Jurisdiction of Bankruptcy Courts to Hear Innocent Spouse Cases

The case of In re Bowman, No. 20-11512 (E.D. La. 2021) denies debtor’s motion for summary judgement that Ms. Bowman deserves innocent spouse relief.  On its own, the court reviews the issue of its jurisdiction to hear an innocent spouse issue as part of her chapter 13 bankruptcy case and decides that it has jurisdiction to make such a decision.  The parties did not raise the jurisdiction issue, which is not surprising from the perspective of the plaintiff but may signal a shift in the government’s position since it had previously opposed the jurisdiction of courts, other than the Tax Court, to hear innocent spouse cases.

read more...

The court addresses the issue of its jurisdiction at the outset of the opinion.  It first cites 28 U.S.C. § 1334 and the Order of Reference from the district court before stating that this is a core proceeding.  This part of the opinion addresses the basic issue of bankruptcy courts’ jurisdiction in all issues, stemming from the litigation in the Marathon Oil case from 40 years ago (challenging the basic authority of bankruptcy courts under the then-newly-created bankruptcy code).

Moving past the bankruptcy court’s basic basis for jurisdiction, the court hones in on its ability to hear an innocent spouse case.  It first states:

Although it is true that “Section 6015(f) does not allow a bankruptcy court to exercise initial subject matter jurisdiction over an innocent spouse defense because only the Secretary [of the IRS] receives the equitable power to grant innocent spouse relief under that Section,” here, it is undisputed that the Debtor sought such relief from the Secretary in July 2019 and the Secretary denied the request.  

This aspect of jurisdiction would apply to any court hearing an innocent spouse case.  In essence, the statute requires a taxpayer claiming this relief to exhaust their administrative remedies before seeking to have a court determine relief.

Next, the court turns to its specific ability to hear an innocent spouse case and cites heavily from an earlier case from Texas:

Section 6015(e)(1) states that, in a case where an individual requests equitable relief under Section 6015(f), “[i]n addition to any other remedy by law, the individual may petition the Tax Court to determine the appropriate relief available to the individual under this section . . . .” 26 U.S.C. § 6015(e)(1)(A). It is unambiguous that a Tax Court—and not just the Secretary—may grant relief to an individual. Moreover, the remedy available in the Tax Court is “[i]n addition to any other remedy provided by law.” 26 U.S.C. § 6015(e)(1)(A).

11 U.S.C. § 505 is another “remedy provided by law.” Section 505(a)(1) specifically provides bankruptcy courts with remedial power over tax liabilities and penalties . . . . This statutory language provides a bankruptcy court with the power to determine the legality of taxes and tax penalties.

Pendergraft v. United States Dep’t of the Treasury IRS (In re Pendergraft), 119 A.F.T.R.2d (RIA) 2017-1229 (Bankr. S.D. Tex. Mar. 22, 2017)

Because it determines that the tax liability directly impacts the administration of the bankruptcy case and because the IRS has filed a proof of claim seeking to have Ms. Bowman pay the liability for which she seeks relief, the court finds that it has jurisdiction while also noting that the IRS has not objected to its jurisdiction.

The opinion is important for being only the second court to deal with the issue of whether a bankruptcy court has jurisdiction to decide § 6015 relief.  The court says that it does have such jurisdiction because 6015(e)(1)(A) (giving the Tax Court jurisdiction) is only “in addition to any other remedy provided by law” and that the bankruptcy court is another such remedy.  The court cites the Pendergraft case, which is the only other opinion from a bankruptcy court on this matter.  The court conveniently doesn’t mention all the district court opinions holding that 6015 relief jurisdiction does not exist in collection suits or (in one opinion) in refund suits, but resides only in the Tax Court.

The last district court case to render an opinion on this issue was Hockin v. United States, 400 F. Supp. 3d 1085 (D. Or. 2019).  We blogged on the Hockin case here.  In Hockin, the district court rejected earlier district court opinions and found it had jurisdiction to hear an innocent spouse case.  The case never went to trial because the parties settled.  The issue highlighted differences in the Tax Division of the Department of Justice where the trial sections argued that the district courts lacked jurisdiction while the appellate section simultaneously argued that they had jurisdiction and used that argument as a basis for dismissing innocent spouse cases filed late in the Tax Court as having missed a jurisdictional deadline.  The Tax Clinic at Harvard filed an amicus brief in Hockin pointing out the dissonance in the positions taken within DOJ, and the court noted the conflicting positions.

Perhaps the failure to raise jurisdiction as an issue in Bowman means that DOJ has abandoned the issue that only the Tax Court has jurisdiction to hear innocent spouse cases, or perhaps a split now exists within the trial sections at DOJ.  Another possibility is that DOJ distinguishes between district court and bankruptcy court cases raising this issue.  In its motion to dismiss in the Hockin case, DOJ stated:

The language of Section 6015(e)(3) explicitly strips the Tax Court of jurisdiction once a refund suit is filed in district court, which avoids parallel proceedings. But another court explicitly rejected Boynton. In re Pendergraft, 16-33506, 2017 WL 1091935, at *3 (S.D. Tex. B.R. Mar. 22, 2017). That court held that it could consider an innocent spouse defense as part of a bankruptcy court’s powers to determine the amount or legality of a tax under 11 U.S.C. § 505. The court was unconcerned with the possibility of inconsistent judgments, finding that jurisdiction cannot be “based on a hypothetical possibility that concurrent proceedings could produce inconsistent results. That issue, if it ever exists, should be left to Congress.” Id.

Pendergraft is an outlier decision, and it ignores Boynton’s most convincing point: if Congress intended to provide two equally accessible lanes for a taxpayer to seek review of an innocent spouse determination, why does Section 6015(e)(3) treat the process as a one-way street? The Tax Court is clearly divested of jurisdiction when a refund suit is filed in district court, yet the statute is silent on the reverse scenario. Section 6015 sets out a clear, detailed process for funneling review of innocent spouse determinations to the Tax Court. That statute provides no such scheme for the district courts.

DOJ did not try to distinguish Pendergraft because bankruptcy is different.  In Pendergraft, the DOJ argued that the availability of a Tax Court 6015 action precluded 6015 relief under BC 505. The Pendergraft opinion provides a lengthy response disagreeing with the DOJ and its citations — but one that does, in part, rely on the purpose of BC 505.  Section 505 grants jurisdiction to bankruptcy courts to resolve tax merits issues.  The Pendergraft court says that BC 505 is a remedy encompassed by the “in addition to any other remedy provided by law” clause in 6015(e)(1)(A).

Going past the jurisdictional issue, the court in Bowman declined petitioner’s invitation to grant her relief based on summary judgment.  Here is her motion and here is the DOJ response.  She sought relief under 6015(f) but did not submit an affidavit or much other information related to the factors that the IRS has established as required for relief in Rev. Proc. 2013-34.  The court found that insufficient evidence was presented to allow it to grant relief at this stage.  Of course, she can still succeed if she puts on adequate evidence at trial.  At least, based on the court’s finding of jurisdiction, she will have that opportunity.

