IRS further clarifies innocent spouse equitable relief.

Sec. 6015 includes procedures to allow a taxpayer who has filed jointly relief from Sec. 6013(d) s joint and several liability standard. Introduced in the IR8 Restructuring and Reform Act of 1998, Sec. 6015 was intended to address inequities in the innocent spouse statutes first enacted in 1971 and broaden the availability of relief. Since that time, 2002 final regulations, Tax Court decisions and numerous IRS promulgations (including three issued in 2003) have further clarified this very complex area.

Background

In Rev. Rul. 2003-36, (1) reversing its prior position, the Service held that an executor (or any other duly appointed estate representative) may either (1) pursue an existing claim for spousal relief made during a decedent's life-time or (2) file Form 8857, Request for Innocent Spouse Relief (And Separation of Liability and Equitable Relief), on a decedent's behalf for spousal relief under Sec. 6015, as long as the decedent met any applicable requirements while alive. (2) Rev. Proc. 2003-19, (3) effective for relief claims filed after March 31, 2003, provided that a nonrequesting spouse (i.e., the spouse who filed jointly, but did not request innocent spouse relief), like a requesting spouse, can file a written protest and have an administrative conference with the Service's Office of Appeals as to the 1RS's decision to grant partial or full relief to the requesting spouse. The request must be filed within 30 calendar days of the mailing date of the notification letter to the nonrequesting spouse advising him or her of the IRS's preliminary determination. (4)

Rev. Proc. 2003-61

Rev. Proc. 2003-61 (5) provided guidance on equitable relief from the underpayment of tax liabilities under Sec. 66(c)'s or 6015(f)'s innocent spouse provisions. Sec. 66(c) provides relief from income tax liability to taxpayers domiciled in a community property state, but who do not file jointly. Under Sec. 6015(f), the IRS may grant equitable relief if, taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion thereof).

The procedure enumerates the threshold conditions for an equitable relief request to be considered, sets forth the criteria under which relief will ordinarily be granted and includes a noninclusive list of factors in determining whether it would be inequitable to hold a requesting spouse jointly and severally liable for a deficiency or an unpaid liability. Rev. Proc. 2003 61, which supercedes Rev. Proc. 2000-15, (6) is effective for relief requests filed after Oct. 31,2003, and for relief requests pending on Nov. 1,2003, for which no preliminary determination letter had been issued as of that date.

Threshold conditions: A requesting spouse must meet all seven of the following threshold conditions to be eligible for Sec. 6015(f) relief; under Sec. 66(c), a requesting spouse must meet all but the first two. (Rev. Proc. 2000-15 had included the first six conditions.)

1. The requesting spouse filed a joint return for the tax year for which he or she seeks relief.

2. Relief is not available under Sec. 6015(b) or (c).

3. The requesting spouse applies for relief no later than two years after the date of the Service's first collection activity (as defined in Regs. Sec. 1.6015-5(b)(2)(i)) after July 22,1998,as to that spouse.

4. No assets were transferred between the spouses as part of a fraudulent scheme. As defined in Regs. Sec. 1.6015-1 (d), a fraudulent scheme includes one to defraud the Service or another third party, including, but not limited to, creditors, ex-spouses and business partners.

5. The nonrequesting spouse did not transfer "disqualified assets" to the requesting spouse. Sec. 6015(c)(4)(B) defines disqualified assets as assets, the principal purpose of whose transfer was avoidance of tax or payment of tax. If such a transfer did occur, relief will be available only to the extent the income tax liability exceeds the disqualified assets' value.

6. The requesting spouse did not file (or fail to file) a return with fraudulent intent.

7. The income tax liability from which the requesting spouse seeks relief is attributable to an item of the nonrequesting spouse, unless one of the following applies:

* Attribution. If attribution to the requesting spouse is due solely to the operation of community property law, the item is deemed attributable to the nonrequesting spouse.

