Better Late Than Never: New Relief for Joint Filers

By Deborah J. Muhlbauer

In July of 1998, Congress passed the IRS Restructuring and Reform Act of 1998. Although much of this legislation is political rather than logical, one major change that will provide true benefits to taxpayers is in relation to relief from joint and several liability. Since 90% of the taxpayer's that sought relief in Tax Court under the old legislation were women, this new relief should be of particular interest to the membership of WBASNY, as both practitioners and taxpayers. However, to understand the magnitude of the changes, it is necessary to first briefly review the law prior to the new legislation.

INNOCENT SPOUSE UNDER THE OLD LAW

After 1984, in both omitted income cases and deduction cases, a taxpayer qualified for relief as an innocent spouse if all of the following requirements were met.

 

• That a joint return was filed.
   
  
• That the return contained a substantial understatement of tax, i.e. $500.00 or more, exclusive of interest and penalties.
   
  
• That the substantial understatement was attributable to "grossly erroneous items" of the non-innocent spouse. Omitted income is per se grossly erroneous, but disallowed deductions, credits, or basis must also be proven to have had "no basis in fact or law".
   
  
• That when the innocent spouse signed the return, he/she did not know, or have reason to know of the understatement contained on the return.
   
  
• That it would be inequitable to hold the innocent spouse liable under all of the facts and circumstances.

In addition to the above, in cases of grossly erroneous items involving deductions, credits or basis, the spouse had to also demonstrate that in the preadjustment year, i.e. the year prior to the issuance of the notice of deficiency, the substantial understatement in issue exceeded one of the following:

• 10% of the innocent spouses adjusted gross income if the AGI was $20,000.00 or less, or
   
  
• 25% of the innocent spouses AGI if the AGI was $20,001.00 or more.

The innocent spouse’s AGI in the preadjustment year had to include the income of a spouse, whether or not the spouse in the preadjustment year is the spouse from the year the understatement arose. The taxpayer had the burden of proof on each and every element.

INNOCENT SPOUSE UNDER THE NEW LAW

The IRS Restructuring and Reform Act of 1998 eliminated subsection (e) of §6013 from the Code and replaced it with new IRC §6015 which expanded the innocent spouse provisions of the Code by eliminating the taxpayer’s need to establish the following:

1. That the return contained a substantial understatement.
    
   
2. That the understatement was grossly erroneous.
    
   
3. That the taxpayer meets the AGI limitations in the preadjustment year.

Therefore, to establish entitlement to innocent spouse relief under current law, the taxpayer need only show the following:

1. That a joint return was filed.
    
   
2. He/she did not know or have reason to know of the understatement.
    
   
3. That it would be inequitable to hold the innocent spouse liable under all of the facts and circumstances.

NEW APPORTIONED RELIEF

The new legislation also provides for apportioned relief where the taxpayer is unable to establish that he/she did not know or have reason to know of the understatement contained on the return, but rather can establish that he/she did not know the extent of such understatement. In such a case the taxpayer can obtain relief from the tax, penalties and interest to the extent that the liability is attributable to the portion of the understatement about which he/she did not know or have reason to know.

NEW ELECTION FOR DIVORCED OR SEPERATED TAXPAYERS

In addition to the above, the IRS Restructuring and Reform Act of 1998 includes added relief for divorced or separated taxpayers. New IRC §6015(c) provides for an election that enables an individual to limit his/her liability to that portion of a joint deficiency that is attributable to items allocable to that individual. Items of income are allocated to the respective individuals who earned the income. For deductions or credits, the amount of the deficiency allocated is limited to the amount of income or tax allocated to such spouse that was offset by the deduction or credit.

A taxpayer is eligible to make this election if one of the following applies:

1. The taxpayer is no longer married to the spouse with whom the joint return was filed.
    
   
2. The taxpayer is legally separated from the spouse with whom the joint return was filed.
    
   
3. The taxpayer and the spouse with whom the joint return was filed have lived apart for more than 12 months.

The burden of proof with respect to the appropriate allocation is on the taxpayer. Additionally the election is not available if the Secretary can establish one of the following:

1. That the assets were transferred between the joint filers as part of a fraudulent scheme, or
    
   
2. That the taxpayer had actual knowledge of the understatement (unless the return was filed under duress).

EQUITABLE RELIEF

In addition to the two enumerated relief provisions now provided for in the Code, IRC §6015(f) provides the Secretary with the power to provide a taxpayer with relief from a joint liability based on principles of equity. This discretion applies both to deficiencies and understatements and applies only where relief under one of the specific enumerated provisions is not available.

This provision, while not limited to non-payment cases, will for the first time provide relief to spouses in situations where tax is shown on a return but not paid. In a recent Announcement from the IRS the Service detailed some of the items that will be considered in making an equitable analysis of entitlement to relief. These items include but are not limited to the following:

1. Has the applicant spouse paid his/her fair share? (If a single, rather than joint, return had been filed, did the applicant spouse pay tax on his/her personal liability?
    
   
2. Did the applicant spouse benefit from the underpayment?
    
   
3. Is the spouse seeking relief still married or living in the same household?

 

Applications for equitable relief must be signed by the applicant spouse under penalty of perjury. The Service will assume that all statements contained in the application are true unless contrary information is discovered. The Service may interview the other spouse. However, the Service's Announcement pledges that inquiry will not be expanded into the entire marital relationship, but rather will be limited to the issues of equity. Finally, although it may not be equitable to relieve a taxpayer of the tax, the Service may provide relief by abating penalties and/or interest related to the tax liability.

THE PROCEDURE

In order for a taxpayer to claim innocent spouse status or entitlement to proportionate liability, he/she must make an election on a form proscribed by the Secretary not later than 2 years after the date the Secretary has begun collection activities with respect to the individual making the election. For cases open at the time of enactment the election must be made within 2 years of the Secretary’s first collection activity that occurs after the date of enactment. This means that it is retroactive without limitation for all collection cases that are open at the time of enactment.

If the taxpayer makes an election and the IRS mails a notice denying the relief requested under either provision, or if the Service does not act within 6 months of the request, the taxpayer can petition the United States Tax Court within 90 days of the earlier of the IRS denial or the expiration of the six month period following the filing of the election. The IRS is prohibited from taking any collection action from the filing date of the election until after the expiration of the 90 day period discussed in the preceding sentence, or if a petition to the US Tax court is filed, until after the Tax Court decision becomes final, plus 90 days. During the time that collection is prohibited, the statute of limitations on collection is tolled, plus 60 days.

CONCLUSION

Although the Restructuring and Reform Act is obviously the by-product of an election year, it does include a few major benefits to taxpayers. One such benefit with the greatest potential to impact the largest number of taxpayers is the addition of Section 6015 to the Code. Any practitioner who is currently representing a taxpayer in a collection dispute arising from a joint return must consider the potential application of this new Section. Although not quite the abolition of joint and several liability that took effect after January 1, 1999 in New York State, it's a close second.

Deborah J. Muhlbauer is a partner with the law firm of Bluestein & Muhlbauer, P.C. specializing in tax controversies and estate planning and is an adjunct professor of tax practice and procedure at the State University of New York at Buffalo, School of Law.

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