by Mark W, Sullivan, EA
D R Sullivan & Company, CPA PC
For married taxpayers, joint and several liability is the obligation that accompanies the privilege of filing a joint [tax] return (i). Prior to 1998 it did not matter if a divorce decree stated one spouse was solely responsible for payment of the unpaid taxes. Internal Revenue Code Sec 6013(e) only allowed conditional relief to an innocent spouse if all of the following requirements were met:
a joint return was filed for the tax year
there was a substantial understatement of tax attributable to grossly erroneous items of the other spouse on the return
the innocent spouse established he or she did not know or have reason to know of the understatement; and
it would be unfair to hold a taxpayer liable for the understated tax(1).
As a result, there was no relief available to a divorcee whom the IRS was taking enforced collection action against for underpaid taxes(ii). Because, they did not have a substantial understatement on their return, they were disqualified from requesting innocent spouse relief; the majority of divorced taxpayers fell into this category(2).
Passage of the IRS Restructuring & Reforming Act of 1998 amended IRC Sec 6013 creating four types of relief and expanding the concept of equitable relief for underpayments of tax:
Innocent Spouse: A petition for Innocent Spouse relief can only be filed where there is an understatement of tax. Understatements arise as a result of an IRS examination (audit) to a previously filed return(3).
Separation of liability relief: A petition for Separation of liability relief can only be filed where there is an understatement of tax(4).
Equitable relief: A petition for Innocent Spouse - Equitable Relief is the only type available for an underpaid tax. Underpayments arise as a result of a return being filed without payment of the tax due on the return(5).
Relief from liability arising from community property law: Residents of the nine community property states can file a petition for Innocent Spouse or Equitable Relief(6).
What constitutes equitable relief? The IRS defines it simply as, “Taking into account all the facts and circumstances, the IRS determines it would be unfair to hold you liable for the understated or underpaid tax(7). Unfortunately, reflecting on established case law and published IRS guidance, it is not surprising to those who regularly practice in the area of tax controversy that the IRS views “fairness” far differently from the general taxpaying public.
Example 1: Petitioner was a college graduate and a nurse by training. In 1997, she married a California doctor. They filed joint federal income tax returns during this period. In the years that followed, his medical practice became quite profitable. Petitioner quit working so that she could stay at home to raise her children and do charitable work. The income from the practice was substantially the sole source of support for the family. She relied on him and his accountant to attend to the tax returns and would sign the prepared tax forms without reviewing their contents. Her husband generally did not share financial information concerning his practice with taxpayer, but taxpayer was aware that the books maintained for her husband’s practice were not kept in an orderly fashion. She later learned from an early point in their marriage that the doctor was involved in extramarital affairs. She commenced divorce proceedings in May 2004 and subsequently filed for Innocent Spouse relief with IRS(8).
Most persons would conclude the facts and circumstance establish that Mrs. Taxpayer was an innocent spouse who dutifully stayed home to raise her children.
U S Tax Court Opinion: The tax court held that taxpayer did not qualify for Innocent Spouse Relief. The tax court also held that taxpayer did not have reasonable cause for reliance on her husband and accountant to attend properly to tax matters and was therefore subject to penalties for late filing, negligence, and underpayment of estimated taxes.
Example 2: Petitioner was a mid-level executive with a large corporation. The husband worked full-time for a parcel delivery company and operated a home renovation business on the side. They filed joint federal income tax returns for 2006 and 2007 claiming $15,000 in refunds during this period. Her husband’s friend, an unlicensed return preparer, prepared the returns. Petitioner was not present at the time the tax forms were electronically filed and did not sign the Form 8879 (electronic return declaration). The IRS audited their income tax returns. IRS proposed additional taxes for substantial understatement of income from the husband’s renovation business and unreported income from Petitioner’s 401(k) withdrawal.(iii)
Relying on the first example most persons would conclude that a corporate executive who underreported income was not an innocent spouse.
