The Internal Revenue Service (“IRS”) has acquiesced in the U.S. Court of Appeals for the Ninth Circuit’s decision in Wilson v. Commissioner, 705 F.3d 980 (9th Cir. 2013), aff’g, Wilson v. Commissioner, T.C. Memo. 2010-134. The Ninth Circuit Court of Appeals held that the United States Tax Court may consider new evidence outside the IRS’s administrative record when reviewing appeals for equitable innocent spouse relief from joint and several liability for unpaid taxes under Internal Revenue Code (“IRC”) Section 6015(f). Now, the IRS will no longer argue that the Tax Court should review requests for relief under IRC Section 6015(f) for abuse of discretion, or that the Court should limit its review to the IRS’s administrative record only.
When married individuals file a joint income tax return, each taxpayer is jointly and severally liable for the entire tax, as well as any interest, and penalties by the IRS and applicable to the return. Innocent spouse relief was enacted for circumstances where it is generally inequitable to hold one spouse liable for the tax of the other spouse. Prior to enactment of the Innocent Spouse Act of 1971, the only way a spouse could avoid joint and several liability for taxes owed from a joint return was to prove that he or she signed a joint tax return under duress. In 1998, Congress liberalized the innocent spouse relief provisions and created three kinds of separate innocent spouse relief which may relieve a taxpayer of outstanding tax liabilities, including penalties and interests, incurred as a result of filing a joint federal tax return with a current or former spouse.
The three types of relief from joint and several liability for spouses who file joint returns are:
- Traditional Innocent Spouse Relief, pursuant to IRC Section 6015(b), provides a taxpayer with relief from tax, interest, and penalty owed if the spouse or former spouse failed to report income, reported income improperly, or claimed improper deductions or credits;
- Separation of Liability Relief, pursuant to IRC Section 6015(c), allows the IRS to allocate the additional tax and interest owed between the taxpayer and former spouse or current spouse from whom the taxpayer is separated because an item was not reported properly on a joint return. The amount of the tax allocated to the taxpayer requesting relief is the amount for which the taxpayer is responsible; or
- Equitable Relief, pursuant to IRC Section 6015(f), may apply when a taxpayer does not qualify for Traditional Innocent Spouse Relief or Separation of Liability Relief for income not properly reported on a joint income tax return and is attributable to the spouse. In addition, a taxpayer may qualify for equitable relief if the correct amount of tax was reported on the joint return but for some reason, the tax remains unpaid.
In the Wilson case, Petitioner Karen Wilson (“Wilson”) requested equitable relief under IRC Section 6015(f) from the joint income tax liabilities with her former spouse. From 1997 to 1999, Wilson’s former spouse went from earning $30,000 annually as an insurance salesman to $360,000 a year as a participant in a Ponzi scheme. The IRS assessed an income tax liability of $540,000 for the increased income from 1997 through 1999. Wilson filed a request for innocent spouse relief, which was denied by the IRS forcing Wilson to appeal the decision to the Tax Court.
The Tax Court reviewed the appeal using a de novo review standard and allowed Wilson to introduce evidence outside the IRS’s administrative record to prove her case. Using the de novo scope of review and without deference to the IRS’s initial decision, the Tax Court determined that the following factors weighed in favor of equitable relief:
- Wilson was divorced from her spouse at the time of the Tax Court’s second trial;
- Wilson did not receive a significant benefit from her husband’s unpaid liability or have knowledge or reason to know of the $540,000 underpayment of income tax;
- Wilson would suffer significant economic hardship if the tax liability were imposed; and
- The tax liability was solely attributable to her former spouse’s participation in the Ponzi scheme.
The IRS appealed the Tax Court’s decision. Following the U.S. Court of Appeals for the Eleventh Circuit’s decision in Commissioner v. Neal, 557 F.3d 1262 (11th Cir. 2009), the Ninth Circuit Court of Appeals held that the statutory language and Congress’s choice of the word “determine”, as used in IRC Section 6015(e)(1)(A), and the phrase “taking into account all the facts and circumstances”, as used in IRC Section 6015(f)(1), provides both a de novo standard and a de novo scope of review at the Tax Court in equitable innocent spouse relief cases. Moreover, the Court of Appeals held that Congress intended for the Tax Court to consider evidence outside the administrative record when reviewing the Service’s denial of innocent spouse relief requests. Finally, the Court of Appeals stated that a de novo standard of review is appropriate because an appealing taxpayer does not have the right to conduct discovery, present live testimony under oath, subpoena witnesses for trial, or conduct cross-examination at any time during the administrative process until he or she appeals to the Tax Court.
On August 12, 2013, the IRS subsequently issued proposed regulations concerning the time and manner in which a taxpayer may request equitable innocent spouse relief. The proposed regulations offer the following changes:
- A spouse may request innocent spouse relief as part of a collection due process (CDP) hearing under IRC Sections 6320 and 6330;
- The two-year deadline in which a spouse must request equitable relief pursuant to Treasury Regulation Section 1.6015-4 is replaced with a requirement that a request for equitable relief must be filed with the IRS within the period of limitation in IRC Section 6502 for collection of tax or the period of limitation in IRC Section 6511 for credit or refund of tax, as applicable to the specific request;
- The proposed regulations clarify what constitutes “collection activity” for purposes of starting the two-year deadline for traditional innocent spouse relief and separation of liability relief, and upon finalizing the proposed regulations, the two-year period will begin from the date the IRS mails a notice of intent to levy and right to request a CDP hearing (IRC Section 6330 notice); and
- The proposed regulations clarify that after a final administrative determination, a requesting spouse may not, even under the procedures for a CDP hearing, again request relief under IRC Section 6015 with respect to the same joint tax liability. The Service has developed procedures in the Internal Revenue Manual to reconsider a final administrative determination if a requesting spouse submits additional information not previously submitted and considered and the requesting spouse does not petition the Tax Court from the prior final administrative determination.
The Wilson decision by the Tax Court, now affirmed by the Ninth Circuit Court of Appeals, and the IRS’s issuance of proposed regulations is certainly a welcomed change and great news for taxpayers requesting innocent spouse relief. In reviewing requests for equitable innocent spouse relief, the Tax Court will review such appeals using a de novo standard of review and will allow taxpayers to introduce new evidence and other information during any appeal which may lead to relief. Additionally, the proposed regulations provide taxpayers with additional time and options to request equitable innocent spouse relief.