Who Won the Sanchez Case?

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Today we welcome first time guest blogger Bob Nadler. Bob is the perfect guest for this post about an innocent spouse issue because he authors “A Practitioner’s Guide to Innocent Spouse Relief.”  The ABA Tax Section published second edition of his book last year.  He also co-wrote the chapter on innocent spouse issues in the 6th Edition of “Effectively Representing Your Client before the IRS.” For over a decade Bob has represented low income taxpayers as an attorney at the Legal Aid Society of Middle Tennessee and the Cumberlands. Before becoming a representative of low income taxpayers, Bob worked for the Office of Chief Counsel, IRS for over 30 years in its Nashville office and was a valued colleague for me there as he is now as a clinician. Keith 

In sports, sometimes a team loses an important game and later is awarded the victory because the other team was disqualified. That is what may happen in the recently decided case,  Sanchez v. Comm.  In Sanchez, the taxpayer sought innocent spouse relief in the Tax Court and lost her case because the Court held no joint return was filed.  But the underlying assessment of a joint tax may have been erroneous.  If the assessment is found to be invalid the taxpayer will probably have no tax liability.

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Background 

The taxpayer and her spouse were married in 1988 and separated in November 2006. The taxpayer filed for divorce in 2007 and it became final in 2011.

For all years before 2006, the taxpayer and taxpayer’s husband (hereafter the TPH) filed joint returns. They relied upon an accountant, who communicated solely with the TPH.  Although she did not review the returns, the taxpayer did sign the prior year returns.

The TPH separately filed his 2006 income tax return in October 2007 and claimed a filing status of single. He did not claim the taxpayer as a dependent.  The taxpayer did not file an income tax return for 2006.  The taxpayer first became aware of the TPH’s return after it was selected for examination.

The Court noted in the opinion that the record was unclear if the taxpayer had a duty to file a separate 2006 income tax return.

After the IRS proposed a deficiency, the examiner informed the taxpayer and the TPH that it would benefit them if they filed a joint return. The benefit was the tax due would be less.  The taxpayer and the TPH signed a Form 4549 agreeing to the proposed adjustments to tax.   One of the adjustments involved a change in filing status from single to joint filing status.  In agreeing to the adjustments, the taxpayer agreed to joint and several liability.   The IRS accepted the agreement and assessed the tax as a joint tax.

On May 16, 2011, the taxpayer filed a claim for innocent spouse relief on Form 8857.

The IRS disallowed the claim and the taxpayer filed a petition in Tax Court.

The Court held that no joint return was filed.

A Joint Return is an Element of section 6015.

As the Court noted, section 6013(a) provides that a married couple may elect to file a joint return.    If a joint return is filed, both spouses are jointly and severally liable for the tax.  If a joint return has been filed, a taxpayer can file a claim for relief from joint and several liability.  A claim for innocent spouse relief request is normally initiated by filing a Form 8857 with the IRS.

Section 6015 provides for three types of innocent spouse relief.   All three subsections require that a joint return must have been filed.  See IRC sections 6015(b), (c) and (f). If no joint return has been filed, the taxpayer is not jointly and severally liable and the Court does not acquire jurisdiction to consider a claim for innocent spouse relief.

Was a Joint Return Filed in the Sanchez Case?

The threshold issue in the Sanchez case was whether a joint return was filed by the taxpayer and her spouse.    Whether married taxpayers file a joint income tax return is a question of fact.   As the Court noted in Estate of Campell, “Married taxpayers must intend to file a joint return.”  Many fact scenarios can arise.  For example, sometimes one spouse has not signed the return.  Another situation, which was presented in this case, is where one spouse files separately and then later the second spouse agrees to file a joint return.   The right to make a joint return after one spouse files a separate return is subject to certain exceptions not presented in the Sanchez case.  See IRC sec. 6013(b)(2).

The Court recognized the taxpayer’s right to file a joint return after her spouse’s separate return had been filed, but the Court concluded that the taxpayer’s efforts to file a joint return were not sufficient to constitute an election.

