Defining the revised innocent-spouse provisions.

• Author: Ely, Mark H.

To address widely perceived injustices arising from joint and several liability for spouses who fried joint returns, Congress, as part of the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA), expanded the possibilities for relief from joint liability. In enacting Sec. 6015, Congress provided three separate statutory bases for innocent-spouse relief. Two of these arise only when a taxpayer's tax increases.

Relief from Tax Increases

Sec. 6015(b) provides relief from joint liability if five conditions are met:

1. A joint return was filed;

2. On the return, an understatement of tax was attributable to erroneous item(s) of the spouse (i.e., the non-requesting spouse) with whom the spouse requesting relief (i.e., the requesting spouse) filed the return;

3. The requesting spouse established that at the time that the return was signed, he had no knowledge or reason to know of a tax understatement;

4. Taking into account all the facts and circumstances, holding the requesting spouse liable for the understatement would be inequitable; and

5. The requesting spouse elected the benefits of Sec. 6013(b) no later than two years after the date collection activities began as to him.

Sec. 6013(b) is analogous to pre-IRSRRA Sec. 6013(e), but was expanded to include all items adjusted (but not limited to those that were "grossly erroneous").

Relief is not available to a spouse whose income or deductions or both are the cause of the tax increase.

The third requirement of Sec. 6015(b), that the requesting spouse had no knowledge or reason to know of a tax understatement at the time the taxpayers filed the joint return, was considered by the Tax Court in Butler, 114 TC 276 (2000). In Butler, the court adopted its precedents on pre-IRSRRA Sec. 6013(e). It stated:

... if a reasonably prudent taxpayer in his or her position, at the time he or she signed the return, could be expected to know that the return contained an understatement or that further investigation was warranted. The spouse seeking relief has a "duty of inquiry" ... In deciding whether a spouse "has reason to know" of an understatement, we undertake a subjective inquiry, and we recognize several factors that are relevant to our analysis, including: (1) The alleged innocent spouse's level of education; (2) the spouse's involvement in the family's business and financial affairs; (3) the presence of expenditures that appear lavish or unusual when compared to the family's past income levels, income standards, and spending patterns; and (4) the culpable spouse's evasiveness and deceit concerning the couple's finances.

In Braden, TC Memo 2001-69, the court compared two of its prior holdings--Cheshire, 115 TC 15 (2000) and Varney, TC Memo 1991-14 --as illustrative of the facts that distinguish between a requesting spouse having reason to know and meeting his duty to inquire.

In Cheshire, the, requesting spouse knew that her husband had received a large sum from his retirement plan. The retirement proceeds were incorrectly reported as partially nontaxable on the taxpayers' joint return. The court concluded the requesting spouse had knowledge of the amount of the retirement distribution and that she "knew or had reason to know of the understatement."

In Varney, distributions from an IRA belonging to the requesting spouse's deceased wife were not reported. Before dying, the wife withdrew the funds from her IRA and deposited them into a joint account. When the requesting spouse inquired about the large deposit into the couple's joint account, his wife told him that the funds were from accumulated savings. The Braden court concluded that "the taxpayer had satisfied his duty of inquiry and did not know that the funds received were the result of a distribution from his...