Requesting Innocent Spouse Relief: How long is long enough to request relief? Not two years. Another reflection on the NTA’s recent Innocent Spouse blog

We welcome guest bloggers Robert Horwtiz, Hochman Salkin Rettig Toscher & Perez, P.C., and Carolyn Lee, Morgan, Lewis & Bockius LLP. Both Robert and Carolyn practice tax controversy and litigation in California. They each have extensive experience with section 6015 innocent spouse matters – many involving no- or low-income taxpayers. In addition, they each have a history of pro bono service including volunteering with state and county Bars and low-income tax clinics, and assisting taxpayers during the Tax Court Calendar Call. The comments and recommendations in this post are Robert’s and Carolyn’s personally, and do not represent the views of their firms or any Bar Association. 

Robert and Carolyn reached out to us after the recent post providing statistics on the timing of innocent spouse relief. They are promoting a legislative change to the innocent spouse provisions that eliminates the time limitation for requesting relief. Their proposal, as explained in detail in the post and attachment below, would eliminate a restriction on requesting relief that does not follow the spirit of the statute. In a recent post regarding time frames and notice, Carl Smith discussed Mannella v. Commissioner, 132 T.C. 196, 200 (2009), rev’d and remanded on other issue, 631 F.3d 115 (3d Cir. 2011) as well as the regulation comments that he and I and others made in response to the proposed “new” regulations for 6015 resulting from the IRS pull back of the two year rule formerly applicable by regulation to section 6015(f). Robert and Carolyn take a broader view of the problem and seek legislation to eliminate the time period entirely. Doing so lines up with the goal of innocent spouse relief. For a host of reasons, discussed below, discussed in our regulation comments, discussed by the NTA and highlighted by cases like Mannella, individuals caught up in domestic break ups need time to sort through the resulting problems in their lives. I have not met clients who postponed dealing with their tax issue out of a desire to inconvenience the IRS. Any delay usually results from factors outside the control of the applicant or factors related to the necessity to secure basic human needs such as safety, shelter, food, and employment (recall Maslow’s hierarchy of needs) before getting to the tax problem. By thinking big to address the problem, Robert and Carolyn may convince Congress to set the statute right. Keith  

Recently Procedurally Taxing commented upon the May 23, 2018 National Taxpayer Advocate (NTA) blog discussing current trends in innocent spouse (§6015) determinations of relief. Another feature of the NTA blog was her observation about the effect on application volume of the IRS’s 2011 decision to accept requests for §6015(f) equitable relief through the end of the §6502 statutory collection period – typically at least ten years. The request period for equitable relief is significantly longer than the statutory two-year request period for the other two avenues to §6015 relief, §6015(b) (traditional relief) and §6015(c) (allocated relief). We believe this is a mistake. The §6015 request period should be the same for qualifying requesting spouses regardless of the avenue to relief, and it should extend through the end of the §6502 collection period.

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The NTA noted that extending the equitable relief period from two years to at least ten years did not result in a tsunami of requests. Both the NTA and Procedurally Taxing blogs describe the judicial and legislative route to the longer period to request equitable relief. They observed that §6015(b) and §6015(c) were enacted in 1998 with a two-year request period. Also relevant to the discussion is that the earliest statutory versions of relief from joint and several liability for innocent spouses did not include a two-year limitation on the request period. Inexplicably, the two-year period was included with other, more beneficially expansive revisions to innocent spouse relief with the enactment of §6015 in 1998. The legislative history is silent about the selective limitation. Legend has it there was a concern the Agency would be overwhelmed with requests if the application period were longer. Thanks to the NTA’s research, we know this concern was unfounded.

We see no valid reason to maintain the two-year statutory period to request traditional or allocated relief. A person claiming relief as an innocent spouse under §6015(b), §6015(c) or §6015(f) should be allowed to elect relief at any time during which the IRS has authority to collect the tax underpayment. A truncated period to request relief under two of the three §6015 subsections is at odds with the character of the statute, which is to make the benefits of §6015 relief available to taxpayers who qualify on the merits of their facts and circumstances. A longer statute of limitations acknowledges the complexities of marital relations. Congress enacted three distinct legal remedial forms of §6015 relief. The two-year period to request the benefits of traditional or allocated relief effectively nullifies two §6015 subsections for many requesting spouses.

Last May, as part of the 2018 Washington DC delegation sponsored by the Taxation Section of the California Lawyers Association and the Taxation Committee of the Los Angeles County Bar, we spoke with representatives of the IRS, Treasury, and National Taxpayer Advocate, as well as House and Senate Tax committee staff members about such a change. We advocated for an amendment to §6015 to extend the period of time to request relief for §6015(b) and §6015(c) through the end of the §6502 collection period, as under §6015(f). In a happy coincidence, the Taxpayer First Act, HR 5444, had recently passed the House of Representatives without opposition and was pending in the Senate. The Taxpayer First Act is an ideal legislative vehicle to effect the proposed amendment, including as it does §11303 to codify the extended §6015(f) period to request relief through the end of the §6502 collection period. It is a noncontroversial – dare we say nonpartisan – matter to change §11303 to codify the same extended request period for all three avenues to relief.

