Innocent Spouse Income Tax Relief

Take-Away: In order for a spouse, or former spouse, to benefit from innocent spouse relief under the Tax Code, the spouse must show more than just that he or she did not understand the tax return and/or the amounts on the return were either misstated or not reported on the return. Signing the return without properly reviewing it does not excuse the spouse from knowing or having reason to know of the misstatement on the return. Such ignorance will not provide any bliss when the IRS comes calling.

Background: When spouses file a joint income tax return, they are jointly and severally liable on that return for any unpaid taxes or penalties that arise from that Form 1040 tax return. However, a spouse can obtain relief from their joint and several income tax liability by later seeking relief from the IRS. The spouse who seeks this relief must comply with several factors that are spelled out in IRC 6015. Revenue Procedure 2013-34 lists these factors. A spouse’s failure to meet the rigorous burden of proof standard under IRC 6015 was on full display in a recent Tax Court Summary Opinion. Mindy Lessard et. al. v. Commissioner, No. 31667-15S, 2017-95. December 27, 2017.

Facts: The facts in Lessard were fairly common. Spouses filed a joint tax return for 2013. On their tax return they failed to report $20,500 in withdrawals that husband took from his IRA after being injured in an auto accident and being unemployed for part of the year (his income was about $24,000.) Husband was issued a Form 1099-R. Also unreported on their return was $19,700 in cancellation of credit card debt; apparently each spouse had the unpaid balance of a credit card written off, resulting in the issuance of Form 1099-Cs to each spouse. Husband’s cancellation of debt was in the amount of $15,000. Wife contested that she owed anything on several credit cards at the time the one Form 1099-C was issued to her for $4,800. Husband prepared the Form 1040 tax return and he presented it to his wife on April 14, 2014 which she signed without studying the return- apparently she only skimmed it before signing it. Neither Form 1099-C nor the Form 1099-R were attached to the 2013 Form 1040 income tax return. Husband and wife divorced in June 2014 after 20 years of marriage. Wife subsequently sought relief from joint tax liability under IRC 6015 claiming that she relied on her husband with respect to the income tax returns preparation, that’s she was unaware that her husband had not reported the amounts withdrawn from his retirement savings plan or their cancellation of debt income at the time she signed the tax return. With regard to the forgiveness of indebtedness income, wife explained that she was not aware of the credit card accounts until she received the Forms 1099-C at the end of 2013, and she was communicating with the credit card companies at the time the 2013 Form 1040 income tax return was filed, contending that she had not opened that account (her claim was that her husband opened the credit card accounts in her name without her knowledge.) The husband was a former banker who had historically prepared the parties income tax returns, but as noted, he was unemployed through most of 2013 recovering from injuries sustained in an auto accident. Wife was employed in 2013 earning close to $100,000 a year. Wife admitted that at one point in late 2013 she went to the bank and signed a spousal waiver form that permitted the husband to withdraw money from his retirement account without her further consent.

Law: Generally, spouses who file a joint Form 1040 income tax return are each fully responsible for the accuracy of their return and for the full tax liability. IRC 6013(d)(3).

IRC 6015(e) Relief: This Code Section provides three separate bases upon which a spouse, or former spouse, may claim innocent spouse relief from their joint and several liability under jointly filed income tax returns. However, obtaining any relief under any of the three bases is not very easy . The petitioner, Ms. Lessard, bears the burden of proof to show that she is entitled to this relief.

