Under Internal Revenue Code (hereinafter “IRC” or “Code”) § 6013(d)(3), spouses who file joint tax returns are jointly and severally liable for all tax due and owing for the tax year, as well as any penalties or interest that accrue on the tax liability. Because the debt is joint and several, the IRS can choose to collect the outstanding tax in its entirety from a single spouse. Further, a divorce settlement or other state court document directing a spouse to pay the tax liability is not binding on the IRS.
In certain circumstances, imposing joint and several liability on both spouses can create inequitable results. For instance, a spouse that is completely unaware of an item of income attributable to the other spouse, and did not benefit from the income, is still held liable for payment of tax on the income under the provisions of § 6013(d)(3). Recognizing the potential for inequity, Congress added provisions to the Internal Revenue Code which set forth grounds upon which so-called “innocent spouses” can obtain relief from the general imposition of joint and several liability.
Recently, changes have been made to the innocent spouse provisions that make their scope and applicability more available for taxpayers. This blog entry will first provide a general overview of the Internal Revenue Code’s innocent spouse provisions, and will then highlight the key recent modifications to those provisions.
Overview of Innocent Spouse Provisions
Innocent spouse relief is set forth in § 6015 of the Code. Generally, three types of relief are potentially available, depending on the individual spouse’s circumstances. Each of the three bases for relief has unique characteristics, but there are some universal conditions which must be met before any of the three types of relief can be utilized. First, there must a valid joint return (i.e. the taxpayers’ marriage must be valid, the signature of a spouse cannot be forged or coerced). Without a valid joint return, there is no joint and several liability. Second, the request for relief, form 8857, must be timely filed. In most circumstances, the deadline to file is two years from when the IRS first begins collection action. However, as explained below, the time limit may be different depending on which basis for relief the spouse invokes in his or her request. Third, the liability must arise out of income taxes. Most taxes required to be included on a joint return are income taxes, so this requirement is usually not a significant obstacle. One example of a tax that is required to be reported on a joint return but is not considered income tax is the tax imposed on domestic employment service (i.e. working in the employer’s private home) by § 3510 of the Code. Fourth, a court cannot have rendered a judgment as to the liability of the spouse requesting relief (hereinafter “requesting spouse”). If the requesting spouse participated in a proceeding regarding the liability and had a chance to request relief but failed to do so, relief is also precluded.
Once these threshold requirements are met, it is necessary to determine which specific type of relief under IRC § 6015 is potentially available to the requesting spouse.
i. Innocent Spouse Relief: IRC § 6015(b)
The first type of relief, set forth under IRC § 6015(b), is called “Innocent Spouse Relief.” This relief is potentially available to all joint filers. To qualify for this relief, in addition to the universal requirements set forth above, the following requirements must be met:
- There must be an understatement of tax, i.e. the amount stated on the return is less than the amount actually due. This is distinguished from anunderpayment of tax, where the correct amount is stated on the return, but not enough money was paid toward the liability;
- The understatement must be based on an erroneous item (either unreported income or an incorrect deduction, credit, or determination of basis) attributable to the other spouse;
- The requesting spouse must be without knowledge of the understatement, and without a reason to know of its existence;
- Taking into account all facts and circumstances it would be unfair to hold the innocent spouse liable for the tax.
A determination of whether a spouse had reason to know of the understated tax, thus precluding that spouse from taking advantage of § 6015’s equitable relief, is based on factors such as the educational background of the requesting spouse, the business experience of the requesting spouse, and whether the erroneous item represents a departure from a recurring pattern in previous tax years. This is not an all or nothing proposition—a spouse can be aware of some erroneous items (and thus remain jointly and severally liable for those items) but still gain equitable relief for other items of which he or she was not aware.
In determining whether it is unfair to hold a spouse jointly and severally liable, the IRS will look to several factors, including whether the claiming spouse benefitted from the understated tax (for instance, by living a lavish lifestyle while tax liabilities went unpaid), whether the parties were divorced, and whether one spouse deserted the other.
It is also important to note that relief under § 6015(b) does not provide relief for underpayments of tax. For example, if the return states a tax due of $5,000.00 and only $3,000.00 is paid, § 6015(b) would be unavailable to a spouse seeking relief from the balance of $2,000.00, regardless of any of the innocent spouse factors.
ii. Separation of Liability Relief: IRC § 6015(c)
A distinct form of equitable relief is available to innocent spouses under IRC § 6015(c) if the spouses are divorced, legally separated or living apart. The understated tax can be allocated based on amounts for which each spouse is responsible. In addition to meeting the universal requirements set forth above, there are a few key points regarding relief under § 6015(c) that should be highlighted.