Enactment of this simple statutory amendment will bring consistency and increased fairness relative to the statute’s first gate; i.e., the period for requesting relief. The amendment will make relief pursuant to §6015(b) and §6015(c) available to the taxpayers whom these separate forms of relief were intended to benefit, and whose requests are rejected because the two-year application period closed and they cannot qualify for equitable relief pursuant to §6015(f). The change will not increase stress on the IRS or the Tax Court, which have been administering and deciding §6015 matters for almost two decades. Any concern about an overwhelming volume of applications for relief may be assuaged based on data the NTA analyzed. (Please note that the NTA has not commented on the proposal to extend the statutory period of time to request relief from joint and several liability pursuant to §6015(b) and §6015(c).) All the other existing, rigorous requirements to qualify for relief remain the same. This proposal is not a liability give-away. It is no easy task to obtain relief.

The longer request period will make a material difference for requesting spouses who merit relief. Some clients may make a dash for a low-income tax clinic. For those clients, one might conclude the §6015(f) request period could have remained two years. No one is suggesting the NTA’s findings support that argument. However, in our experience, the current two-year request period is too short for most taxpayers dealing with unexpected erroneous tax items, typically during times of family, financial and emotional distress. We find that for every client who acts quickly on IRS collection correspondence there are many dozens more who cannot bring themselves to even open the envelope. Or the second envelope. Paralyzing panic sets in.

The two-year period for seeking relief under §6015(b) and §6015(c) can result in unduly harsh consequences for taxpayers too late to satisfy the statutory two-year period. This is especially true where the spouses do not divorce or become legally separated until after the two-year period, or begin living in separate households more than one year after collection activity begins. In addition, pro se taxpayers – the vast majority of taxpayers who might qualify for relief – likely find the two-year statute a trap for the unknowing. The unintentional adverse collateral consequences of the truncated statute of limitations to request relief pursuant to §6015(b) and §6015(c) have emerged as the law has been applied.

It is important to highlight that §6015(f) equitable relief is not a safety net for requesting spouses after the §6015(b) and §6015(c) gate shuts. Like §6015(b) and §6015(c), equitable relief under §6015(f) serves its own legal purpose, with its own raft of eligibility factors to consider. As applied, §6015(f) is not an avenue to liberally granted relief for requesting spouses who could qualify for traditional or allocated relief but for missing the two-year request period. In fact, §6015(f) expressly is intended to apply when the requesting spouse fails to qualify based on the merits of §6015(b) and §6015(c). For example, requesting spouses may fail to qualify for equitable relief because the requesting spouse has financial resources, which is a factor weighing against equitable relief. Or, the requesting spouse may satisfy the §6015(c) “actual” knowledge test regarding the erroneous item, but fall short on the highly subjective and seemingly all-embracing equitable test for “reason to know” of the erroneous item. There are many circumstances when §6015(f) would not offer a safe harbor to requesting spouses who would qualify for traditional or allocated relief if only they had applied in time.

In addition, §6015(f) as applied by the IRS often fails to serve requesting spouses. The Service simply gets the equitable analysis wrong. As recent examples, two applications for relief were rejected by the IRS Innocent Spouse unit because the requesting spouses failed to establish they suffered abuse. There is no basis in any of the guidance provided by the IRS or the courts to apply a requirement of abuse in order to obtain equitable relief. To the contrary, Revenue Procedure 2013-34 describing factors to consider when determining eligibility for §6015(f) relief expressly expanded the factual parameters pertaining to physical and emotional abuse to make relief more available in such circumstances. Unrepresented taxpayers confronted with incorrect administrative rejections may not have the wherewithal to rebut these determinations, including undertaking the next – potentially remedial but perhaps overwhelming – step of petitioning for Tax Court review.

As another collateral consequence, if the government brings an action to reduce to judgement joint liabilities against a taxpayer who may be eligible for innocent spouse relief after the two-year period for requesting relief, the taxpayer would be unable to defend based upon being an innocent spouse.

We could go on, and did go on during the DC Delegation meetings. We continue to monitor the Taxpayer First Act, with the hope that the legislation will be amended to extend the period of time to request §6015 relief for each of the three avenues to relief to be coterminous with the period of time to collect the tax. Doing so is only fair, and better serves Congress’s wish to put innocent spouses first, thus permitting the IRS to collect tax on erroneous items from the taxpayer responsible for them.

 

 

 

 

Requesting Innocent Spouse Relief

The National Taxpayer Advocate posted a blog detailing the impact of the change in the time period for requesting innocent spouse relief as a result of the litigation concerning the regulation under IRC 6015(f). The result of the study regarding the volume of the requests made after the change in the regulation makes clear that opening the time period for requesting relief under (f) from two years to the full period of the statute of limitations on collection has not had a material impact on the number of requests for innocent spouse relief. This information refutes concerns raised by the IRS in the litigation that opening up the time period would open the floodgates of cases seeking 6015 relief. The IRS makes similar floodgate arguments in the equitable tolling cases with similar empirical data to support its claim.