IRC 6015(b): To qualify for relief under this section, the taxpayer must meet a burden of proof on each of 5 separate requirements: (i) a joint return was made for the taxable year in question; (ii) on that return there was an understatement of tax attributable to erroneous items of the taxpayer’s spouse in filing the joint return; (ii) the other individual spouse filing the joint return shows that in signing the Form 1040 return he or she did not know, and had no reason to know, that there was such an understatement; (iv) taking into account all of the facts and circumstances, it is inequitable to hold that other individual liable for the deficiency in tax due to that understatement; and (v) the taxpayer seeks relief, within two years of when collection activities began by the IRS. With regard to factor (iv) in determining when holding a taxpayer liable would be inequitable, the Tax Court often looks to whether there has been a significant benefit to the spouse who claims the relief sought and whether the failure to report the correct tax liability on the joint return resulted in concealment, overreaching, or any other wrong-doing on the part of the other spouse.
IRC 6015(c): This relief section applies only after the spouses have divorced or have not lived together for 12 months. It permits an allocation of the income tax deficiency; the petitioning taxpayer bears the burden of proof to establish the portion of the deficiency allocated to that taxpayer. But an allocation is not permitted if the IRS shows that the individual taxpayer who seeks this relief had actual knowledge, at the time the return was signed, of any item that gives rise to the deficiency (or portion of that deficiency) which is not allocable to that individual. Unlike the relief available under IRC 6015(b) equitable considerations to exonerate the petitioner from liability are not available, i.e. concealment, overreaching, or wrong doing will not be considered.
IRC 6015(f): If neither IRC 6015(c) nor IRC 6015(b) are available, the Secretary of the Treasury is given discretion to grant innocent spouse relief to an individual, if taking into account all facts and circumstances, it would be inequitable to hold that individual liable for any unpaid tax or deficiency (or any portion of either.) The petitioning taxpayer carries the burden of proof to established that he or she is entitled to the equitable relief. A taxpayer must meet 7 separate threshold conditions before discretionary relief will be granted under this section: (i) the spouse filed a joint income tax return for the taxable year for which he/she seeks relief; (ii) relief is not available under either IRC 6015(b) or IRC 6015(c); (iii)the claim for relief is timely; (iv) no assets were transferred between the spouses as part of a fraudulent scheme engaged in by the spouses; (v) the non-requesting spouse did not transfer disqualified assets to the requesting spouse; (vi) the requesting spouse did not knowingly participate in the filing of a fraudulent joint return; and (vii) the income tax liability from which the requesting spouse seeks relief is attributable to an item of the non-requesting spouse’s income.

Lessard Holdings: The Tax Court shot-down Ms. Lessard’s claim for relief under each of the three possible sections that might have led to her being an innocent spouse.

6015(b): Lessard was denied relief because she: (i) signed the spousal waiver letting her husband have access to his retirement account assets, thus she was aware of the potential for his later withdrawals; (ii) was aware of the Form 1099-R issued to her then-husband prior to filing the Form 1040 return; and (iii) admitted that she ‘looked over’ the prepared Form 1040 income tax return before it was filed, but she relied on her husband’s ‘expertise’ in preparing the return. ” Her signing the return without properly reviewing it does not excuse her from knowing or having reason to know of the misstatement on the return.” Finally, there was the retirement plan withdrawals were used by her husband to pay their usual living expenses, which indirectly benefited Ms. Lessard. Moreover there was no showing of concealment, overreaching or wrongdoing on the part of her husband to justify that it would be inequitable to hold Ms. Lessard liable for the income tax deficiency.
IRC 6015(c): Generally, a tax deficiency will be allocated between joint filers as if they have filed separate income tax returns. See IRC 6015(c)(3). But no relief will be granted if the requesting spouse had actual knowledge at the time the individual signed the joint return of any item that gives rise to a deficiency which is not allocable to such individual. But the knowledge requirement does not require the requesting spouse know the tax consequences that arise from the item that leads to the deficiency, or knowledge that the item on the return is incorrect. Only a showing that the electing spouse actually knew of the item on the return that gave rise to the deficiency will be treated as knowledge. Ms. Lessard was aware both of the retirement account distribution to her husband and the cancellation of their indebtedness by virtue of her knowledge of the existence of both the Form 1099-R and the Form 1099-Cs. “Her failure to fully understand the tax consequences of those items [Forms 1099-R and 1099-C] does not provide a basis for relief.”
IRC 6015(f): Under this discretionary 7 factor ‘facts and circumstances’ analysis, Ms. Lessard fared well on some factors while she failed on other factors. Ultimately the Tax Court held against Ms. Lessard in part because: (i) there was no showing of economic hardship (supporting this finding was her earning close to $100,000 that year); and (ii) there was no showing of abuse or exercise of financial control by her husband that would affect any of the other factors. Again, the Tax Court found that her ignorance is not the basis for granting relief to promote an equitable result: “An important factor is whether petitioner had actual knowledge of the disputed items of income (the retirement withdrawals and the cancellation of debt income) as well as the amounts thereof that gave rise to the deficiency at the time she signed the joint 2013 return. The fact that petitioner did not understand the tax return and/or that these amount were either misstated or not reported on the turn is of no import. Petitioner’s signing of the return without properly reviewing it does not excuse her from knowing or having reason to know of the misstatements on the return.”

Conclusion: It is clear from the Lessard Tax Court decision that ‘ignorance is not bliss’ when it comes to the IRS. Relying upon a spouse to prepare a Form 1040 income tax return will not permit a spouse to later claim innocent spouse relief. As indicated by the numerous conditions imposed or required ‘showings’ under the three statutory bases for relief from joint and several liability, a spouse, or former spouse, will have to meet a very high burden of proof in order to claim innocent spouse relief. In sum, it is best to not only read the proposed Form 1040 income tax return, but actually ask questions about it.