- For § 6015(c) to apply, the spouses must be divorced, legally separated, or living apart. While the status of being divorced or legally separated is clear, “living apart” is less clear. Based on guidance published by the IRS, spouses are living apart if they are not members of the same household during the 12-month period ending on the day innocent spouse relief is requested. Even if spouses are separated, if the home is maintained in anticipation of the spouse’s return (for example, if one spouse is in prison or away on military service), then the spouses are not considered to be living apart.
- Equitable relief is not available under § 6015(c) to the extent that the requesting spouse had actual knowledge of the understatement. This is a different standard than that set forth under 6015(b); simply having reason to know of the erroneous item is not a basis upon which a court can draw the inference that the spouse had actual knowledge of the understatement. However, a spouse that deliberately avoids learning about the erroneous item, or if the erroneous item is the result of property that the spouses jointly owned, then a determination of actual knowledge is more likely.
- Equitable relief is precluded in its entirety if the IRS can prove that the spouses transferred assets to each other as part of a fraudulent scheme. Additionally, if property is transferred to the requesting spouse in an effort to avoid the incurrence or payment of a tax liability, then the understatement of tax attributable to the requesting spouse is increased by the value of the property transferred to the requesting spouse. If a transfer of property is made to the requesting spouse within one year before the IRS sends its first notice of the proposed deficiency, then a presumption arises that the transfer was made to avoid the incurrence or payment of tax.
- Like § 6015(b), this section only applies to understatements of tax. No relief is provided under this section for underpayments of tax.
- In allocating liability, the requesting spouse does not have to establish his or her innocence regarding the deficiency. If the requesting spouse proves that any part of the understatement is not attributable to him or her, relief must be granted unless the IRS can prove a condition defeating relief exists.
iii. Equitable Relief: IRC § 6015(f)
In the event a spouse does not qualify for relief under IRC §§ 6015(b) or (c), the spouse may still pursue relief under the catchall of IRC § 6015(f), generally described as “equitable relief.”
Equitable relief under this provision is unique in that it can provide relief from both an understatement of tax and an underpayment of tax.
In addition to meeting the universal requirements set forth above, several other conditions must be met before a spouse is eligible for relief under § 6015(f):
- Relief under either IRC § 6015(b) or (c) cannot be available to the requesting spouse;
- Assets cannot have been transferred between the spouses as part of a fraudulent scheme or in an effort to avoid tax;
- The requesting spouse cannot have knowingly participated in the filing of a fraudulent return;
- The liability at issue must be attributable to the non-requesting spouse (this requirement can be disregarded in in certain circumstances, such as when the non-requesting spouse engages in fraud, or the requesting spouse is the victim of domestic violence);
- The non-requesting spouse cannot have transferred “disqualified assets” to the requesting spouse. A “disqualified asset” is one that was transferred to the non-requesting spouse with the principal purpose of the avoidance of tax or payment of tax. A presumption arises that an asset is disqualified if it is transferred within a year of the IRS contacting the taxpayers about a proposed deficiency.
Once the threshold requirements for relief under § 6015(f) are met, the next determination the IRS will make is whether the case is “streamlined” or not. Under newly issued IRS guidelines, set forth in Rev. Proc. 2013-34, equitable relief cases under IRC § 6015(f) are divided into streamlined and non-streamlined categories. If a case is streamlined, relief is generally granted. A case is considered streamlined if all of the following conditions are met:
- The spouses are either divorced, legally separated, have not been members of the same household for a year or more, or one of the spouses is deceased;
- The requesting spouse will suffer economic hardship if the IRS does not grant the requested relief;
- The requesting spouse did not:
- Know of or have reason to know of the deficiency, or
- Know of or have reason to know that the non-requesting spouse would not or could not pay the underpayment
If streamlined treatment is not available, then the IRS will weigh the particular facts and circumstances applicable to the requesting spouse to determine whether it would be inequitable to hold the requesting spouse partially or wholly responsible for the at-issue liability. The factors the IRS looks to in making this determination include:
- Whether the spouses are separated or divorced;
- Whether the requesting spouse would suffer significant economic hardship if relief is not granted;
- Whether one or both of the spouses has a legal obligation under a divorce decree to pay the tax;
- Whether the requesting spouse received a significant benefit (beyond normal support) from the underpaid tax or the item giving rise to the understatement of tax;
- Whether the requesting spouse has made a good faith effort to comply with the tax laws; and
- Whether the requesting spouse knew or had reason to know about the item that caused the understatement or that the tax would not be paid.