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For those not familiar with the issue, the 1998 Restructuring and Reform Act significantly changed the innocent spouse provisions and created three forms of relief available under subsections (b), (c) and (f) of IRC 6015. The legislation capped the time period for taxpayers to claim relief under (b) and (c) but was silent regarding (f) relief. The IRS promulgated regulations providing a two year period for seeking relief under (f) to match the time period under the other subsections. Low income taxpayer advocates Paul Kohlhoff and Bob Nadler attacked the regulation in the case of Lantz v. Commissioner, 132 T.C. 131 (2009), rev’d, 607 F.3d 479 (7th Cir. 2010). Although they convinced the Tax Court that this provision of the regulation was contrary to the statute, the Seventh Circuit reversed and upheld the regulations. Two other circuits upheld the regulations and cases were pending in other circuits when a letter from numerous members of Congress convinced the IRS to reverse its position and pull the regulation. [As a side note, the IRS issued Rev. Proc. 2013-34 following its change in course but has yet to publish a new regulation despite seeking comments several years ago.]

Since (f) relief is available to individuals who cannot obtain (b) or (c) relief, one of the IRS arguments in support of the two year limit on (f) relief was that it was necessary in order to avoid an end-run around the time limitation and open the door to a high volume of innocent spouse requests. The statistics published in the NTA’s blog suggest that the IRS fears of a high volume of requests due to the expanded time frame have not materialized. The relatively flat number of requests for relief before and after the change in the regulation suggest no need exists for Congress to amend (f) in order to protect the integrity of the innocent spouse statute.

The lack of any material change suggests that most individuals seeking relief do so relatively shortly after learning of their liability for a tax debt they believe they should not owe. My own experience with individuals seeking this relief supports this conclusion. Most of the time these individuals have ended the marriage and they seek to correct the problem as soon as possible. This is not something about which they procrastinate. The receipt of the IRS notice and demand letter individually and the prospect of facing the IRS collection system usually drive them to seek relief as soon as possible.

The post by the NTA also contains statistics concerning the percentages related to granting of innocent spouse relief. These statistics show a recent decline in the number of cases in which the IRS has granted relief. The statistics match the anecdotal concerns of advocates requesting innocent spouse relief. It is not clear if the quality of the requests has gone down, the review has become tougher or some other factor has influenced the rate at which the IRS grants these requests. As with most matters, it does make a difference if the individual is represented. I would be curious if statistics exist showing whether the number of requests from individuals representing themselves have increased or if the decline in acceptance of these requests reflects an across the board decline. My clinic usually gets involved in these cases when the individuals learn of the clinic after filing a Tax Court petition. Finding a way to have qualified individuals seeking this relief to come to clinics at an earlier stage in the process might improve the success rate of those seeking innocent spouse relief.

 

 

Innocent Spouse Status versus the Federal Tax Lien

The case of United States v. Kraus, No. 3:16-cv-5449 (W.D. Wash. April 3, 2018) demonstrates the problems that can occur when your spouse engages in tax protestor action even if you were “innocent.” The result here for the wife is the loss of her home, even though she has no personal liability for the unpaid tax. She argues that such a result renders her innocent spouse status somewhat meaningless; however, the court points out that innocent spouse status relieves the individual of personal liability but does not destroy the federal tax lien or the remedies available in connection with the lien.

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Ms. Lao married Mr. Kraus in 1988. At the time of the decision, they had three children ages 16, 24, and 27. During almost all of the marriage, Mr. Kraus earned the money used by the couple and she took care of the family. He handled all of the family finances, including tax filing, and gave her an allowance for household expenses. He stopped filing taxes in 1999, claiming that only federal employees need file tax returns. He ran a jewelry business with his brother. When the IRS audited the business and him individually, he did not engage in the audit, causing the agent to determine taxable income without the benefit of his assistance. As a result, the agent determined a huge liability because of the lack of expenses to offset the income. In addition to owing taxes for the years of non-filing, Mr. Kraus had numerous frivolous filing penalties for his tax protestor submissions to the IRS in response to its correspondence.

The couple sold their prior residence in 2003 and purchased a new home. At the time of the suit to foreclose, they had almost completely paid off the home. Mr. Kraus had also “transferred” the home to a trust though the couple and their children continued to live in the home, make all decisions related to the home, and pay all of the bills. Mr. Kraus told Ms. Lao that the transfer to the trust was for estate planning purposes and to protect the property from frivolous suits.

The couple was divorced in 2010 and she began working at a retail store. Mr. Kraus continued to live in the marital home and they split the bills. When the tax situation arose, she applied for and received innocent spouse status under IRC 66, since Washington is a community property state. Despite her innocent spouse status, the IRS sought to foreclose its lien on the property owned by the couple. The court quickly brushed aside the fraudulent transfer and determined that the lien attached to the property. Ms. Lao argued that allowing the IRS to foreclose on the house would render her IRC 66 relief “an empty shell of false security.” The court responded that IRC 66 relief does not entitle her to prevent foreclosure. “While innocent spouse relief prevents the assessment of a tax against Lao individually in any separate property she may possess, it does not affect the ability of the Government to pursue collection remedies against Lao’s interest in community property.” Under Washington law, “all debts of each spouse that are acquired during the marriage attach to the marital community as a whole and one spouse’s tax liabilities are presumed to be community debts if they are incurred during the marriage.”

Even if she obtained a separate property interest after the divorce, she took that interest subject to the preexisting liens or mortgages. “Any separate interest that Lao possesses in the subject property must lie in the equity that exceeds the preexisting mortgage and liens.”

