The Intersection of Foreclosure and Innocent Spouse

In United States v. Charles LeBeau, No. 3:17-cv-01046 (S.D. Cal. Oct. 16, 2018) the district court stayed a foreclosure action brought by the IRS to allow the taxpayer’s wife to pursue her innocent spouse claim. Because the innocent spouse claim has a ways to go from a procedural perspective, it may be some time before the foreclosure case starts back up. The case provides an interesting look at the intersection of foreclosure and innocent spouse and deserves some discussion.

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Victoria and Charles LeBeau were married at some point prior to 1980. They remain married though they are now legally separated. While the separation is legal, they continue to reside in the same house in La Jolla, California. For anyone not familiar with La Jolla, it generally has very nice houses near the ocean just north of San Diego. I will leave it to Bob Kamman to fill in the rest of the story on the value and location of the house. I am sure that Bob will find some interesting facts here that the opinion does not contain and that I am not tracking down. Keep a lookout in the comment section.

They bought the house in 1980 as joint tenants; however, they deeded the house to Victoria for no consideration in 1987. In 1988 Victoria transferred the property back to both of them for no consideration. Five days later they executed a deed of trust in favor of Security Allied Services to secure a loan of just over $300,000. In August of 1989, the couple transferred the property solely to Victoria again for no consideration. Charles created an entity known as Casa de Erin, LLC which the court describes as the alter ego/nominee of Charles and/or Victoria and in 2003 Victoria transferred the property to Casa de Erin for no consideration. In 2006 Casa de Erin rescinded the deed and transferred the property back to Victoria for no consideration and she remains the property’s nominal owner. The court notes that “upon information and belief, Charles LeBeau has continued to reside at the Property and has retained all the benefits and burdens of ownership.”

The IRS has already reduced its assessments to judgment and this case seeks to foreclose its lien on the property.

Given the recitation of facts in this case, I would not place a high value on Victoria’s chances of achieving innocent spouse status. If she was actively engaged in all of these transfers, innocence is not the word that comes to mind. In fact, the IRS denied her request for relief for many years though it did apparently grant her partial, but significant ($193,272) relief for 1995. She filed a petition with the Tax Court seeking review of the denial of relief on June 22, 2018. Charles has intervened in her Tax Court case presumably to argue that she should not be relieved of liability. (This is one of those cases where it might be really interesting to follow the pleadings if it did not require a trip to DC to the clerk’s office and 50 cents per page.) She asks that the district court stay the foreclosure of what I am presuming is a very nice place where they live and engage in deed swapping at a prodigious pace.

In the discussion section of the opinion the court first says that “the district court has no jurisdiction to decide an innocent spouse claim” citing to United States v. Boynton, 2007 WL 737725 (S.D. Cal. 2007) and Andrews v. United States, 69 F.Supp. 2d 972 (N.D. Ohio 1999). I do not necessarily agree with the court on this issue as discussed in the post in the Chandler case; however, the DOJ Trial Section attorney would have had difficulty arguing the opposite side of that issue.

The court next notes that it has broad discretion to stay proceedings noting that it must consider:

  • the possible damage which may result from the granting of a stay, (2) the hardship or inequity which a party may suffer in being required to go forward, and (3) the orderly course of justice measured in terms of the simplifying or complicating of issues, proof, and questions of law which could be expected to result from a stay.

The defendants made the following arguments in support of a stay:

On the third factor, Defendants seek a stay pending resolution of the issues of “fraudulent transfers” and “nominee theory of ownership” now before the U.S. Tax Court arguing that Court lacks jurisdiction to consider these issues and a stay would avoid inconsistent rulings. On the second factor, they argue that a stay would cause hardship by being required to pursue litigation in two different courts. Lastly, on the first factor, Defendants content that a stay would not prejudice the government.

