By Stephen J. Dunn
The filing of a joint income tax return has the legal effect of an irrevocable election by each spouse to be jointly and severally liable for tax reported, or properly reportable, on the return. In other words, each spouse can be held liable for the full amount of the tax, though the IRS can collect the tax only once.
Internal Revenue Code Section 6015 authorizes the IRS to grant a spouse relief from a joint return, where it is inequitable to hold the spouse bound for the return. In Revenue Procedure 2003-61, the IRS set forth the following eight factors to be weighed in deciding requests for innocent spouse relief:
Marital status. Whether the spouse requesting relief from the joint income tax return (“requesting spouse”) is separated or divorced from the nonrequesting spouse.
Economic hardship. Whether the requesting spouse would suffer economic hardship if the Service does not grant relief from the income tax liability.
Knowledge or reason to know. Whether the requesting spouse had knowledge or reason to know that the nonrequesting spouse would not pay income tax liability properly reported on the joint income tax return (underpayment case), or of a deficiency of tax in the joint tax return (deficiency case). A tax deficiency generally results from under-reporting of gross income or over-reporting of deductions.
Nonrequesting spouse’s legal obligation. Whether the nonrequesting spouse has a legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement. This factor will not weigh in favor of relief if the requesting spouse knew or had reason to know, when entering into the divorce decree or agreement, that the non-requesting spouse would not pay the income tax liability.
Significant benefit. Whether the requesting spouse received significant benefit (beyond normal support) from the unpaid income tax liability or item giving rise to the deficiency.
Compliance with income tax laws. Whether the requesting spouse has made a good faith effort to comply with income tax laws in the taxable years following the taxable year or years to which the request for relief relates.
Abuse. Whether the nonrequesting spouse abused the requesting spouse.
Mental or physical health. Whether the requesting spouse was in poor mental or physical health on the date the requesting spouse signed the joint income tax return or at the time the requesting spouse requested relief from that return.
The last two factors above if present weigh in favor of relief, but if absent do not weigh against relief.
Rev. Proc. 2003-61 provides that its list is nonexclusive, and that the Service will consider and weigh all relevant facts and circumstances in deciding applications for equitable relief under Code Section 6015. In practice, however, the IRS and the U.S. Tax Court applied only the above eight factors. The factors were given equal weight, except that in a deficiency case, the requesting spouse’s knowledge of the item giving rise to the deficiency (understated gross income or overstated deductions) was “a strong factor weighing against relief.”
A requesting spouse was thus denied relief unless she could prove a majority of applicable factors weighing in her favor. And the Tax Court, at the urging of IRS counsel, went to unrealistic lengths in finding that spouses failed the factors in litigated cases. In one of my recent cases, the evidence showed that the spouses had filed joint income tax returns throughout their marriage. When a joint return was filed with a balance owing, it had always been paid. An accounting firm retained by the husband delayed in preparing the couple’s income tax returns for four years. When the accounting firm finally prepared the returns, they were joint returns, with a substantial balance owing for each year. IRS counsel urged, and the Tax Court found, that the requesting spouse (the wife) had reason to know that the unpaid balances on the tax returns in question would not be paid.
In the same case, the couple had sent all four their sons to a parochial high school. The couple liked the values instilled by the parochial school. The tax years in controversy were the younger sons’ high school years. The husband had paid the sons’ tuition at the parochial high school the parochial school tuition. How could the family send the older sons to the parochial high school but not the younger sons? IRS counsel urged, and the Tax Court found, that the parochial school tuition was a lavish expenditure, not “normal support,” and thus that the wife had realized substantial benefit from the husband’s income.
Economic hardship is the toughest factor for a requesting spouse to meet. You would think that if a requesting spouse has a moderate income, and uses all of it for her family’s support, that holding her bound for hundreds of thousands of dollars in tax liability would impose an economic hardship on her. Not so says the Tax Court. She can enter into an installment agreement and make monthly payments to the IRS. Never mind that the IRS issues a Notice of Federal Tax Lien against both of the spouses and records it in the local register of deeds’ office, disabling both spouses from selling or mortgaging an interest in real property, or from securing new employment. Any why should the requesting spouse have to make installment payments on tax on her husband’s income?
In an indictment of the lack of due process for taxpayers in U.S. Tax Court, the IRS recently issued Notice 2012-8 relieving requesting spouses from the severity of Tax Court cases decided under Rev. Proc. 2003-61. Notice 2012-8 is immediately effective, superseding Rev. Proc. 2003-61. After a period of public comment, the IRS intends to issue Notice 2012-8 as a Revenue Procedure. I plan to file comments with the IRS on Notice 2012-8.
