The Tax Court's enhanced power to help innocent spouses.
Signing a joint return can be a bit like walking into a minefield. For example, a taxpayer, James, left preparation of their joint 2000 federal income tax return to his wife, Joanne. Unknown to him, Joanne had won $200,000 in a state lottery in May 2000, put the money in a Swiss bank account and failed to report it on their return. James, who was never told about the lottery winnings, signed the return.
Under federal tax law, James and Joanne are jointly and severally liable for the tax on the $200,000 of unreported income. (Assuming they are in the 36% federal tax bracket, they owe $72,000 in additional tax alone.)
When the IRS inquires about the omission, and seeks full payment of the tax, it can proceed against either Joanne, or James, or both, even if, at that time, they are separated or divorced. James may claim he was an "innocent spouse"--that when he signed the return he had no knowledge of the omitted income. If the IRS denies his claim for innocent spouse relief, James can take his plea to the Tax Court. CPAs need to be familiar with the scope of the innocent spouse claim to advise clients properly.
In the past, the Tax Court had limited ability to review an IRS denial of innocent spouse relief. That changed in 1998.
In a number of decisions last year, the Tax Court explained its expanded ability to review requests for innocent spouse relief under IRC section 6015, which was enacted by section 3201 of the IRS Restructuring and Reform Act of 1998 and amended by section 4002(c) of the Tax and Trade Relief Extension Act of 1998. (For a detailed discussion of the innocent spouse rules, see Bryant and Fleischman, "How Innocent Spouses Spell Relief," JofA, Mar.00, page 63.)
Before the 1998 IRS restructuring act, the Tax Court generally had jurisdiction to hear innocent spouse claims only in cases in which there was a tax deficiency, not a refund. The act's provisions empowered the court to review IRS denials of (or failures to rule on) innocent spouse relief in both deficiency and refund cases, generally effective for any liability for tax arising after (or unpaid on) July 22, 1998, if a petition seeking such relief is timely filed with the court in accordance with IRC section 6015(e). As long as such liability remains unpaid after July 22, 1998, the Tax Court's expanded jurisdiction applies, even if the innocent spouse claim arose prior to that date.
Generally, an eligible taxpayer can make one of two elections under IRC section 6015:
n An "innocent spouse" election, if the taxpayer had filed jointly and is still married to that spouse, under section 6015(b).
n A "separate liability" election, if the taxpayer had filed jointly and, at the time of the election, is no longer married to, is regally separated from or has lived apart from that spouse for the past 12 months, under section 6015(c).
If a taxpayer does not qualify for either of the above, the IRS may nevertheless grant "equitable relief" under section 6015(f) if undue hardship would otherwise result (and if other requirements are met). In any case, the remedy is apportioned relief for the part of the tax understatement about which the taxpayer has no knowledge or reason to know. (James might argue that he is entitled to relief from the entire tax understatement, as he had no knowledge or reason to know of the $200,000 of omitted income.)
Section 6015(e)(1)(A) provides that, if the taxpayer timely files a petition, the Tax Court can review the IRS's denial of relief in section 6015(b) and (c) election cases.
TAX COURT'S RIGHT TO REVIEW IRS DENIAL OF RELIEF
In Michael B. Butler v. Commissioner (114 TC 276 (2000)), the taxpayer sought section 6015(b) relief. The IRS denied it and section 6015(f) relief. The issue was whether the Tax Court had jurisdiction to review the IRS's denial of section 6015(f) relief.
The Tax Court held that its jurisdiction is not limited to review of denials of section 6015(b) and (c) relief; there is a strong presumption administrative agency actions are subject to judicial review unless specifically precluded by statute or the action is committed to agency discretion by law.
According to the court, nothing in the statute or legislative history bars the Tax Court from reviewing an IRS denial of section 6015(f) relief. (See also Fredie Lynn Charlton v. Commissioner (114 TC 333 (2000).)
However, in Butler, the Tax Court went on to uphold the IRS's denial of innocent spouse relief, holding that the taxpayer had reason to know of the tax understatement and showed no economic hardship. (See also Kathryn Cheshire v. Commissioner (115 TC no. 15 (8-30-00).)
In Diane Fernandez v. Commissioner (114 TC 324 (2000)), the taxpayer sought section 6015(b), (c) and (f) relief, which the IRS denied. The Tax Court held it had jurisdiction to review the denial of section 6015(f) relief when an election was made under section 6015(b) or (c) and a timely petition filed under section 6015(e). According to the court, the legislative history supports the interpretation that the court has jurisdiction to review relief requests under all of section 6015. The court thus denied the IRS's motion to dismiss the taxpayer's suit.
FAIRNESS TO NONELECTING SPOUSE
In Thomas Corson v. Commissioner (114 TC 354 (2000)), the taxpayer's spouse sought and was granted section 6015(c) relief from a joint tax deficiency; the taxpayer had argued he had the right under section 6015(e)(4) to litigate the IRS's decision to grant such relief. Section 6015(e)(4) provides that, in an innocent spouse proceeding, the nonelecting spouse will be given adequate notice and an opportunity to become part of the section 6015(b) or (c) proceeding (see "Spouses Can Challenge Innocent Spouse Relief Petitions," JofA, Jan.01, page 79).
The IRS contended that only the electing spouse had the section 6015(e) right to bring a Tax Court proceeding, and only after innocent spouse relief was denied; the nonelecting spouse could not bring such a proceeding when the IRS had granted the electing spouse relief.
The court held that, read together, section 6015(e)(1), (e)(4) and (g)(2) showed a concern for (1) fairness to the nonelecting spouse and (2) providing him or her an opportunity to be heard on the innocent spouse claim. Thus, the court ruled that the taxpayer could intervene, in the interests of ensuring that innocent spouse relief was granted on the merits.
Butler, Fernandez and Corson demonstrate that the Tax Court has expanded the grant of jurisdiction provided in section 6015(e).
Chief Counsel Notice N(35)000-338 (6-5-00) announced a change in the IRS's litigating position on judicial review of its spousal relief determinations. In light of Butler, Fernandez and Charlton, the IRS will no longer contest the ability of the Tax Court, district courts (including bankruptcy courts) or the Court of Federal Claims to review a Service denial of equitable innocent spouse relief under section 6015(f). For eligible spouses, this should make the initial decision to elect innocent spouse relief easier.
The IRS also released publication 971 (revised 4/00), Innocent Spouse Relief (And Separation of Liability and Equitable Relief), to explain the three types of relief available. It describes who may qualify for innocent spouse relief, separation of liability or equitable relief and how to apply.
The publication is free and can be obtained by calling 800-829-3676 or by downloading it from the Internet at www.irs.gov/prod.
The Tax Court's enhanced jurisdiction is good news indeed when the IRS has denied innocent spouse relief. More than ever, CPAs need to be familiar with the innocent spouse option in suitable cases.
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|Author:||Laffie, Lesli S.|
|Publication:||Journal of Accountancy|
|Date:||Feb 1, 2001|
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