The court cites the Supreme Court’s decision in United States v. Rodgers, 461 U.S. 677 (1983) regarding its discretion to foreclose a federal tax lien on taxpayer’s property. We have discussed Rodgers before here in a case blogged by Les with some similarities to the LeBeau’s situation. After discussing the general Rodgers factors a court should weigh in deciding whether to permit foreclosure, the district court here cites to two prior cases in which someone claiming innocent spouse status sought to use that status as a basis for postponing foreclosure based on the Rodgers’ factors. In the first case, United States v. Battersby, 390 F. Supp. 2d 865 (N.D. Ohio 2005) the court did stay the action while in the second case, United States v. McGrew, 2014 WL 7877053 (C.D. Cal. 2014), aff’d, 669 Fed. App’x 831 (9th Cir. 2016) the court concluded Rodgers was inapplicable stating that “innocent spouse protection does not entitle [non-liable spouse] to prevent foreclosure on the Government’s tax liens.”

A third case exists out of South Carolina, which the LeBeau court does not mention, in which Carl Smith and Joe DiRizzo sought to assist the wife in her effort to stop foreclosure and seek innocent spouse relief, United States v. Dew. The IRS brought a foreclosure proceeding to sell some jointly owned property for liabilities of both Mr. and Mrs. Dew.  Late during the proceeding, Mrs. Dew filed a Form 8857, which had not yet been ruled on by the IRS.  The DOJ first asked the district court to ignore this belated filing.  And the court essentially did so in 2015 U.S. Dist. LEXIS 112979 (D. S.C. 2015), where it wrote in footnote 1:

The Court notes that Mrs. Dew filed objections asserting an “innocent spouse” defense pursuant to 26 U.S.C. § 6015(f). Even assuming such a claim can properly be raised for the first time in the objections, the innocent spouse defense cannot be considered by this Court because it lies within the exclusive jurisdiction of the tax court. See Jones v. C.I.R., 642 F.3d 459, 461 (4th Cir. 2011) (noting that § 6015(f) authorizes the “Secretary of the Treasury” to grant an innocent spouse relief; see also United States v. Elman, No. 10 CV 6369, 2012 U.S. Dist. LEXIS 173026, 2012 WL 6055782, at *4 (N.D. Ill. Dec. 6, 2012) (stating that “exclusive jurisdiction over [the defendant’s] innocent spouse defense under § 6015(f) lies with the Tax Court.”).

The Dews filed an appeal to the 4th Circuit arguing that the collection suit could not go forward.  Section 6015(e)(1)(B)(i) provides:

Except as otherwise provided in section 6851 or 6861 [26 USCS § 6851 or 6861], no levy or proceeding in court shall be made, begun, or prosecuted against the individual making an election under subsection (b) or (c) or requesting equitable relief under subsection (f) for collection of any assessment to which such election or request relates until the close of the 90-day period referred to in subparagraph (A)(ii), or, if a petition has been filed with the Tax Court, until the decision of the Tax Court has become final.

Mrs. Dew filed a response with the District Court arguing that 6015(e)(1)(B) was mandatory and asked, therefore, that foreclosure be stayed.  In response to this filing, the government finally agreed that it could not pursue collection against her for the taxes subject to the Form 8857, but still asked the court to foreclose and sell the property to satisfy Mr. Dew’s tax debts and Mrs. Dew’s tax debts that were not covered by the Form 8857.  See attached response. The court went ahead with the sale and instructed the distribution of proceeds in accordance with the government’s revised listing (excluding the Form 8857 liabilities). See the final revised order confirming the sale here.  The 4th Cir. then decided the appeal and held against the Dews.  670 Fed. Appx. 170 (4th Cir. 2016).  The entire text of the 4th Cir. opinion is as follows:

James and Veronica Dew (Appellants) appeal the district court’s order and judgment granting the United States’ motion for summary judgment in the United States’ action seeking to reduce to judgment Appellants’ federal income tax liabilities, and to foreclose the federal tax liens securing those liabilities on Appellants’ jointly owned real property. We have reviewed the record and have considered the parties’ arguments and discern no reversible error. Accordingly, we grant James Dew’s application to proceed in forma pauperis and affirm the district court’s amended judgment. United States v. Dew, No. 4:14-cv-00166-TLW (D.S.C. May 19, 2016). We dispense with oral argument because the facts [**2]  and legal contentions are adequately presented in the materials before this court and argument would not aid the decisional process.

