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AYARLAW.COM
Venar Ayar, Founder AYAR LAW
Venar Ayar’s expertise is in favorably resolving Federal and State tax problems. He knows the procedural rules inside and out, and how things actually work at the IRS.
Feel free to call or email Venar anytime (no charge) and he’ll be happy to answer any questions you might have, such as:
Some example questions you can ask Venar:– "How do I advise a certain client who has fallen behind in personal or business taxes?"– "What's the best way for one of my clients to deal with an audit?"– "Can I get a client off the hook through a Penalty Abatement or Innocent Spouse Relief?"
Innocent Spouse Relief: A General Overview
What is Innocent Spouse Relief?
• Joint and Several Liability• When two spouses file a joint return, they are both responsible for the full
amount of the tax due• When a spouse signs a joint return, they are liable for the tax shown on return AND any
additional tax due based on an audit
• Doesn’t matter which spouse made the additional income
• Even if the spouses are divorced
• Under Community Property Laws, can be held liable even if filing separate
• “Innocent Spouse” refers to relief from Joint and Several Liability for one spouse or the other.
3 Types of Relief
• IRC §6015 creates 3 grounds for relief
• Innocent Spouse relief - §6015(b)
• Separation of liability relief - §6015(c)
• Equitable relief - §6015(f)
Innocent vs. Injured Spouse
• Innocent Spouse commonly confused with Injured Spouse
• Innocent Spouse deals with a situation where there is a refund due on a 1040, and one spouse owes money to the IRS and the other doesn’t
• Injured Spouse is a way to allocate the tax refund, and split it between the liable spouse, and the nonliable (i.e. Injured) spouse
• Idea is to prevent the portion of the refund attributed to the nonliable spouse from being garnished to satisfy a debt of the other spouse
How to Request Innocent Spouse Relief
Claiming Innocent Spouse Relief
• Form 8857- Only way to formally request innocent spouse
• Complete and send in form, with explanation. IRS will review and let you know if you qualify
• When to File• File as soon as aware of tax liability you think spouse should be liable. Some ways to become
aware
• IRS is auditing your return and proposing an increase in tax, or
• The IRS sends you a notice
• Deadline to file is no later than two years after the first time the IRS attempts to collect.• IRS offsets your tax refund, and sends notice of right to file 8857
• Filing of a claim in court by the IRS, including proof of claim in bankruptcy
• Filing of a suit against you
• Issuance of FNOITL (§6630 notice)
Exceptions to 2 Year Time Limit
• Exception for Equitable Relief:• If claiming equitable relief, then 2 year time limit does not apply. Can claim
any time the debt is outstanding, or within the SOL for claiming a refund
• Exception for community income relief
• 8857 Filed on Behalf of Decedent• Executor or personal representative may file an 8857 as long as decedent
satisfied requirements while alive
Disqualifying Situations
• 4 Situations in which you can not claim Innocent Spouse:
1. A court already considered whether you qualify for Innocent Spouse and you lost
2. A court did not consider whether to grant you relief, but you meaningfully participated in the proceeding and could have asked for relief
3. You entered into an Offer in Compromise
4. You entered into a closing agreement
IRS Contact of Former Spouse
• Because other spouse is theoretically harmed by granting of innocent spouse, they are provided an opportunity to participate in the proceedings.
• No exceptions to this, even for victims of spousal abuse or domestic violence
• IRS will notify spouse or former spouse of your claim, and allow him or her to participate.
• IRS will also notify other spouse of preliminary and final determinations
• IRS could disclose all information about application, except “personal” information• Current Name
• Address
• Phone Number
• Employment Information
• Income / Assets
• If concerned about privacy, be sure to redact where appropriate
Appeals Process
• After submitting 8857, IRS will review and respond (sometimes takes 18 months). If the response is negative:
• Issuance of 30 day Letter – Gives right to file administrative appeal• Appeal hearing will be held at the local office of appeals (or over the phone), and make a decision
• Process usually takes 3-6 months from issuance of denial to hearing date
• Appeals officer makes decision after you have opportunity to present case
• If no appeal is requested, or appeals officer decides against you –issuance of Notice of Determination
• “Ticket to Tax Court”
• 90 Days to file petition
• Other Spouse has right to participate
Innocent Spouse Relief
Innocent Spouse Relief - §6015(b)
• If 5 Requirements are met, then relief should be granted
• Joint Return
• Understatement of Liability
• Lack of Actual or Constructive Knowledge
• Equitable Result
• 2 Year deadline
Joint Return
• Only joint returns are eligible for innocent spouse relief.
• If the innocent spouse signed under duress, the signature was involuntary and therefore it is not a valid joint return.
• IRM 25.15.1.2.3; Stanley v. Comm’r (1966)
• Two elements to prove duress:
• Taxpayer could not resist the demand to sign.
• But for duress, taxpayer would not have signed.
Understatement of Liability
• There must have been an understatement on the return• Unreported income; or
• Incorrect deduction, credit, or basis
• “Understatement” is not “underpayment.” If the return was accurate but the taxpayer did not pay the entire amount due, regardless of cause, there is no innocent spouse relief available.
• Equitable relief may be available in underpayment cases.