* Nominal ownership. The requesting spouse may rebut the presumption that an item titled to his or her name is attributable to him or her. Rev. Proc. 2003-61 uses an example to clarify this provision.

* Misappropriation of funds. If the requesting spouse did trot know, and had no reason to know, that funds intended for the payment of tax were misappropriated by the nonrequesting spouse for his or her benefit, the Service will consider granting equitable relief to the extent of the funds taken, even though the underpayment may bc attributable in part or whole to an item of the requesting spouse.

* Abuse not amounting to duress. If the requesting spouse establishes that he or she was the victim of abuse before the return was filed, and that, as a result of such abuse, he or she did not challenge the treatment of any return items for fear of retaliation, the Service will consider granting equitable relief, even though the deficiency or underpayment may be attributable in part or whole to an item of the requesting spouse. (If the abuse amounted to duress, the election to file a joint return would be invalid and Sec. 6015 would not apply.)

Safe-harbor rules: Once all of the above thresholds have been met, the procedure lists several safe-harbor circumstances under which the Service ordinarily will grant Sec. 6015(f) equitable relief for underpayments on joint returns. All three of the following elements must be met:

1. On the date relief was requested, the requesting spouse is no longer married to, or is legally separated from, the nonrequesting spouse, or has not been a member of the same household as the nonrequesting spouse at any time during the 12 month period ending on the date of the relief request.

2. On the date the requesting spouse signed the return, he or she had no knowledge or reason to know that the nonrequesting spouse would not pay the income tax liability. The requesting spouse must establish that it was reasonable for him or her to believe that the nonrequesting spouse would pay the reported income tax liability. If a requesting spouse would otherwise qualify, for relief under this provision, except for the fact that the requesting spouse's lack of knowledge or reason to know relates only to a portion of the unpaid income tax liability, he or she may receive relief to the extent that the liability is attributable to that portion.

3. The requesting spouse will suffer economic hardship if relief is not granted. The Service will base its determination of economic hardship on rules similar to those in Regs. Sec. 301.6343-1(b)(4). After the requesting spouse is deceased, there can be no economic hardship. (7)

Rev. Proc. 2003-61 relief is subject to one limit--if the Service adjusts the joint return to reflect a tax understatement, relief will be available only to the extent of the liability shown on the joint return before any such adjustment.

Equitable relief factors: Rev. Proc. 2003-61 includes a nonexclusive list of factors (the same list contained in Rev. Proc. 2000-15, but revising the weight given to the knowledge or reason-to-know factor) that may be relevant in determining whether it is inequitable to hold the requesting spouse liable for all or part of the unpaid income tax liability or deficiency, and whether full or partial equitable relief should be granted under Sec. 66(c) or 6015(f) for taxpayers who do not meet the safe harbors discussed above. The Service will consider and weigh all relevant factors, with no single factor deemed determinative. A requesting spouse who does not satisfy the conditions listed below may still be eligible for full or partial relief.

1. Marital status (i.e., whether the requesting spouse is separated (legally or living apart) or divorced from the nonrequesting spouse.) A temporary absence (due to incarceration, illness, business, vacation, military service or education) is not a separation for tiffs purpose if it can be reasonably expected that the absent spouse will return to a household maintained in anticipation of his or her return.

2. Economic hardship (i.e., whether the requesting spouse would suffer economic hardship (as defined above) if the Service does not grant rebel).

3. Knowledge or reason to know, as follows:

* Underpayment cases, in which the tax was properly reported but not paid (i.e., whether the requesting spouse did not know and had no reason to know that the nonrequesting spouse would not pay the income tax liability).

* Deficiency cases, in which the requesting spouse did not know and had no reason to know of the item giving rise to the deficiency. Reason to know of the item giving rise to the deficiency will not be weighed more heavily than other factors. Actual knowledge of the item giving rise to the deficiency, however, is a strong factor weighing against relief; it may be overcome if the factors in favor of equitable relief are particularly compelling. In those limited situations, it may be appropriate to grant relief under Sec. 66(c) or 6015(f), even though the requesting spouse had actual knowledge of the item giving rise to the deficiency.