In the Lebeau’s case the district court determined that the foreclosure case should be stayed against the LeBeaus until the end of the innocent spouse case. I do not find this result satisfying. Even if the Tax Court finds Victoria innocent, the IRS can still foreclose on the house and sell it subject to her interest. The decision would be much more satisfying if the court had explained why the Rodgers factors might weigh against allowing foreclosure to go forward. Was there something special about Victoria’s need for the house or even Charles’ need? I am assuming that they are not young at this point since they bought the house almost 40 years ago. Absent something special, I would allow the sale to go forward and hold her half in escrow. Since the innocent spouse determination does not prevent the sale, it does not seem that, by itself, it should hold up the sale.

It is possible that I am also someone jaundiced about her innocence given all of the transfers of the property recounted by the court but I recognize that there could be facts that would support a finding of innocent spouse status not brought out in this opinion. The significant delay that the court has provided here does prejudice the IRS unless one assumes that the property will continue to go up in value and that delay will ultimately benefit the IRS in that fashion.

 

Litigating Innocent Spouse Cases in District Court – Does the Department of Justice Tax Division Trial Section Talk to Its Appellate Section?

Jurisdiction is not something that the Department of Justice can confer upon the courts, but it is interesting when one part of the Tax Division files motions to dismiss cases for lack of jurisdiction for seeking a refund based on innocent spouse relief while another part argues to appellate courts that a party seeking a refund based on innocent spouse relief could do so in district court. The recent decision in Chandler v. United States, 122 AFTR 2d 2018-XXXX, (N.D. Tex. Sept. 17, 2018) highlights the division between sections at the Department of Justice. The decision in the Chandler case was written by the magistrate to whom the case was referred.  The District Court judge has since issue an order adopting the decision and a judgment.  Since the Chandler case could now move from one section to the other if an appeal occurs, the Appellate Section might get the chance to let the court know it disagrees with the Trial Section. [The case of Hockin v. United States (PACER login required), Civil No. 3:17-CV-1926-PK, pending in the District of Oregon raises the same issue and the Federal Tax Clinic at the Legal Services Center of Harvard Law School may file an amicus brief in that case.] read more...

Ms. Chandler filed a joint return with her then husband for the tax years 1997 through 2002. The IRS made adjustments to the returns and ultimately additional assessments. In 2011 Ms. Chandler, now divorced from her husband with whom she filed the joint returns, requested innocent spouse relief claiming, inter alia, that she did not know exactly what was on the returns and had simply signed them in the appropriate box when the returns were placed in front of her after preparation by an accounting firm.

The IRS denied her relief and she failed to file a Tax Court petition within 90 days thereafter. She then filed another request for innocent spouse relief and the IRS considered her new request before denying it as well. Her attorney tried three more times with the IRS denying each attempt for lack of new information.

In June of 2013 she received a CDP notice and timely made a CDP request. The IRS denied her relief in the CDP process and thereafter began collecting from her. It collected $22,890 through levy before writing off the balance based on the statute of limitations. In July 2015 she filed a claim for refund seeking return of the levied money. The IRS denied the claim and she brought suit in the Northern District of Texas to recover her refund.