At the outset, it is surprising that the issue of whether a joint return was filed even arose in Sanchez.  Normally, you would expect this issue to arise in a case where a taxpayer contends that he or she either did not file a joint return or never intended to file a joint return.  For example, if one spouse insists that the other spouse improperly signed his or her name.  These cases often involve opposing testimony and might turn on a number of factors including whether the taxpayer tacitly approved the spouse signing their name to the original return.  It is unusual, in my experience, for the issue of a joint fling to arise when both the IRS and the taxpayer agree there was a joint filing.

In Sanchez, the court rejected the taxpayer’s argument for the following reasons: the Court held that the consent, Form 4549, signed by the taxpayer and her spouse agreeing to the joint and several liability should not be treated as a joint return.

The original return in the Sanchez case was audited and the revenue agent proposed a deficiency. During discussions with the spouse, who filed the original return, and the taxpayer, the revenue agent explained that if the spouse and the taxpayer agreed to file a joint return, the proposed deficiency would be reduced.  Although the full nature and extent of the discussions is not known, apparently the taxpayer concluded that it was in her best interests to agree to a joint filing.  It is not clear from the reported case, but it appears that the taxpayer may not have had any income in the taxable year.  So, in making the computation of taxable income, the revenue agent proposed making adjustments relating to the TPH’s income and the revenue agent also proposed making an adjustment to the filing status claimed on the original return.  Because the taxpayer was agreeing to joint filing, the filing status on the Form 4549 was changed from “single” to “joint”.  It is routine for the IRS and taxpayers to resolve cases through the use of Form 4549.  Further, it is not uncommon for a change in the filing status of taxpayers to be included on a Form 4549.

Under the Beard test, a document must meet four tests to be a return:  (1) purport to be a return, (2) be executed under penalty of perjury, (3) contain sufficient data to allow the calculation of tax, and (4) represent an honest and reasonable attempt to satisfy the requirements of the law.   In Sanchez, the Court rejected the Form 4549 in large part because the Form 4549, signed by the parties, did not contain language regarding perjury.   Notwithstanding the absence of a jurat, the author believes that the IRS and the taxpayer made an honest and reasonable attempt to satisfy the requirements of the law.

While the Court rejected the Form 4549 as sufficient to establish a joint filing, there is much to suggest that signing the Form 4549 is sufficient. First, the parties made mutual promises.  The IRS allowed the spouse and the taxpayer to benefit from the more favorable tax rates for joint filers.  On the other side, the taxpayer agreed to joint and several liability for the taxes.  It does not matter if the taxpayer fully understood the consequences of agreeing to the joint return.  What matters is that she understood that she was filing a joint return and receiving consideration – a lower tax – for her consent.   It is a fair bargain and it should be binding on the IRS and the taxpayer.

Certainly both the IRS and the taxpayer went forward with the belief that the taxpayer had elected a joint filing. Based upon the taxpayer’s agreement to be bound by the joint filing, the IRS assessed the tax and began collection activity.  On the other side, believing that she owed the taxes, the taxpayer eventually filed for innocent spouse relief.  The IRS accepted the Form 8857 for processing.  It is a condition for processing a request for innocent spouse relief that the taxpayer has filed a joint return.   If the IRS did not believe that there had been a joint filing, it would not have made a final determination denying innocent spouse relief.  The final determination was the basis for the court proceeding in the Sanchez case.

But the court has now ruled that no joint return was filed and there is no appeal from a small case and the Court’s decision will soon be binding on both parties.

Tax Consequences 

Normally, after a decision in an S case, the amount of a deficiency, if any, is established.  But that is not the case in the Sanchez case.  The tax liability was not before the court – only the innocent spouse issue.   Because the filing of a joint return is a prerequisite to the Court granting appropriate relief under IRC section 6015(e), the Court never reached the merits of the Service’s final determination denying innocent spouse relief.  The Court’s decision denied the taxpayer a right to review, but the decision appears to have created other rights.

At the end of the opinion, the court wrote:

…it is appropriate to state that nothing in this Summary Opinion should be taken to comment as to the assessment made against petitioner on the basis of the consent.

