Have the new innocent spouse rules, as applied and interpreted by the IRS and the courts, resulted in the relief which Congress envisioned in enacting the 1998 legislation?

• Author: Sheehy, Frances D.
• Position: The Continuing Evolution of the "New" Innocent Spouse Rules as Implemented and Interpreted by the Internal Revenue Service and the Courts: - Part I:

On July 22, 1998, new legislation governing "innocent spouse" relief from joint tax liability became effective. (1) Congress enacted this legislation to make it easier to obtain relief under the innocent spouse provisions of the Internal Revenue Code. (2) Part I of this two-part article will discuss the old innocent spouse rules, the new innocent spouse rules under IRC [section] 6015(b) and (c), and the courts' interpretation of those provisions. Part II (March 2002) will discuss [section] 6015(D of the new law, the proposed regulations pending approval by the Department of Treasury, the Internal Revenue Service procedures, what to expect after submission of an innocent spouse claim, and whether the flexibility in application of the innocent spouse criteria which Congress envisioned has been attained.

Former Innocent Spouse Rules

Generally, the filing of a joint tax return subjects each spouse to joint and several liability for payment of the tax on the return and for any deficiency determined subsequent to the filing of the return. Prior to 1998, to qualify for relief from joint liability, the spouse claiming to be "innocent" had to prove: 1) that the liability at issue was the result of a joint return; 2) that the return had a substantial understatement of tax, which exceeded certain limits in amount and percentage of adjusted gross income, and that the understatement was due to grossly erroneous items of the "non-innocent" spouse; 3) that in signing the return, the innocent spouse did not know, and had no reason to know, of the substantial understatement of tax; and 4) that, under the facts and circumstances, it would be inequitable to hold the innocent spouse liable for the tax deficiency. (3) The innocent spouse had the burden of proving each and every element and was precluded from qualifying as an innocent spouse if he or she failed to prove them all. (4)

The IRS, however, was reluctant to grant innocent spouse relief, sometimes resulting in harsh consequences. (5) Some circuit courts of appeal, on the other hand, were less rigid in their interpretation of the innocent spouse rules under the former law and ruled against the IRS, granting the taxpayer innocent spouse relief. (6) Proving actual ignorance was not enough under prior law. Judicial interpretation of the "not know, and had no reason to know" criteria imposed the reasonably prudent taxpayer standard to determine if the innocent spouse had "reason to know" of the understatement. (7) In determining this knowledge prong, the courts looked at all the facts and circumstances, including education, involvement in the family's finances, deceit of the non-innocent spouse, and lavish expenditures or other clues which might alert the innocent spouse to the validity of the return. (8) Nonetheless, meeting this burden of proof, especially years after the filing of the return (as in the case of tax shelter assessments made decades after the returns were filed), was difficult, if not impossible, for most innocent spouses seeking relief.

The IRS Restructuring and Reform Act of 1998

The Congressional reports expressed concern that the IRS' handling of innocent spouses under the prior law was unreasonable. (9) The new law was intended to expand application of innocent spouse relief and alleviate some of the technical barriers to granting relief. The new legislation, in some respects, mirrors the more favorable circuit court decisions in expanding the availability of innocent spouse relief. The new act replaces IRC [section] 6013(e) with [section] 6015, and applies to any liability for tax arising after July 22, 1998, and to any unpaid liability arising on or before that date. Taxpayers must file the election for relief prior to July 22, 2000, or within two years after the IRS begins collection activities. (10)

Section 6015(b)

* The Expanded Traditional Innocent Spouse - 6015(b)(1)

The primary changes which IRC [section] 6015(b) imposes on the prior law are elimination of the requirement that the understatement be "substantial," and the requirement of "grossly" erroneous items. The $500 threshold and the threshold with respect to the innocent spouse's adjusted gross income are eliminated. The knowledge requirement and the determination that it must be inequitable to hold the innocent spouse liable remain. This change does not eliminate any of the subjective tests which precluded relief under the old law, as interpreted by the IRS and criticized by Congress as being sometimes unreasonable. Under the new law, an innocent spouse requesting relief under [section] 6015(b) must establish that: 1) the joint return contains an understatement of tax due to the erroneous items of the non-innocent spouse; 2) at the time the return was signed, the innocent spouse did not know, and had no reason to know, that the return contained an understatement of tax; and 3) taking into account all the facts and circumstances, it is not inequitable to hold the innocent spouse liable for the understatement. (11)

* The Partially Innocent Spouse -- 6015(b)(2)

The apportionment provisions of IRC [section] 6015(b)(2) afford semi-innocent spouse relief by apportioning the liability, much like the Ninth Circuit approach in Wiksell v. Commissioner, 96-2 USTC 50,398 (9th Cir. 1996). (12) Under this provision, an innocent spouse is responsible only for the tax, interest, and penalties relating to the portion of the understatement of which the spouse has knowledge, or reason to know. (13) As under prior law, the innocent spouse has the burden of proving lack of knowledge and reason to know of the specific items giving rise to the understatement of tax.

* How the Courts are Interpreting IRC [section] 6015(b)

Because the basic requirements to obtain innocent spouse relief under [section] 6015(b) are virtually unchanged from those under former [section] 6013(e), the Tax Court is relying on cases decided under former [section] 6013(e) for guidance in deciding claims for relief under [section] 6015(b)...