The government filed a motion to dismiss for lack of jurisdiction. The magistrate judge determined that the court did not have jurisdiction, citing United States v. Elman, 110 AFTR 2d 2012-6993 (N.D. Ill. 2012) which stated “although the statute itself does not address whether the Tax Court’s jurisdiction is exclusive, courts interpreting the statute have concluded that it is.” This quote, in part, refers to the language in IRC § 6015(e) providing for Andrews v. United States Tax Court jurisdiction which makes no mention of district court jurisdiction. The magistrate judge went on to cite the cases of United States v. LeBeau, 109 AFTR 2d 2012-1369 (S.D. Cal. 2012) and Andrews v. United States, 69 F. Supp. 2d 972, 978 (N.D. Ohio 1999) which held that district courts did not have jurisdiction to decide an innocent spouse issue unless the taxpayer files a refund suit while an innocent spouse case is pending in the Tax Court. Here, the taxpayer missed her chance to bring a Tax Court case. The court also cited United States v. Stein, 116 AFTR 2d 2015-6504 (W.D. Ky. 2015) holding “no part of § 6015 confers jurisdiction to the federal district courts to determine innocent spouse claims in the first instance.”

This seems like a lot of precedent in favor of dismissing the case; however, none of the district court opinions on which the court in Chandler relied involve refund lawsuits, nor does the court cite the three opinions, discussed below, where refund suits proceeded under § 6015 without objection by the DOJ as to jurisdiction.  The cited cases all involve § 6015 raised as a defense in a suit brought by the government for collection. Further, no Circuit court has yet weighed in on this jurisdictional issue either in the context of refund suits or of collection suits.

For decades, the courts have allowed district court and Court of Federal Claims refund suits considering relief under § 6015 and its predecessor innocent spouse provision without discussion or government objection. In enacting and amending § 6015, Congress expressed its understanding that district court refund suits raising innocent spouse relief were permitted under former § 6013(e). Congress did not repeal this prior law by implication when, in 1998, it added new, additional ways to raise innocent spouse relief in the Tax Court under §§ 6015(e)(1)(A), 6320, and 6330.

Several cases held that former § 6013(e)(1) relief, the code section for innocent spouse relief from 1971 to 1998, could be raised by a taxpayer who paid an assessed deficiency in full and brought a refund suit in district court or the Court of Federal Claims. These cases existed in several circuits: Yuen v. United States, 825 F.2d 244 (9th Cir. 1987); Busse v. United States, 542 F.2d 421, 425-427 (7th Cir. 1976); Sanders v. United States, 509 F.2d 162 (5th Cir. 1975); Dakil v. United States, 496 F.2d 431 (10th Cir. 1974); Mlay v. IRS, 168 F. Supp. 2d 781 (S.D. Ohio 2001). In research for an amicus brief on this issue, the tax clinic at Harvard could not find that any party ever argued that such a suit was barred because the taxes were not “erroneously or illegally assessed or collected”, within the meanings of § 7422(a) and 28 U.S.C. § 1346(a)(1).

Several cases have also held that taxpayers claiming innocent spouse status under former § 6013(e)(1) could raise that status as a defense to reduce tax assessments to judgment under § 7402 in district court suits brought by the United States; United States v. Grable, 946 F.2d 896 (6th Cir. 1991); United States v. Diehl, 460 F. Supp. 1282 (S.D. Tex. 1976), aff’d per curiam, 586 F.2d 1080 (unpublished opinion) (5th Cir. 1978); or to foreclose on tax liens under § 7403. United States v. Shanbaum, 10 F.3d 305 (5th Cir. 1994); United States v. Hoffmann, 1993 U.S. Dist. LEXIS 15872 (D. Utah 1993). They also held that former § 6013(e)(1) relief could be raised in a bankruptcy proceeding. In re Hopkins, 146 F.3d 729 (9th Cir. 1998); In re Lilly, 76 F.3d 568 (4th Cir. 1996).

