Taft v. Comm’r: Innocent Spouse Relief Generates a Refund

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We welcome back frequent guest blogger Carl Smith who writes about an innocent spouse case in which the Tax Court granted relief under a subsection permitting the innocent taxpayer to obtain a return of money previously taken from her to satisfy the liability caused by her ex-spouse.  Because the IRS frequently defaults to granting relief in a way that prevents the innocent spouse from obtaining refunds, this case shows a path to a more complete victory.  Keith

A number of people have congratulated Keith for contributing to a victory last month for a taxpayer seeking a $1,500 refund under the innocent spouse provisions at section 6015See Taft v. Commissioner, T.C. Memo. 2017-66.  Keith and I had filed an amicus brief in the case on behalf of the Harvard Federal Tax Clinic.  In it, we agreed with pro bono Florida attorney Joe DiRuzzo and his firm that a regulation on which the IRS relied to deny the refund under subsection (f) (equitable relief) was invalid – though invalid for different reasons than articulated by Joe and his firm.  But, as noted in footnote 4 near the end of the opinion, Tax Court Judge Vasquez never had to discuss the regulation’s validity, since he found the refund authorized under subsection (b) (traditional relief), even though the taxpayer had also been nominally granted relief under subsection (c) (separation of liability relief), which does not allow for refunds.  So, really, Keith and I did not win this case.  Rather, the taxpayer, aided by Joe and his firm, did.

In any event, the Taft opinion provides a useful reminder of some of the rules on getting a refund under the innocent spouse provisions.  And a post on it may alert others who find themselves in this position to the regulation invalidity argument.

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The traditional way to bring a refund suit is to file an administrative claim, which, if not allowed, forms the basis of a suit for refund in district court or the Court of Federal Claims.  But, when Congress, in section 6015(e)(1)(A), also gave the Tax Court stand-alone jurisdiction to “determine the relief available to the individual under” section 6015, that included also determining whether a taxpayer was due a refund, even in the absence of predicate unpaid taxes.  Thus, Ms. Taft had her choice of bringing this refund action in any of three federal courts.

The pro se Ms. Taft first filed a Form 8857 seeking a refund under section 6015.  Note that she could not have used a Form 1040X to seek the refund, since the year involved, 2010, was one in which she had filed a joint return, and she did not want to file a joint amended return with the former husband that she had divorced in 2013.  The IRS treats a Form 8857 as a refund claim for purposes of the section 6511 statute of limitations.  Prop. Reg. § 1.6015-1(k)(4) (Nov. 19, 2015) (“Generally the filing of Form 8857, ‘Request for Innocent Spouse Relief,’ will be treated as the filing of a claim for credit or refund even if the requesting spouse does not specifically request a credit or refund.”).  Her refund request was timely because the IRS had taken about $1,500 of her reported overpayment on her 2012 return (filed in 2013) and applied it to fully pay the 2010 joint deficiency at issue.  She filed the Form 8857 less than two years after the overpayment was applied, so she qualified under the 2-years-from-payment refund statute of limitations in section 6511(a).

Since, by the time she filed the Form 8857, she was divorced, she was entitled to elect (c) (separation of liability) relief.  This led to the first complication, since relief under (b) and (f) can entitle a taxpayer to a refund, but relief under (c) cannot.  Section 6015(g)(3).  The reason why Congress made a refund under (c) unallowable is because it made relief under (c) so easy to obtain.

Relief under (c) applies to deficiencies when, at the time the Form 8857 is filed, the taxpayer is divorced, legally separated, or has been living apart from the taxpayer’s spouse for at least 12 months.  For relief under (c), a taxpayer merely elects to separate his or her liability from that of his or her spouse based on their respective contributions to causing the deficiency.  In this case, the deficiency was tax on about $4,500 of unreported dividends from stock Mr. Taft owned and that he had acquired as an employee of the supermarket chain, Publix.  Mr. Taft had worked for many years at Publix until he was fired in 2009.  Relief is available under (c) even where it would not be inequitable to hold the electing spouse liable (e.g., where he or she significantly benefited from the underpayment and would have no hardship in paying the amount).  The only way the IRS can deny relief under (c) is for it to prove (note the burden shift) that the taxpayer had actual knowledge of the item giving rise to the deficiency.  The IRS concluded that Ms. Taft did not see the statements addressed to Mr. Taft that would have shown the exact amount of dividends that were unreported, so, in the notice of determination, the IRS conceded that Ms. Taft was entitled to relief under (c) because she did not have actual knowledge.  But, that relief under (c) did absolutely nothing for Ms. Taft, since she had (involuntarily) already fully paid the deficiency and was only seeking a refund, which could not be granted under (c).

The IRS then went on to deny Ms. Taft the refund under (b).  Under (b), relief is only available in the case of deficiencies if, among other things, a taxpayer had no reason to know of the deficiency and it would be inequitable to hold the taxpayer liable for the deficiency.  The IRS argued that she should have known that there were unreported dividends from Publix because for many prior years she had signed joint returns that reported such dividends.  The IRS also argued that it would not be inequitable to hold Ms. Taft liable for the deficiency.