• Understatement must be attributable to other Spouse
No Actual or Constructive Knowledge
• Plain reading would make ignorance of law a defense
• Courts have used “knowledge of the transaction” test• If spouse claiming relief either knows or has reason to know of the transaction
or item, s/he will fail this requirement
• For Erroneous deductions, test is if “reasonably prudent person could be expected to know that the return contained the substantial understatement”
• Whether spouse could be expected to know the stated liability was erroneous or that further investigation is warranted
No Actual or Constructive Knowledge
• “Reason to Know” factors• Nature and amount of erroneous item
• Financial situation of the two spouses
• Level of education
• Involvement in family’s business and financial affairs
• Presence of expenditures that appear lavish or unusual compared to past level of income, standard of living, and spending patterns
• Culpable spouse’s evasiveness and deceit concerning finances
• Failure to ask about items that a reasonable person would question
Imposing tax would be inequitable
• Equitable test, depends on facts and circumstances. Would it be unfair to hold you responsible for the tax?
• Idea is that innocent spouse should be a sympathetic person who has been wronged by other spouse
Imposing tax would be inequitable
• Factors to consider• Most frequent issue is whether applicant received a significant benefit from
understatement• Any benefit in excess of “normal support”
• Did failure to report income results from concealment, overreaching, or other wrongdoing by other spouse?
• Did the other spouse desert the spouse seeking relief?
• Are the spouses divorced or separated?
• Relative financial condition?
• Abuse (physical or emotional)?
Two Year Limit
• Innocent spouses must bring claims within two years after collection activity begins.
• That usually means the first notice of delinquency, but does not include a notice of audit or other correspondence sans a demand for payment.
Common Issues With Time Limit
• There is no discovery rule.
• The clock begins ticking as soon as the IRS sends the first notice, whether or not the innocent spouse understood the notice or even knew about it.
• Responsible spouses often hide these notices or even redirect them to another address.
Separation of Liability Relief
Separation of Liability 6015(C)
• In a joint return, the filers are jointly and severally liable regardless of their respective ability to pay.
• If successful, the IRS apportions liability on the 1040 according to the spouses’ income and assets.
• SOL is only available if the claimant does not qualify for traditional innocent spouse relief. Frequently, the claimant cannot pass the knowledge test.
Element No. 1: Joint Return
• To recap:
• If the innocent spouse signed under duress, the signature was involuntary and therefore it is not a valid joint return.
• IRM 25.15.1.2.3; Stanley v. Comm’r (1966)
• Two elements to prove duress:
• Taxpayer could not resist the demand to sign.
• But for duress, taxpayer would not have signed.
Element No. 2: Divorce or Separation
• Divorced or legally separated when the claim was filed (not when the hearing occurs). Must be a final decree, but opportunity to appeal need not have ended,
• Widowed, or
• 12-month physical separation and intent to permanently divorce.
Element No. 3: No Actual Knowledge
• No deliberate effort to avoid knowledge, or
• No joint ownership of suspect property (e.g. W had no ownership interest in a business connected with fraudulent deductions).
• Abuse may be relevant to determining knowledge in equitable relief cases (Wilson v. Comm’r (9th Cir. 2013-footnote 17)).
Element No. 4: No Culpable Conduct
• No tax-avoiding, inter-spouse property transfer.
• Example: If W in Reser v. Comm’r had had set up the company andactively participated in the fraudulent deductions, W may be ineligible for SOL relief.
Equitable Relief
Equitable Relief 6015(f)
• Claimant must be ineligible for both traditional innocent spouse and SOL relief before requesting equitable relief.
• 6015(f) applies to underpayment of taxes as well as understatement of income.
Element No. 1: Inequitable
• “[T]aking into account all the facts and circumstances, it would be unfair to hold you liable for the understatement or underpayment of tax.”
• Irs.gov/Businesses and Self-Employed/Small Businesses and Self-Employed/Equitable Relief
Factors
• A legal or practical divorce or separation. The length of separation is relevant, as are the conditions of separation and the permanency of separation.
• Significant economic hardship (i.e. inability to pay basic living expenses).
• Spouse’s obligation to pay under a court order; not relevant if claimant knew other spouse wouldn’t pay.
Factors Cont.
• Significant benefit. Publication 971 defines the phrase as “any benefit in excess of normal support,” which is a rather low standard.
• Compliance, or good faith effort to comply, in subsequent tax years.
• For constructive knowledge, IRS essentially uses part of the Greerreason-to-know test (education level, involvement in current financial affairs, and any unjust enrichment).
• Constructive knowledge is not weighed any heavier than any other factor.
• In contrast, actual knowledge “is a strong factor weighing against relief” that can only be overcome “ if the [other] factors in favor of equitable relief are particularly compelling.”
One-Way Factors
• If present, they add to the claimant’s case for relief; if absent, they do not bolster the case for paying the tax.
• Abuse and poor health
Other Elements
• No fraudulent transfer (i.e. claimant has no financial culpability), and
• Other spouse was responsible for the act or omission from which relief is sought.
Lantz v. Comm’r (7th Cir.-2010)
• H and W received a notice of levy. H assured W he would handle it, and he then died.
• W argued that the two-year requirement did not apply to her Section 6105(f) equitable relief claim.
• This provision has no reference to a deadline and Tax Courts had not imposed one.
• Court ruled that IRS had a reasonable basis for the two-year limit, viz, cutting off claims.
• Tax court issued a similar ruling in Hall v. Comm’r (2010).
IRS Notice 2011-70
• Issued as a reaction to the Lantz decision.
• Removes the 2 year time limit for Equitable Relief claims
• Reverts to the rule in Publication 971
Sample 8857 Form