In the 1998 legislation in which the new IRC § 6015 was enacted, the Ways and Means Committee explained:

The proper forum [under present law] for contesting a denial by the Secretary of innocent spouse relief is determined by whether an underpayment is asserted or the taxpayer is seeking a refund of overpaid taxes. Accordingly, the Tax Court may not have jurisdiction to review all determinations of innocent spouse relief . . . . The Committee is concerned that the innocent spouse provisions of present law are inadequate. . . . The bill generally makes innocent spouse status easier to obtain. The bill eliminates all of the understatement thresholds and requires only that the understatement of tax be attributable to an erroneous (and not just a grossly erroneous) item of the other spouse. . . . The bill specifically provides that the Tax Court has jurisdiction to review any denial (or failure to rule) by the Secretary regarding an application for innocent spouse relief. The Tax Court may order refunds as appropriate where it determines the spouse qualifies for relief . . . .

Rep. 105-364 (Part 1), at 61 (emphasis added).

In the first two quoted sentences above, Congress implicitly acknowledged that it understood that § 6013(e) issues could be raised in refund suits in district courts or the Court of Federal Claims brought under 28 U.S.C. § 1346(a)(1) and nowhere did it state in its Committee reports that it intended to remove the jurisdiction of those courts to hear innocent spouse refund suits.

The transfer provision now at § 6015(e)(3) also provides support for the conclusion that district courts have refund jurisdiction over innocent spouse cases. The only jurisdictional basis of a “suit for refund . . . begun by either individual filing the joint return pursuant to section 6532” (i.e., the suit to which the Tax Court proceeding would be transferred) is 28 U.S.C. § 1346(a)(1). Even if language in § 7422(a) and 28 U.S.C. § 1346(a)(1) might arguably not cover innocent spouse relief under the government’s reading, Congress clearly legislated in 1998 on the assumption that refund suits raising innocent spouse relief had been proceeding under the 1971 legislation and should continue to proceed under the 1998 legislation. The language of § 7422(a) and 28 U.S.C. § 1346(a)(1) should be given a practical construction regarding innocent spouse relief in accordance with Congress’s clear intentions.

At least three cases since the enactment of § 6015 have moved forward in district court with no finding of a jurisdictional bar. In Jones v. United States, 322 F. Supp. 2d 1025 (D.N.D. 2004) – a refund suit predicated originally on former § 6013(e) relief – during the course of the case, Congress enacted § 6015, and thereafter, the taxpayer filed a Form 8857 requesting § 6015 relief and sought a refund under the new provision for some taxable years. There is no evidence in the opinion that the government made the claim that it makes here that the district court lacked jurisdiction to conduct a refund suit under § 6015 in the absence of a petition to the Tax Court under § 6015(e). Probably for that reason, the court does not even discuss this potential jurisdictional issue.

In Favret v. United States, 2003 U.S. Dist. LEXIS 21969 (E.D. La. 2003), the court denied a government motion to dismiss an innocent spouse refund suit for failure to state a claim (i.e., a motion on the merits). The case later settled. There is again no evidence in the opinion that the government made any claim that the court lacked jurisdiction of § 6015 refund suits in the absence of a prior petition to the Tax Court under § 6015(e).

In Flores v. United States, 51 Fed. Cl. 49 (2001), the Court of Federal Claims heard a refund suit where the taxpayer sought relief under § 6015(f). The court found the taxpayer entitled to relief. In a footnote, the court indicated that it had considered whether it had jurisdiction to so hold and explained (rather summarily) that both the government thought so and the court did, as well. The court wrote:

The court initially was concerned with whether it had jurisdiction to review a determination made by the Secretary of the Treasury not to render innocent spouse relief under section 6015(f) of the Code (discussed, infra). In their supplemental memoranda, both parties argue that this court has such jurisdiction, directing this court to the legislative history of section 6015, the cases construing that legislative history, and the amendments made to section 6015 by section 1(a)(7) of the Consolidated Appropriations Act of 2001, Pub. L. No. 106-554, 114 Stat. 2763. Based on its review of these materials, the court now agrees that it has jurisdiction to review whether the Commissioner has abused his discretion under section 6015(f), as well as to determine whether that subsection is applicable to plaintiff under the effective date provisions of the Act. See, e.g., Butler v. Commissioner, 114 T.C. 276, 290 (2000) (concluding that Congress did not intend to commit the determination under section 6015(f) to unreviewable agency discretion).

