Author's Note: This is my 10oth Lesson published on TaxProfBlog. I continue to be very grateful to Paul for this opportunity. I have learned loads from the cases and I enjoy sharing what I learn.
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Section 6015 is not titled “Innocent Spouse Relief.” It is titled “Relief From Joint and Several Liability on Joint Return.” And you will not find the word “innocent” (or any cognate) in the statute’s text. But we still call the relief granted by §6105 “innocent spouse relief.” Two cases from last week teach why. In Habibe Kruja (Petitioner), Ermir Kruja (Intervenor) v. Commissioner, T.C. Memo. 2019-136 (Oct. 15, 2019) (Judge Buch) the Tax Court granted partial relief under §6105(c). In Lori D. Sleeth (Petitioner), David T. Sleet (Intervenor) v. Commissioner, T.C. Memo. 2019-138 (Oct. 15, 2019) (Judge Goeke), the Court denied relief under §6015(f). Both cases show that the idea of innocence plays an important, if often implied, role in the application of §6015. Details below the fold.
Section 6013 permits spouses to file a joint return. Doing so, however, means spouses are jointly and severally liable for the taxes owed on a jointly filed return. Section 6105 permits spouses to obtain relief from that joint liability. To understand the role of innocence in §6015, we need a brief historical review.
For the first five years of the modern income tax (1913-1918) joint returns were not permitted. Congress first allowed joint returns in the Revenue Act of 1918, 240 Stat. 1057, 1074 (§223). Almost immediately taxpayers and the IRS fought over whether joint filers were jointly liable. Taxpayers won in court. See. e.g. Cole v. Commissioner, 81 F.2d 485 (9th Cir. 1935). But the IRS ultimately won in Congress. Section §51(b) of the Revenue Act of 1938, 352 Stat. 447 created the joint liability rule.
Ostensibly, after 1938 there was no relief from the joint liability rule. Case continued to arise, however, where a spouse would argue that it was unfair to impose the joint liability. Typically a divorced wife would be the one seeking relief when her husband had omitted reporting income, often illegal income. Those cases became more frequent as the divorce rate rose and then after Supreme Court decided, in 1961, that embezzled money was gross income to the embezzler, creating additional tax consequences for its omission . James v. United States, 366 U.S. 213 (1961).
The workaround was the duress rule. That is, while no relief was available when the joint return was properly signed, taxpayers seeking relief increasingly argued that it was unfair to say they had really signed the returns. Lower courts increased the scope of the duress doctrine. For example in Furnish v. Commissioner, 262 F.2d 727 (9th Cir. 1958) the husband used nominees to siphon off money from his medical practice. His wife knew nothing of this and signed joint returns that omitted reporting the income. She argued that she had signed blank returns totally under her husband’s control. The Tax Court rejected the argument, but the 9th Circuit reversed and remanded, holding that if she could show that she just signed blank returns, then there was “no exercise of her free will” in signing the returns and she could be relieved of liability. That's a stretch, but the court gave this reason for making it:
“We agree with appellant Emilie Furnish Funk that the Tax Court here holds liable an innocent party for the fraudulent activities of a former spouse, when in fact said innocent party had no knowledge of, had not concurred in, nor received benefit, direct or indirect, from said fraud.”
Other courts followed Furnish, notable Scudder v. Commissioner, 405 F.2d 222 (6th Cir. 1969). In 1971, Congress used the 9th Circuit’s idea to create the first innocent spouse relief in 1971, codified at that time in §6013(e). Here is the relevant language from the Senate Finance Committee Report, Senate Report No. 91-1537, at page 2. Notice how it mirrors the Furnish language:
“Numerous cases have arisen in which the imposition of joint liability upon an innocent spouse has resulted in the committee's opinion, in grave injustice. ...This liability may be imposed upon the spouse even though she had no knowledge of her husband's activities and the resulting omission from income, and even though she did not benefit in any way from the use of the funds.”
Consequently, the 1971 legislation granted relief when the requesting spouse was both innocent of knowledge and innocent of benefit. The idea of innocence expressed in both the Furnish opinion and the Finance Committee Report was imported from the then dominant rules of divorce law, as I explain in great detail in “The Unhappy Marriage of Law And Equity in Joint Return Liability," 108 Tax Notes 1307 (September 12, 2005). But once taken into tax law, it has stuck around.
