Under current federal tax law, married persons may choose to either file their income tax returns jointly or separately. The decision can be significant. For example, many provisions of the Internal Revenue Code (Code) severely limit or completely disallow certain tax benefits if a married couple fails to file a joint tax return. Thus, standard advice seems to be to file a joint income tax return to take advantage of these benefits.
However, there can be unforeseen disadvantages in filing a joint tax return when married. Under Section 6013(d)(3) of the Code, if the parties file a joint tax return for any year, both are jointly and severally liable for all of the tax debts associated with the joint return. In layman’s terms, this means that the IRS can go after either spouse for any additional tax and/or failure to pay tax showing on the return.
Predictably, this rule can lead to unfairness. For example, assume one spouse commits illegal or illicit acts without the other spouse’s knowledge and fails to report any income associated with the unlawful conduct on the joint return. In these instances, the IRS can (and often times will) seek the unpaid taxes related to the unlawful income from both spouses if a joint return has been filed. Regrettably, in my professional career, I have seen this happen on more than several occasions.
To alleviate against these injustices, Congress has amended the Code several times over the last few decades. In 1971, Congress passed its first Innocent Spouse Act. See Pub. L. No. 91-679, 83 Stat. 675 (1971). Decades later, Congress strengthened protections afforded to innocent spouses through passage of the IRS Restructuring and Reform Act of 1998, Pub. L. No. 105-206. Today, the innocent spouse provisions are located in Section 6015 of the Code.
This Insight first discusses the history of innocent spouse relief. It then discusses the requirements of innocent spouse relief today under Section 6015 of the Code and provides guidance on the factors the IRS and federal courts look to in determining whether to grant innocent spouse relief. Finally, it concludes with typical circumstances in which innocent spouse relief can be raised, either administratively or judicially.
History of Innocent Spouse Relief
When our federal tax laws first arose, married couples were required to file separate income tax returns. This continued until 1918 when Congress passed legislation permitting married spouses to file joint income tax returns. Not long after, the IRS began to argue that spouses who filed joint income tax returns should be jointly and separately liable for the tax debts associated with those joint tax filings. See, e.g., Gummey v. Comm’r, 26 B.T.A. 894, 895-96 (1932). Some federal courts disagreed with the IRS’ position and believed that the IRS should be required to apportion tax liability on the basis of each spouse’s respective income. See Cole v. Comm’r, 81 F.2d 485, 489 (9th Cir. 1935). But Congress ultimately sided with the IRS and adopted its theory of joint and several liability. Revenue Act of 1938, 52 Stat. 447, 476 (1938).
Of course, inequities occurred as a result of the 1938 legislation. As mentioned above, many spouses found themselves liable for tax debts created solely by their former spouse’s unlawful conduct and activities. In these cases, innocent spouses often had to argue that the tax return was signed under duress, which if successful, would relieve them from the joint tax debts.
In 1971, Congress stepped in to alleviate some of the harsh results that had occurred as a result of its 1938 legislation. Specifically, it enacted the Innocent Spouse Act, which permitted an innocent spouse to escape joint and several tax liability in limited instances relating to unreported income, but only if the innocent spouse could satisfy certain strict requirements. In 1984, Congress again expanded innocent spouse relief through enactment of the Deficit Reduction Act of 1984, Pub. L. No. 98-369, 98 Stat. 494. Under this legislation, an innocent spouse was not liable for joint tax liabilities if the innocent spouse could show: (1) a joint return was filed for the tax year; (2) the joint return contained a substantial understatement of tax attributable to grossly erroneous items of the other spouse; (3) the innocent spouse did not know (and had no reason to know) of the substantial understatement at the time the return was signed; and (4) it would be inequitable to hold the innocent spouse liable for the tax.
But still more criticism continued as more and more innocent spouses were unknowingly caught bearing the tax debts for unlawful acts they did not know or participate in with their former spouses. Thus, Congress enacted the IRS Restructuring and Reform Act of 1998, Pub. L. No. 105-206, 112 Stat. 685. Under this legislation, an innocent spouse can qualify for relief if they meet the requirements of either Section 6015(b), (c), or (f) of the Code.
Section 6015 Relief
Section 6015 relief only applies to tax liabilities imposed under Subtitle A of the Code, i.e., those related to income taxes. Because self-employment income taxes are in Subtitle A, it includes these taxes. However, it does not include other filings, such as employment tax returns. See also Treas. Reg. § 1.6015-1(a)(3).