Although the court’s comment does not address the tax consequences of the decision, the tax consequences appear to heavily favor the taxpayer.  While she did not achieve a favorable result on her request for innocent spouse relief, she did not leave the court without a potential remedy.  While an S case cannot be cited as precedent and may not be appealed, the decision is final as between the parties. See  IRC section 7463(b).

The court ruled that the taxpayer did not file a joint return with her spouse.  The decision has significant legal impact on the taxes assessed pursuant to the consent.   As assessment based upon a joint filing no longer exists.  Moreover, the statute of limitations for filing a joint return has probably expired.  See IRC section 6013(b)(2)(A).  It is hard to imagine that the IRS would take the position that petitioner remained liable for the taxes based upon the reported income of the taxpayer and her spouse.  If the statute of limitations on assessment is still open, it is far more likely that the IRS will split the joint account into two separate accounts and recompute each individual’s separate tax based upon their separate income and expense items.  But, the year involved is 2006 and it is unlikely that the statute of limitations on assessment is still open.

If the IRS stubbornly continues to pursue collection, it seems to me that the taxpayer could file a petition in Tax Court alleging that the IRS had not followed the deficiency procedures and was collecting the tax based upon an illegal assessment.  The Tax Court would almost certainly rule in the taxpayer’s favor.

At the end of the day, it turns out that the taxpayer in Sanchez, not the IRS, may be the ultimate winner in this dispute.

Comments

  1. Jason T. says:

    Sanchez is a case of administrative ineptitude and a waste of taxpayers’ monies.

    The revenue agent must have slept through the class that taught:

    “Signing Form 4549, Income Tax Examination Changes, or Form 870, Waiver of Restrictions on Assessment & Collection of Deficiency in Tax & Acceptance of Overassessment, without the appropriate return form is not sufficient for making the election because these documents to not purport to be returns and do not contain a ” jurat” with the penalty of perjury clause.” IRM Part 4.4.6.2 (3.).

    The CCISO certainly dozed. It failed to ask itself question no. 1: where is the joint return that gave rise to this joint liability? Unfortunately, the Tax Court does not reveal on what ground(s) CCISO (and perhaps Appeals) denied spousal relief.

    As for Chief Counsel, who should have known better, it must have napped. It had to have known that no joint return meant, not only that Ms. Sanchez did not qualify for spousal relief, but that she had no joint tax liability. What Chief Counsel argued in the case is a mystery because, again, the Tax Court does not tell us.

    Does anyone know George L. Willis, the attorney who eventually represented Ms. Sanchez? I wonder if the Tax Court, although it reached the correct result (and hinted at a future correct result), chose to shield the revenue agent, CCISO and Chief Counsel from the professional rebuke that each deserved.

    • Carl Smith says:

      George Willis has been for a long time the distinguished Director of the Chapman U. Law School Tax Clinic in Orange County, CA. He is well-known both to the low-income taxpayer community, and he chaired the ABA Tax Section’s Low Income Taxpayer Committee.

      • Could someone then ask Mr. Willis: In Sanchez, (1) on what ground(s) did CCISO deny spousal relief? and (2) what argument(s) did Chief Counsel make?

        • I did write to George Willis to let him know about the comments on the post to see if he could respond and shed more light. George said he is too busy at the moment to get back into the case. Perhaps he will have time in the future. The Chapman clinic handles a very heavy volume of cases because of the shortage of clinics in Los Angeles. These are good questions that might provide more insight into the case for everyone. I hope we will be able to run down answers.

  2. Bob Kamman says:

    The Form 4549 signature must have occurred after the wife had filed for divorce. Why was she even showing up to meetings with the revenue agent? Was there a deal with her husband involving division of assets, spousal maintenance, child support and child custody that required her to help him save some taxes?

    Since this happened in a community-property state, my guess is that the revenue agent was threatening an income split that would have required her to file a return reporting half the income at MFS rates. Perhaps that will be the next step for IRS. After all, she still hasn’t filed.

    • Jason T. says:

      Great point about the community property angle, Bob. I believe you nailed it. I missed that connection despite Carl’s saying Mr. Willis is based in California.

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