Innocent spouse rules provide relief.

• Author: Foran, Nancy J.

EXECUTIVE SUMMARY

* The new relief provisions are a response to congressional concerns that the former provisions were inadequate.

* An eligible spouse can now make an innocent spouse or separate liability election or seek equitable relief.

* The Sec. 6015 provisions apply without regard to community property laws.

The Internal Revenue Service Restructuring and Reform Act of 1998 ushered in a new era of taxpayer-favorable innocent spouse relief. Three avenues of relief are offered under new Sec. 6015. This article explains the provisions, compares the new and old law and offers clarifying examples.

The Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98), Section 3201, substantially changed the Code's innocent spouse relief provisions by (1) enacting Sec. 6015, (2) repealing Sec. 6013(e) and (3) amending Secs. 66(c) and 6230(c)(5). Prior law had limited innocent spouse relief to large tax understatements and "grossly erroneous" items. Sec. 6015, which makes innocent spouse relief easier to obtain, was later clarified by Section 4002(c) of the Tax and Trade Relief Extension Act of 1998 (TTREA '98). For certain innocent spouse claims fried before Dec. 7, 1998, a Taxpayer Advocate Directive(1) ordered abatement of penalties.

Sec. 6015 and the amendments to Secs. 66(c) and 6230(c)(5) are effective for tax liabilities arising after (or unpaid as of) July 22,1998. Because Sec. 6015 applies to all unpaid tax liabilities, even if the taxpayer was not eligible for innocent spouse relief under former Sec. 6013(e), the IRS is currently receiving approximately 1,000 innocent spouse relief claims per week.(2)

Background

In recent years, Congress became concerned that the existing innocent spouse provisions were inadequate. According to the IRSRRA '98 Conference Report,(3) Congress thought the law deficient in the following respects:

1. Limiting innocent spouse relief only to large understatements and grossly erroneous items was inappropriate.

2. It was unclear whether partial relief could be granted for part of an understatement.

3. Spouses who were no longer married, legally separated or lived apart should be able to elect to limit their tax liability to the tax attributable to their income and to items of which they had knowledge.

4. Taxpayers were not adequately informed of their right to apply for innocent spouse relief and did not have a means to apply for it.

5. The Tax Court did not have jurisdiction to review all denials of relief.

   Reform

   The IRSRRA '98 responded to these perceived deficiencies by:

1. Eliminating understatement thresholds, allowing relief for items that are only "erroneous" and providing three methods for obtaining innocent spouse relief.

2. Allowing relief on an apportioned basis.

3. Allowing a separation of tax liability for taxpayers who are no longer married, are legally separated or live apart.

4. Requiring that taxpayers be notified of joint and several liability and the innocent spouse provisions and providing a form to apply.

5. Allowing the Tax Court to review denied applications for relief and order refunds for tax overpayments.

6. Extending equitable relief to married taxpayers in community property states.

7. Conforming the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) proceedings requirements to the new innocent spouse rules.

   Exhibit 1 on p. 30 summarizes the innocent spouse relief requirements and compares the former Sec. 6013(e) requirements to new Sec. 6015.

   [TABULAR DATA 1 NOT REPRODUCIBLE IN ASCII]

   Relief Categories

   Sec. 6015 provides three categories of innocent spouse relief:(1) innocent spouse election; (2) separate liability election; and (3) equitable relief. The innocent spouse and separate liability elections can only be made for proposed or assessed deficiencies; they do not apply to tax liabilities properly reported on a return, but unpaid. According to the Conference Report,(4) the Sec. 6015(f) equitable relief method may be available for such unpaid liabilities.

   Although not provided for in Sec. 6015, Notice 98-61(5) states that if a taxpayer signed a joint return involuntarily while under duress, the signature is not valid and a joint return was not made. Therefore, the taxpayer is not jointly and severally liable for that return's tax liability and Sec. 6015 does not apply.

   Innocent Spouse Election

   Sec. 6015(b)(1) allows an innocent spouse to elect relief from any tax understatement (including interest and penalties) attributable to an erroneous item of his spouse if (1) a joint return was filed, (2) the innocent spouse did not know and had no reason to know of the understatement, (3) it would be inequitable to hold the innocent spouse liable for the tax and (4) such relief is elected within two years after the IRS began collection activities (e.g., levy, garnishment of wages) against the taxpayer making the election.

   The understatement is no longer required to be substantial and items are no longer required to be grossly' erroneous. In addition, any disallowed deduction, credit or basis will qualify for relief; it is no longer necessary for these items to have no basis in law or fact. "Erroneous items" include deductions for fictitious or nondeductible expenses. Sec. 6015(b)(3) refers to the Sec. 6662(d)(2)(A) definition of "understatement" which is the excess of the tax required to be shown on a return over the tax actually shown. According to the Senate Report,(6) the election does not extend the statute of limitations (SOL). Under Sec. 6015(g) (2), the IRS must notify the taxpayer's spouse of the election and must allow him to participate in the determination of the relief granted.

   Apportioned relief: Sec. 6015 (b) (2) allows apportioned relief if the taxpayer meets all of the sec. 6015(b)(1) requirements, except that he knew or had reason to know of an understatement. The taxpayer will be relieved only of the portion of the tax attributable to the understatement for which he did not know or had no reason to know of the extent of the understatement.

   Example: H and W reported $30,000 of taxable income on their joint return and paid $4,500 of tax. An audit revealed that W did not report $10,000 of interest, of which H knew of $3,000; H did not know of, had no reason to know of and received no benefit from, the other $7,000 of interest. His eligible for innocent spouse relief for $1,050 of the liability. This is the difference between (1) the $6,000 tax on $40,000 of taxable income ($30,000 reported + $10,000 unreported) and (2) the $4,950 tax on $33,000 of taxable income ($30,000 reported + $3,000 Unreported income H knew of).

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