Significant Changes in New Draft Form 8857

We welcome as her second visit to the blog my colleague in the tax clinic at the Legal Services Center of Harvard Law School, Audrey Patten.  Audrey has developed a significant docket of innocent spouse cases and is currently working with Christine to write the third edition of A Practitioner’s Guide to Innocent Spouse Relief.  Look for their book in the coming year.  She also worked with clinic student Madeleine DeMeules on the oral and written comments to Form 8857 discussed here. As Audrey discusses below, their comments led to some changes to the newly revised form.  With the new emphasis on the administrative record, the request for relief from joint liability takes on a high level of importance from the first submission.  Keith

Submitting Internal Revenue Form 8857 to the IRS is the starting point for seeking administrative relief from joint and several liability under IRC §6015, generally called “innocent spouse relief.” The current version of Form 8857 dates to 2014 and has come under scrutiny for being difficult to understand, especially for pro se taxpayers, and unclear as to what relevant information and documentation a taxpayer should submit. With the Taxpayer First Act’s new requirement in IRC §6015(e)(7) that the Tax Court must limit its review of innocent spouse cases to the administrative record, Form 8857, and its use in eliciting relevant taxpayer information, is now crucial to setting up a strong Tax Court case.

The IRS has released a draft update to Form 8857, with a revision date of June 2021. The new form has several improvements. These include various changes that the Low Income Taxpayer Clinic at Harvard suggested in a written comments submitted to the IRS last year and that have been advocated by other LITCs and the ABA. The draft form’s layout and presentation, however, will still be challenging to many taxpayers, especially those with limited resources, education, or writing skills. Practitioners must therefore continue to be mindful about preparing well-crafted narrative statements for clients that track the equitable relief factors in Rev. Proc. 2013-34 and that synthesize relevant facts and documentation to ensure a complete administrative record.

read more...

Use of Form 8857

For those unfamiliar with innocent spouse practice, the most common pathway to relief begins by sending Form 8857 directly to the IRS unit dedicated to §6015 relief in Covington, KY. The unit consists of examiners and appeals officers trained in handling innocent spouse cases. While there are three types of innocent spouse relief available to taxpayers (located in IRC §6015(b), (c), and (f)) the taxpayer only submits one copy of Form 8857. Form 8857 does not ask taxpayers what type of §6015 relief they are seeking. Rather the IRS uses that one form to automatically review the application for all three types of relief. It is therefore important that taxpayers are able to present a full picture of their circumstances. The best practice is to ensure that the information on the form and accompanying attachments can support the factors used to weigh “equitable relief” under §6015(f) so that the provision can be properly evaluated if the taxpayer is denied (b) or (c) relief. These factors are found in Rev. Proc. 2013-34 §4.03 and allow for the most comprehensive evaluation of the taxpayer’s circumstances.

Major Changes on the June 2021 Draft Form 8857

1. The “Important Things You Should Know” box at the top of the form has added key important provisions to its bullet point list:

           i. It now directs taxpayers to consult Publication 971 “for help in completing this form and for a description of the factors the IRS takes into account in deciding whether to grant innocent spouse relief.” That citation was a specific recommendation the Harvard clinic included in our comments because, without such a reference, Form 8857 leaves taxpayers completely in the dark as to whether a balancing test of factors even exists. Taxpayers unfamiliar with Rev. Proc. 2013-34 may not understand why certain information is being requested on the form and therefore have a harder time interpreting the questions. That being said this addition has its limitations. Publication 971 lists out the equitable relief factors in a section entitled “Equitable Relief,” (in reference to §6015(f) relief) which is separate from the Publication 971 section called “Innocent Spouse Relief” (in reference to §6015(b) relief). Someone unaware that equitable relief is indeed a form of innocent spouse relief to be considered on Form 8857 might be quite confused and potentially skip that section of the Publication 971 altogether.

            ii. Another bullet point is added that notes the new administrative record rule, warning that the Tax Court may only be able to review information the taxpayer, or their spouse, submits or that is in the IRS file. This is also reinforced by yet another new bullet point asking the taxpayer to attach documentation to Form 8857 and by more frequent reminders throughout the form that additional pages can be attached to lengthen written answers.

2. The draft form adopts another of our clinic recommendations by asking the taxpayer to indicate if English is their primary or preferred language. This is a welcome question because, not only does it assist in picturing the overall life situation of the individual tax payer, it also allows for the collection of aggregate data on the languages needs of potential innocent spouses. This will in turn open the possibility to direct resources to identify language groups that may be considered frequently encountered and help develop language access resources for the innocent spouse unit at the IRS.

3. The draft form includes a new check box asking if the taxpayer consents to receiving voicemails from the examiner. This addition will be of great benefit to those taxpayers who may work jobs that do not allow them to readily answer the phone during business hours. Strict adherence to working hours and restrictions on calls are disproportionately a feature of many service industry, manufacturing, caretaker, and manual labor jobs that are held by lower income taxpayers. By allowing flexibility in communications, it is more likely that taxpayers using Form 8857 may be able to stay in contact with the IRS examiner and lead to a successful resolution of their case.

4. The draft form also adopts a change the ABA has suggested for many years. That is the adjustment to ask whether the taxpayer intended to file a joint return as opposed to whether they did sign a joint return. This language adjustment can account for scenarios where someone signed under duress. Conversely, it also covers taxpayers who did not physically sign or file the return but did expect a joint return would be filed.

5. Part III of the Form 8857 deals with taxpayer’s involvement with the couples’ finances. Under the current version, the questions are structured with mandatory check box answer lists for taxpayers to rate their level of knowledge for each question followed by an open-ended direction to explain the checked answer in more detail. This format raised concerns in the past that taxpayers were being required, under pains and penalties of perjury, to check off a rating of knowledge that could not capture any nuance. The new draft form eliminates those check boxes and replaces them with a series of open ended questions. It should be noted however that the new questions are almost paragraph length and the sheer volume of words in the questions may drive away some taxpayers with limited education or writing skills.

Areas of Continued Concern

Like the existing version, the new draft form does not explicitly guide taxpayers through the potential factors that the IRS will consider. It also does not give equal weight to the information it collects. For example, there is only one question devoted to mental or physical health (Question 9). Meanwhile, the draft form devotes at least 8 separate open-ended questions that appear directed at the knowledge factor (Questions 12-19). The unwary taxpayer, who may not realize that all factors are subject to a balancing test, with no one factor automatically weighing more than the others, may be under the impression that the mental or physical health question is of comparatively minimal importance and not devote enough time to thoroughly answering it.

Another example is the one question on the form that seems to speak to the significant benefit factor as well as the knowledge factor (Question 18). Question 18 asks if, during the year at issue, the taxpayer or the non-requesting spouse “incur[red] any large purchases or expenses?” It is followed by Question 19 which asks about transferred assets. But neither of these questions asks the taxpayer to describe whether they actually were able to use, enjoy, or benefit from such purchases, expense, or assets. Practitioners should advise their clients that affirmative answers to those questions can be supplemented with a statement describing whether they actually received a significant benefit.

Part V of the draft form is the section asking about domestic violence and abuse. It has been revised to remove the 10 check boxes that described potential types of abuse and leaves the original open ended question (Question 23b) asking the taxpayer to describe the abuse they experienced. While check boxes to evaluate abuse may seem inappropriate, they do serve an important function on the existing form in that they flag types of behavior that count as abuse, including things that may not seem obvious to a taxpayer unfamiliar with the broad definition of abuse found in Rev. Proc 2013-34. For example, the list includes asking whether the non-requesting spouse did things like “withholding money for food, clothing, or other basic needs,” “criticize, insult or frequently put you down,” or “Abuse alcohol or drugs.”

