Update on innocent spouse relief.

Since the enactment of the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98), taxpayers have been enjoying the benefits of liberalized rules for innocent spouse relief. Former Sec. 6013(e) enumerated a list of strict conditions that resulted in denial of most applications; under new Sec. 6015(b), (c) and (f), a taxpayer may generally qualify for relief on a jointly filed return under one or more of the following circumstances:

1. One spouse establishes that, in signing the return, he did not know (and had no reason to know) there was an understatement of tax attributable to the erroneous items of the other spouse, or did not know the understatement's extent;

2. A divorced or separated individual requests allocation of a liability, so that he becomes responsible only for the portion of the deficiency allocable to that person; or

3. A taxpayer is not eligible for relief under one of the first two categories, but it would be equitable to grant relief, given consideration of the facts and circumstances.

(For a full discussion of the provisions, see Foran and Foran, "Innocent Spouse Rules Provide Relief" TTA, Jan. 2000, p. 26.)

Initial Cases

Cases filed under prior law have been considered under the new provisions. In the first half of 2000, the Tax Court handed down three decisions that addressed whether it had jurisdiction to review an IRS denial of relief requested under Sec. 6015(b), (c) or (f). In Field Service Advice 9929019, the Service agreed that the Tax Court had jurisdiction to review denials of requests under Sec. 6015(b) and (c). However, because Sec. 6015 (e) explicitly sets out the rules for petitioning the Tax Court and the equitable relief provision is spelled out in Sec. 6015 (f), the IRS strongly contended that the court did not have jurisdiction to review denials for relief under Sec. 6015(f). However, in Michael B. Butler, 114 TC 276 (2000), and Diane Fernandez, 114 TC 324 (2000), the Tax Court disagreed. In each case, the taxpayer had requested relief under Sec. 6015(b) or (c) or both, as well as under Sec. 6015 (f), and, in each, the Tax Court held that it had jurisdiction to review a denial of Sec. 6015(f) relief.

In Thomas Corson, 114 TC 354 (2000), the Tax Court pulled together different parts of the statute to support its ruling that a nonelecting spouse should receive notice and could be a party to considerations, when the Service had granted the electing spouse relief. (See News Notes, "Innocent Spouse Relief" TTA, July 2000, p. 460, for a fuller explanation.)

Since those cases, the Tax Court has confirmed (or extended) its position on its jurisdiction under Sec. 6015 in several additional decisions; see Fredi Lynn Charlton, 114 TC 333 (2000); Kathy A. King, 115 TC No. 8; and Kathryn Cheshire, 115 TC No. 15, in which the IRS was still contending that the Tax Court lacked jurisdiction to decide whether it properly denied Sec. 6015 (f) relief to a taxpayer. The court referred to its reasoning in Butler, and reaffirmed its jurisdiction. It also invited the spouse to file a motion if the Service denied relief.

Later Tax Court Cases

In King, a divorced husband and wife were each assessed identical deficiencies. Although the husband did not contest the assessment in court, he contended that he should be allowed to challenge his ex-wife's request for innocent spouse relief. The Tax Court said in part:

The issue we must decide for the first time is whether a spouse (or former spouse), who is not a petitioner, may intervene and become a party in a deficiency case where the other spouse (or former spouse) is a petitioner who is claiming relief from joint liability pursuant to section 6015. While we have not previously addressed this specific issue, we have previously allowed one spouse to challenge the other spouse's claim for relief under section 6015 where both spouses were before the Court as petitioners in the same deficiency case.

The court relied on Charlton, Butler, Fernandez and particularly Corson, and extended the taxpayer's rights further:

We hold that whenever, in the course of any case proceeding before the Court, a taxpayer raises a claim for relief from joint liability under section 6015, and the spouse (or former spouse) is not a party to the case, the Commissioner must serve notice of claim on the other individual who filed the joint return for the year(s) in issue. The notice shall advise such other individual of his or her opportunity to file a notice of intervention for ... relief from joint liability pursuant to section 6015.

The Tax Court noted in Cheshire that the IRS "acknowledges that we have jurisdiction to review his denial of innocent spouse relief under section 6015(f)."