* In both underpayment and deficiency cases, in determining whether the requesting spouse had reason to know, the Service will consider the requesting spouse's education level, degree of involvement in the activity generating the tax liability, involvement in business and household financial matters, level of business and financial expertise, any deceit or evasiveness on the nonrequesting spouse's part and any lavish or unusual spending compared with past levels.

4. Nonrequesting spouse's legal obligation (i.e., whether the nonrequesting spouse has a legal obligation to pay the outstanding income tax liability under a divorce decree or agreement, as long as the requesting spouse did not know or have reason to know that the nonrequesting spouse would not pay).

5. Significant benefit (i.e., whether the requesting spouse received a significant benefit (beyond normal support) from the unpaid income tax liability or item giving rise to the deficiency).

6. Compliance with income tax laws (i.e., whether the requesting spouse made a good-faith effort to comply with income tax laws in the tax years following the tax year(s) to which the relief request relates).

Additional factors that, if" present, will weigh in favor of equitable relief (but will not weigh against equitable relief if absent) include:

1. Abuse (i.e., whether the nonrequesting spouse abused the requesting spouse; a history of abuse may mitigate a requesting spouse's knowledge or reason to know).

2. Mental or physical health (i.e., whether the requesting spouse was in poor mental or physical health on the dare he or she signed the return or at the time he or she requested relief). The Service will consider the nature, extent and duration of such illness.

Refunds: The procedure offers guidance for cases involving deficiencies, as well as for underpayment cases. For a deficiency, a requesting spouse is eligible for a refund of payments made under art installment agreement that the requesting spouse entered into with the Service, if the requesting spouse has not defaulted on such agreement. Only installment payments made after the date the requesting spouse filed the relief request are eligible for refund. Further, the requesting spouse must establish that he or she provided the funds for which a refund is sought.

For this purpose, a requesting spouse is not in default if the Service did not issue a default notice to the requesting spouse or take any action to terminate the agreement. For an income tax underpayment, a requesting spouse is eligible for a refund of separate payments he or she made after July 22, 1998, if he or she establishes that he or she provided the funds used to make the payment for which a refund is sought. A requesting spouse is not eligible for refunds of payments made with a joint return, joint payments or payments the nonrequesting spouse made. In both situations, refund availability is subject to the Sec. 6511 refund limits.

A requesting spouse must file Form 8857 (or other similar statement signed under penalties of perjury) within two years of the first collection activity (as defined in Regs. Sec. 1.6015-5(b) (2) (i)) against the requesting spouse.

(1) Rev. Rul. 2003-36, IRB 2003-18,849.

(2) See News Notes, "Innocent Spouse," 34 The Tax Adviser 385 (July 2003).

(3) Rev. Proc 2003-19, IRB 2003-5, 371.

(4) See Tax Trends, "Nonrequesting Spouse May Seek Administrative Appeal of, Innocent Spouse Relief," 34 The Tax Adviser 372 (June 2003).

(5) Rev Proc. 2003-61, IRB 2003-32,296.

(6) Rev. Proc. 2000-15, 2000-1 CB 447.

(7) See Est. of Barbara J. Jonson, 118TC 106, 126 (2002), aff'd, 10th Cir., 12/30/03; see Tax Trends, "Separate Liability, Requirements Must be Met Prior to Spouse's Death," p. 182, this issue.

ELLEN D. COOK, MS, CPA, ASSOCIATE PROFESSOR OF ACCOUNTING, UNIVERSITY OF LOUISIANA-LAFAYETTE, LAFAYETTE, LA, AND STEVENS. GOODMAN, CPA, THE GOODMAN CPA GROUP PLLC, STATEN ISLAND, NY, MEMBERS, AICPA TAX DIVISION'S INDIVIDUAL INCOME TAXATION TECHNICAL RESOURCE PANEL