IRS Still Ignores Allocation of Underpayment Mandated by 2011 Pullins Opinion in Computing Section 6015(f) Relief

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I came back out of retirement to become the acting director of the Harvard Federal Tax Clinic for the first six months of this year, while Keith is on sabbatical.  One of the depressing things I just discovered is that the IRS is still ignoring the method for computing innocent spouse relief in underpayment cases under section 6015(f) that the Tax Court adopted (at least for some cases) in Pullins v. Commissioner, 136 T.C. 432 (2011).  In a nutshell, the IRS computers take the joint tax return liability as reported and allocate it between the spouses based on each’s relative proportion of total reported taxable income.  But, in Pullins, the court said that, at least in that case, relief should be to eliminate all tax except that which would be paid by the requesting spouse had she filed a married filing separately return.

I dealt with this issue when I was the director of a tax clinic at Cardozo School of Law some years ago, and every time I saw the allocation the IRS had done of the spouse’s taxes for purposes of underpayments cases, I had to ask the IRS to recompute the relief consistently with Pullins.  The IRS always did so at my request, increasing the amount of relief.  But, I shouldn’t have had to ask.  And I wondered about all the thousands of pro se requesting spouses out there who were seeking (f) relief in underpayment cases.  They would never have known to challenge the IRS computations of their relief the way I knew to make the challenge.

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Last week, I consulted with a taxpayer who had reached a resolution of a Tax Court section 6015(f) underpayment case and who asked me to look at the IRS settlement computations.  Once again, the computations ignored Pullins.  The amount by which the taxpayer was being cheated was $300.  However, after I pointed this out to her, she decided not to make a fuss about this – not wanting to possibly jeopardize the settlement that she had already achieved on the major issue of getting relief at all.

But, I want to alert everyone to what is going on, and I hope the National Taxpayer Advocate will look into this matter.  After all, it is now almost 8 years since Pullins rejected the way the IRS computers are programmed to calculate section 6015(f) relief in underpayment cases.

The goal of the innocent spouse provisions (at least where there has been no abuse) is to relieve a requesting spouse only of the tax on the nonrequesting spouse’s income, not the tax on the requesting spouse’s income.  But, implementing this goal can be tricky.

If the tax as to which innocent spouse relief is sought is a “deficiency” – i.e., attributable to an audit adjustment increasing reported tax (a situation involving an “understatement”) – then relief may be available to the taxpayer under section 6015(b), (c), or (f).  Congress provided rules for calculating relief under section 6015(c) that provide, as a general rule, that “[t]he portion of any deficiency on a joint return allocated to an individual shall be the amount which bears the same ratio to such deficiency as the net amount of items taken into account in computing the deficiency and allocable to the individual under paragraph (3) bears to the net amount of all items taken into account in computing the deficiency.”  Section 6015(d)(1).  In a simple example, if the deficiency were $30,000, and the underlying adjustments to income were $80,000 of unreported income of the husband and $20,000 of unreported income of the wife, and the wife requested section 6015(c) relief, she could be relieved, at most, of 80% of the $30,000 deficiency – or $24,000.

The IRS uses this allocation system for subsection (c) relief also when computing relief from deficiencies under subsections (b) and (f).  And I take no issue with the IRS doing so.

However, there is no provision of section 6015 that tells the IRS how to compute relief under subsection (f) in an underpayment case – i.e., where the IRS has no issue with the tax reported on the return except that, when the return was filed, not all of the tax shown thereon was paid.  The IRS has filled this gap only in Manual section 25.15.3.9.2.1(7) (7/29/14), which states, in part:

If liability is attributable to both the RS [requesting spouse] and NRS [nonrequesting spouse], equitable relief will only be considered for the portion attributable to the NRS.

Note:

. . . .  Underpayments of tax are allocated based on each spouse’s pro rata share of the joint taxable income.

Note:

For purposes of determining how much of an underpayment is attributable to each spouse, the EITC and ACTC is allocated to each spouse in proportion to the spouse’s share of the adjusted gross income.