So, in a few instances, refund suits involving § 6015 have been allowed to proceed in the absence of a petition to the Tax Court under § 6015(e).

IRS National Taxpayer Advocate (“NTA”) Nina Olson agrees with the position that district courts can hear refund claims based on innocent spouse status. Since 2007, Ms. Olson has been alerting Congress to the incorrect district court rulings under § 7402 and § 7403. NTA 2007 Annual Report to Congress, Vol. I, p. 631; NTA 2008 Annual Report to Congress, Vol. I, p. 525; NTA 2009 Annual Report to Congress, Vol. I , pp. 494-495; NTA 2010 Annual Report to Congress, Vol. I, pp. 504-505; NTA 2012 Annual Report to Congress, Vol. I., pp. 648, 652; NTA 2015 Annual Report to Congress, Vol. I, pp. 532-536. In her 2013 report, Ms. Olson wrote:

As the National Taxpayer Advocate has pointed out, these district court decisions are inconsistent with the statutory language of IRC § 6015, which does not give the Tax Court exclusive jurisdiction to determine innocent spouse claims, but rather confers Tax Court jurisdiction “in addition to any other remedy provided by law.” Nothing in IRC § 6015 prevents a district court from determining, in a collection suit, whether innocent spouse relief is available. . . . Moreover, the refusal to allow a taxpayer to raise IRC § 6015 as a defense in a collection suit may create hardship because a taxpayer may be left without a forum in which to raise IRC § 6015 as a defense before losing her home to foreclosure by the IRS.

NTA 2013 Annual Report to Congress, Vol. I, pp. 416-417. Ms. Olson has asked that, if the courts do not correct their rulings, Congress adopt legislation that would make it even more clear that § 6015 relief is available as a defense in a district court collection suit. NTA 2007 Annual Report to Congress, Vol. I, pp. 549-550; NTA 2009 Annual Report to Congress, Vol. I, pp. 378-380; NTA 2010 Annual Report to Congress, Vol. I, p. 378-382; NTA 2017 Annual Report to Congress, Purple Book, p. 53.

In a series of recent court of appeals cases brought by the tax clinic at Harvard, the Clinic has represented taxpayers who had filed late pro se stand-alone petitions in the Tax Court under § 6015(e)(1)(A) seeking relief under § 6015(b), (c), and/or (f). In each case, the IRS misled the taxpayer with respect to the last date to file such petition. The Tax Court dismissed the petitions for lack of jurisdiction as untimely. In each case, the Department of Justice (“DOJ”) Tax Division Appellate Section attorneys assured the courts, both in their briefs and at oral argument, that the courts should not worry that the taxpayers were left without a remedy because each taxpayer could pay the liability in full and sue for a refund in district court or the Court of Federal Claims, where each could still seek relief under § 6015. For example, at page 48 of its appellee’s brief in the Nauflett case, the Appellate Section attorneys wrote:

We note, however, that this does not mean that taxpayers who miss the deadline in § 6015(e)(1)(A) may never seek judicial review of the IRS’s determination that they are not entitled to innocent-spouse relief. As the Tax Court recognized (A. 29-30), a taxpayer like Nauflett who misses the 90-day filing window may nevertheless pay any assessment made by the IRS, file a timely administrative claim for refund, and then file a refund suit in either a federal district court or the Court of Federal Claims six months later (or earlier, if the refund claim is denied before the expiration of that six-month period). See I.R.C. §§ 6511(a), 6532(a)(1), 7422(a); see also id. § 6015(e)(3) (stating that jurisdiction over any pending petition for relief under § 6015 is transferred from the Tax Court to any district court that acquires jurisdiction over the relevant years as part of a refund suit filed by either spouse pursuant to I.R.C. § 6532).

