Tara Revisited: The New
"Innocent Spouse" Rules
Series: Dealing With The IRS Collection Division
© by Burton J. Haynes, Esq.
Scarlett: But Rhett darling, our Separation Agreement requires you to pay any taxes resulting from the IRS
audit that was going on during our divorce. Now Revenue Officer Sherman has levied my
wages and seized my horse and my last mint julep!
Rhett: Frankly, my dear, I don't give a damn.
Sound familiar? Ever represent a client whose ex-husband
invested in tax shelters or claimed erroneous deductions on a joint return without her
knowledge? Or a widow left holding the bag when the IRS gets done auditing her late
With half of all marriages ending in divorce, there are many
ex-spouses who owe insurmountable tax debts resulting from IRS audit adjustments to joint
tax returns they signed during their marriages. Often one spouse takes the lead in
financial and tax matters, and the other has little or no knowledge of what's on the
returns. In these situations the IRS Collection Division has shown a remarkable proclivity
to attack the party who is easiest to find, while ignoring the other ex-spouse entirely.
And sometimes the IRS, despite its best efforts, is unable to collect from the other
ex-spouse because he or she has no assets or no income, or has discharged the tax
liabilities in bankruptcy.
Taxpayer Bill of Rights 3.
Before the Internal Revenue Service Restructuring and Reform
Act of 1998, poor Scarlett might have been in deep grits. But the Taxpayer Bill of Rights
3, part of the new Act, has greatly enhanced the ability of a spouse, especially one who
is widowed, divorced or separated, to escape the "joint and several liability"
which normally results from the filing of a joint return. And because in the end the
Congress chose to follow the Senate version of H.R. 2676 instead of the original House
language, this relief is available with respect to all tax deficiencies which are unpaid
as of the date of enactment, regardless of the tax year involved. Indeed, it may permit
the recovery of some taxes previously paid.
The Taxpayer Bill of Rights 3 has added §6015 to the Internal Revenue Code, replacing the
innocent spouse provisions which were found in IRC §6013(e).
Two levels of relief from tax deficiencies are available: one applies to all joint filers,
while the other applies only to persons who are divorced, or widowed, or who have been
separated for 12 months. In narrow situations yet to be defined, relief may also available
from taxes reported on joint returns but not paid if the IRS, in its administrative
discretion, finds that it would be "inequitable" to hold one spouse liable.
I. Tax Deficiencies.
A. Relief available to all joint
The relief available to all joint filers, even those who are
still married, is described in new IRC §6015(b).
The "innocent spouse" will be relieved of joint and several liability for a tax
deficiency under the following circumstances (let's call our taxpayers Rhett and Scarlett
for the sake of clarity):
Rhett and Scarlett filed a joint income tax return.
On the return there was "an understatement of tax
attributable to erroneous items" relating only to Rhett.
Scarlett establishes that she "did not know, and had no
reason to know," of the tax understatement.
Scarlett convinces the IRS (or the Tax Court, more on this
below) that "taking into account all the facts and circumstances, it is
inequitable" to hold her liable for the understatement.
Scarlett seeks the benefits of IRC §6015(b) in the manner prescribed by the IRS, within
two years of the time the IRS begins collection action against her.
This is similar to the innocent spouse relief heretofore
available under IRC §6013(e). However, several
important restrictions and limitations have been eliminated.
First, under IRC §6013(e)
the tax understatement had to be attributable to "grossly erroneous items." All
omissions of income met that requirement, but many disallowed deductions did not. Relief
was limited to the consequences of deductions which were "wholly without basis in law
or fact." And the IRS and the Tax Court were quite miserly in construing this phrase.
Most tax shelter deductions, for example, though routinely disallowed and thus giving rise
to massive liabilities for taxes, penalties and interest, nevertheless did not satisfy the
higher standard of "wholly without basis in law or fact." As a result, many
ex-wives who were entirely "innocent" in the conventional sense were denied
relief. The definitional complexities of "grossly erroneous items" and
"wholly without basis in law or fact" have now been removed.