Section 6015(b) Relief
A requesting spouse can qualify for Section 6015(b) relief of all or a part of the joint tax liabilities if the requesting spouse can show:
- A joint tax return was filed;
- The joint tax return has an understatement of tax attributable to erroneous items of the nonrequesting spouse. For these purposes, an erroneous item is an income, deduction, credit, or basis item that is omitted from or incorrectly reported on the joint tax return. See Reg. § 1.6015-1(h)(4).
- When the requesting spouse signed the return, he or she did not know or have reason to know of the understatement;
- Under the applicable facts and circumstances, it would be inequitable to hold the requesting spouse liable for the joint tax liability; and
- The requesting spouse elected relief within 2 years after the IRS began collection activities against him or her.
Generally, federal case law and the Regulations have concluded that a requesting spouse has the requisite knowledge and is therefore disqualified from relief if: (1) he or she actually knew of the understatement, or (2) a reasonable person under the relevant circumstances would have known of the understatement. Treas. Reg. § 1.6015-2(c). Because it is often difficult for the IRS to show actual knowledge, the relevant inquiry often turns on whether a reasonable person under the circumstances would have known of the understatement.
For these purposes, relevant facts may include: (1) the nature and amount of the erroneous item at issue; (2) the couple’s financial situation; (3) the requesting spouse’s educational background and business experience; (4) the extent of the requesting spouse’s participation in the activity that resulted in the erroneous item; (5) whether the requesting spouse failed to inquire, at or before the time the return was signed, about the items on the return that a reasonable person would have questioned; and (6) whether the erroneous item represents a departure from a recurring pattern reflected in prior year returns. Treas. Reg. § 1.6015-2(c). Proposed Regulations have also added to this list the following factors: (1) whether there was any deceit or evasiveness by the nonrequesting spouse; (2) the requesting spouse’s involvement in business or household financial matters; and (3) any lavish or unusual expenditures compared with past spending habits. Prop. Reg. § 1.6015-2(b).
To determine whether it would be inequitable to hold a requesting spouse jointly and severally liable for an understatement under Section 6015(b), the IRS and federal courts often look to whether the requesting spouse benefitted in any significant manner beyond normal support from the understatement. See Cheshire v. Comm’r, 282 F.3d 326 (5th Cir. 2002). Other equitable factors tinclude: (1) whether the nonrequesting spouse has deserted the requesting spouse; (2) whether the spouses are divorced, separated, or living apart; (3) whether the requesting spouse would suffer economic hardship if relief is not granted; (3) whether the nonrequesting spouse has a legal obligation to pay the tax debts pursuant to a divorce decree or other instrument; and (5) whether the requesting spouse has made a good faith effort to comply with the income tax laws in years after the request for relief is made.
Section 6015(c) Relief
Section 6015(c) provides relief with respect to joint tax debts that arise from deficiencies associated with the nonrequesting spouse. To qualify for relief under this provision, the requesting spouse must show the following:
- A joint tax return was filed;
- When the innocent spouse requests relief, the innocent spouse is no longer married to the nonrequesting spouse or they are legally separated, widowed, or had not lived in the same household for the 12 months immediately prior to the election;
- The IRS cannot show that the requesting spouse had actual knowledge, at the time the joint tax return was signed, of any item giving rise to the deficiency; and
- The innocent spouse elected relief within 2 years after the IRS began collection activities against him or her.
If these requirements are met, Section 6015(c) effectively serves to shift a portion of the deficiency to the nonrequesting spouse. The general effect of Section 6015(c) is that the tax liabilities are determined on a separate return basis, subject to some exceptions.
However, the requesting spouse is not entitled to relief under Section 6015(c) if the IRS can show that, at the time he or she signed the return, the requesting spouse had “actual knowledge” of any item giving rise to the deficiency. Section 6015(c)(3)(C). In these cases, the IRS has the burden of proof to show by a preponderance of the evidence that the requesting spouse had actual knowledge of the erroneous item. Treas. Reg. § 1.6015-3(c)(2).
The degree of actual knowledge often depends on the character of the item at issue. If the deficiency relates to omitted income, the IRS must show the requesting spouse’s actual knowledge of the receipt of income. Treas. Reg. § 1.6015-3(c)(2)(i)(A). If the deficiency relates to an erroneous deduction or credit on the return, the IRS must show the requesting spouse’s actual knowledge of the facts that made the item not allowable or permitted as a deduction or credit. Treas. Reg. § 1.6015-3(c)(2)(i)(B)(1). Finally, if the deficiency relates to a fictitious or inflated deduction, the IRS must show that the requesting spouse actually knew that the expenditure was not incurred or not incurred to that extent. Treas. Reg. § 1.6015-3(c)(2)(i)(B)(2).