The court finds an open question of whether the lien could continue to grow after her interest in the property separated from the marital community. The court said that interest accruing after the divorce may only attach to his separate property and requested additional briefing on this point. It appears that the IRS will obtain permission to foreclose on the entire property and sell it, leaving her with money from the sale but no home where she and the children, one of whom is a minor, have lived for 15 years. I was surprised that the court did not apply the equitable factors in United States v. Rogers, 461 U.S. 677 (1983) to decide whether selling the home under these circumstances was appropriate. Applying the factors in that case might cause the court to pause in making the decision to sell the property at this time – at least until the youngest child reaches the age of majority.

The case demonstrates the limits of innocent spouse status. Being an innocent spouse does not stop the IRS from taking collection action that can have a negative impact on the innocent spouse where property interests of the non-liable spouse remain intertwined with the liable spouse. While she will receive some equity from the sale of the home, this situation causes her to lose her home despite being innocent of the actions causing the liability.

For those interested in the power of the federal tax lien, the Pro Bono & Tax Clinics committee of the ABA Tax Section will host a panel discussing Kraus and other lien cases at the May Meeting in D.C. next week. Christine

 

Proving Actual Knowledge in a 6015(c) Case

The case of Bishop v. Commissioner, T.C. Summ. Op. 2018-1 although not precedential, provides comfort for spouses seeking relief under the provision available for those who are divorced, widowed, or separated. This case has a couple of unusual aspects worth noting before discussing the main issue – actual knowledge. First, the person claiming innocent spouse status is the former husband. Only a small percentage of innocent spouse cases present the situation in which the husband claims innocence and seeks relief. Second, this case involves an intervenor, the former wife, who is represented by a low income taxpayer clinic. It is unusual to see a clinic on the side of the intervenor though certainly not unprecedented.  (I corresponded with the Lewis & Clark clinic director, Jan Pierce, about the case.  Jan indicated that the clinic picked up the case at calendar call.  This is something the opinion does not indicate.  Because I also pick up cases at calendar call and litigate and lose them, I think it would be nice if the Court somehow made mention of the fact that a clinic or pro bono counsel came into the case at calendar call.  It provides a little background about the limited ability of the representative in the case.)

Here, the parties admit that the wife inherited a retirement account from her father in 2009. They admit that after she inherited this account she received distributions from the account each year and they admit that the distribution made in 2014 in the amount of $15,068 was left off of their return. They also admitted that $6,000 of the distribution went into a joint checking account that both had access to and that the balance was used to benefit the wife’s daughter. The husband claims that he was generally aware of the retirement account but did not know that a distribution occurred in 2014 and, therefore, had no actual knowledge of the amount left off the return. Because he did not have actual knowledge, he asserts that he qualifies for relief from the additional tax liability based on the language of IRC 6015(c).

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The court starts out stating that a “question exists as to where the burden of proof lies in cases when, as here, the IRS favors granting relief and the nonrequesting spouse intervenes to oppose it. The Court has resolved such cases by determining whether actual knowledge has been established by a preponderance of the evidence as presented by all parties.” To determine if a spouse had actual knowledge the IRS considers “all of the facts and circumstances” as required by Treas. Reg. 1.6015-3(c)(2)(iv). The test imposed by the Tax Court examines the surrounding facts and circumstances for “an actual and clear awareness (as opposed to reason to know)” of the omitted income causing the deficiency.

In a situation like this where both spouses know of the retirement account, both spouses know that money has been distributed from the retirement account in each of the five years preceding the year at issue, and both spouses have access to the bank account into which $6,000 of the retirement account distribution in 2014 was made, the person claiming innocent spouse status would seem to bear a heavy burden to demonstrate that he did not know about the distribution. In the background portion of the opinion, the Court noted that the parties separated twice during 2014 before permanently separating in 2015. These facts suggest that the parties did not enjoy harmonious relations in 2014 and that undoubtedly was a factor in the Court’s decision.

The Court states that “he argues that intervenor deliberately deceived him, but he relies on her silence and does not identify any specific misrepresentations by her.” It also states that “he acknowledges that he was at fault for not checking the records on the joint bank account maintained by him and intervenor.”

The wife attacked his credibility and argued that he had actual knowledge of the distribution because it was deposited in their joint bank account seven months before the filing of the return. During that time he wrote checks on the account and used debit cards to access the account. She did not testify that she specifically told him about the distribution and she testified that they both forgot about it when they provided their accountant with the information necessary to prepare the return.

The Court finds that the “history of withdrawals from the retirement account used by the parties over a period of years and the transactions by petitioner with reference to the joint bank account support a conclusion that petitioner should have known about the distribution. The amount was very large in relation to the average balances and other transactions in the account.” Having made that finding which seems very damaging to the petitioner, the Court went on to conclude however that “there is no evidence … that petitioner saw the bank records before the joint return for 2014 was filed. His denials are not incredible, implausible or contradicted by direct evidence.” So, the Court concludes that “regardless of the strong indications of constructive knowledge, the evidence falls short of establishing actual knowledge of any specific amount of the distribution in 2014.”

The case should provide great comfort to anyone seeking to use section 6015(c) if knowledge is the crucial point of contention. The evidence here of constructive knowledge could hardly have been greater and yet the Court declines to rely on the strong evidence of constructive knowledge instead insisting on proof of actual knowledge. Since he denied actual knowledge and she did not testify that she specifically told him about the distribution, there was no evidence that he had specific knowledge. The opinion is consistent with the language of the statute and upholds the actual knowledge requirement in a very literal way.