These descriptive examples of different kinds of abuse are useful because the IRS’ definitions of abuse in Rev. Proc 2013-34 is far more expansive than many state law definitions of abuse that a taxpayer may be more familiar with. The IRS definition is not limited to physical abuse and includes emotional abuse, financial control, and substance abuse. The ten examples in the current version can guide taxpayers as they prepare their open ended answer. The new draft form, however, provides no examples before that question as to what types of scenarios can be considered abuse. Moreover, the open ended question is immediately followed by an invitation to attach documents normally related to physical abuse, such as court documents, medical records, police reports, and injury photos. This set-up easily leaves the impression that only physical abuse is truly relevant. Question 23a, which asks if abuse was present, does have a note in parenthesis that says abuse may be “physical, psychological, sexual, emotion, or financial abuse, and can include the abuser making you afraid to disagree with him or her or causing you to fear for your safety.” However, the note is easily missed. It also leaves out substance abuse. Removing the requirement to check the ten boxes but, still leaving the list of behaviors in place as illustrative examples, would be a better approach.

In sum, while there have been some welcome adjustments to Form 8857, the new draft version will still be quite challenging for the average pro se taxpayer unfamiliar with the factors the IRS weighs in these cases and with the types of documentation needed to bolster their case. Although IRS employees in the innocent spouse unit are able to elicit more information based on answers to the form if they call the taxpayer, that is not a reliable fallback. The new administrative record rule means that if the taxpayer ends up taking the case to Tax Court, it will be their loss if facts did not make it on the record. Practitioners will therefore need to be vigilant about ensuring that narratives are able to track the factors in Rev. Proc. 2013-34 and are supported with clearly labeled documentation. Failure to do so will result in limitations in the ability to present the case in the Tax Court should the IRS not grant administrative relief.

The Fatty Rule for Post TFA Innocent Spouse Cases? An Early Look at the Otherwise Unavailable Evidence Exception

The Taxpayer First Act changed the scope of review in innocent spouse cases. Rather than allow parties to introduce evidence at trial, as we have discussed (see for example Christine’s post Taxpayer First Act Update: Innocent Spouse Tangles Begin) the TFA restricts the parties to the administrative record. TFA contains two exceptions: when there is evidence that is newly discovered or was otherwise unavailable.  There is considerable uncertainty surrounding this new rule, as well as how the Tax Court will define and apply the newly discovered and otherwise unavailable exceptions.

This past March in Fatty v Commissioner, Judge Holmes issued a bench opinion in an S case that gives an early nonprecedential look at the otherwise unavailable exception. 

read more...

The case itself is a fairly straightforward application of the equitable relief factors arising from an approximately $7,000 reported liability attributable to the withdrawal of funds from Mrs. Fatty’s retirement account. At the time the then-married Mr. and Mrs. Fatty used the money to pay for expenses associated with the purchase a house. They later divorced, and pursuant to the divorce agreement Mrs. Fatty, who retained ownership of the home, was responsible for the tax liability. 

Despite Mr. and Mrs. Fatty entering into and complying with an installment agreement (with Mrs. Fatty paying the monthly amounts) Mr. Fatty sought relief from the joint and several liability. Mrs. Fatty intervened and the case went to trial. 

In normal deficiency cases, and in innocent spouse cases prior to the TFA changes, at trial, Mr. Fatty would have the opportunity to testify and introduce other evidence. In setting up the opinion, Judge Holmes summarized the TFA changes:

Until recently, the scope of review in a Tax Court case involving a request for innocent spouse relief is also de novo. People would come, they’d introduce evidence, and I as a judge would look at it with fresh eyes. Congress has more recently changed that scope of review. Now I am supposed to look at what is called the administrative record. The administrative record consists of all the documents and the evidence that the IRS looked at when Mr. Fatty first applied for relief.

Judge Holmes also explained the two exceptions to the TFA record rule:

I am supposed to look only at the administrative record, with two exceptions. And those two exceptions are evidence that is newly discovered or evidence that was previously unavailable. This is a change in the law, and the Fattys are one of the first cases to come after this change in the law.

Here is where the opinion gets interesting. As I mentioned, the TFA does little to expand upon what either exception means.  As a practical matter, these exceptions will likely be important, especially with pro se taxpayers who may fail to develop a case before the centralized and correspondence based IRS innocent spouse unit.

In Fatty, Judge Holmes takes a very generous view of  the meaning of otherwise unavailable, offering one approach that takes into account the absence of trial like procedures in IS administrative determinations:

However, in this particular case, I just assumed that testimony given under oath and subject to cross-examination, like the testimony given by both Mr. and Mrs. Fatty, is this newly available evidence, because when Mr. Fatty applied for innocent spouse relief, he wasn’t able to give sworn testimony and neither he nor his wife were subject to cross-examination

This approach, if adopted in other cases, leaves open the possibility for witness testimony, given the absence of sworn testimony and the right of cross examination in administrative IS determinations.  

To be sure, it is hard to read too much into this: this is just a bench opinion in an S case and the language discussing the exception is a bit garbled. Judge Holmes notes the limits: “As I said, I’m not deciding this for all cases in the future. This is an S case.” Yet for practitioners this is an important early development. It provides a convincing approach to allow parties to testify despite the TFA record rule limiting the scope to the record below. We will see if the Tax Court adopts it, or whether other Tax Court judges apply it in future nonprecedential opinions. 

What about the Fattys’ case? As with many Judge Holmes opinions he transparently discusses his approach, which is refreshing in a case implicating a multi-factor balancing test.

What I look at, and what I think is the appropriate fulcrum, is the extent to which the economic immunity of a household that files a joint return has been broken down by the actions of the non-requesting spouse in a way that didn’t allow the requesting spouse’s reasonable exit from having joint returns and a joint liability.

The opinion notes that the parties equally enjoyed the benefits of the income and explains that the IRS is not bound by the parties’ divorce agreement. After walking through the factors and emphasizing that Mr. Fatty had remedies under state law if Mrs. Fatty failed to pay on the agreement and the IRS collected from him, Judge Holmes held that Mr. Fatty was not entitled to relief. 

Innocent Spouse Updates

The 11th Circuit upheld the decision of the Tax Court in Sleeth v. Commissioner, — F.3d — 2021 WL 1049815 (11th Cir. 2021), holding that Ms. Sleeth was not an innocent spouse.  The Sleeth case continues the run of unsuccessful taxpayer appeals of innocent spouse cases following the major structural changes to the law in 1998.  Another taxpayer is trying to break the string by appealing the Tax Court decision in Jones v. Commissioner, TC Memo 2019-139 to the 9th Circuit.  I will discuss both cases below.

read more...

Sleeth

The Sleeth case is the second case the Tax Clinic at the Legal Services Center of Harvard Law School appealed to a circuit court.  If you are interested in the oral argument, you can listen to it here.  Madeleine DeMeules argued on behalf of the clinic and did an excellent job but faced significant headwind from the court because of the burden that an appellant must meet to overcome a trial court decision.   

In both cases argued by the tax clinic the Tax Court found multiple positive factors and only one negative factor applying the tests of Rev. Proc. 2013-34.  Yet, despite the multitude of factors favoring relief in each case the Tax Court found that the knowledge factor was negative for the taxpayer and denied relief.  The pattern developing in these cases suggests that the Tax Court views the knowledge factor as a super factor, despite changes in IRS guidance no longer describing it as such.  In this post, Carl Smith discussed Seventh Circuit’s decision in the Jacobsen case, the first of the two cases the tax clinic took to a circuit court, and cites to all of the unsuccessful appeals of innocent spouse cases.

In Sleeth the court knocked down each of the three arguments for petitioner.  The appeal challenged the decision of the Tax Court regarding the knowledge element, the economic hardship element and the overall application of the factors.  Ms. Sleeth signed three joint returns at once, two of which were delinquent, showing liabilities totaling a few hundred thousand dollars.  She did not work, and her then-husband was a doctor who worked as a contractor rather than an employee.  In prior years he had also run significant liabilities which he had always paid off in relatively short order.  They had not filed delinquent returns before, so both the number of returns with an unpaid liability and the total amount of the liability exceeded prior circumstances.  She testified she expected he would pay off these liabilities, and he might have but he lost his job and ultimately paid in enough money to almost fully pay one of the years, but which still left a hefty balance.  The 11th Circuit found the Tax Court’s determination that she should have known he would not pay off the liabilities reasonable under the circumstances.

