6320 involving tax lien notices and section 6330 involving tax levies.

Wenner (116 TC 284) opened another avenue for taxpayers. A widow objected to an interest assessment following an IRS audit that increased income on returns filed during her husband’s life. The Tax Court confirmed that a taxpayer could raise a section 6015 claim in a request to abate interest under IRC section 6404. The IRS argued section 6015 wasn’t appropriate because the petitioner had not filed a claim under sections 6015(b) or 6015(c). The Tax Court ignored the IRS argument and permitted section 6015 as a defense. Wenner suggests to CPAs and their clients that the Tax Court is willing to consider section 6015(f) equity claims without accompanying 6015(b) and 6015(c) elections in a variety of circumstances.

NONELECTING SPOUSE INTERVENTION
The new Tax Court rules (noted previously) require the IRS to notify the nonrequesting party of his or her right to intervene in court proceedings. Treasury regulations section 1.6015-6 requires the nonrequesting party to have the opportunity to participate in administrative proceedings. If a taxpayer has been a victim of domestic violence and fears that filing an innocent spouse claim will result in retaliation, CPAs should write “Potential Domestic Abuse Case” at the top of form 8857. This will alert the IRS to the taxpayer’s situation. Taxpayers should also explain their concerns in a statement attached to the claim. The IRS will not release to a taxpayer’s nonrequesting spouse (or former spouse) a new name, address, employer information, phone or fax number or other details not related to deciding the innocent spouse claim.

The Tax Court has been aggressive in allowing the nonrequesting party to participate in the proceedings. In Corson (114 TC 354) the IRS issued a deficiency notice to the taxpayers, who had petitioned the Tax Court to review the dispute. After the case began, the IRS approved section 6015(c) relief for the requesting spouse. The nonrequesting spouse objected and asked the Tax Court for the right to intervene (prohibited under prior law). The IRS argued a nonrequesting party had no right to intervene in a section 6015 request where the IRS grants relief. The IRS considered irrelevant the fact the agreement occurred after litigation had begun.

The Tax Court decided that because section 6015(e)(4) provided for a nonrequesting party to be part of a section 6015 determination, a similar provision should be added to traditional jurisdiction rules under section 6213 deficiency proceedings. The court ruled the process that brought the section 6015 claim before it should not result in different rules. Thus, just as Congress extended participatory rights to the nonrequesting party, the Tax Court decided Congress intended the same rights to exist under section 6213—even after the IRS has granted relief.

In King (115 TC 118) a spouse asked for innocent spouse relief under old section 6013(c) following a deficiency determination. The IRS denied the request. After Congress passed section 6015 and litigation had begun, the IRS determined the spouse was entitled to section 6015 relief. The nonrequesting party was not a petitioner, as in Corson . Thus, the King court allowed the nonrequesting party to enter the litigation to contest the section 6015 claim. The court upheld electing spouse relief under 6015(c). Whether a nonrequesting party can successfully petition the Tax Court for review after the IRS grants section 6015 relief to a requesting spouse is uncertain. King indicates to CPAs that the answer is probably no, and Corson indicates maybe yes.

Because the nonrequesting party can intervene in both the IRS and Tax Court proceedings, the process can take on the tone of a divorce hearing. The issues the nonrequesting party may address include anything that may have a bearing on innocent spouse relief.

For example, the requesting party may claim the nonrequesting party’s conduct constituted duress. If a requesting spouse had signed a return under duress, it is not a joint return and the taxpayer is not liable for the tax shown or any deficiency. The IRS adjusts the return to reflect only the tax liability of the individual who voluntarily had signed the return; the liability is determined as though the married individual had filed a separate return.

In Hinckley , (256 Br. 814), the requesting party had no chance to review the return. However, she conceded she did have actual knowledge of the understatement. Her defense focused on alleged duress from her ex-husband’s coercing her to sign the return. The IRS claimed there had been no duress because she offered no evidence of specific threats or intimidation. The court disagreed, using a two-pronged analysis to reach its verdict that the ex-wife was not liable. It determined she had been unable to resist her husband’s belligerent demands to sign the return. The court also found she would not have signed except for having been constrained to do so.

EQUITABLE RELIEF
The IRS issued revenue procedure 2000-15 which outlines the factors that will support an equitable relief application. IRS regulations indicate to CPAs it will consider the same factors in making the equitable determination required under section 6015(b). The list of factors is not exhaustive because the IRS can consider any relevant information. The factors that support equitable relief are:

Economic hardship. This consideration involves the requesting party’s inability to pay basic living expenses.

Abuse. Ask the question: Was the taxpayer subject to abuse by the nonrequesting party?

Lack of knowledge or reason to know. It will be helpful if the requesting party did not know and had no reason to know of the items resulting in the additional tax.

Nonrequesting party’s legal obligation. He or she may have a legal obligation created by agreement or divorce decree to pay the tax.

Attribution. The tax item at issue is attributable to the nonrequesting party. For example, the tax deficiency arose from the nonrequesting spouse failing to report business income received in cash.

No benefit. The individual did not significantly benefit (beyond normal support) from the unpaid liability or items giving rise to the deficiency.

In Kalinowski (TC Memo 2001-21), the Tax Court considered the equity requirement under section 6015(b). The factors it used to deny relief included: no present financial hardship because of the continuing marriage, financial benefit from the electing spouse’s understatement and no “overreaching” by the nonrequesting spouse using unscrupulous methods.

Based on litigation under the pre-1998 innocent spouse law, the court does not consider personal tragedies in making its decisions. Medical problems such as chronic ailments and alcohol addiction, for example, are not relevant while mental illness is. Misunderstanding the law is no defense unless there is overreaching by the other spouse. Involvement in financial affairs weakens a relief claim.

In Cheshire (166 TC 183) the court said the most important factor in determining equity was whether the spouse seeking relief significantly benefited from the understatement. This benefit can be indirect, such as a spouse’s receiving more than he or she otherwise would have gotten as part of a divorce settlement. The requesting party in Cheshire received—as part of a divorce settlement—the marital residence, its value enhanced by the use of untaxed retirement distributions to repay the mortgage. The requesting party also received the family car purchased with retirement distributions. In Gurr (TC Summary Opinion 2002-7) the wife had received real estate transfers related to denied losses; thus, she was not granted relief.

WORK, WORK, WORK
Although the innocent spouse law has already increased the workload of the IRS and Tax Court, this mediation role has the potential to grow even more. Currently, the IRS refuses to process a section 6015 election where there is no additional tax liability or underpayment. However, as other responsibilities decline, the IRS and Tax Court may be more aggressive in processing such claims. CPAs will find their familiarity with innocent spouse rules will increase a success rate that has historically been relatively low. The IRS has denied 40% of section 6015 claims because they failed to meet its eligibility requirements. It has granted full or partial relief for 45% of claims that have passed initial muster. From 1999 to 2002, the U.S. Tax Court heard 33 innocent spouse cases and upheld the IRS in 20 of them. In light of this, practitioners should pay close attention to section 6015 claims to increase the chances clients will succeed in gaining relief.