If you were advising a client you might tell them to make sure that their spouse knows about all of the income coming from their side of the family equation so that your client could testify that the former spouse had actual knowledge but who engages in this type of planning discussion – not many people.

This case demonstrates how difficult proving actual knowledge will be for the IRS or the intervenor. This difficulty is good news for divorced, separated, or widowed spouses who want to avoid a liability caused by income of their former spouse. Remember that to obtain (c) relief you must make the request within two years of collection action. The timing of the request for innocent spouse relief in this situation could be critical because taxpayers like Mr. Bishop may not qualify for relief under IRC 6015(f) and (c) relief may be the only door available in order to walk away from the liability.

 

The Intersection of Innocent Spouse Relief and Offers in Compromise

In Harris v. Commissioner, T.C. Summ. Op. 2017-77, the Tax Court denied a request for innocent spouse (IS) relief to a petitioner whose wife had obtained an offer in compromise (OIC) for the liability from which he sought relief. The Court found that her OIC did not pave the road for him to obtain IS relief. Because the Harvard clinic, like most low income tax clinics, does a high number of OICs and a lesser but still substantial number of IS cases, I read the opinion with interest. I do not remember a previous case in which these two forms of relief from the collection of an assessed liability crossed paths in precisely this manner.

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Mr. and Mrs. Harris got married on December 21, 2012, and continue to reside together in marital harmony at the time of the IS trial in Mr. Harris’ case. The opinion does not discuss whether the timing of their wedding sought to obtain tax benefits available from joint filing or if the timing of the wedding was somehow inextricably driven by factors other than tax. They timely filed their 2012 return (already I am pulling for them – this fact alone makes them an unusual couple to be discussing on the electronic pages of PT.) In 2012, Mr. Harris received wages of $3,877 and non-employee compensation of $3,074 while Mrs. Harris netted $71,784 from three Schedule C businesses. Though they timely filed and made some remittance, they still owed $4,295 of the taxes reported on their return. Both husband and wife participated in filing the return and both knew that their taxes were not fully paid.

In subsequent years, they continued to timely file their returns and Mrs. Harris continue to earn the lion’s share of the family income from her Schedule C businesses. For the year 2013, Mrs. Harris failed to report about $45,000 she received from a distribution from a retirement account. This resulted in an additional assessment for that year. Mrs. Harris also brought into the marriage unpaid taxes for several years. She owed taxes for failure to remit, and she had entered into and defaulted on installment agreements during those years because she continued to fail to make estimated payments.

She decided to request an offer in compromise. Mr. Harris knew about her decision. She submitted an offer for the years 2007 through 2012 (the year of their first joint return.) After some back and forth, the IRS accepted her OIC for a lump sum payment of $7,458 on April 14, 2014. It’s hard to make informed decisions based on limited information but I am shocked that the IRS accepted an offer of this amount given that her 2012 income was $71,784 and her 2013 income was $106,410. Her monthly income leading up to the OIC would have been almost $9,000. Even though she may have had no assets, I would have expected her reasonable collection potential to be approximately $3-5,000 x 12. I am not sure if I want to start having my offers worked in Memphis, send my offers out to whoever prepared hers, or both. Despite my surprise at the amount of the offer, the fact is the IRS accepted it and it may have been a great deal for the IRS for all I know.

The OIC only covered Mrs. Harris and did not cover Mr. Harris. He came to regret this fact and he became very interested in obtaining an OIC himself. He filed doubt as to liability OICs in the four consecutive months of October 2014 through January 2015. The IRS denied each of the OICs, stating that he did not raise an “issue regarding the accuracy or correctness of your tax liability.”

In March of 2015, he took a different tack and filed a request for IS relief. He put in this request that Mrs. Harris should have included him in the OIC she submitted. The IRS denied his request for relief and he filed a Tax Court petition. Mrs. Harris chose not to intervene. Because this is an underpayment case, Mr. Harris needs to obtain relief under IRC 6015(f). The Court looked at Rev. Proc. 2013-34 and the seven conditions listed there. While noting that the factors do not bind the Court, it went through them and found two did not favor relief and five were neutral or weigh slightly against relief. Additionally, the Court pointed out that Mr. and Mrs. Harris left income off their 2012 (his) and 2013 (hers) returns.

Mr. Harris argued that it would be inequitable to hold him liable for the 2012 liability because he should have been included on the OIC. After looking at the circumstances, the Court determined that he was not entitled to 6015(f) relief. The failure to include him on the OIC did not result from fraud or deceit on the part of either Mrs. Harris or the IRS. While it was unclear why he was not included, the failure does not form the basis for IS relief. The result is logical. If he wanted to be on his wife’s OIC, he should have affirmatively taken steps to make it happen. Even if 2012 got added to the OIC at the last minute, the failure to include him does not form the basis for relief through the IS process.

The Court described the four OICs he submitted as being doubt as to liability OICs. Perhaps he should seek to file a doubt as to collectability OIC instead. Mrs. Harris income continues to be relatively high and that may prevent him from obtaining an OIC, but his chances seem better in the collectability realm and non-existent on the liability front. The case points to the need for spouses to coordinate their efforts to obtain relief from the IRS. It is not unusual for one spouse to need relief for liabilities existing before the marriage or separate liabilities during the marriage. In seeking that relief, the spouses need to talk to each other and to professionals. It may be that they need to talk to separate professionals because their interests do not perfectly align. Here, the failure to properly set up her OIC leaves him holding the bag for a liability created by her income. This is both an unfortunate and an avoidable result.