A requesting spouse may get around the actual knowledge disqualification if he or she can show domestic abuse or violence by the nonrequesting spouse. Treas. Reg. § 1.6015-3(c)(2)(v). To be eligible in these instances, the requesting spouse must show that: (1) he or she was a victim of domestic abuse before signing the return, and (2) he or she did not challenge the treatment of any items on the return for fear of the nonrequesting spouse’s retaliation. In many cases, the requesting spouse in these circumstances can also request to be relieved from joint liability on the basis that he or she signed the return under duress. Id.
Section 6015(f) Relief
Section 6015(b) and (c) may not cover all instances of inequity. For example, neither of those provisions provides relief to an innocent spouse if a joint return has been filed, it is correct in every respect, but the nonrequesting spouse failed to pay the amount of tax liability reported on the return (perhaps even while reassuring the innocent spouse that the tax would be paid). Here, Section 6015(f) can provide relief if the requesting spouse can show:
- The requesting spouse does not qualify for relief under Section 6015(b) or Section 6015(c) above; and
- Under all the facts and circumstances, it would be inequitable to hold the taxpayer liable for the underpayment or deficiency.
Generally, the federal courts and the IRS look to Rev. Proc. 2013-34 in determining whether an innocent spouse qualifies for equitable relief under Section 6015(f). However, the Tax Court has held on numerous occasions that it is not bound by guidelines in the Revenue Procedure. See Pullins v. Comm’r, 136 T.C. 432 (2011); Porter v. Comm’r, 132 T.C. 203 (2009). Rather, the court may look to all of the relevant facts and circumstances.
Rev. Proc. 2013-34 has three significant and distinct parts: (1) threshold requirements; (2) streamlined determinations; and (3) non-streamlined determinations based on all the facts and circumstances.
Threshold Requirements of Rev. Proc. 2013-34
The threshold requirements of Rev. Proc. 2013-34 are located in Section 4.01. These threshold requirements for Section 6015(f) relief include: (1) the requesting spouse must have made a joint return for the year relief is sought; (2) relief must not be available under Section 6015(b) or (c); (3) the individual must apply for relief within the period of limitations on collection under Section 6502 (generally, 10 years subject to tolling in certain instances); (4) no assets must have been transferred between the requesting and nonrequesting spouses as part of a fraudulent scheme; (5) no disqualified assets must have been transferred to the requesting spouse from the nonrequesting spouse; 6) the requesting spouse must not have knowingly participated in the filing of a fraudulent joint return; (7) the tax debt from which the requesting spouse seeks relief must be attributable (either in whole or in part) to an item of the nonrequesting spouse or an underpayment resulting from the nonrequesting spouse’s income (subject to some exceptions more clearly described in the Revenue Procedure).
If the requesting spouse satisfies all of the threshold requirements, the IRS will proceed to determine whether the requesting spouse is entitled to relief under Section 6015(f) under a streamlined determination. To meet the streamlined determination criteria, the requesting spouse must show:
- The requesting spouse is no longer married to the nonrequesting spouse;
- The requesting spouse would suffer economic hardship if relief were not granted; and
- The requesting spouse did not know or have reason to know that there was an understatement or deficiency on the joint income tax return or did not know or have reason to know that the nonrequesting spouse would not or could not pay the underpayment of tax reported on the joint income tax return. However, if the requesting spouse can show the nonrequesting spouse abused the requesting spouse or maintained control over household finances by restricting the requesting spouse’s access to financial information, this factor may nevertheless be satisfied.
Non-Streamlined Determinations (Facts and Circumstances)
If the requesting spouse does not qualify for a streamlined determination, the requesting spouse may still be entitled to relief under Section 6015(f) based on the facts and circumstances. These include:
- Whether the requesting spouse is no longer married to the nonrequesting spouse as of the date the IRS makes its determination. If the requesting spouse is married to the nonrequesting spouse, this factor is neutral. If the requesting spouse is no longer married to the nonrequesting spouse, this factor weighs in favor of relief. Generally, for purposes of this inquiry, the requesting spouse is considered no longer married if he or she is divorced, legally separated, or has not been a member of the same household as the nonrequesting spouse for a period of 12-months prior to the IRS’ determination.