The size of the liability significantly exceeded her assets and her income was essentially non-existent.  The Tax Court found the economic hardship factor neutral, and the clinic argued on appeal it should be a positive factor for her, since devoting her assets to a partial payment of the liability would have left her homeless and penniless.  The 11th Circuit found that she might have had some assets other than her modest townhome, with which she could have paid a relatively small fraction of the outstanding liability. The court also foundthat she did not show she could not pay something toward the liability.  The Tax Court record regarding her assets and ability to pay was not as robust as it might have been.

Taking all factors into consideration and having agreed with the Tax Court on the two contested factors, the 11th Circuit did not find it unreasonable to deny Ms. Sleeth innocent spouse relief, even through the court had found three positive factors for relief and only one negative factor.  The case shows the importance of creating a strong record in the Tax Court and of prevailing at the Tax Court.  Overturning a primarily factual decision will never be easy.

Jones

Despite the difficulty in obtaining a reversal on an innocent spouse decision, Ms. Jones seeks to do exactly that in the 9th Circuit.  The Jones case involves not only a determination of her status as an innocent spouse but also the issue of whether she filed a joint return.  The tax clinic recently filed an amicus brief in the case on the issue of tacit consent.  We have not written much on tacit consent, but it is a regular feature in innocent spouse cases where one spouse, almost always the same spouse arguing for innocent spouse status, asserts that they did not agree to sign the joint return.  In many cases the spouse’s actual signature is not on the return, because the return was filed electronically or because the other spouse signed for both.  The Tax Court has created a body of case law deciding when the non-signing spouse intended the joint filing of a return and refers to the taxpayer’s consent in these situations as tacit consent.

Some of the factors the court relies upon in deciding whether a non-signing spouse intended to create a joint return are (1) whether the non-signing spouse objected to the filing of a joint return; (2) whether prior filing history of the couple during the marriage suggests an intent; (3) whether the non-signing spouse filed a separate return if that spouse had a filing requirement; (4) whether general reliance on one spouse for financial matters existed and (5) whether the couple had specific rules between themselves governing signing for one another.  While the issue of abuse and duress goes beyond tacit consent, it can play a role here.  If one spouse physically or emotionally intimidates or abuses the other, it could invalidate even an actual signature or could influence a court’s decision on the granting of tacit consent.

Taxpayer’s contesting a joint return liability should always look first to determine if they have an argument that no joint return exists.  Knocking out the existence of the joint return provides a surefire way of avoiding any liability stemming from the spouse’s income or other tax issues (note however that this does not hold true in a community property state, where the innocent spouse will still be required to include their share). Taxpayers can easily argue that they did not sign a joint return but face a much more difficult argument regarding their intent.  Bob Nadler wrote a post on the joint return issue several years ago in which he touched on tacit consent but the case did not focus on this issue.  Bob wrote the book on innocent spouse issues.  Christine Speidel and Audrey Patten are in the process of updating the book and the third edition should go to press later this year. 

Ms. Jones argues she did not intend to file a joint return and that if she did file a joint return, she should receive innocent spouse relief.  She is being represented by Lavar Taylor, a frequent guest blogger.  The case is still in the briefing stage and will not get argued until later this year.  Perhaps Ms. Jones can break the string of taxpayer defeats in appellate courts on the innocent spouse issue or avoid the innocent spouse issue altogether with a victory on tacit consent.  For those interested in innocent spouse issues, the case is worth following.

Offset of Rebate Recovery Credit and Some Innocent Spouse News

We have written several posts on offset over the past year and offset posts continue to be the most popular posts we write.  It might be possible to start an offset blog based on reader interest.  Some prior posts are here (injured spouse offset issues); here (CARES Act offset exceptions); and here (offset bypass rules – most heavily visited post on our site.)

read more...

The issue of offset of stimulus payments took an interesting turn this past week.  As you probably remember last year, in passing the CARES Act Congress took the extraordinary step of excepting from offset all debts except for past due child support.  This meant that stimulus payments in the first and second rounds went directly into the hands of taxpayers who would ordinarily have simply received a letter notifying them that their refund was taken to satisfy some past due debt. 

It looked like individuals who did not receive their stimulus payment for the first or second round and who could claim it as a Recovery Rebate Credit (RRC) as they filed their 2020 return would have the disadvantage of having the payment subject to federal tax offset and all of the other available offsets.  A recent post by the National Taxpayer Advocate (NTA) sets out some of the history on what the IRS did as it moved into the 2020 filing season. 

The bottom line is that the IRS has now decided to exercise its discretion under 6402(a) with respect to the offset of federal tax refunds to federal tax liabilities.  The IRS will allow refunds based on RRC to pass through to taxpayers without being offset to satisfy prior federal tax debts.  Great news for persons with only federal tax debts in their portfolio of debts subject to offset under the Treasury Offset Program (TOP) but less good news for taxpayers with other outstanding obligations.  For a detailed discussion of offset and an explanation of TOP, you can read an article recently written by Michael Waalkes and me found here.

The NTA points out two problems with the otherwise good news regarding the IRS decision to forego offset of refunds based on RRC.  First, the decision happened in the middle of the filing season after many taxpayers had already filed and already had their refunds offset.  A similar offset decision occurred last year when the Department of Education decided during the middle of the filing season not to exercise its right to offset federal tax refunds (and other federal payments) against outstanding student loan debts.  Individuals who filed early (i.e., those most likely to have substantial refunds) get treated differently than those who wait.  A similar issue has occurred during this filing season with unemployment benefits that Congress decided mid filing season to exclude from income.  (Though yesterday the Commissioner in his testimony before Congress said that the IRS was working on a way to fix this for early filing taxpayers without the need for them to file a superseding or amended return.) 

Should the unfairness of the treatment of early filers versus later filers cause the IRS not to adopt a change like this in the middle of a filing season?  Should the IRS (can the IRS) reverse the offsets it has already made during this filing season and put everyone on equal footing?  The NTA says “For taxpayers who already have had their RRCs offset to repay federal tax debts, we will work with the IRS to try to identify a way to make them whole.”  So, perhaps a fix will come for early filers with RRC based refunds, similar to what will happen for early filers reporting unemployment income.  This is a lot of extra work for the IRS when it is already strained recovering from the pandemic and pushing out stimulus payments.  If it can make this happen, it will be impressive.

The NTA pointed out a second problem with the IRS decision to exercise its discretion to allow the RRC refunds to bypass the federal tax offset – the IRS does not have the ability to keep these refunds from offset through TOP.  IRC 6402(a) gives the IRS discretion to waive offset of federal tax refunds but does not give it authority to waive offset of the other offsets that occur when a taxpayer has a federal tax offset.  The NTA says “Therefore, there remains a significant disparity between the treatment of taxpayers who received advance payments and the treatment of taxpayers who did not receive advance payments and are claiming their benefits as RRCs.”

Fixing the second problem requires Congressional action and passage of a bill with language similar to the CARES Act legislation last year.  There is no indication that such legislation is coming.  When the IRS is considering offset bypass refunds (OBR) discussed in the post linked above and in the article, it does not exercise its discretion when it can see a debt indicator on the taxpayer’s account alerting the IRS that the exercise of discretion will not put the money in the taxpayer’s hands but simply send it to the Bureau of Fiscal Services to satisfy another federal or state outstanding debt.  Because of the blanket decision to exercise discretion made with respect to RRCs, the IRS will benefit other federal and state creditors in some instances rather than the taxpayer.  While not optimal, this is the most the IRS can do with the authority it has.  It also provides a model for IRS moving forward that could benefit recipients of certain types of refunds, such as those generated by the earned income tax credit or other programs designed to put money in taxpayers’ hands.

