Getting a Second Chance: The Need for Tax Court Jurisdiction Over IRS Denials of Relief Under Section 66

• Author: Adrianne Hodgkins
• Position: J.D./B.C.L. Candidate, May 2005, Paul M. Hebert Law Center, Louisiana State University.
• Pages: 1167-1201

Page 1167

Introduction

Imagine owing thousands of dollars to the Internal Revenue Service (the "Service") for taxes assessed on income you never earned. For some Americans, that nightmare is a reality. The Service claims that they owe unpaid taxes, with penalties and interest, on income earned by their spouses or ex-spouses about which they never knew and from which they never received any benefit. For many of these spouses, paying the tax is financially impossible.

Fortunately, two provisions in the Internal Revenue Code (the "Code") allow the Service to relieve such taxpayers, so-called "innocent spouses," from this tax liability. Married taxpayers who file a joint return are jointly and severally liable for the taxes reported on the return.¹ Under certain circumstances, section 6015 of the

Code relieves a taxpayer from this joint and several liability for the taxes due on a joint return.² In community property states, the rule of Poe v. Seaborn requires married taxpayers who file separate returns to each report and assume liability for the taxes owed on one-half of all community income regardless of which spouse earned it.³ Under certain circumstances, section 66 of the Code relieves a taxpayer from the liability imposed by Poe v. Seaborn for the taxes on one-half of his or her spouse's income.⁴ Obtaining relief under these two provisions, however, is difficult and often places the taxpayer at the whim of the Service. Page 1168 option for these taxpayers is litigation in the United States district court or Court of Federal Claims. Separate filers living in noncommunity property states have no need for this relief. In a noncommunity property state, each spouse is liable only on the filing taxpayer's own income as reported on the separate return.

Under the current law, innocent spouses living in non-community property states are given greater procedural protection than those living in community property states. The availability of Tax Court review to some taxpayers and not others creates geographic inequality. Congress's past efforts have evidenced an intent to strive for geographic equalization in the tax law. In addition, although an innocent spouse denied Tax Court review may petition the United States district court or the Court of Federal Claims for review, the requirement that the taxpayer pay the disputed tax before litigating in those fora makes litigation there difficult, if not impossible, for the innocent spouse. To remedy these problems, Congress must give all innocent spouses denied relief by the Service a right to seek Tax Court jurisdiction to review all denials of innocent spouse relief whether brought under section 6015 or section 66.

This comment discusses the disparate procedural treatment provided to taxpayers under the innocent spouse provisions of the Code, sections 6015 and 66. Part I outlines the relief available to taxpayers under sections 66 and 6015. Part II analyzes the jurisdiction of the Tax Court to review denials of relief under these sections. This section will explain how the language and interpretation of the innocent spouse provisions have created disparate procedural remedies for taxpayers who are denied relief under sections 6015 and 66. Part III illustrates the problem with a hypothetical analyzing the treatment of taxpayers under the provisions protecting innocent spouses. This section will show how the innocent spouse provisions operate differently depending on the taxpayer's geographic location. Part IV presents the case of Whitacre v. Commissioner,⁵ the real life plight of a taxpayer denied innocent spouse relief under section 66 and Tax Court review of that denial. Part V explores Congress's intent in limiting Tax Court jurisdiction over innocent spouse relief. This section will establish Congress's stated intention that the Tax Court be available to all innocent spouses. This section will also point out that, despite its stated intention, Congress failed to grant Tax Court jurisdiction in section 66. Part VI presents and examines arguments for expanded Tax Court jurisdiction to review the Commissioner's denials of relief of the effects of community property law under section 66 of the Code. This section will establish Congress's attempt at geographic Page 1169 equalization in the Code and explain the fundamental differences between the Tax Court and the other fora available for determination of an innocent spouse claim. Finally, part VII proposes that Congress give the Tax Court the ability to review the denials by the Commissioner. Congress must give the Tax Court jurisdiction to review all denials of innocent spouse relief by the Service to adequately protect innocent spouses.

I The innocent spouse provisions

The Code gives married taxpayers two options for filing their income tax return each year. Spouses may either file separate tax returns, each reporting his or her own income, or file one joint return, combining all income earned by both spouses.⁶ When married taxpayers file separate returns, each spouse is individually liable for the taxes owed on his or her own income.⁷ Spouses electing to file ointly, however, share joint and several liability for the taxes reported on the return.⁸ They also share joint and several liability on any deficiency, interest, or penalties assessed by the Service.⁹

For taxpayers living under a community property regime, the rule of Poe v. Seaborn¹⁰ sometimes imposes tax liability on the non- earning spouse. In community property states, each spouse acquires an undivided one-half interest in all community income from the moment the income is earned. Because each spouse owns half of the income, the rule of Poe v. Seaborn requires each spouse to report one-half of his own income and one-half of his spouse's income on a separate tax return.¹¹ Consequently each spouse is individually liable for one-half of the tax on all community income, regardless of which spouse earned the income or whether the non-earning spouse received Page 1170 any portion of the income.¹² When the spouses file a joint return, they remain jointly and severally liable for the entire tax liability.¹³

The joint and several liability and liability for taxes on one-half of community income can create a hardship for some taxpayers, so- called "innocent spouses." An "innocent spouse" is a taxpayer who owes taxes on some item of income, attributable to the other spouse, from which the taxpayer never benefitted. The Service, nonetheless, often seeks payment of the tax liability from the innocent spouse because the other spouse, for one reason or another, cannot be found. Page 1171

Two provisions of the Code provide relief to spouses saddled with a tax liability on income about which they never knew and from which they never benefitted. The first provision, section 6015 of the Code, applies to a taxpayer who filed a joint tax return and later seeks relief from joint and several liability for the taxes owed.¹⁴ The second, Section 66 of the Code, relieves a spouse in a community property state who filed a separate tax return from liability for taxes owed on community income earned by the other spouse.¹⁵

A Section 6015: Relief from Joint and Several Tax Liability for Joint Filers

Because married taxpayers who file a joint return are jointly and severally liable for the tax due on the income earned by both spouses, either spouse may be required to pay the entire amount.¹⁶ Section 6015 gives taxpayers several different ways to seek relief from this joint and several liability.¹⁷

Under section 6015(b)(1), a spouse requesting relief will not be liable for tax attributable to an understatement of income made on the tax return if: (1) a joint return was filed for the taxable year in question; (2) an understatement of tax was made on the return, which is attributable to an erroneous item of the other spouse; (3) the spouse requesting relief did not know or have reason to know of the understatement; (4) holding the requesting spouse liable for the tax deficiency would be inequitable; and (5) the requesting spouse files for relief within two years of the beginning of collection activities.¹⁸

If all of these requirements are met, the statute states that the requesting spouse "shall be relieved of liability for tax (including interest, penalties, and other amounts) . . . attributable to such understatement."¹⁹ Meeting every requirement, section 6015(b)(1) guarantees relief from joint and several liability for the tax, interest, Page 1172 and penalties with respect to the item of income that caused the understatement.²⁰ Page 1173

However, many innocent spouses fail to meet every requirement of section 6015(b)(1). Thus, section 6015 provides other avenues for relief from joint and several liability. Even if the requesting spouse knew of the...