In 1998 Congress moved the spousal relief provisions into their current location, §6015. The idea of innocence followed. Basically, §6015 gives taxpayers three pathways to obtain relief from unpaid tax liabilities associated with a joint return. Innocence plays a role in each.
The first pathway to relief is §6015(b). It contains the 1971 traditional innocent spouse rules. It only applies to deficiencies. Put another way, it may only be used when there has been an understatement of tax liability on the return. When available, it allows relief when the requesting spouse shows: (1) they filed a joint return; (2) it had an understatement of tax attributable to the other, non-requesting, spouse; (3) the requesting spouse both did not know and did not have any reason to know about the underlying cause of the understatement; and (4) it would be inequitable to hold the requesting spouse liable for the liability (that is, they must show they did not benefit from the cause of the understatement). Innocence here plays a central role: the requesting spouse bears the burden to show they neither knew nor should have known about the items giving rise to the deficiency. It’s that “should have known” part that is often what kills relief.
The second pathway is §6015(c). This path also applies only to understatements of tax. But it is an easier path. It allows the requesting spouse to simply “unwind” a joint return if (1) the requesting spouse had no actual knowledge that there were erroneous items on the return; and (2) the requesting spouse is now divorced or separated under the applicable rules. Thus, the requesting spouse does not have to show innocence. Subsection (c) presumes innocence. Even better, it does not play the "should have known" card against the taxpayer but instead shifts the burden to the IRS to show actual knowledge of item giving rise to the understatement.
Still, the idea of innocence is still in play in §6105(c). If the IRS can show that the requesting spouse was not innocent of knowledge about the item giving rise to the deficiency, then relief will be denied. The courts have repeatedly said that the IRS need only prove that the requesting spouse had actual knowledge of the facts surrounding the item giving rise to the deficiency. Ignorance of the law is not innocence. See e.g. Cheshire v. Commissioner, 282 F.3d 326 (5th Cir. 2002)(actual knowledge that husband withdrew retirement money was sufficient even though requesting spouse had been assured by husband that using the money to pay off mortgage meant it was not gross income).
The third pathway is §6105(f). It a broader path but more difficult to navigate. It is broader because it applies to both understatements and underpayments. That is, it can apply even if there is no deficiency but simply an unpaid tax liability. It also has a much broader time limit. A taxpayer can seek (f) relief during the entire time that the IRS can collect from the taxpayer. In contrast, (b) or (c) relief must be requested within 2 years after the IRS starts collection against the requesting spouse. See §6105(b)(1)(E) and (c)(3)(B). The basis for relief is also very broadly worded: the statute allows a spouse who cannot get relief under either §6015(b) or (c) to be relieved of responsibility for an unpaid liability when “taking into account all the facts and circumstances, it is inequitable to hold” the requesting spouse liable.
The tricky navigation comes from how the IRS has implemented (f) relief. The IRS has published guidance on what “facts and circumstances” it will consider in Rev. Proc. 2013-34. While the Tax Court repeatedly says it is not bound by the Rev. Proc., as a practical matter it always follows the Rev. Proc.’s approach to evaluating the suitability of relief.
I teach Rev. Proc. 2013-34 as creating three equity screens, each of which asks slightly different questions, all variants of “is it unfair to make the requesting spouse pay the tax?” Section 4.01 sets up a threshold screen that consists of a checklist of procedural hoops. If a taxpayer does not meet the threshold conditions, the IRS rejects the request without further analysis. When a taxpayer satisfies the threshold requirements the IRS applies a second screen, found in §4.02. This second screen applies three additional conditions. If all three apply, then the IRS will grant relief without the need for further analysis. So this second screen is called the “streamlined determination.”
What is relevant to today’s lesson is the third screen. It applies when a taxpayer passes the threshold requirements but does not qualify for the streamlined determination. Then §4.03 lays out seven non-exclusive factors that the IRS will consider in deciding whether to grant the requested relief. If the requesting spouse shows there was physical or emotional abuse by the non-requesting spouse, that is not a separate factor but instead affects the analysis of certain other factors.
Nowhere in §4.01, §4.02, or §4.03 does the IRS use the word “innocent." The point of today’s lesson is to see how the concept of innocence is nonetheless embedded in the inquiry.
Facts and Lesson in Kruja: The Role of Innocence in §6015(c) Relief
This case involves §6015(c) relief. Judge Buch writes: “the sole issue before the Court is whether Ms. Kruja is entitled to innocent spouse relief under section 6105.” (emphasis supplied). Notice his use of the term “innocent spouse relief.” There is a reason why that is an accurate description of (c) relief.