Innocent Spouse news regarding the administrative record

We received correspondence from PT reader James Everett of DeFranceschi & Klemm, PC in Boston.  Mr. Everett represents the taxpayer in Sutherland v. Commissioner which Christine blogged here and I blogged here in the year in review post because of the importance of this case.  For those who do not remember Sutherland, it involves the issue of IRC 6015(e)(7) which limits Tax Court review in innocent spouse cases to the administrative record, including cases pending at the time of enactment that had already gone through the administrative process prior to the legislation creating the limitation.  The case was originally set for trial on December 2, 2020 in Boston but continued and rescheduled for trial on St. Patrick’s Day in Phoenix.  Most Bostonian’s would welcome a trip to Phoenix during the winter.  Alas, this trip was a virtual one. 

Here is the news from Mr. Everett regarding the IRS position on the administrative record:

The national office interjected itself into the case and the IRS objected to all documents that we wanted to include with the stipulation that weren’t part of the “administrative” record (i.e. documents not provided during the administrative stage).  In other words, it looked like the IRS was setting this case up for an appeal.  There was really no way of telling what the AO or CISCO actually reviewed previously because records weren’t kept in that fashion (since it didn’t matter with a de novo review).  Judge Lauber was going to require the IRS to call the appeals officer as a witness at the trial to discuss the record.  A few days before the trial, the IRS dropped its administrative record objections.  Judge Lauber asked the respondent’s counsel if this was reflection of Service wide policy (i.e., the IRS agreed that §6015(e)(7) didn’t apply to pending cases), respondent’s counsel candidly replied that this was above his paygrade to comment on – he could only speak to the case at hand. Thought this might be helpful to the readers of your blog.  

The withdrawal of objection to the administrative record is welcome news but does not resolve the issue.  The administrative record rule presents significant problems for individuals who go through the administrative process pro se, since they often fail to develop the full record needed if litigation occurs.

Two Against One in Innocent Spouse Case Decided by Judge Vasquez the Subject of New Book

Innocent spouse cases and dependency exemption cases can seem like divorce court once-removed.  Most tax practitioners decide not to be family lawyers because they have personalities that are dry as toast and want to avoid the emotional rollercoaster of domestic disputes.  Nonetheless, taxes provide the opportunity for plenty of ongoing domestic disputes as the case of Leith v. Commissioner, TC Memo 2020-149 demonstrates.  For an excellent write up of the case you should also read Bryan Camp’s post on this case as part of his Lessons from the Tax Court.

read more...

Judge Vasquez

Before I get to the case, I want to pause for a commercial interlude.  The Leith case is decided by Judge Vasquez.  This month the ABA Tax Section has published a biography of Judge Vasquez, From the Texas Cotton Fields to the United States Tax Court: The Life Journey of Juan F. Vasquez.  This is the first biography of a Tax Court judge and a remarkable story about his path to the court.  Judge Vasquez was originally appointed by President Clinton and became a senior judge in 2018 – the status all Tax Court judges must take when they reach the age of 70.  The path of each judge to the Tax Court differs but few follow a path remotely like the one taken by Judge Vasquez.

Intervention

When a taxpayer seeks innocent spouse relief, they usually begin by filing a Form 8857 with the IRS asking the IRS to abate all or part of a joint tax liability assessed against them.  The IRS has centralized consideration of innocent spouse requests in the Cincinnati Service Center, which is actually located in Covington, Kentucky.  At this location a group of IRS employees spend all day, every day reading the sad stories of individuals who have signed on for something they wish they had not.  When a taxpayer submits a request for innocent spouse relief, thereby becoming the requesting spouse (RS) in innocent spouse parlance, the IRS provides the non-requesting spouse (NRS) with notification of the request giving the NRS the opportunity to comment on whether the IRS should grant the request.  We have written about intervention before here, here and here.

Fears of Innocent Spouse Applicants

One problem with giving the NRS the notice of the innocent spouse request stems from the fact that some persons requesting relief have fled from the NRS as victims of domestic violence.  These victims often do not want the NRS to know that they have requested relief, because it could enrage their spouse or former spouse and lead to additional violence.  They also worry that making the request could alert the NRS to their whereabouts.  While the IRS does not provide the NRS with the Form 8857, the NRS can obtain the form and other data through FOIA.  The IRS would seek to protect the address and other identifying information in the case of an innocent spouse request involving domestic violence, but the RS would rightfully be nervous about relying on the IRS to carefully redact everything that might serve to identify where they lived.

I have had victims of domestic violence come to my clinic seeking assistance who backed away once they learned that the NRS could have access to the information submitted even if it was limited access.  In those cases there are strategies to pursue to protect the RS and still provide some relief.  The safest strategy for obtaining relief in that situation is probably an offer in compromise.  For one spouse to compromise a joint debt does not allow the other spouse to comment or see the file.  Some clients have even been concerned about that level of information sharing with the IRS and prefer to just wait out the statute or at most seek currently not collectible status.

Finding an Ally in IRS

In this case Ms. Leith finds the IRS in agreement with her application for innocent spouse relief.  In a case in which the NRS has intervened, a petitioner cannot simply sign a decision document with the IRS agreeing to the result.  So, the case goes to trial even though the taxpayer and the IRS agree as to the result.  This procedure gives the NRS the opportunity to keep the RS from leaving the NRS as the only liable spouse.

I certainly do not know the whole back story, but the timing of the tax problem lines up with the economic problems the country faced following the Great Recession.  My clinic still serves several clients who trace their tax problems back to that recession.  At the time the recession began petitioner worked at home taking care of the children while NRS had a job outside of the home which he lost in 2009.  Petitioner took a job as a waitress while NRS formed a partnership with two others to clean out foreclosed homes.  Petitioner had no connection to the business.

The couple’s financial difficulties continued into 2010 and 2011.  She tried to find a position in the mortgage industry where she had worked before becoming a mother but was unsuccessful and ended up working more shifts as a waitress.  NRS withdrew money from a retirement account.  Early withdrawals were so common following the Great Recession that the students in my clinic at the time became experts in IRC 72(t), seeking to find ways to fit the client into an exception to the imposition of the 10% excise tax.  When I turned 59 and ½ they threw me a 72(t) party complete with cake and decorations.  That’s how focused we were on that life milestone because of the number of clients we had draining their retirement accounts.  It was good to see that Congress had learned from that experience and provided some relief for this problem in the CARES Act.

The returns were audited resulting in additional tax.  They also filed their 2013 with a balance due and no remittance.  In Tax Court both were pro se; however, by virtue of having the IRS in agreement with her, petitioner in certain respects did have representation.  For example, when the NRS sought to introduce documents not properly exchanged prior to trial, the IRS attorney objected to the violation of the Court’s order and succeeded in keeping the documents out of the record.  Having persuaded the IRS, the petitioner also had an advantage in persuading the Court regarding her credibility in a case that became somewhat of a he said/she said.  Much of the opinion describes her credibility and the NRS failure to bring forth credible evidence.  Nowhere does credibility become more important than in her allegations of abuse.