Imagine a case where the total tax shown on the joint return was $6,400 and the return only showed two items of income:  $80,000 of wages of the husband and $20,000 of wages of the wife.  After standard deductions for a married filing jointly return and two personal exemptions, assume that the taxable income is $58,000.  Imagine that the balance unpaid on that return is currently $4,000.  How much the requesting spouse should be relieved of under (f) is determined, in part, by how much of the total $6,400 of tax the requesting spouse already paid – either through income tax withholding, estimated tax payments, and payments made after the IRS commenced collection.  Under the Manual provision, though, the IRS would also say that the $6,400 of total tax should be allocated to the spouses 80% to the husband and 20% to the wife because that is their relative shares of the taxable income reported.  So, the wife would be allocated $1,280 of the reported joint tax liability of $6,400.

Pullins presented a similar fact pattern – i.e., the wife sought relief, and the wife’s income was relatively small compared to the total reported joint taxable income. Judge Gustafson, though, rejected the method the IRS used to determine section 6015(f) relief in that underpayment case.  Instead, he noticed that, had the wife filed a return as married filing separately, she would have had less tax.  That is because, by adding her income to her husband’s to file a joint return, both spouses got taxed at a high bracket.  But, her income alone would have been taxed at a low bracket if she had filed married filing separately.  In my example in the previous paragraph, the wife could have filed a married filing separately return showing only $20,000 of gross income.  Taking a combined standard deduction and personal exemption of, say, $11,000, the wife’s taxable income would have been only $9,000.  All of that $9,000 would be subjected only to the 10% tax bracket, so the tax she would have paid would have been about $900 – $380 less than her proportionate share of the joint liability.

In Pullins (at page 432), the judge wrote:

As we stated above, for purposes of determining the extent of her liability for or overpayment of tax on her own income, we use Ms. Pullins’s computation on the basis of married-filing-separately status, rather than the IRS’s computation that made a pro rata allocation of the reported liability (based on married-filing jointly status). To reckon the amount of tax liability that Ms. Pullins should have to pay because it is fairly attributable to her, we think that on the facts of this case it is reasonable to figure Ms. Pullins’s tax liability separately. The IRS’s method assumes a joint liability and then attributes to her a pro rata share of the joint liability, but the purpose of section 6015 is to grant relief from joint liability.  Under the IRS’s method, if we found Ms. Pullins to be otherwise entitled to section 6015 relief, we would nonetheless leave her liable for a portion of the joint liability.  Our aim here, however, is to figure Ms. Pullins’s own liability apart from joint liability and then ensure that we do not excuse her from paying her own liability.  To accomplish that aim, a determination of her separate liability, rather than an allocation of the joint liability, is most reasonable here. [footnotes omitted]

In footnote 8 on that page, the judge noted that the allocation that he was making was similar to one that would be made if it was determined that there was no joint return at all because the return had been signed under duress.  The footnote reads:

As an analogy, see 26 C.F.R. sec. 1.6013–4(d) (to allocate liability where a supposedly joint return was signed under duress, ‘‘The return is adjusted to reflect only the tax liability of the individual who voluntarily signed the return, and the liability is determined at the applicable rates in section 1(d) for married individuals filing separate returns’’ (emphasis added)). [emphasis in the Pullins original]

I think that Judge Gustafson declined to set down a general rule for all underpayment cases under section 6015(f) because he might want to adopt the IRS system of allocating the reported joint tax in proportion to relative taxable income when the requesting spouse was a person with much higher gross income than the nonrequesting spouse.  Also, there is the problem of the earned income tax credit.  If that credit applies for a married couple, it is only available if they file married filing jointly.  The nonrequesting spouse could not get any earned income tax credit with married filing separately status.  Section 32(d).

The case on which I was recently consulted was one like Pullins, where the requesting spouse had relatively small income compared to her husband’s and her income would have been taxed at a much lower rate had she filed a married filing separately return.  The return also involved no earned income tax credit.  Over the years, I have probably seen a half-dozen of this kind of case.  All presented this fact pattern.  My suspicion is that this is the typical innocent spouse case because, in my experience, the requesting spouse is usually the low earner in the family.

