Innocent Spouse Rules Eased Retroactively
Under prior law, spouses filing a joint return were jointly and severally liable both for the tax shown on the return and any tax which should have been shown on the return but was not. Under innocent spouse rules at old Code §6013(e), in the event that tax was underreported, a spouse could be relieved of liability for the tax deficiency only if (1) the erroneous deduction, credit, or omitted income was an item of the other spouse, (2) the spouse had no knowledge or reason to know that there was an understatement of tax, (3) equity favored relieving the spouse, (4) in the case of an erroneous deduction or credit, the deduction or credit was "grossly erroneous" (i.e., was so erroneous that it had "no basis in fact or law"), and (5) the tax understatement was "substantial" (i.e., it exceeded a percentage of the spouse's adjusted gross income, not in the tax year at issue, but in the last tax year ending before a notice of deficiency was sent). An innocent spouse was expected to make that claim in response to a notice of deficiency and prove the above facts in Tax Court. Otherwise, the innocent spouse would have to pay the tax (if the other spouse did not) and file a refund claim.
In the past, when a joint notice of deficiency was issued, often the culpable spouse would handle the tax litigation on behalf of both spouses and the innocent spouse defense would not be raised. Once the Tax Court case was over, if the culpable spouse lost, the other spouse would then be foreclosed from ever raising the innocent spouse argument under the doctrine of res judicata.
In Tax Court cases where the innocent spouse claim was raised and deductions or credits were at issue (typical in 1980s tax shelter cases), the culpable spouse would argue for the validity of the very items which the potentially innocent spouse would simultaneously argue had no basis in fact or law. Often, the culpable spouse's arguments, although not sufficient to prevail, would undermine an innocent spouse defense by demonstrating some basis in fact or law. Even if the culpable spouse did not challenge the notice of deficiency, a spouse seeking relief under §6013(e) had to prove that tax shelter items were grossly erroneous; in effect, this required a spouse unfamiliar with a shelter having to argue a case from the perspective of the IRS, but with a higher burden of proof than the IRS had to meet merely to disallow the items.
Congress heard the pleas of many testifying innocent spouses and, at Act §3201, repealed Code §6013(e) and replaced it with a new Code §6015. Under the new section, a spouse who did not meaningfully participate in any Tax Court case where innocent spouse status could have been raised may now wait to be contacted by IRS collection agents before raising the innocent spouse issue. In fact, any joint filer seeking relief under §6015 need only file an election (on a form the IRS will create) no later than two years after the IRS begins collection activities against that person. Once an election for relief under §6015 is made, the IRS must cease collection actions and consider the merits of the election. If the IRS denies innocent spouse status, it sends the electing person a notice of deficiency, which can be protested to Tax Court. Collection activity is again suspended during the Tax Court proceeding.
New §6015 is both prospective and retroactive to all prior tax years to the extent the amount due has not yet been paid. In no event will the period for making the election expire before July 22, 2000. This means that even as to spouses who have been pressed for collection by the IRS for years, there is now a two-year window for electing new §6015.
New §6015 not only provides this new way to raise innocent spouse claims during the collection process, but also changes the substantive rules -- again, retroactively. Spouses no longer have to prove that the deductions or credits were grossly erroneous (i.e., had no basis in fact or law). A spouse merely has to show that the deductions or credits were erroneous -- something which the IRS will have already proven or will concede.
Further, new §6015 eliminates the complex requirement for proving that there was a substantial understatement exceeding a percentage of adjusted gross income in a different year. Now, all tax understatements, even of $1, can get relief under the innocent spouse rules.
For some spouses, §6015 relief is even easier to obtain. For spouses who, at the time the election is filed, (1) are divorced, (2) are legally separated, or (3) have not been members of the same household for the prior 12 months, relief will be granted even if the spouse had reason to know, but not actual knowledge, of the understatement. For such spouses who can also show that they signed the return under duress, relief will be granted even if the spouse had actual knowledge. Relief for these spouses is provided essentially by recomputing their taxes as if single and using a complex proportional method of allocating the joint liability. The provisions of §6015 are very detailed. This article gives only a brief overview of them.
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