 

 

Sometimes Participation Is Bad: To Participate Meaningfully and Barring the Right to Claim Spousal Relief

Keith, Stephen and I are in the thrice-annual process of sifting through hundreds of developments and choosing the cream of the crop for inclusion and analysis in the Saltz/Book treatise. A case that slipped through when it came out earlier this year is Rogers v Commissioner, which discusses the modified version of res judicata that applies to requests for spousal relief. We discuss the issue extensively in Chapter 7C, which is a standalone chapter addressing relief from joint and several liability.

Rogers provides another piece in the puzzle as to when a taxpayer will be prevented from claiming innocent spouse relief by virtue of failing to raise the claim in an earlier proceeding.

I will briefly discuss the issue and the case below.

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The doctrine of res judicata, or claim preclusion, provides that a previously litigated matter may not be pursued further by the same parties once there has been a final decision on the merits. Section 6015(g)(2) modifies the common law doctrine of res judicata with regard to claims for relief from joint and several liability. It provides that judicata does not bar a taxpayer from requesting relief under section 6015(b), (c), or (f) if: (1) relief from joint and several liability under section 6015 was not an issue in the prior proceeding; and (2) the taxpayer did not participate meaningfully in the prior proceeding.

The statute does not discuss what it means to participate meaningfully in the prior proceeding. Over the years, there have been a handful of cases that have set out what it means to meaningfully participate in a prior proceeding.

Back quickly to the facts of Rogers. Mrs. Rogers and her spouse were no stranger to taxes or tax problems. Mr. Rogers was a tax lawyer who gained some attention principally by putting together debt distressed investments in Brazilian consumer receivables that purportedly generated worthless debt deductions.

The opinion discusses how IRS examined the Rogers’ joint 2004 return, which eventually led to a notice of deficiency proposing an approximate $466,000 tax adjustment mostly stemming from unreported income and excess deductions from Mr. Rogers. The Rogers’ petitioned and tried the matter in Tax Court; Mr. Rogers was counsel for both himself and his wife (as he was for Mrs. Rogers in this matter).

In a 2014 Tax Court opinion, the Tax Court mostly agreed with the IRS and found that they failed to 1) include  income from the husband’s activity and 2) substantiate some business  deductions.  On appeal the 7th Circuit affirmed the Tax Court.

In the original Tax Court deficiency case, Mrs. Rogers did not claim relief under Section 6015. After the Tax Court decision became final, Mrs. Rogers filed a Form 8857, claiming spousal relief for a number of years, including 2004, the year that was the subject of the deficiency proceeding.

IRS denied the claim, and Mrs. Rogers filed a standalone petition to Tax Court seeking court review of the IRS’s denial. IRS moved to dismiss the case as per Section 6015(g)(2) on the grounds that she had her chance in the deficiency case to raise a claim for spousal relief and she was not now entitled to a second apple bite.

This teed up the issue: did Mrs. Rogers materially participate in the deficiency case? If she did, Section 6015(g)(2) would prevent her from having the opportunity to get relief from joint and several liability.

Prior cases discuss meaningful participation as essentially a facts and circumstances analysis, with the opinions identifying specific acts such as signing documents and participating in settlement discussions with IRS as indicative of someone meaningfully participating. The cases also look to the sophistication and experience of the person who later seeks relief.

With that context, the opinion describes the wife’s background: she was independently wealthy, had a long career as a teacher and school administrator, went to law school after her education career ended (and before the tax problems that generated the claim for relief from joint liability) and started a practice that focused on appealing local property tax assessments.

Despite her experience, Mrs. Rogers claimed that she relied fully on her husband in the Tax Court deficiency case and did not sign documents or otherwise engage in the specific acts leading up to the trial and in the trial itself that suggested involvement. As a result, she claimed that she was generally unaware of the defenses and arguments in the prior case.

The Tax Court disagreed, with her education, experience and resources all working against her:

Petitioner’s testimony about the extent of her ignorance is not credible. She was an educator and administrator and the holder of several advanced degrees, and her husband of 45 years was an extremely well-practiced tax attorney. Before the 2012 trial she had successfully completed at least four courses in tax and accounting. She maintained substantial real property, bank accounts, and other assets in her own name. During 2004 and in later years petitioner managed and participated in significant business dealings involving her own properties. Her tax returns show she was an active real estate agent.

The opinion concluded with a statement that Section 6015(g)(2) was not meant to “provide a second chance at relief for a litigant who had the wherewithal and the opportunity to raise a claim in a prior proceeding.”

Conclusion

This opinion shows the risks of not raising a request for relief from joint and several liability when the opportunity is there in a deficiency case. Sophisticated and well-resourced litigants who do not raise the claim will have a hard time, even if as in here the underlying deficiency case involved the other spouse’s business and the other spouse was an experienced tax lawyer who tried the case.