After almost 8 years since the issuance of Pullins, I think it high time that the IRS modify its Manual provision to reflect the Pullins system for calculating section 6015(f) relief in underpayment cases.  The IRS can adopt exceptions to deal with (1) the unusual situation of tax on a married filing separately return basis exceeding the allocation of the joint return tax in proportion to relative taxable income and (2) earned income tax credit returns.  I like the idea of allocating that credit between the spouses, though I would modify the allocation to be based on relative shares of the total earned income, not adjusted gross income.  After all, the tables for the earned income tax credit are computed with respect to combined earned income.

Carlton Smith About Carlton Smith

Carlton M. Smith worked (as an associate and partner) at Roberts & Holland LLP in Manhattan from 1983-1999. From 2003 to 2013, he was the Director of the Cardozo School of Law tax clinic. In his retirement, he volunteers with the tax clinic at Harvard, where he will be Acting Director from January to June 2019.

Comments

  1. Carlton, it’s been a while since I looked at these cases and IRM provisions. In the last case I had involving liability for unpaid taxes, the NRS had been obligated by a divorce decree to pay the entire unpaid balance, which all parties agreed was attributable to the NRS’s income, so your issue wasn’t presented. In a case like yours, does the IRS or the Tax court take each spouse’s tax payments [including withholding and estimated tax payments, in addition to credits] into account in determining the unpaid tax attributable to the RS and the NRS? For example, if the RS’s wage withholding more than satisfied the RS’s share of tax liability under either a joint return calculation or a MFS allocation calculation, then the NRS should be 100% liable for the unpaid balance.
    Ron Wiener, Philadelphia

    • Carlton Smith Carlton Smith says

      The short answer, Ron, is “yes”. In computing how much is still owed by the requesting spouse, first, one should calculate (under Pullins) the tax that would be payable if she filed as MFS or (under the Manual) her share of the joint tax based on her share of relative taxable income. Then, you line up under the RS’s tax so computed the withholding done from the RS’s wages and all other payments the RS had made toward the joint liability. There may be a balance due or a refund. If the RS had been properly withheld on the RS’s own income, then the RS may owe little or nothing.

  2. Folks east of Wisconsin and Louisiana (and west of Puerto Rico) need to remember the 30% of Americans who live in community property states. How are allocations made, when half the income belongs to each spouse? And is that in fact what IRS does when it looks like they are not following Pullins? I don’t think they are, or should be. But attribution of undisputed income is not as easy as one might think.

  3. Is of this is inapplicable to community property states, eh?

  4. Carlton Smith Carlton Smith says

    The flush language at the end of section 6015(a) states: “Any determination under this section shall be made without regard to community property laws.” Reg. 1.6015-1(f) states:

    (f) Community property laws —
    (1) In general. In determining whether relief is available under § 1.6015-2, 1.6015-3, or 1.6015-4, items of income, credits, and deductions are generally allocated to the spouses without regard to the operation of community property laws. An erroneous item is attributed to the individual whose activities gave rise to such item. See § 1.6015-3(d)(2).
    (2) Example. The following example illustrates the rule of this paragraph (f):
    Example. (i) H and W are married and have lived in State A (a community property state) since 1987. On April 15, 2003, H and W file a joint Federal income tax return for the 2002 taxable year. In August 2005, the Internal Revenue Service proposes a $ 17,000 deficiency with respect to the 2002 joint return. A portion of the deficiency is attributable to $ 20,000 of H’s unreported interest income from his individual bank account. The remainder of the deficiency is attributable to $ 30,000 of W’s disallowed business expense deductions. Under the laws of State A, H and W each own 1/2 of all income earned and property acquired during the marriage.

    (ii) In November 2005, H and W divorce and W timely elects to allocate the deficiency. Even though the laws of State A provide that 1/2 of the interest income is W’s, for purposes of relief under this section, the $ 20,000 unreported interest income is allocable to H, and the $ 30,000 disallowed deduction is allocable to W. The community property laws of State A are not considered in allocating items for this purpose.