Recent Modifications to Equitable Relief under § 6015(f)
The determination of whether a spouse is entitled to equitable relief under IRC § 6015(f) has recently undergone significant modification. Specifically, in Rev. Proc. 2013-34, a link to which is provided above, the IRS superseded its previous guidance (Rev. Proc. 2003-61) and modified, in a manner favorable to taxpayers, certain substantive considerations in determining whether a spouse is entitled to equitable relief.
i. Substantive Modifications of Rev. Proc. 2013-34
Rev. Proc. 2013-34 primarily altered the substantive analysis the IRS will undertake when determining whether a requesting spouse is entitled to equitable relief. Keep in mind that the changes set forth in Rev. Proc. 2013-34 are most relevant when a case is not “streamlined” and the IRS is therefore required to engage in a balancing test to determine whether holding the requesting spouse liable would be inequitable.
The changes set forth in Rev. Proc. 2013-24 are almost uniformly taxpayer-friendly. More than anything, these changes represent awareness on the IRS’s part of the severe hardship spouses in abusive or domineering relationships face. Below is a brief summary of the significant changes:
- Rev. Proc. 2013-34 directs the IRS to place greater emphasis on, and grant more deference to, the issue of whether the spouse suffered from domestic abuse. The weight given to the existence of domestic abuse is significant enough that it will negate other factors that might have weighed against a finding of entitlement to equitable relief.
- The determination of whether economic hardship would result if equitable relief were denied was modified to be based on minimum standards of income, expenses, and assets. Further, a finding that economic hardship will not result from a denial of the requested relief does not, in and of itself, weigh against a granting equitable relief as it previously did. Instead, it is now treated as neutral factor.
- A finding that the requesting spouse had actual knowledge of the item causing the understatement is not weighed more heavily than other factors, as it was previously. Additionally, if the requesting spouse did not challenge the non-requesting spouse’s treatment of any tax items out of fear of retaliation, then even actual knowledge of improper treatment of an item will not preclude equitable relief.
- Similarly, abused spouses, or those spouses with no control over financial decisions, will not suffer from having the “significant benefit” factor weigh against them in the determination of equitable relief.
- A spouse’s subsequent compliance with the tax laws will weigh in favor of a request for equitable relief. Prior to Rev. Proc. 2013-34 it was merely a neutral factor.
- Whereas previously the liability from which the requesting spouse sought relief had to be attributable to the non-requesting spouse, relief under § 6015(f) is available even if the item is attributable to the requesting spouse if the tax deficiency is the result of the non-requesting spouse’s fraud.
- A legal obligation of the requesting spouse to pay the liability is taken into consideration. Previously, only whether the non-requesting spouse had a legal obligation to pay the liability was taken into account.
ii. Procedural Modifications
Additionally, recent changes to the application of IRC 6015(f) have eased time constraints on filing relief requests. Whereas previously claims for equitable relief had to be filed within two years of the IRS’s first attempt to collect the liability (as is still the case under IRC §§ 6015(b) and (c)), in IRS Notice 2011-70, the time period was extended to match the IRS’s general collection deadline of 10 years after the assessment of the liability. This provision was recently adopted as part of a proposed treasury regulation, and is likely to become final regulation. We previously blogged about this change here and here.
The modifications to equitable relief set forth in Rev. Proc. 2013-34 are a clear sign that the IRS is beginning to recognize the reality that its previous standards in evaluating equitable relief claims were too stringent. Abused spouses, or those spouses who have no control over the household’s finances and fear retaliation from their spouse if any attempt to assert control is made, should not be forced to incur joint and several liability based on the actions of their spouse. Further, the two-year deadline on filing equitable relief claims was too strict. Given the turmoil that divorced or separated spouses often face, resolving past tax liability may, initially, be a low priority. The extended time limit allows spouses to focus on more immediately pressing concerns before addressing their tax debt.
Innocent spouse relief under IRC § 6015 is a crucial lifeline to many taxpayers facing severe, unexpected tax burdens due to the actions of their spouse. Reforms liberalizing the application of section 6015, like Rev. Proc. 2013-34, should be both welcomed and taken advantage of by taxpayers.
The attorneys at Fuerst, Ittleman, David & Joseph have extensive experience working with taxpayers facing tax deficiencies and IRS collection efforts. We will continue to monitor the development of innocent spouse relief under the Internal Revenue Code, and we will update this blog with relevant information as often as possible. You can reach an attorney by calling us at 305-350-5690 or emailing us at firstname.lastname@example.org.