Case Pushes Limit of Law in Tax Battles by Ex-Spouses.

WHAT'S fair when ex-spouses battle over whom owes an unpaid income tax? How expensive did Congress intend that battle to be?

These issues are being raised in a federal lawsuit in California. Judy Conn Corson (now Judy Conn) is fighting her ex, Tom Corson, for the right to be ruled an "innocent spouse."

An innocent spouse is someone who trustfully signs a joint tax return, not knowing that something on the return is wrong. In the typical case, the husband handles the tax return. He might take illegal deductions or fail to report all his income. His wife has no idea what's going on.

After an audit, the IRS assesses back taxes, plus interest and, often, penalties. If the couple has divorced, the IRS may pursue the wife as well as the husband for the full amount.

Occasionally, an innocent husband is left holding the bag. But this is mostly a woman's issue.

But how do you show you're an innocent spouse? The rules used to be tough. Few women passed the test. So in 1998, Congress changed the law, to make your innocence easier to prove.

Enter the Corsons. Tom owns his own business. Judy, a consultant, lectures part time at the University of California in Riverside. They married in 1980 and divorced in 1985.

During their marriage, Tom invested in an oil-and-gas tax shelter and took a big deduction on their tax return. The IRS challenged the legality of the particular shelter Tom chose.

The case against the shelter dragged on for years. The IRS finally won, definitively, in 1996. Today, the Corsons' original liability has ballooned from $21,711 to an estimated $140,000, in back taxes and interest.

Tom thought the original deductions were OK and told Judy about the investment. Judy says it was all Tom's deal. She had no idea how risky it was.

Judy asked the IRS to treat her as an innocent spouse. At first, it said no. Tom gave evidence that Judy knew about the tax shelter. Therefore, the tax debt was just as much hers as his.

But when Congress passed the new, more forgiving law in 1998, Judy asked again. Under the new rules, the IRS said, she indeed was innocent. She didn't know enough about the investment to take the blame. Effectively, Tom would have to pay the entire bill.

Formerly, Judy's case would have been closed. Tom had a chance to give evidence against her during the IRS investigation (and he did). Once the question was decided in her favor, Tom couldn't continue the dispute.

The new law, however, contains some language that appears to change the rules. It gives the opposing spouse -- in this case, Tom -- the right to be "a party to a proceeding." So Tom asked the Tax Court for a chance to argue that Judy shouldn't be let off the hook.

Is this what Congress intended when it put that new language in the law? Did it mean that a spouse should be able to draw a battle out? The legislative record isn't clear.

Judy's attorneys, Arthur Oshiro of Long Beach and Teresa Rhyne of Riverside, argued that Congress meant only that Tom should be heard during the IRS proceeding; he shouldn't be able to challenge the finding in court. The IRS took that position, too.

Tom's lawyer, Stephen Benda of Palo Alto, argued that Tom should be able to pursue the decision as far as he wants. The judge sided with Tom, saying that he deserves "his day in court." A trial is set for September.

The big question, for all innocent spouses, is whether the Corsons' struggle will affect them, too. Will it be harder and more expensive for them to make their case?

The IRS handles claims of innocence with an administrative hearing. You can get a lawyer to help with the hearing, but you don't necessarily need one.

If you have to go to court, however, you'll need extensive legal help. Some innocent spouses -- usually wives with modest earnings -- might not have enough money to defend themselves. (Judy's lawyers are working free.)

Divorce-tax attorney Marjorie O'Connell of Washington, D.C., doubts that the Corson case will apply to very many other people. "The facts of this case are unique," she says: "As a rule, tax courts won't want to replay people's divorces."

But Rhyne worries that this decision will be interpreted broadly. "Women will not only have to win their innocent-spouse claim in front of the IRS," she says, "their spouses could drag them into court to fight it out again."

Stay tuned.

Syndicated columnist Jane Bryant Quinn