Relief under subsection (f) (including refunds) is available if only two conditions are met:  First, relief is “not available” under subsections (b) or (c).  Second, it would be inequitable to hold the taxpayer liable for the deficiency or underpayment.  Reg. § 1.6015-4(b) (which applies to relief under (f)), states:  “This section may not be used to circumvent the limitation of § 1.6015-3(c)(1) (i.e., no refunds under § 1.6015-3) [i.e., the regulations under subsection (c)]. Therefore, relief is not available under this section to obtain a refund of liabilities already paid, for which the requesting spouse would otherwise qualify for relief under § 1.6015-3.”  This regulation was controversial before it was enacted in 2002.  It seems to prohibit a refund under (f) – even if the taxpayer can show that it would be inequitable for the taxpayer to be held liable for the deficiency – because of qualification for nonexistent relief under (c) (which does not require proof of inequity).  The IRS argued that since relief had been “available” to Ms. Taft under (c), she was not entitled to a refund attributable to the Publix dividend underreporting deficiency.  The IRS also argued that it was not inequitable to hold Ms. Taft liable, in any event.

Judge Vasquez held that, even though Ms. Taft could not get a refund under (c), she could get a refund under (b).  Mr. Taft had started an affair, which Ms. Taft discovered in 2011.  During 2010, Mr. Taft, unbeknownst to Ms. Taft, liquidated all the family savings (including the Publix stock) and spent them on himself and his girlfriend.  Wanting to conceal his affairs (both emotional and financial) from Ms. Taft, when it came time to prepare the 2010 joint Form 1040, he did so with the long-time accountant without her present and had the return e-filed.  That return revealed all the income from liquidating the family assets, though mistakenly left off the Publix dividends.  Mr. Taft did not let Ms. Taft see a copy of the return, though he assured her that it had been properly prepared by the long-time accountant.  Given all this secretiveness, Judge Vasquez held that Ms. Taft had no reason to know of the deficiency for purposes of that requirement for (b) relief.

Given the fact that Mr. Taft had wasted the family assets in his affair and so Ms. Taft did not benefit in the slightest from the Publix dividends and Ms. Taft’s lack of knowledge of the underreporting, Judge Vasquez also held that it would have been inequitable to hold Ms. Taft liable – another condition for (b) relief.

Since the judge granted Ms. Taft a refund under (b), he no longer had to reach the issue of refunds under (f) and the possible invalidity of the regulation under (f).

The Regulation’s Possible Invalidity

Joe DiRuzzo took on the Taft case pro bono at a Tax Court calendar call.  It was his first innocent spouse case, so, knowing I was experienced in this area, he gave me a call about it later that day.  We both were worried that the judge might find that Ms. Taft should have known about the unreported Publix dividends based on the prior-year reporting of similar dividends.  In that event, Ms. Taft could not get relief under (b), and the issue of relief under (f) (and the validity of the regulation under (f) possibly prohibiting a refund) would be squarely presented.

Despite the small amount involved in the case, Joe asked the court for permission to do post-trial briefs.  And he then immediately did a FOIA request of the IRS for all comments submitted on the proposed regulations that were finalized in 2002.  Finding a few comments objecting to the proposed (f) refund regulation limitation and not feeling the IRS had adequately responded to those comments, in his brief in Taft, Joe challenged the validity of the regulation under the Administrative Procedure Act.  He made the same argument that had recently been successful in Altera Corp. v. Commissioner, 145 T.C. 91 (2015) (currently on appeal in the Ninth Circuit):  that the IRS had not sufficiently responded to the comments or provided a “reasoned explanation” for why it reached the result that it did under the standard set out in Motor Vehicle Mfrs. Ass’n of the U.S. v. State Farm Mut. Auto Ins. Co., 463 U.S. 29 (1983).

Keith and I then got permission from the court to weigh in as amicus, arguing in our brief in Taft that the regulation was invalid under the tests of Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).  We argued that the regulation added a limitation on getting a refund under (f) that was not in the statute – i.e., preventing circumvention of the no refund rule of subsection (c).  We pointed out that there could be no circumvention because a refund under (f) was not automatic, since, under (f), one had to prove inequity (something that was irrelevant under (c)).  We cited to the Tax Court’s opinions in Lantz v. Commissioner, 132 T.C. 131 (2009), revd. 607 F.3d 479 (7th Cir. 2010), and Hall v. Commissioner, 135 T.C. 374 (2010), which made similar points that the 2-year period for requesting (f) relief imposed by § 1.6015-5(b)(1) did not need to be imposed to prevent the circumvention of the 2-year periods provided by statute for (b) and (c) relief because (f) relief (by contrast) requires additional proof of a number of events that may occur years after the returns are filed.

In the end, the work that Joe DiRuzzo and his firm and that Keith and I did was irrelevant to the court’s decision to grant a refund in Taft under (b).  But, we know this situation occurs now and then.  Recently, at least one attorney with a section 6015 refund case contacted me with the same problem concerning refunds under the regulation under (f) where useless (c) relief was arguably “available”.  I have linked to the two briefs filed in the Taft case, just in case anyone might be helped in a future litigation by seeing the arguments we raised.  And readers should also know that Joe DiRuzzo has on a disk copies of all the comments made on the section 6015 regulations that were adopted in 2002, which is not only a resource for this issue under the (f) regulations, but for any other challenge to the 2002 regulations.

Finally, I would note that the IRS proposed new section 6015 regulations on November 19, 2015, that are still awaiting adoption.  The proposed regulations retain the current sentences quoted above, but add this:  “For purposes of determining whether the requesting spouse qualifies for relief under § 1.6015-3, the fact that a refund was barred by section 6015(g)(2) [res judicata] and paragraph (k)(2) of this section [no refunds under (c)] does not mean that the requesting spouse did not receive full relief.” Prop. Reg. § 1.6015-1(k)(3).  The IRS is trying to buttress its argument that even relief under (c) that is, as a practical matter, useless (because no refund is allowed under (c)), is relief that precludes a refund under (f).

 

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