The administrative record in the case at bar provides a detailed account of intervenor’s psychological abuse and physical intimidation of petitioner. In her second request petitioner stated unequivocally that she had been a victim of spousal abuse or domestic violence. She attached to the second request a letter containing detailed descriptions of intervenor’s abusive behavior. Such behavior included: (1) locking petitioner out of the house when she was pregnant because he was angry that petitioner had left the house to run an errand and (2) screaming at petitioner and kicking household objects. Petitioner also discovered three large kitchen knives underneath her mattress, causing her to fear for her and her daughters’ safety.

The trial record reinforces the abuse allegations petitioner made during the administrative process. At trial petitioner credibly testified that intervenor was controlling and prone to outbursts.

Spouses who can prove abuse stand a very high chance of success in an innocent spouse case because such abuse pervades all of the factors in Rev. Proc. 2013-34 published by the IRS to set out the criteria for determining innocent spouse status under IRC 6015(f).  Although not required to do so, the Court here faithfully followed the factors set out in the Rev. Proc.  The Court goes so far in following the Rev. Proc. as to base its determination on the streamlined factors in the Rev. Proc.:

We find that petitioner is entitled to streamlined relief from joint and several liability pursuant to section 6015(f) for the years at issue to the extent of the tax items attributable to intervenor.

Nothing in the statute or regulations mentions regular or streamlined paths to innocent spouse relief.  It is interesting that the opinion reviews her qualifications for a streamlined path to victory.

Also interesting in this case is the determination of abuse.  The IRS, unlike many state laws concerning abuse, creates a recognition of abuse that does not require physical abuse.  This case involves non-physical abuse.  The IRS and the Tax Court deserve kudos for recognizing that many forms of abuse do not involve mere physical actions.  The abuse discussion in the opinion is not unique in Tax Court jurisprudence but does a good job of highlighting that the path to proving abuse need not go through the hospital emergency room.

Conclusion

This is not a precedential opinion.  Perhaps there is little new here but the opinion reinforces the importance of the non-binding Rev. Proc.; displays the benefits of having the IRS on your side in court; and provides a good example of abuse in a situation in which the petitioner did not suffer physical abuse.

When Does an Innocent Spouse Request Stop a Levy

The case of Landers v. United States, 3:20-cv-00455-G (N.D. Tex. 2020) raises the issue of the timing of the injunction against collection vis a vis the completion of a bank levy.  This case appears to break ground not previously broken, as Ms. Landers seeks to undo the levy because she filed her innocent spouse request during the 21-day period the bank was holding the funds in the joint account after receipt of the levy.  The court decides that the language stopping collection resulting from the filing of an innocent spouse request does not stop the bank levy during the 21-day period.  The opinion goes through an analysis of the Anti-Injunction Act to get there.

For those interested in a deeper dive on the issue presented by the case and the arguments made by the parties you can find the following case documents: motion to dismiss; affidavit of Revenue Officer; plaintiff’s brief; IRS reply; and plaintiff’s sur reply.

read more...

Ms. Landers and her ex-husband jointly filed a 2016 return at the end of 2017.  The IRS assessed a liability of $742,728 against them jointly and severally in January of 2018.  Although the opinion does not say this explicitly, I assume from the timing of the assessment that the IRS assessed a tax shown on the return.  The couple divorced on September 14, 2018.  On December 5, 2019, the IRS issued a levy to a bank where Ms. Landers had an account owned solely by her.  The bank received the levy notice on December 11 which started the 21 day holding period after a bank levy.  On December 20, 2019, Ms. Landers submitted a request for innocent spouse relief.  At the conclusion of the 21-day period, the bank turned over all of the money in her account as of December 11.

She filed this action on February 24, 2020 seeking relief, arguing entitlement to an injunction for return of the funds because the IRS should have ceased the levy upon the filing of the innocent spouse relief request until the conclusion of the innocent spouse case pursuant to IRC 6015(e)(1)(B)(i). This subsection provides:

no levy or proceeding in court shall be made, begun, or prosecuted against an individual making [an innocent spouse claim] . . . for collection of any assessment to which such election or request relates until the close of the 90th day referred to in subparagraph (A)(ii) . . . .

Additionally, she argued that she deserved declaratory or injunctive relief under 28 U.S.C. 2201 and 5 U.S.C. 702 for harm caused by the action and she deserved mandamus relief under 28 U.S.C. 1361 requiring the IRS to return the money acquired through the levy.

Injunctive Relief

The IRS filed a motion to dismiss for lack of subject matter jurisdiction citing the Anti-Injunction Act (AIA) creating a situation of dueling injunctive provisions.  The innocent spouse provisions contain one of the enumerated exceptions to the AIA in subsection 6015(e)(1)(B)(ii) which provides:

Notwithstanding the provisions of section 7421(a) [the AIA], the beginning of such levy or proceeding during the time the prohibition under clause (i) is in force may be enjoined by a proceeding in the proper court[.]

The court states that it must decide two questions: (1) what is the scope of the exception to the AIA provided in the innocent spouse provision and (2) do the facts of Ms. Lander’s case fall within the scope of the innocent spouse exception to the AIA.  It then states that the innocent spouse exception to the AIA does not provide an exception upon which she can rely in these circumstances.

The parties focused extensively on the phrase in (B)(i) “no levy or proceeding in court shall be made, begun, or prosecuted.”  The court, however, notes that the discussion of the language in (B)(i) must be tied into the language in (B)(ii) to determine if the court has jurisdiction to enjoin the IRS from this collection activity.  It finds that the phrase “the beginning of such levy” in (B)(ii) crucial to its determination of jurisdiction.

The court noted the absence of case law interpreting the phrase and resorted to rules of statutory construction.  It finds that (B)(ii) allows taxpayers to seek a preemptive injunction against the IRS starting the levy process but does not provide an indefinite right allowing an injunction after a levy has issued.  I find this peculiar.  What taxpayer wants to bring a suit to enjoin the IRS from issuing a levy before it does so?  Such a construction would suggest taxpayers should preemptively bring injuction suits after filing innocent spouse requests rather than rely on the statute to stop such actions.  Courts would not look kindly on such suits.

The logical conclusion of the court leaves taxpayers helpless if they do not preemptively sue to enjoin the IRS before it issues a levy.  Ms. Landers points this out to the court arguing that its interpretation makes the injunction in the innocent spouse provision toothless.  In answer the court says it seeks to read both the innocent spouse provisions and the AIA in such a way as to protect the purposes of both statutes.  It also notes that the AIA provides a broad restriction requiring strict enforcement.  It points out that Ms. Landers had more than a year after her divorce before she filed her innocent spouse request and she received notice of the intent to levy giving her a further, more specific opportunity to act before she did.  She had a broad window for seeking an injunction and missed it.  It concludes the first section of its opinion by providing:

Without deciding when exactly the levy began (and the court’s power under subsection (B)(ii) expired), the court concludes that Landers was long past that point when she sought injunctive relief, more than a month after the funds had already been turned over to the government by ICU. Therefore, the court is without subject matter jurisdiction over Landers’ claims for injunctive relief, and they must be dismissed.

Mandamus Relief

The court relies heavily on its decision regarding the injunction to reach its conclusion here.  It points out that the mandamus provisions cannot override the AIA by obtaining injunctive relief in the guise of a mandamus.  It basically dismisses this action because it attempts to end run the AIA, which the court believes serves to prevent injunctive relief here.

Declaratory Relief

The court points out that the exception in the Declaratory Judgment Act (DJA) for taxes intended to leave the Flora rule intact requiring full payment before seeking a return of money.  It looks to the case of Cohen v. United States, 650 F.3d 717,729-31 (D.C. Cir. 2011) to find an answer to the jurisdictional issue raised here.  In Cohen the court found that the relief sought was simply a declaration with no effect on the assessment and collection of taxes.  It finds that to the extent Ms. Landers seeks merely a declaration her case closely mirrors the Cohen case.