At oral argument in the Matuszak and Nauflett cases, the tax clinic at Harvard pointed out that the taxpayers could not afford to fully pay all asserted liabilities for all years before filing district court refund suits, so the alternative remedy of a suggested refund suit was of little practical use to them. Doubtless for this impracticality reason, at footnote 5 of Matuszak, the court wrote:

Although the Tax Court lacks jurisdiction to review an untimely petition for innocent spouse relief, taxpayers who miss the ninety‐day deadline in § 6015(e)(1)(A) may have other means, outside the Tax Court, to seek review of the IRS’s determination. See Appellee’s Br. 47 (suggesting that a taxpayer may pay the assessed deficiency and then seek review of the IRS’s denial of innocent spouse relief in a refund suit in federal district court or the Federal Court of Claims). We express no opinion on the availability of those alternative remedies in this case. [Emphasis added.]

The argument by the Trial Section attorney in Chandler directly contradicts what the DOJ Tax Division Appellate Section has recently argued in the cases of the clients of the tax clinic at Harvard. The government should get its story straight. The Appellate Section is right and the Trial Section is wrong. The court in Chandler gets it wrong because of the argument made by the Trial Section. The Tax Division should come to the court and get its position straight.

 

 

 

IRS Revenue Agent Entitled to Relief from Joint Liability

A recent summary opinion in Tax Court highlights some of the procedural twists that can turn in cases where an ex seeks to challenge a former spouse’s entitlement to relief from joint and several liability.  The case has some added interest because the spouse seeking and getting relief is an IRS revenue agent.

As guest poster Professor Scott Schumacher discussed a few years ago, some times tax cases turn into a “he said she said” dispute. In the tax context, he said/she usually involve cases with disputes over credits or deductions determined with reference to attachment to children and in innocent spouse cases when former spouses disagree about the other’s entitlement to relief from joint and several liability.

Merlo v Comm’r is a recent Tax Court case that involves the latter scenario.  In this case, the ex-husband (Mr. Merlo) is an IRS revenue agent. He prepared the return, and his former spouse (Ms. Nelson) claimed that he had knowledge of $4,629 of disability income she received and they omitted from their 2011 joint return, which was filed on extension in October 2012, when the soon to be divorced Merlos were separated.

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The joint return omitted the disability income that had been reported on a W-2. IRS picked up the omission, and issued a stat notice. Mr. Merlo petitioned Tax Court, asserting Section 6015(c) relief as an affirmative defense to the deficiency based on his lack of knowledge of Ms. Nelson’s receipt of the disability income. IRS granted him relief from the liability. Ms. Nelson joined the Tax Court case as an intervenor, and she argued that Mr. Merlo should not be entitled to relief because he had knowledge of her omitted disability income and that he intentionally left it off the return to cause her problems with the IRS.

This involves Section 6015(c), which generally allows a separated or divorced spouse to elect to limit the liability for any deficiency assessed with respect to a joint return to the portion of the deficiency that is properly allocable to the electing individual under Section 6015(d).

Section 6015(c)(3)(C) denies relief to the electing spouse if it is shown that he or she “had actual knowledge, at the time such individual signed the return, of any item giving rise to a deficiency (or portion thereof) which is not allocable to such individual under subsection (d)”

One of the challenges for the IRS in these cases is that the burden on showing actual knowledge rests with the IRS, and the level of proof the Commissioner needs to establish is a preponderance of the evidence. Here, the Commissioner conceded the issue and agreed that Mr. Merlo did not have actual knowledge of the existence of the disability income.

So how does the court address the issue of burden of proof when the IRS agrees that one of the exes is entitled to relief but the other does not?  The opinion notes that the “[c]ourt has resolved this problem by determining whether actual knowledge has been demonstrated by a preponderance of the evidence as presented by all three parties.”