- Whether the requesting spouse will suffer economic hardship if relief is not granted. For these purposes, an economic hardship exists if satisfaction of the tax debt in whole or in part would cause the requesting spouse to be unable to pay reasonable basic living expenses. If denying relief from joint and several liability will cause the requesting spouse to suffer economic hardship, this factor weighs in favor of relief. Conversely, if denying relief from joint and several liability will not cause the requesting spouse to suffer economic hardship, this factor will be neutral.
- For understatement cases, whether the requesting spouse knew or had reason to know of the item giving rise to the understatement or deficiency as of the date the joint return was filed. If the requesting spouse did not know and had no reason to know of the item giving rise to the understatement, this factor weighs in favor of relief. On the other hand, if the requesting spouse knew or had reason to know of the item giving rise to the understatement, this factor weighs against relief.
- For underpayment cases, whether the requesting spouse knew or had reason to know that the nonrequesting spouse would not or could not pay the tax debt at the time the return was filed or within a reasonable period of time after the return has been filed. This factor weighs in favor of relief if the requesting spouse reasonably expected the nonrequesting spouse to pay the tax debt reported on return.
- Whether the requesting spouse or nonrequesting spouse has a legal obligation to pay the outstanding federal tax debts, g., under a divorce decree. This factor weighs in favor of relief if the nonrequesting spouse has the sole legal obligation to pay the outstanding income tax debts pursuant to the agreement. If the requesting spouse has the sole obligation to pay, this factor weighs against relief.
- Whether the requesting spouse significantly benefitted from the unpaid tax debts or understatement. For these purposes, a significant benefit is any benefit in excess of normal support. Thus, if the requesting spouse enjoyed the benefits of a lavish lifestyle, such as owning luxury assets and taking expensive vacations, this factor would weigh against relief. But if the nonrequesting spouse controlled the household and business finances or there was abuse, then this may mitigate any expensive lifestyle decisions rendering it as a neutral factor. If only the nonrequesting spouse significantly benefitted from the unpaid tax or understatement, and the requesting spouse had little or no benefit, or the nonrequesting spouse enjoyed the benefit to the requesting spouse’s detriment, this factor weighs in favor of relief.
- Whether the requesting spouse has made a good faith effort to comply with the income tax laws in the tax years following the tax year or years to which the request for relief relates.
- Whether the requesting spouse was in poor physical or mental health. This factor weighs in favor of relief if the requesting spouse was in poor mental or physical health at the time the return or returns were filed or at the time the requesting spouse requested relief.
These factors are only “guides” and are not intended to comprise an exhaustive list of relevant factor. Other factors may be relevant in determining whether the requesting spouse is entitled to relief. In addition, no one factor or majority of factors necessarily determines whether the requesting spouse qualifies for relief.
How to Request Innocent Spouse Relief
There are a variety of recognized methods to raise innocent spouse relief. The most common method is where the requesting spouse files a Form 8857, Request for Innocent Spouse Relief, with the appropriate IRS office. The IRS Form 8857 is designed to elicit responses and information related to many of the factors and requirements for relief discussed already above. Without doubt, the most important portion of the Form 8857 is Part VI which permits the requesting spouse to tell her story to the IRS as to why innocent spouse relief should be granted. A good narrative will weave in concrete and substantiated facts in conjunction with the relevant factors necessary for relief. If the IRS denies relief based on the submission of a stand-alone Form 8857, the requesting spouse can file a petition with the U.S. Tax Court to seek a redetermination of that decision. See Section 6015(e); Francel v. Comm’r, T.C. Memo. 2019-35.
Another method to request innocent spouse relief is through asserting it as an affirmative defense in a Tax Court petition after the IRS has issued a notice of deficiency. See, e.g., Young v. Comm’r, T.C. Memo. 2012-255. Moreover, innocent spouse relief can be raised at the collections phase in response to the IRS’ issuance of a notice of federal tax lien or a proposed levy. Specifically, the requesting spouse can assert it during the Collection Due Process (CDP) hearing that follows after these collection actions. Prop. Reg. § 1.6015-5(a)(2); see also Section 6330(c)(2)(A)(i).
Congress has continuously provided broader protections to innocent spouses to cure inequities that can (and often do) occur after a marriage fails. Where appropriate, innocent spouses should not be fearful in raising it as a defense to a deficiency or underpayment of federal income taxes.
Need assistance in managing the Tax Compliance process? With our unique substantive and procedural knowledge, we can provide a comprehensive approach to the tax dispute resolution process, often collaborating with clients’ existing tax professionals to formulate creative solutions to the most complex tax problems. Freeman Law offers value-driven legal services and provides practical solutions to complex tax issues. Schedule a consultation now or call (214) 984-3000 to discuss your tax concerns and questions.