The IRS no longer requires that an application for innocent spouse relief be filed within two years after it first acts to collect the joint tax liability in question. Notice 2012-8 acknowledges that an innocent spouse claim may be filed at any time during the period of the collection statute of limitations. The collection statute of limitations runs ten years from the time the tax is assessed. Tax is assessed by the filing of a tax return, or by IRS examination. Various events toll the collection statute, including the filing of a bankruptcy case or an offer-in-compromise by the taxpayer.
Notice 2012-8 provides that, “[A]ll the facts and circumstances of the case are to be taken into account. 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. It is not intended that only the factors described in this paragraph are to be taken into account in making the determination. No one factor or a majority of factors necessarily determines the outcome.”
Notice 2012 relaxes the proof requirements for the identified factors:
Marital status. Under Rev. Proc. 2003-61, that the requesting spouse remained married to the nonrequesting spouse and not separated from him weighed against relief. This was abhorrent policy. Notice 2012-8 changes this, providing that, “[I]f the requesting spouse is still married to the nonrequesting spouse, this factor is neutral.”
Economic hardship. Notice 2012-8 provides that, “[E]conomic hardship exists if satisfaction of the tax liability in whole or in part will cause the requesting spouse to be unable to pay reasonable basic living expenses. Whether the requesting spouse will suffer economic hardship is determined based on rules similar to those provided in §301.6343-1(b)(4) [of the Income Tax Regulations], and will take into consideration a requesting spouse’s current income and expenses and the requesting spouse’s assets.” This is muddled and not an improvement. Apparently the requesting spouse still fails to satisfy this factor if she can enter into an installment agreement and make payments, however small, on the non-requesting spouse’s tax liability. Then the IRS writes this factor out of the analysis by providing that, “If denying relief from joint and several liability will not cause the requesting spouse to suffer economic hardship, this factor will be neutral.”
Abuse. Notice 2012-8 makes great strides concerning emotional abuse. “[I]f the requesting spouse was abused by the nonrequesting spouse . . ., or the nonrequesting spouse maintained control of the household finances by restricting the requesting spouse’s access to financial information and, therefore, the requesting spouse was not able to question the payment of the taxes reported on the joint return or challenge the nonrequesting spouse’s assurance regarding payment of the taxes for fear of the nonrequesting spouse’s retaliation, this factor will weigh in favor of relief even if the requesting spouse had knowledge or reason to know regarding the nonrequesting spouse’s intent or ability to pay the taxes due.
“Abuse comes in many forms and can include physical, psychological, sexual, or emotional abuse, including efforts to control, isolate, humiliate and intimidate the requesting spouse, or to undermine the requesting spouse’s ability to reason independently and be able to do what is required under the tax laws. All the facts and circumstances are considered in determining whether a requesting spouse was abused. The impact of a nonrequesting spouse’s alcohol or drug abuse is also considered in determining whether a requesting spouse was abused.”
Significant benefit. On whether the requesting spouse realized significant benefit from the nonrequesting spouse’s income in question, Notice 2012-8 provides, “If the requesting spouse enjoyed the benefits of a lavish lifestyle, such as owning luxury assets and taking expensive vacations, this factor will weigh against relief.” There is no indication of whether the IRS continues to regard parochial school tuition as evidence of a “lavish lifestyle.” Notice 2012-8 provides, however, that, “If the nonrequesting spouse controlled the household and business finances or there was abuse . . . such that the nonrequesting spouse made the decision on spending funds for a lavish lifestyle, then this mitigates this factor so that it is neutral.”
Knowledge of Right to File Separate Return
Notice 2012-8 continues to fail to recognize a requesting spouse’s lack of knowledge of her right to file as married filing separately, or of the consequences to her of filing a joint return (see first paragraph above). Notice 2012-8 does provide, however, that the factors discussed therein are not exclusive, and that all pertinent facts and circumstances will be considered. In the case described above, the wife was handed four years of joint tax returns and told to sign them. The returns reported substantial amounts of tax liability, all of it attributable to the husband. Wife was trained as a school psychologist. She had no background in taxes. Wife did not know of her right to file as married filing separately, or of the consequences to her of filing jointly.
Where the requesting spouse did not know of her right to file as married filing separately, or of the consequences to her of filing separately, this factor should be argued in her favor.
In Notice 2012-8, the IRS has significantly lowered the bar for innocent spouse relief. The rules of the game have changed. A spouse who was denied relief under the old rules should consider applying for innocent spouse relief under Notice 2012-8, provided the ten-year collection statute has not expired on the taxes in question. I have clients who have litigated in U.S. Tax Court under the old rules and lost who will apply for innocent spouse relief under the new rules.