Litigating Your Innocent Spouse Claim in Bankruptcy

If you were interested in yesterday’s post concerning the mismanagement over a period of years of the account of Mr. Fagan, please read the comment posted yesterday by Bob Kamman.  Bob took the time to call Mr. Fagan and get the kind of background details not possible to find by just reading the opinion.  Based on the information from Mr. Fagan, his efforts to fix the problem in TAS, Appeals and Chief Counsel where he was working face to face with a real human were totally unsuccessful.  This is the type of case I expected Senator Roth to find in his hearings before the 1998 legislation.  These cases exist because sometimes accounts get badly mangled.  I did not expect to see Chief Counsel litigating such a case.  From the comments it appears that accounts management was not the only place badly managed on this case.

In March, the bankruptcy court for the Southern District of Texas ruled in In re Pendergraft that it had jurisdiction under Bankruptcy Code 505(a) to determine whether Jane Pendergraft qualified for relief from her joint and several liability under IRC 6015(f).  The IRS strenuously objected to the bankruptcy court’s decision that it had the power to decide she qualified for innocent spouse relief.  It views the Tax Court as the exclusive avenue for obtaining such relief.  The case, which maybe the first case to decide this issue – at least the first one to decide the case favorably to the taxpayer, deserves attention because it may open up opportunities for relief in a forum previously unused for this purpose and because the of policy tensions that support the bankruptcy court’s decision even if the language of the statute may not.

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Section 505(a) of the bankruptcy code offers taxpayers in bankruptcy the opportunity to contest their tax liabilities in that forum instead of the more traditional forums of Tax Court, district court, or Court of Claims.  The reason that Congress granted this power to the bankruptcy court is that sometimes the tax liability needs to be final in order to the bankruptcy case to move forward.  The time frame for deciding a tax case in the other forums does not necessarily match the time frame for the bankruptcy case.  By giving the bankruptcy court the ability to decide the tax matter, Congress allowed it to control the timing.

The reasoning behind the grant of jurisdiction to the bankruptcy court to hear the tax matter extends to the determination of innocent spouse status; however, the decision of whether someone is an innocent spouse does not turn on whether the tax is due, i.e., the merits of the liability, but rather whether this person claiming innocent spouse status should be relieved of the liability even though it is due.  The IRS argues that this distinction precludes the bankruptcy court from deciding the innocent spouse issue because its authority under section 505(a) covers determining the merits of the liability and does not extend to the issue of innocent spouse status even though such a determination would clearly have an important outcome on a taxpayer’s bankruptcy case and whether the debtor could confirm a plan.

The facts of the case are not unusual for an innocent spouse argument.  Mrs. Pendergraft, who was 66 at the time of the decision, married Mr. Pendergraft in 1988.  During the period of their marriage, they split household responsibilities with Mr. P taking on “exclusive responsibility for the financial activities of the homestead, including the preparation and paying of taxes.”  Mrs. P operated a private psychotherapy practice part time and took primary responsibility for child care and household maintenance.  For the years 2001-2006, the Pendergrafts failed to file tax returns or to pay the taxes.  Mrs. P alleged that she did not know of the failures and signed returns for each year expecting her husband to file them.

She learned of the problem when the IRS levied on her separate bank account in 2008.  Although Mr. P initially denied knowledge of the problem he eventually confessed to her he had forgotten to pay the taxes for one year.  He later informed her that he had retained attorneys and accountants to fix the IRS problem, that the agreement required they pay the IRS $10,000 a month for an extended period, and that he would make sure all future returns were timely filed.  She alleged that he may have misappropriated money she gave to him between 2008 and 2016 to deal with the IRS and that he caused the IRS to mail all correspondence to his office address preventing her from learning of ongoing problems.

In late June 2016, she attended a meeting with their attorney in which she alleges that she learned for the first time that their income and property taxes had not been paid for 15 years and that they faced criminal prosecution.  According to her, this attorney advised her that she must join her husband in filing for bankruptcy in order to prevent the IRS from seizing their house and from prosecuting them.  I note that if the attorney gave such advice, it incorrectly described the effect of bankruptcy on possible criminal tax prosecution.  Bankruptcy code section 362(b)(1), one of the exceptions to the automatic stay, provides that bankruptcy has no impact on criminal prosecution.  By October of 2016, she had obtained permission of the bankruptcy court to proceed with divorce and in November she asked the bankruptcy court to determine that she qualified as an innocent spouse.  The IRS filed a motion to dismiss the request for an innocent spouse determination arguing ‘that a bankruptcy court’s jurisdiction is limited by the fact that it is a judicial offer of the district court, that the structure of 26 U.S.C. 6015(f) vests the determination of innocent spouse relief strictly in the IRS and tax courts, and that the United States has not consented to being sued on the innocent spouse issue in bankruptcy court.”

The bankruptcy court looked at section 6015(e)(1)(A) which allows a court to grant innocent spouse relief if the IRS fails to make a determination within 6 months.  The bankruptcy court pointed to the language of the statute providing that the remedy available in Tax Court for innocent spouse determinations is “[i]n addition to any other remedy provided by law.”  Bankruptcy section 505(a) is another “remedy provided by law.”  The bankruptcy court looked at applicable 5th Circuit law on the application of section 505(a) which it found supported the court’s ability to make an innocent spouse determination.  The court acknowledged the case law cited by the IRS finding bankruptcy court an inappropriate forum for innocent spouse determinations.

The bankruptcy court rejected the authorities provided by the IRS for three reasons: 1) the case law did not address 5th Circuit precedent interpreting 505(a); 2) the plain language of the statute; and 3) a decision by the bankruptcy on this matter would not lead to inconsistent judgments or conflict with basic principles of judicial economy.