Second, under the old law spouses could obtain relief only if
the amount involved exceeded certain limitations. First, the tax deficiency had to be more
than $500. In addition, the tax, penalties and interest had to exceed certain percentages
of the innocent spouse's adjusted gross income for the year prior to the year in which
relief was sought. If AGI for the prior year was $20,000 or less, the amount at issue had
to exceed 10% of AGI; if AGI exceeded $20,000, the liability had to exceed 25% of such AGI
to warrant relief. And most unfairly, if the innocent spouse had remarried, the AGI to be
considered included that of his or her new spouse, even if they did not file a joint
return! All of these dollar limitations are now gone.
The above-described changes alone would have been quite helpful
to those of us who routinely represent taxpayers before the IRS Collection Division. But
there is much more:
B. Relief for divorced, widowed and separated spouses.
Note that under IRC §6015(b),
like the old §6013(e), Scarlett has to
demonstrate that it would be "inequitable" to hold her responsible for the
deficiency. Have you ever tried to convince an IRS Revenue Officer that it would be
"inequitable" to collect taxes from your poor client? He's heard it all before,
and he doesn't want to hear it again. Now, under IRC §6015(c)
and (d), a divorced, widowed or separated spouse may simply elect to have his or
her share of the deficiency recomputed on a "proportional" basis. In effect, the
taxes are recomputed as though the spouses had filed separate returns, and they then share
responsibility for the deficiency in the same proportion.
The application of the new rules is quite simple. To have her
liability for a deficiency on a previously filed joint return recomputed and apportioned
under IRC 6015(c), Scarlett need only show that at the time her election is filed with the
Service she and Rhett are "no longer married," or are "legally
separated," or that they have not been members of the same household for the
preceding 12 months. Scarlett must file the election to apportion liability for the
deficiency within two years of the time the IRS begins collection action against her. Act '3201(g)(2) provides that the two year period for
filing a claim for relief under either §6015(b)
or (c) starts with the first collection action taken by the IRS against the taxpayer after
the date of enactment.
To counter a demand for apportioning responsibility for a
deficiency in the case of a divorced, widowed or separated spouse, the IRS has only a few
limited arguments available to it under the new law. First, the Service can demonstrate
that Scarlett is ineligible for relief because assets were transferred between her and
Rhett "as part of a fraudulent scheme." This language was included in response
to the IRS's concerns that a pure proportional liability system would be subject to
manipulation and impossible to administer. The burden of proof to demonstrate the
existence of a fraudulent asset transfer scheme rests with the IRS.
Related to this, even if the asset transfers do not constitute
a fraudulent scheme, the IRS can increase Scarlett's apportioned part of the joint return
deficiency "by the value of any 'disqualified asset'" transferred to her by
Rhett. A disqualified asset is any "property or right to property transferred to an
individual making the election . . . by the other individual filing such joint return if
the principal purpose of the transfer was the avoidance of tax or payment of tax."
Congress, in its wisdom, included in the new law a presumption that any transfer made
within one year before the issuance of a 30-day letter with regard to a proposed
deficiency is such a transfer. This is a "rebuttable" presumption, which
Scarlett can overcome with evidence that the transfer had some other objective as its
principal purpose. Furthermore, the presumption does not apply to any transfer made
pursuant to a decree of divorce or separate maintenance.
Second, the IRS can try to prove that Scarlett "had actual
knowledge, at the time [she] signed the return, of any item giving rise to a deficiency. .
." Even this exception, however, does not apply where an individual who did
have such actual knowledge demonstrates that he or she signed the tax return under duress.
In the many such cases I have handled over the past two decades, I have been astounded at
how often great emotional and even physical pressure is brought to bear on a wife to
induce her to sign a joint tax return with her soon to be ex-husband.
Short of proving actual knowledge or prohibited asset transfers
as outlined above, the IRS must allow the parties to recompute and apportion their
liability for deficiencies on joint returns. The procedures for determining the portion of
the deficiency allocable to the respective spouses are explained in IRC '6015(d). It involves the allocation of each item of
income, deduction and credit between the spouses "in the same manner as it would have
been allocated if the individuals had filed separate returns for the taxable year."