In Cheshire, a husband had retired early and taken a distribution of his retirement account. Some of the money was rolled over to a qualified account, but about $180,000 was used to pay off the couple's mortgage and other family and business expenses. The wife was fully aware of the retirement distribution, as well as the interest earned on the unspent funds. When signing the tax return (which the husband had prepared), the wife inquired about the distribution's taxability. The husband falsely told her that he had consulted with a CPA, who said that the amount used to pay off the mortgage was not taxable. (Some interest income was also omitted from the tax return.) The wife accepted this explanation and signed the return.

After the divorce, the wife applied for innocent spouse relief under Sec. 6015(b), (c) and (f). The Service allowed her relief for her ex-husband's Schedule C expenses and some other items he had omitted. However, the IRS asserted that the wife had actual knowledge of the distribution and the omitted interest and was, therefore, liable for the understatement on those items, as well as for the accuracy-related penalty. At trial, the wife claimed that she did not have knowledge of the distribution's tax consequences and, therefore, fulfilled the statute's requirement. The Tax Court disagreed:

In our opinion, the knowledge requirement of section 6015(c)(3)(C) does not require the electing spouse to possess knowledge of the tax consequences arising from the item giving rise to the deficiency or that the item reported on the return is incorrect. Rather, the statute mandates only a showing that the electing spouse actually knew of the item on the return that gave rise to the deficiency (or portion thereof).

Based on this interpretation, the court held that the wife was not entitled to innocent spouse relief for the omitted retirement distribution or interest. The court examined the Service's denial of relief from the accuracy-related penalty under Sec. 6015(f). Because the wife did ask her husband about the tax consequences and he told her that he had consulted a CPA, it was inequitable to hold the wife liable for the accuracy-related penalty. Thus, it determined that the IRS had abused its discretion in failing to grant this portion of the relief sought under Sec. 6015(f).

Other Jurisdictions

As of this writing, other courts have not yet addressed the issue of Sec. 6015(f) relief. One recent case avoided any review of innocent spouse relief, basing its decision on other grounds. In Stolle, DC Cal., 3/15/00, a California district court stated that enough community property was available to satisfy a deceased husband's debt under California law. The court did not address whether his wife was an innocent spouse. Instead, it said that:

Even if Helen Stolle were an innocent spouse, the liens still arose against all of Emile's property, and all of the community property available to satisfy Emile's debt.... Nothing in the language or the case law suggests that the "innocent spouse" provisions of the Internal Revenue Code prevents the government from collecting against community property in accordance with state law.

The court found for the IRS in French, Bank DC Ohio, 5/1/00, holding that the Service appropriately refused the innocent spouse claim presented under Sec. 6015(b). It then went on to state:

[T]he Court finds that as the language of section 6015(f) is unambiguous, it must apply the statute as written.... Therefore, as Congress chose to exclude from judicial review the issue of whether a taxpayer is entitled to equitable relief under section 6015(f), this Court is the improper forum to raise such an issue.

Conclusion

Soon after French, IRS Chief Counsel issued N(35)000-338 to announce the IRS'S change in litigation position on whether its determination under Sec. 6015(f) can be reviewed by a court. N(35)000-338 directs staff not to contest the jurisdiction of the Tax Court, district court, bankruptcy court or the Court of Federal Claims to review abuse-of-discretion denials for Sec. 6015(f) relief. This may pave the way for more courts to examine whether the Service has abused its discretion in not granting equitable relief to claims under the innocent spouse rules. However, for the near term, it may be wiser for a claimant to look to the Tax Court, which has explicitly claimed jurisdiction to review Sec. 6015(f) refusals, rather than taking a chance on an unknown result in another court.

FROM HARRIET A. JACOBS, CPA, MST, SKOKIE, IL

Editor's note: Mr. Ely is former chair of the AICPA Tax Practice and Procedures Committee. Ms. Jacobs and Messrs. Dougherty, Marchbein and Burke are committee members.

Mark H. Ely, J.D., CPA
Partner
Washington National Tax
KPMG LLP
Washington, DC