In other words, the DJA does allow courts to issue declarations regarding procedural issues so long as the declaration does not run afoul of the AIA by interfering with the assessment and collection of taxes. Taxpayers may seek a declaration of their procedural rights, but that declaration cannot be used to bootstrap a right to injunctive relief.

The court finds that it has jurisdiction over her DJA claim as long as she only seeks a declaration that the IRS followed proper levy procedures and does not seek an injunction or return of the levy proceeds.

Obtaining a statement that the IRS did not follow procedures but can still keep the money may not help Ms. Landers very much.  If she wins her innocent spouse case, will the IRS return the money at that point or will it require her to finish paying off the balance of the large assessment before she can sue for refund.  If she seeks a refund will the IRS argue that the district court has no jurisdiction over that case as it has done in the past despite the contrary arguments it has made to appeals courts.  Ms. Landers’s path to recovery of the levy proceeds remains unclear.  Simply obtaining a statement that the IRS did not properly follow procedures will not put food on the table.  This cases raises interesting questions.  We may not have seen the last of it.

The APA: The Other Taxpayer Bill of Rights

The Taxpayer First Act (TFA) provides that the Tax Court apply a de novo standard of review of a section 6015 determination of the IRS based on (1) “the administrative record established at the time of the determination” and (2) “any additional newly discovered or previously unavailable evidence”.  In today’s guest post practitioner Steve Milgrom advances a novel argument, that the TFA’s changes to Section 6015 open the door to the possibility that IRS innocent spouse hearings should be subject to the formal adjudication rules under the APA. Steve’s provocative post raises the soon to be very important problem of ensuring that parties requesting relief from joint and several liability are entitled to present relevant evidence that may be difficult or impossible to present administratively. While I am skeptical of the solution that Steve proposes, it is likely that at a minimum the Tax Court will be wrestling with the terms “newly discovered” or “previously unavailable” in fashioning broad exceptions that will allow the Tax Court to evaluate difficult cases that often implicate circumstances (like abuse) that may not be fully developed via centralized correspondence-based determinations that are the hallmarks of the current regime under Section 6015. Les

Unlike other Federal government agencies that routinely hold trial like hearings on the record, the IRS stopped doing so back in the 1920’s.  In the case of §6015 innocent spouse determinations, this may be about to change. 

The road to this change in IRS procedure begins with a bill of rights.  No, not that Bill of Rights, the first ten amendments to the US Constitution (although even this Bill of Rights may come to play a critical role).  I’m not even referring to the Taxpayer Bill of Rights, Code §7803(a)(3).  Here I refer to the bill of rights Congress passed in 1946 to protect us against the Federal government:

[A] bill of rights for the hundreds of thousands of Americans whose affairs are controlled or regulated in one way or another by agencies of the Federal Government.  S.Doc. No. 248, at 298.

The 1946 bill of rights is the Administrative Procedure Act (APA), which is found at 5 U.S.C §551-§706. While the Taxpayer Bill of Rights has not gotten much traction in the courts, the APA is a significant restraint on Federal administrative agencies.

read more...

Before I delve into the mysteries of the APA keep in mind that, like all statutes, standing atop the APA is the U.S. Constitution and its Bill of Rights.  Whether or not the APA applies to agency action, compliance with the Due Process Clause of the 5th Amendment to the Constitution is also required.    PBGC v. LTV Corp., 496 U.S. 633, 655 (1990).  See also, Wong Yang Sung v. McGrath, 339 U.S. 33, at 49 (1950) (The constitutional requirement of procedural due process of law derives from the same source as Congress’ power to legislate and, where applicable, permeates every valid enactment of that body.)

Another preliminary matter is APA §559, dealing with the effect of subsequent statutes on the APA.  §559 states that a “[s]ubsequent statute may not be held to modify” the APA “except to the extent that it does so expressly.”  Faced with the prospect of having to comply with the APA’s formal procedural requirements the IRS might argue that the recent amendment to Code §6015 that I discuss below expressly modified the APA.  Arguments that tax law provisions are express modifications of the APA have gotten traction when made in connection with the judicial review of IRS proceedings.  See Kasper v. Commissioner, 150 TC 8 (2018).  However, these cases do not deal with how the agency itself must proceed and the change to §6015 doesn’t modify the APA in any way.  §6015 states that the procedures for the IRS to make a determination are to be prescribed by the Secretary of the Treasury.    Clearly the procedures prescribed by Treasury have to comply with the APA.  Mayo Foundation for Medical Education v. U.S., 131 S.Ct. 704 (2011).  

The APA covers a lot of ground.  It sets forth rules for agency rule making, agency adjudications, and for judicial review of agency proceedings.  To understand the APA one must first study the definitions.  “Rule making” is defined as an agency’s process for formulating, amending, or repealing a rule.  An “adjudication” is any agency process for the formulation of an order.  An “order” is a final disposition of an agency in a matter other than rule making.  APA §§551(5), (6), and (7).  Basically, adjudications are the things that agencies do other than rule making.  

Another important distinction made by the APA is between what are known as formal vs. informal agency proceedings, both in the context of rule making and adjudications.  The formal vs. informal dichotomy determines which set of procedural requirements apply to agency action.  Both rule making and adjudications are allowed to proceed informally unless the statute governing the agency activity requires it to hold a hearing on the record.  In the tax world, the statute governing agency activity is the Internal Revenue Code (Code).  If the statute calls for a hearing on the record, then the formal procedural requirements of the APA must be following by the agency.  Formal rule making is governed by §§556 and 557.  Formal adjudications are covered in §§554, 556, and 557.  Informal rule making and informal adjudications are covered by §553 and §555, respectively.

Agency adjudication can still avoid being subject to the formal procedural requirements of the APA based upon six specific exemptions, one of which is relevant to this discussion.  APA §554(a)(1) provides that any matter “subject to a subsequent trial of the law and the facts de novo in a court” is exempt from the formal procedural requirements of the APA.  Note that this is not an exemption from the APA itself, only from the formal rules. It is this exemption that has historically allowed the IRS to proceed, in APA parlance, informally.

The exception of matters subject to a subsequent trial of the law and facts de novo in any court exempts such matters as the tax functions of the Bureau of Internal Revenue (which are triable de novo in the Tax Court).  S. Comm. On the Judiciary, 79th Cong., 1st Sess., Administrative Procedure Act.  (emphasis in original).

Last year, in the Taxpayer First Act (TFA), Congress rewrote the rules applicable to the Tax Court’s determination of the availability of innocent spouse relief.  See Taxpayer First Act, Pub. L. No. 116-25, §1203, adding Code §6015(e)(7).  While §6015(e)(7) retains the rule that the Court’s review of an IRS determination is de novo, it is now to be based on the administrative record.  No more trial of the facts de novo.  The exemption provided by APA §554(a)(1) no longer applies.  Does this change mean that the IRS must now comply with the formal procedural requirements of the APA when making an innocent spouse determination? Only if the Code requires the adjudication “to be determined on the record after opportunity for an agency hearing …” See APA §554(a) prefatory language.

The Code says nothing about the IRS holding a hearing when it makes an innocent spouse determination. Might we find the hearing requirement elsewhere?  US v. Florida East Coast Railway Company, 410 U.S. 224, 245 (1973), deals with agency rule making.  However, the language of the APA for adjudications is the same.  In both rule making and adjudications the triggering language is identical, for the formal rules to apply the APA states that the operative statute must require agency action “on the record after opportunity for an agency hearing.”   In Florida East Coast Railway Company the Supreme Court had this to say about these key terms:

… the actual words ‘on the record’ and ‘after … hearing’ used in §553 were not words of art, and that other statutory language having the same meaning could trigger the provisions of §§556 and 557 in rulemaking proceedings. Id, at 238.  (emphasis added)

Other courts have confirmed that there are no magic words. 