    Notably, though, these examples only apply to deficiency cases. Being from New York (where we know little about community property), I have no idea how an underpayment case should be treated beyond what the statute says about not paying attention to the rules of community property. It would have been nice if the IRS gave an underpayment example in the regs. I don’t see one, either, in the Manual.

  5. Norman Diamond says

    “every time I saw the allocation the IRS had done of the spouse’s taxes for purposes of underpayments cases, I had to ask the IRS to recompute the relief consistently with Pullins. The IRS always did so at my request, increasing the amount of relief. But, I shouldn’t have had to ask.”

    As you later pointed out, depending on the spouses’ situations, that recomputation could decrease the amount of relief. It might be reasonable to recompute when asked. It wouldn’t be fair for recomputation to jeapordize a settlement though.

    A footnote in the Pullins case is quoted, though I can’t duplicate the emphasis:

    ‘As an analogy, see 26 C.F.R. sec. 1.6013–4(d) (to allocate liability where a supposedly joint return was signed under duress, ‘‘The return is adjusted to reflect only the tax liability of the individual who voluntarily signed the return, and the liability is determined at the applicable rates in section 1(d) for married individuals filing separate returns’’ (emphasis added)). [emphasis in the Pullins original]’

    In most cases neither individual voluntarily signed the return (they would be labelled tax protesters if they said signing was voluntary). Is there a threshhold below which one spouse doesn’t have to submit a separate return if the other does? Even when a non-resident alien doesn’t have to submit a US return but signs a joint return, the signature is likely under duress because otherwise the decline in after-tax household income affects both spouses.

    By the way it’s possible for there to not be a Non Requesting Spouse, because both spouses can apply for section 6015(f) relief for different characteristics of the same tax year.

  6. Carlton Smith Carlton Smith says

    As to your question whether you might have a situation where one spouse had an obligation to file, while the other did not, the answer is that such situation was fairly common under prior law, where the exemption amount for 2017, say, was $4,050. In many one-earner families, the spouse who staid home with the children often had little or no income (i.e., income below the exemption amount), so had no obligation to file. Section 6012(a)(1)(A) provided (and still provides) that there is no obligation to file if a taxpayer’s gross income does not equal or exceed the exemption amount.

    But for 2018, the rules are different. First, the exemption amount for 2018 is $0 Sec. 151(d)(5)(A). So, at first blush, a spouse who had even $1 of gross income is obligated to file. But, another provision states that in the case of a married couple who is entitled to file jointly, there is an exemption from filing where the combined gross income of the spouses is less than the sum of twice the exemption amount plus the basic standard deduction for a joint return ($24,000 in 2018; see sec. 63(c)(2)(A) and (7)(A)(ii)), but only if the spouses had the same household at the end of the year. Sec. 6012(a)(1)(A)(iv). This exception does not apply to a taxpayer who makes a separate return or if any other taxpayer is entitled to claim a dependency exemption under section 151(c) with respect to the taxpayer. It would appear that the low-earning spouse would have no obligation to file if the combined couple’s income did not exceed $24,000 and the spouses had the same household at the end of the year. The exception to the exception does not apply since the high-earning spouse would never have been entitled to claim a dependency exemption for the other spouse. The high earning spouse might have been entitled to claim an exemption for his or her spouse, but that allowance would be under section 151(b), which is not a dependency exemption under section 151(c). So, it looks like many spouses still do not have a filing obligation where the couple’s combined gross income does not exceed $24,000.

    • Norman Diamond says

      Thank you for the explanation. I’m amazed at how complicated this is even when both spouses are citizens and residents of the US and don’t even have any investment income. Anyway, it appears that if one spouse didn’t have to sign a return then in a way the signature could be considered voluntary (and not be labelled a tax protester). Though there’s still coercion to sign because, if both spouses are citizens and residents of the US, it’s pretty hard to find a situation where household after-tax income wouldn’t decrease when one spouse submits a separate return.

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