II. Taxes Shown on Joint Returns as Filed.
As discussed above, both the old and the new innocent spouse
rules focus on tax "deficiencies," as opposed to balances shown as due on joint
returns but simply never paid. One portion of the new innocent spouse rules, however,
offers at least the hope of some relief for any balances due with respect to joint
returns, even when relief would not be otherwise available. Specifically, new IRC '6015(f) permits the IRS to waive "any unpaid tax
or deficiency (or any portion of either)," if in light of all the facts and
circumstances "it is inequitable to hold the individual liable." The Service is
directed to adopt Regulations to implement this provision for situations in which relief
is not available under §6015(b) or (c). As an
example of what it had in mind, the Report of the Conference Committee suggests that such
relief should be available "to a spouse that does not know, and had no reason to
know, that funds intended for the payment of tax were instead taken by the other spouse
for such other spouse's benefit." It will be interesting to see what situations the
IRS decides warrant relief from collection, and what litigation is brought by taxpayers
seeking to force the IRS to exercise its new found administrative discretion.
III. Petition for Review by the Tax Court.
If the IRS denies a request for relief under IRC '6015(b), or an election for recomputation under IRC '6015(c), the taxpayer can have the issue decided by
the Tax Court. The IRS is instructed to issue a 90-day letter if it denies the claimed
relief, whereupon the taxpayer may file a petition. Furthermore, if the Service fails to
act on a request, six months after the claim is filed the taxpayer may petition the Tax
Court even in the absence of a 90-day letter. And while the innocent spouse claim is under
consideration by the IRS, or by the Tax Court after the filing of a petition, the Service
may not serve levies or take action in court to collect the disputed assessment from the
taxpayer claiming relief. If such collection action is taken, the Service may be enjoined.
In facilitating recourse to the Tax Court, the new law removes
a major obstacle which has prevented many spouses, widows and divorced wives from ever
having their day in court. In law there is a rule of judicial finality known as res
judicata, or "a thing decided." The IRS has routinely raised this as a
defense to innocent spouse claims where the tax deficiency in question resulted from
earlier litigation in the Tax Court.
Far too often in such litigation, however, or in the
preliminary Appeals Office negotiations where the majority of such cases are settled,
lawyers have focused on the businessman or professional husband involved in the dispute,
and completely ignored the separate interests of the wife. And while both spouses were
technically parties because a joint return was filed, the wife had little or no
involvement in any aspect of the case. Indeed, often the spouses were divorced before the
audit adjustments were proposed, or before the matter was settled or litigated. And
usually the first time anyone even thought of the separate legal interests of the wife was
when Attila the Revenue Officer showed up to carry off her car, her bank account, her
furniture, and anything else that wasn't nailed down.
Thankfully, new IRC §6015(e)(3)(B)
has solved this problem. It provides that even if a decision of the Tax Court has become
final in a case involving the same tax year, this will not serve as a bar "with
respect to the qualification of the individual for relief which was not an issue in such
proceeding." The only exception is if the Court finds that the claimant
"participated meaningfully" in the prior case. Thus, if in the typical case no
one bothered to raise the innocent spouse issue on the wife's behalf in Appeals or in the
Tax Court, she will no longer be estopped from raising it as a defense to levy and
distraint action being taken against her by the Collection Division.
As stated at the top of this article, H.R. 2676 as proposed by
the House would have offered protection only against deficiencies assessed in the future,
for tax years beginning after the date of enactment. It would have done absolutely
nothing for thousands of taxpayers, mostly divorced and widowed women, who are already
dealing with the tax collector because of problems caused by their former spouses. The
Senate took a different approach, based on proportional liability for all tax
liabilities, and covering all taxes remaining unpaid on the date of enactment regardless
of the tax year involved. The final legislative compromise applies the proportional
liability approach only to deficiencies, while holding out at least some hope for
discretionary equitable relief from other joint return liabilities. Most importantly, the
law follows the Senate bill in reaching all unpaid taxes, not just taxes assessed in the
All of this gives us as tax professionals the chance to assist
those for whom the disruptions attendant to the loss of a spouse through separation,
divorce or death are exacerbated by burdensome tax liabilities resulting from joint
returns filed during the marriage. In the past many of these situations were beyond
repair. But thanks to the new innocent spouse provisions of the Taxpayer Bill of Rights 3,
that may no longer the case. We should be alert for opportunities to help our clients
obtain the relief to which they may now be entitled.
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