Typically I suspect that Counsel attorneys let the ex spouses duke it out at trial. That is what seemed to happen in this case, with Ms. Nelson testifying that her ex knew about the omitted disability income and Mr. Merlo claiming that the first time he heard about it was when the IRS sent correspondence after they filed the return.

This required the court to dig into the circumstances of the joint filing. As is not unusual with freshly separated and a soon to be divorced couple the communications between the two were not ideal—the opinion notes that Ms. Nelson moved out of the marital residence in May of 2012 and they “seldom spoke, lived in separate households, and communicated primarily through their divorce counsel.”

The 2011 return was on extension and as the October filing deadline neared Mr. Merlo presented evidence that demonstrated to the court that he did not know about the disability income that was left off the return, including a series of emails and a text message and the existence of separate bank accounts. The messages include an exchange where Ms. Nelson proposed to correct the return after a draft return Mr. Merlo prepared included as a gross amount of Ms. Nelson’s income the disability income and about $1,182 in wages from another source, Ethan Allen:

Early on the morning of October 15, 2012, the due date for filing the 2011 return, Mr. Merlo emailed Ms. Nelson the draft Federal return and draft Michigan return for her to review for accuracy. Ms. Nelson responded by text, informing Mr. Merlo that he had misstated her wages from Ethan Allen on the draft returns as equal to $5,811 rather than $1,182, the correct figure. Mr. Merlo, now believing the draft returns to be incorrect, revised them by reducing Ms. Nelson’s wage income from $5,811 to $1,182, a $4,629 difference. Mr. Merlo thereafter emailed Ms. Nelson a revised draft Form 1040 worksheet for her to review at 7:20 a.m. The worksheet listed the Merlos’ wage income as $108,045, consisting of $106,863 in wages from the Department of the Treasury and $1,182 in wages from Ethan Allen.

The opinion noted that a text message from Ms. Nelson specifically identified the wage income she had received from Ethan Allen and made no mention of any disability income, resulting in Mr. Merlo changing the return to reflect only Ms. Nelson’s $1,182 in wages and not the taxable disability income.

Ms. Nelson also testified that her ex had a copy of the W2 that showed the disability income; that would have meant that he had the knowledge necessary to defeat the relief he was seeking.

The opinion then provides more context as to why the court sided with Mr. Merlo’s version of the facts:

Ms. Nelson testified that when she moved out of the marital residence she left copies of all of her Forms W-2, including those from Ethan Allen and Prudential [Prudential is the source of the disability payments], in a tax file maintained there by Mr. Merlo, retaining the originals for herself. Her testimony is uncorroborated, and it is contradicted by Mr. Merlo’s contemporaneous email of October 12, 2012, in which he stated that he did not have a Form W-2 from her. Moreover, we are not persuaded that Mr. Merlo, an IRS revenue agent, would have prepared worksheets that listed Ms. Nelson’s Ethan Allen wages as $5,811 if he in fact had copies of her Forms W-2 showing that her wage income, while in total equal to $5,811, actually consisted of $1,182 from Ethan Allen and $4,629 from Prudential. Finally, we note that Ms. Nelson, having been provided Mr. Merlo’s worksheet accompanying the draft Federal return that made no mention of the Prudential income, had ample opportunity to alert Mr. Merlo to the omission but failed to do so, even though by her own admission she had the originals of the Forms W-2 that had been issued to her. Her silence tended to confirm Mr. Merlo’s belief that he had merely overstated her Ethan Allen wages in the worksheet and had not omitted income from another source.

Conclusion

Spousal relief and intervenor cases in particular are often tough cases. Context matters greatly. In this case, Mr. Merlo’s work as a revenue agent contributed to the court’s conclusion that it found his version of the facts more likely to be true, as the opinion noted that given his “familiarity with IRS procedures, it is not reasonable to believe he deliberately failed to report Form W-2 income for which he had actual knowledge, as he would have been aware that he was creating the same problems with the IRS for himself as Ms. Nelson speculates he intended to cause for her.”

 

 

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.