Having decided that it can decide the innocent spouse issue, the bankruptcy court then determines that it must wait for the IRS to make a decision.  It required Mrs. P to submit to the IRS Form 8857 and indicated that it will make a decision if the IRS fails to do so in six months (not adopting the four-month rule for claims for refund as the shortened time period in 505 cases) or after the IRS makes an adverse decision.  It is possible, of course, that the IRS will decide in her favor in the administrative process.  If it does not, watch this case as I expect the IRS will not give up this issue at the bankruptcy court level.  We looked quickly at the bankruptcy case  and did not see any developments yet on this issue.

 

 

Innocent Spouse Denied Attorney’s Fees

In Kazazian v. Commissioner, T.C. Memo 2017-135, the Court denied attorney’s fees to a petitioner who succeeded in gaining innocent spouse status.  The Court determined that she was not a prevailing party under the statutory definition of IRC 7430.  The Court also determined that even if she were a prevailing party she did not prove that she incurred meaningful costs with the respect to the case.

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Petitioner is a lawyer who had a solo practice run as a Schedule C.  She also owned real estate and the joint return reported losses attributable to the rental real estate activities.  The year at issue in the case is 2009.  She separated from her husband in 2010 and divorced in 2011.  The IRS audited the joint 2009 return and disallowed the rental losses, disallowed some of her claimed Schedule C expenses and disallowed each spouses’ claim for innocent spouse relief.  In Appeals, some losses and some expenses were allowed and the husband was granted partial innocent spouse relief.  Appeals did not grant Petitioner innocent spouse relief.  She agreed to the tax adjustments but did not agree to the determination regarding her status as an innocent spouse.  Both spouses alleged abuse by the other.

Petitioner filed her Tax Court petition on the issue of her status as an innocent spouse.  Shortly before the case was calendared, the IRS agreed that she was entitled to relief under 6015(f) and a stipulation of settled issues was filed.  She requested fees.  As a curious person, I would like to know why the IRS granted her innocent spouse relief since the liabilities seem to stem from adjustments related to her if I am reading the opinion correctly.  That, however, will remain a mystery.

The Court addresses her claim for fees and notes that she makes the request both with respect to both the administrative and litigation phases of the case.  Because petitioner did not file a qualified offer, the Court states that the position of the IRS is “substantially justified” if it is “justified to a degree that could satisfy a reasonable person” and has a “reasonable basis both in law and fact.”  Swanson v. Commissioner, 106 T.C. 76, 86 (1996).  The fact that the IRS ultimately loses or concedes a case does not make the position unreasonable but the Court notes that this can be considered in determining reasonableness.

Petitioner argued that the return preparer acting on behalf of her ex-husband made the decision to treat her as a real estate professional without consulting her.  The Court finds that no factual basis for this argument exists.  It finds she actively engaged with the preparer.  The Court goes through a brief analysis of the determination of the Appeals Officer that she did not qualify for innocent spouse relief.  The Court seems to have the same problem I do understanding why Chief Counsel’s office conceded this case.  It finds the determination of the Appeals Officer reasonable and states that “there is no evidence in the record as to the basis for this concession.”  Neither party is required to put such evidence into the record when making a concession but here it would have been very helpful if petitioner had done so.  If we could know why Chief Counsel decided to concede the case perhaps we could understand why they did so and why it was unreasonable for the Appeals Officer to fail to concede the case.

The Court finds that “notwithstanding this concession, we conclude that the AO’s determination that the petitioner was entitled to no relief under section 6015(f) had a ‘reasonable basis both in law and fact’ and was ‘justified to a degree that could satisfy a reasonable person.’”

Aside from the problem of not providing the Court with an understanding of how she came to win the case and how it was unreasonable for Appeals not to have conceded it, petitioner has the problem of not proving the basis for her claim for a specific amount of fees.  She failed to submit the affidavit required by Rule 232(d) and relied on the declaration included with her original motion.  Because she represented herself (and did a great job), she has trouble showing her costs other than her $60 filing fee.  Her time entries and those of her accountants do not break out the time to reflect time worked on the innocent spouse aspect of the case as opposed to the other issues present.  In response to a request by the IRS for more detailed records regarding the time spent on the innocent spouse issue, petitioner made what the Court deemed as a frivolous response stating that she devoted 1,000 hours over four years to resolve the matter and her billing rate is $350 per hour.  So, she argued she should really receive $350,000.

Petitioner’s path to victory on the innocent spouse issue remains a mystery and that mystery makes it hard for the Court to decide the IRS was unreasonable when it initially decided she did not qualify for such relief.  The case makes the point that when the IRS concedes and you want fees and the basis for the concession does not jump out from the available facts, you must take the time and effort to put into the record the basis for the concession.  I hope there is some reason that the Chief Counsel attorneys conceded what looks like from these facts to be a very strong case on their side of the argument.  Whatever reasons that exist for the concession need to be made known by petitioner in order to show the Court that she substantially prevailed.  Without a qualified offer, it is hard enough to show this.  On these facts it seems impossible.

Of course, showing why the IRS was so wrong is only one thing you must do if you want fees.  You also have to show how you calculated the fees you seek.  Petitioner’s somewhat frivolous response to the request for more data further doomed her chances for recovering fees.