On July 25, 2011, the Internal Revenue Service issued IRS Notice 2011-170, 2011-32 I.R.B. 135 and announced that it will help taxpayers who request innocent spouse relief by eliminating the two-year time limit that applies to equitable relief requests. However, the statutory two-year deadline for filing “traditional” innocent spouse and separate liability relief claims still apply.
When married individuals file a joint income tax return, each taxpayer is jointly and severally liable for the tax, interest, and penalties assessed on the return. Innocent spouse relief was enacted for circumstances where it is generally inequitable to hold a spouse liable for the tax of the other spouse. The innocent spouse relief provisions 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.
Forms of Innocent Spouse Relief
There are generally three available forms of relief: (1) “traditional” innocent spouse relief; (2) separate return liability relief; and (3) equitable relief.
Traditional Innocent Spouse Relief. A requesting taxpayer will be relieved of tax liability under “traditional” innocent spouse relief to the extent a liability is due to an understatement of tax if:
- a joint return was filed for the tax year;
- the tax on the return is understated due to items attributable to the taxpayer’s spouse;
- the requesting taxpayer shows that, in signing the return, he or she did not know or had no reason to know of the understatement;
- under the facts and circumstances, it would be inequitable to hold the requesting taxpayer liable for the deficiency; and
- the taxpayer requests innocent spouse relief within two (2) years from the date the IRS begins collection activities.
Separate Return Liability. Additionally, if the taxpayer is responsible for a portion of the joint tax liability, the taxpayer may elect relief under the separate liability rules. Under the separate return liability rules, a tax deficiency is allocated between the taxpayer and his or her spouse thereby separating the joint tax return liability into two separate liabilities. This relief is only available for unpaid liabilities resulting from the understatement of tax. A requesting taxpayer will not receive any refunds from tax if separate liability relief is granted.
In order to request separate return liability relief, a taxpayer must have filed a joint return, filed for innocent spouse relief within two (2) years from the date the IRS begins collection activities, and meet either of the following requirements at the time of filing:
- the requesting spouse is no longer married to, or are legally separated from, the spouse with whom you filed the joint return for which you are requesting relief; or
- the requesting spouse is not a member of the same household as the spouse with whom you filed the joint return at any time during the 12-month period ending on the date the requesting spouse files IRS Form 8857.
No relief under separate return liability will be granted if a requesting taxpayer transferred or received assets from the non-requesting spouse pursuant to a fraudulent scheme, transferred property between the spouses to avoid payment of tax, or the requesting taxpayer had actual knowledge of an erroneous item that is allocable to the non-requesting spouse.
Equitable Innocent Spouse Relief. Finally, if a taxpayer is not eligible for relief under the “traditional” innocent spouse or separate return liability rules, a taxpayer may elect equitable relief. Unlike the other two forms of innocent spouse relief, a taxpayer may obtain relief from an understatement or underpayment of tax. The IRS will consider all of the facts and circumstances in order to determine whether it is unfair to hold a taxpayer responsible for the understated or underpaid tax.
The following threshold condition must be met for equitable relief:
- the requesting taxpayer filed a joint return for the year;
- relief is not available to the requesting taxpayer under “traditional” or separate return liability relief;
- the requesting taxpayer applies for relief no later than two (2) years after the date of the Service’s first collection activity against the taxpayer;
- there were no transfers of assets between spouses involving a fraudulent scheme;
- the non-requesting spouse did not transfer disqualified assets to the requesting taxpayer;
- the requesting taxpayer did not file or fail to file the return with fraudulent intent; and
- the tax liability is attributable to the taxpayer’s spouse.
If the above factors are met, the IRS will grant relief based on:
- whether the requesting taxpayer is separated or divorced;
- whether the requesting taxpayer would suffer economic hardship;
- whether the requesting taxpayer had actual knowledge or reason to know of the underpayment of tax or deficiency;
- whether the non-requesting spouse has a legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement;
- whether the requesting taxpayer received a significant benefit from the underpayment of tax or deficiency;
- whether the requesting taxpayer has made a good faith effort to comply with income tax laws;
- whether the non-requesting spouse abused the requesting taxpayer; and
- whether the requesting taxpayer was in poor mental or physical health on the date the requesting spouse signed the return or at the time the taxpayer requested relief.
History Prior to the Announcement
Prior to its July 25th announcement, the Internal Revenue Service strictly enforced Treasury Regulation Section 1.6015-5(b)(1) and took the position that innocent spouse relief requests must be filed by a requesting taxpayer within two years after it began collection activity to be eligible for equitable relief. Several taxpayers questioned whether this Treasury Regulation was a valid exercise of rulemaking authority by the Internal Revenue Service. In several opinions, Hall v. Commissioner, 135 T.C. No. 19 (2010); Lantz v. Commissioner, 132 T.C. 131 (2009); Mannella v. Commissioner, 132 T.C. 196 (2009), the U.S. Tax Court held that a requesting spouse does not have to file for innocent spouse relief within two years after the Internal Revenue Service began collection activity for equitable relief.
In Jones v. Commissioner, 642 F.3d 459, 107 A.F.T.R.2d 2011-2475 (4th Cir. 2011), the Fourth Circuit Court of Appeal joined the Third and Seventh Circuit Courts of Appeal in reversing the Tax Court and ruling that the Internal Revenue Service may impose the two-year limitation for a spouse to request equitable relief as provided in the Treasury Regulations. This recent appellate court opinion was adverse to taxpayers living in South Carolina, North Carolina, West Virginia, Virginia and Maryland who wished to file for equitable relief after the two-year period ended.
In early 2011, the Internal Revenue Service launched a review of the equitable provisions of the innocent spouse program and decided to enlarge the availability of equitable innocent spouse relief. The Treasury and Internal Revenue Service will now modify the Treasury Regulations under Section 6015(f) to allow a request to be submitted after two years from the time first collection activity against the requesting spouse begins.
Now, if a taxpayer does not meet the requirements for traditional innocent spouse relief or separation of liability relief and equitable relief is requested two years after the Internal Revenue Service begins collection activity, the taxpayer may still be eligible to equitable innocent spouse relief. Other points of interest include:
- The Internal Revenue Service will no longer apply the two-year limit to new equitable relief requests or requests currently being considered by the agency.
- A taxpayer whose equitable relief request was previously denied solely due to the two-year limit may reapply using IRS Form 8857, Request for Innocent Spouse Relief, if the collection statute of limitations for the tax years involved has not expired. Taxpayers with cases currently in suspense will be automatically afforded the new rule and should not reapply.
- The Internal Revenue Service will not apply the two-year limit in any pending litigation involving equitable relief, and where litigation is final, the agency will suspend collection action under certain circumstances.
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