[W]hether the formal adjudicatory hearing provisions of the APA apply to specific administrative processes does not rest on the presence or absence of the magical phrase “on the record.”  Marathon Oil Co. v. Environmental Protection Agency, 564 F.2d 1253, 1263 (9th Cir. 1977).

Courts often rely upon the Attorney General’s Manual on the Administrative Procedure Act (1947) in interpreting the APA.  See Vermont Yankee Nuclear Power Corp v. Natural Resources Defense Council, Inc., 435 U.S. 519, 546 (1978).  The AG Manual gives examples of statutes that require formal adjudications where the governing statute requires a hearing but says nothing about it being on the record:

[W]hile the … Act does not expressly require orders … to be made “on the record”, such a requirement is clearly implied in the provision for judicial review of these orders … Other statutes authorizing agency action which is clearly adjudicatory in nature … specifically require the agency to hold a hearing but contain no provision expressly requiring decision “on the record”.

The examples in the AG’s Manual deal with statutes that require a hearing but make no reference to its being “on the record.”  Is there any less of an implication when the missing language is reversed, when the statute calls for judicial review of an administrative record but makes no reference to the agency holding a hearing?  

Due process requires every agency adjudication to involve some type of hearing.  Even where there is no “adjudication required by statute,” the APA’s formal procedures have been imposed based upon the hearing requirement of the due process clause.  Wong Yang Sung v. McGrath, 339 US 33 (1950).  The APA provision stating that it is only applicable to hearings “required by statute” exempts agency hearings that are conducted by a lesser authority than a statute, such as by regulation or rule, not hearings that are held out of compulsion, either by statute or constitutional requirement.  Wong Yang Sung, at 50.  So when the Supreme Court referred to “other statutory language having the same meaning” in Florida East Coast Railway Company, to be consistent with Wong Yang Sung it would have been clearer to say “other statutory or constitutional language having the same meaning.”  

Now that §6015(e)(7) requires the Tax Court to perform its review of an IRS innocent spouse determination based upon the administrative record, the IRS must make its determination “on the record.”  While §6015 leaves it to the IRS to establish procedures for making its determinations, as the Attorney General said some 70 years ago, a requirement that an agency act on the record is “clearly implied in the provision for judicial review.”  §6015(e)(7) is just such a provision for judicial review and here you don’t have to search for an “implied” requirement.  The requirement for an administrative record is explicit.

Did Congress intend to force the IRS to hold formal hearings on the record when making a §6015 determination?  While the number of words used to impose the requirement are few, they are unique, this is the only place where the Code uses the phrase “administrative record.”  By adopting a new approach to Tax Court procedure, using a phrase that comes from the world of administrative law, it does seem that this change in judicial review should also change the agency level procedure applicable to innocent spouse determinations.  

Having decided to limit the Tax Court to reviewing the administrative record, maybe Congress was familiar with Wilson v Commissioner, 705 F.3d 980 (9th Cir. 2013).  In Wilson, the 9th Circuit rejected the IRS’s argument that the Tax Court should be restricted to a review of the administrative record in a §6015(f) case.  Wilson rejected what Congress has now made the law.  The rationale of the 9th Circuit explains why it is so important that the IRS be required to follow the formal procedural requirements of the APA in §6015 cases.  The Wilson decision is based in large part on the fact that the pre-TFA process used by the IRS for making a §6015(f) determination did not result in a sufficient record for the Tax Court to review:

There is no formal administrative procedure for a contested case at which the taxpayer may present her case before an administrative law judge.  At no time during the process is the taxpayer afforded the right to conduct discovery, present live testimony under oath, subpoena witnesses for trial, or conduct cross-examination. … [I]t is before the Tax Court that the taxpayer has the vehicle to conduct discovery … subpoena witnesses and documents … and submit evidence at trial.  Wilson, at 990.

The 9th Circuit continued its explanation of the importance of trial like proceedings:

The ability to supplement the administrative record is particularly important in equitable relief cases, which require a fact-intensive inquiry of sensitive issues that may not come to light during the administrate phase of review.  The threshold requirements for innocent spouse relief may present a complicated and contradictory dilemma for the taxpayer.  The innocent spouse must show that he or she is ignorant of the spouse’s tax misdeeds, yet must marshal documentary support to prove it.  The taxpayer often has limited or no access to critical records.  The innocent taxpayer who has been misled by a spouse often may not understand the full extent or scope of the erring spouse’s misdeeds.  Compounding these difficulties is an administrative system where the only opportunity to present a case is through telephonic interviews with an agent in a remote location.  Wilson, at 991.

Since the Tax Court is no longer permitted to decide the facts de novo, the administrative record which the Tax Court reviews must be created by the IRS using the formal procedural requirement of the APA, allowing for discovery, testimony under oath, cross-examination of witnesses, and the many other procedures that are designed to lead to a full and fair determination of the facts.

The last time Congress set up an agency of the Executive branch that conducted the sort of hearings that the APA requires for formal adjudications was 1924.  That agency was named the Board of Tax Appeals (BTA).  In 1969 Congress moved the functions of the BTA out of an administrative agency and placed them in the Judicial branch, in a court known as the United States Tax Court.   Harold Dubroff and Brant J. Hellwig, The United States Tax Court, an Historical Analysis, 49 (2nd ed. 2014).  When the activities of the BTA were moved to the Tax Court, the job of holding formal hearings to determine the facts of a case likewise moved to the judicial branch of our government.  While the 1924 Act that created the BTA did not provide for any direct appellate review of its decisions, the decisions could be collaterally attacked in a suit for a refund where the findings of the BTA were prima facie evidence.  In 1926 the law was amended to permit review of BTA decisions in the Court of Appeals, where review was limited to questions of law.  Why return to a system of agency level factual determinations followed by judicial review of the agency record? The IRS is constantly underfunded.  The Tax Court is fully capable of hearing the facts of §6015 cases de novo.  What can possibly be gained by forcing the IRS to build a whole new infrastructure just for 6015 cases? 

How might the IRS implement this new requirement?  Currently, requests for §6015 relief are handled by a special office in the IRS, known as CCISO.  There is no need for the operations of this office to change.  When Congress changed the §6015 judicial review provisions it also established a new office within the IRS, known as the Internal Revenue Service Independent Office of Appeals.  This office is required to be fair and impartial to both the government and the taxpayer.  While I don’t know what was in the mind of the drafters of the TFA but it seems like this new office was specifically created to, among other things, handle the task of complying with the APA formal procedural hearing requirements. 

The IRS has long argued that the Tax Court’s review of innocent spouse determinations should be restricted to the administrative record.  Since the argument was not based upon a statutory requirement, had the Tax Court agreed with this proposition it would not have triggered the APA’s formal procedural requirements at the agency level.  While the IRS lost in Tax Court, it prevailed in some Courts of Appeal, but not others.  Congress stepped in to resolve the circuit split by adopting the position advocated by the IRS.  There is now a statute that requires judicial review based upon the administrative record, the operative requirement for application of the formal procedural requirements of the APA.  I am reminded of Marty Ginsberg’s maxim of Moses’ rod:

Every stick crafted to beat on the head of a taxpayer will metamorphose sooner or later into a large green snake and bite the commissioner on the hind part.  Ginsburg, Making Tax Law Through the Judicial Process, 70 ABA J. 74, 76 (1984).