IRS Determination: Based on the foregoing the IRS held the Petitioner qualified for Partial Innocent Spouse Relief for the part of the understatements she did not know about. First, the petitioner provided credible testimony. Second, the return preparer could not provide a copy of the Form 8879 showing the petitioner signed the tax returns, which established that she could not know and had no reason to know that the understated tax existed and her 401(k) withdrawal was omitted. Third, the IRS audit file and agent notes(9) established that substantially all of the understated tax was attributable to the husband’s overstatement of expenses and grossly erroneous business deductions from his construction business. The petitioner’s apportioned nominal tax liability was satisfied after application of later year refund.
Example 3: Petitioner was an elementary school teacher with two small children. The Husband was a self-employed commercial real estate agent who had a banner year in 1998. They filed joint federal income tax returns during this period. Petitioner used her salary exclusively to pay the household bills. Her husband did not share financial information concerning his business with the taxpayer. Taxpayer relied on him and his accountant to attend to the tax returns and would sign the prepared tax forms. Petitioner was aware at the time she signed the 1998 return that a $98,000 underpayment of tax existed, but was assured by her husband that he had sufficient funds to pay the tax bill.(iv)
Based on the prior examples most persons would conclude that since the petitioner was aware of the underpayment of tax when she signed the return she was not an innocent spouse.
IRS Determination: Based on the foregoing the IRS held the Petitioner qualified for Innocent spouse - Equitable Relief. First, the petitioner provided credible testimony. Second, petitioner filed married-separate refund returns for all subsequent years until they divorced in 2009. In 1999 her ex-husband stop filing tax returns and paying income taxes. Third, over a 9-year period her teacher salary was intermittently levied, while the self-employed husband escaped collection action. Fourth, she voluntarily remitted monthly payments to the IRS for 72 consecutive months. Fifth, financial records established the husband spent all of his income on lavish expenses for himself and did not contribute to the household expenses. Lastly, the petitioner established that she was the victim of spousal abuse.
Eligibility for equitable relief: A requesting spouse must satisfy all of the threshold conditions of Rev. Proc. 2003-61 to be eligible to submit a request for equitable relief under section 6015(f) or section 66(c). The following is a nonexclusive list of factors that the Service will consider in determining whether, taking into account all the facts and circumstances, it is inequitable to hold the requesting spouse liable for all or part of the unpaid income tax liability or deficiency, and full or partial equitable relief should be granted. No single factor will be determinative of whether to grant equitable relief in any particular case (10).
Knowledge or reason to know.
Nonrequesting spouse's legal obligation.
Compliance with income tax laws.
Mental or physical health
Internal Revenue Service issues are serious matters, but retaining effective counsel who understands the procedural realities of tax enforcement can mitigate the risks of IRS enforced collection action.
- Taxpayers in community property states who file separate returns are governed by IRC Sec 66(c)
- IRC 6013(e)(2) defines grossly erroneous item as there is no basis in fact or law for a deduction, credit or basis claimed.
- IRC 6010(e)
- IRC 6015(b)(2)
- IRC 6015(f)
- IRC 66(c)
- Instructions for Form 8857 (Rev. September 2010)
- Excerpts from U.S. Court of Appeals, 5th Circuit, 92-4031, 12/15/92, 979 F2d 66, Affirming the Tax Court, 62 TCM 976, Dec. 47,682(M) , TC Memo. 1991-510
- Obtained under Freedom of Information Act, 5 U.S.C. Sec. 552
- IRS Rev. Proc. 2003-61
- 1998 Tax Legislation, IRS Restructuring and Reform, 1290, CCH (July 1998)
- 98ARD 028-1, Treasury Department: Report: Joint liability: Innocent spouse: Present law: IRS administration: Reform proposals, (Feb. 11, 1998) proposed requiring the IRS honor a divorce decree that allocated liability for tax on a joint return filed before the divorce and collect such liability only in accordance with the decree. The IRS did not adopt this proposal. (See Instructions Form 8857)
- Mark W. Sullivan, EA, Representative for Petitioner
- Mark W. Sullivan, EA, Representative for Petitioner