Ms. Kruja was married to Mr. Kruja in 2010 and 2011. Both worked. Ms. Kruja was an employee of Cushman and Wakefield. Mr. Kruja was an entrepreneur, running a business called “Bobbie’s Cafe.” They filed joint returns but committed several errors that led the IRS to issue NOLs. First, they failed to report state income tax refunds they had both received, and they failed to report all the Bobbie’s Cafe income. Second, they erroneously deducted unreimbursed employee expenses for Ms. Kruja on Schedule A and wrongly deducted business expenses for Mr. Kruja on Schedule C. The disallowance of the Schedule A errors resulted in the IRS allowing the standard deduction for those years.
After the IRS issued its notices of deficiency, the Kruja’s filed a petition in Tax Court. While it appeared to be a joint petition and while the agreed decision was signed on behalf of both Mr. and Ms. Kruja, the IRS later agreed that Mr. Kruja had pulled a fast one on Ms. Kruja and had kept her in the dark about the litigation. Thus, Ms. Kruja had not meaningfully participated in the Tax Court proceedings and was not precluded from later requesting spousal relief. See §6015(g)(2).
The Kruja’s divorced on April 16, 2015. Ms. Kruja filed a Form 8857 on July 15, 2015. She said she was innocent of actual knowledge about Mr. Kruja’s unreported income and improper deductions for Bobbie’s Cafe. During the development of the case, the IRS agreed that she lacked actual knowledge of the omitted income and erroneous deductions associated with Bobbie’s Cafe. However, the IRS determined that Ms. Kruja had actual knowledge of the state tax refunds because those refunds had been deposited into a joint bank account. Therefore, the IRS determined that Ms. Kruja was eligible for §6015(c) relief for the adjustments attributable to Bobbie’s Cafe should be allocated to Mr. Kruja but not for the adjustments attributable to the disallowed unreimbursed employee expense deductions and the state tax refunds.
Mr. Kruja intervened to oppose relief. He said Ms. Kruja was not so innocent because she had actual knowledge about the Bobbie's Cafe operations because she prepared all their taxes and organized his business paperwork, including the bills and invoices from Bobbie's Cafe.
In a §6015(c) case, innocence is presumed. And it is a pretty strong presumption. The point of the provision is to unwind the marital return. To do that the law presumes the requesting spouse innocent of knowledge of the non-requesting spouse’s income and deductions and innocent of benefit. Only when the IRS or an intervening non-requesting spouse can show actual knowledge or actual benefit by a preponderance of the evidence will a §6015(c) request fail.
The strength of the innocence presumption is illustrated by this case. At trial Judge Buch listened to both parties testify. As to the Bobbie’s Cafe items, Judge Buch found Mr. Kruja’s testimony insufficient to overcome the presumption. As to the state tax refunds, Judge Buch found the IRS evidence insufficient as well. While the IRS proved that the state tax refunds had been deposited into the joint account, Judge Buch said “the record is insufficient to establish that Ms. Kruja had actual knowledge of the unreported State tax refunds.” Therefore, absent the necessary evidence to establish a different allocation, Judge Buch allocated the state tax refunds 50/50.
Thus, thanks to the presumption of innocence that neither Mr. Kruja nor the IRS could overcome, Ms. Kruja was entitled to relief for that much of the tax liabilities attributable to Bobbie’s Cafe and to omission of half the state tax refunds.
Facts and Lesson of Sleeth: The Role of Innocence in §6015(f) Relief
This case involves §6015(f) relief that Ms. Sleeth requested for tax years 2008-2010. Dr. Sleeth married Ms. Sleeth in 1988. However, it appears they actually lived apart for many years during their marriage. The opinion states that during the 3 years at issue in the case Ms. Sleeth lived in a townhouse that Dr. Sleeth had purchased and quitclaimed to her in 2005. It was some 10 miles away from their jointly owned home where they had previously lived together. It is not clear from the opinion whether the Sleeths ever shared a home after that.
They were still married but separated when Ms. Sleeth requested spousal relief in 2017. They were married but separated when the IRS denied her requested relief in March 2018. Their divorce became final in August 2018.
This is an underpayment case. Ms. Sleeth was not eligible for relief under either 6015(b) or (c) because this is not a situation involving an understatement of tax. During the three tax years at issue, the Sleeths filed joint tax returns that properly reported all their income and properly reported tax, penalties and interest due of $163k for 2008, $150k for 2009, and $133k for 2010. However, the Sleeths filed all three years in March 2011. So the 2008 and 2009 returns were filed quite late. And all of the returns reported that nothing had been paid towards any of the tax liabilities for any of the years. Nothing had been paid in 2008, or 2009, or 2010.
It is not difficult to see why the Sleeths failed to pay their taxes for three years starting in 2008. It was the Great Recession, after all, and it appears to be that they were too leveraged. After finishing his medical residency in 2003, Dr. Sleeth bought a home, then in 2004 he bought a boat and a plane, then in 2005 he bought the townhouse. It seems likely he borrowed for much of that and then could not generate the funds necessary to pay off the debt. They put their jointly owned home up for sale in 2008 but were unable to sell it in 2008, 2009, or 2010. Instead, it was repossessed in 2012.
On these facts Judge Goeke held that Ms. Sleeth was not entitled to equitable relief. It was not unfair to hold her jointly and severally liable for the taxes reported on the joint return she signed. Although Judge Goeke goes through the list of equitable factors listed in Rev. Proc. 2013-35, I do not see that those factors alone do not really account for the decision. I think what accounts for the decision is Judge Goeke’s judgement that Ms. Sleeth did not have the requisite innocence, innocence of knowledge that the taxes would, in fact, be paid by Dr. Sleeth.
Of the seven factors from the Rev. Proc., Judge Goeke found that three supported relief, three were neutral, and one weighed against relief. But that one was a biggie, in his judgment.
In underpayment cases, the innocence idea comes into play with respect to knowledge about payment. The Rev. Proc. says that the question is whether “as of the date the return was filed...the requesting spouse knew or had reason to know that the nonrequesting spouse would nor or could not pay the tax liability...” This factor weighs against relief “if...it was not reasonable for the requesting spouse to believe that the nonrequesting spouse would or could pay the tax liability shown on the return.” See Rev. Proc. §4.03(2)(c)(ii).
In this case, what caught and kept Judge Goeke’s attention was that the taxpayers filed all three three years worth of taxes returns at the same time and at a time where the home they needed to sell had been on the market for three years, had a jumbo mortgage on it, and remain unsold. Each tax return reported zero tax paid during the year through withholding, estimated tax payments, or otherwise. So Dr. Sleeth had not paid taxes for three years. In addition, Ms. Sleeth knew that they had failed to pay their 2005 liabilities because they had been on an installment agreement. On these facts, Judge Goeke found that it was simply not reasonable for Ms. Sleeth to believe that Dr. Sleeth would suddenly be able to pay the taxes when he had shown such a long and continuous pattern of failing to pay. Ms. Sleeth apparently admitted in testimony that she did not even ask Dr. Sleeth how he planned to pay the taxes but instead testified that she just assumed he would pay. Under the circumstances, Judge Goeke says, Ms. Sleeth “had a duty to do more than assume intervenor would pay the tax owed.... Her assumption...is unreasonable, and her alleged belief that intervenor would pay is not credible.” He concludes: “Ultimately, we find that petitioner’s unwillingness to confront the financial problems she and intervenor faced weighs strongly against relief. She cooperated in intervenor’s over three-year practice of simply not paying tax.”
Bottom line: Despite other factors favoring relief, it may still not be unfair to collect from a taxpayer who is complicit in nonpayment. Innocence is still important in spousal relief.
Coda 1: The economic hardship factor was not much developed in Sleeth. In her Form 8857 Ms. Sleeth reported monthly income of $21,127, some $390 more than monthly expenses of $20,737. But that income figure apparently included some amount attributable to Dr. Sleeth because it was filed while they were still married. Judge Goeke writes that her income without her husband’s income “would support an economic hardship claim.” The Rev. Proc. says that the economic hardship factor takes into account how much a taxpayer’s monthly income exceeds the taxpayer’s “reasonable basic monthly living expenses.” So I would like to know more about those $20,737 monthly expenses. That number just does not strike me, offhand, as “basic.” I welcome any thoughts on that readers might care to share in the comments.
Coda 2: Practitioners should not overlook duress and other arguments that go to the validity of the signature on the return. After all, joint liability only arises when both spouses have “signed” the return. Accordingly, duress is still a viable alternative to innocent spouse relief because it is premised on the idea that there is simply no valid signature on the joint return. Treas.Reg. 1.6013-4(d).
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.