Paul L. Caron

Monday, February 7, 2022

Lesson From The Tax Court: The Innocence Requirement In § 6015(c) Proportional Relief

Camp (2021)Section 6015 allows taxpayers to obtain relief from an otherwise joint and several liability.  The statute contains three related provisions allowing relief.  Siblings.  First is the eldest child, traditional innocent spouse relief.  It was formerly in §6013(e) and is now found in §6055(b).  Second is the quite middle child, a proportionate relief provision that basically permits unwinding the jointly filed return.  That’s in §6015(c).  Third is the wild child, an equitable relief provision that permits relief when it would be unfair to impose joint liability.  That’s in §6015(f).

Of these three spousal relief provisions, the wild child §6015(f) gets most of the attention, at least in court, because it is a very facts-and-circumstances determination and so leads to the most disputes between a requesting spouse and the IRS.  There is also robust case law on the bossy oldest child §6015(b) because it has been around the longest, since 1971.

Today’s lesson is about §6015(c), the oft overlooked middle child.  While, arguably, all three provisions involve some concept of innocence, we learn today a crucial difference between how that concept works for (c) relief and (b) relief.  In Tara K. Tobin (Petitioner) and Jeffrey Tobin (Intervenor) v. Commissioner, T.C. Summ. Op. 2021-36 (Nov. 16, 2021) (Judge Guy), an IRS audit disclosed multiple items of unreported income.  Ms. Tobin asked for §6015(c) relief, agreeing to take responsibility for her unreported income items and leaving Mr. Tobin responsible for his.  Mr. Tobin objected, claiming that Ms. Tobin was not innocent enough to qualify for proportional relief.  In a short but useful lesson, we learn why the Tax Court decided for Ms. Tobin.  Details below the fold.

Law:  Background
To understand the unwinding rules in §6015(c), you need just a little background on (1) how the traditional “innocent spouse” relief in §6015(b) works, and (2) how §6015(c) came into the Code as part of a legislative compromise.

Congress enacted the first spousal relief provision in 1971 (codified as §6013(e)), modified it in 1984, and then added two more spousal relief provisions in 1998 at which time Congress put all three relief provisions in §6015.  A short review shows how these sibling provisions work.

(1) Traditional Relief under §6015(b). 
The original spousal relief provision is often called “innocent spouse” relief.  That is because it was designed to give relief to spouses from understatements of tax liability when the requesting spouse was both (a) innocent of knowledge of the facts of the omission and (b) innocent of benefit from the income.

The innocence of knowledge requirement is pretty strict, in three respects.  First, from the get-go of the law, courts require the requesting spouse to be ignorant of the very transaction giving rise to the understatement, not just ignorant of the law.  McCoy v. Commissioner, 57 T.C. 732 (1972).  The rationale is more than just ignorance of the law is no excuse.  The Tax Court explained in McCoy: if ignorance of the legal tax consequence of a transaction (as opposed to the transaction itself) were enough to grant relief, then the courts could be stuck with having to place the financial liability on one of two innocent spouses, since both spouses may have been ignorant of the tax consequences.

Second, the requesting spouse bears the burden to establish innocence of knowledge.  That means the presumption is there is no innocence of knowledge.  Id.

Third, and most strict, the innocent knowledge element is a Monday-morning quarterbacking rule. That is, the requesting spouse must not only show that they were actually ignorant (of the transactions underlying the deficiency), they must also prove that they had no reason to knowTreas Reg. 1.6015-2(a)(3) (requesting spouse must establish "that in signing the return he or she did not know and had no reason to know of the understatement”).

(2) Creation of Proportionate Relief Under §6015(c)
Before 1998 there was much commentary critiquing the inadequacies of the traditional innocent spouse relief, particularly with respect to the harsh Monday-morning quarterback rule.  Some commentators, notably the ABA Section on Taxation, urged that relief from joint liability should not be tied to innocence at all; they proposed a proportionate liability regime that allowed ex-spouses should instead be able to opt out of what they had opted into when signing (or tacitly consenting to) a joint return.

In 1998, the Senate Finance Committee listened to those commentators.  It proposed to eliminate the traditional relief entirely and replace it with a straight opt-out provision, whereby a taxpayer, whether married or divorced, could elect to basically unwind a previously filed joint return.  The proposal eliminated the second and third requirements for innocence of knowledge.  That is, it eliminated the presumption and the Monday-morning quarterback rule.  But it did permit the IRS to deny relief if it could show actual knowledge of the item giving rise to the deficiency.  It also offered this relief not only from understatements but also from any part of a self-reported liability, whether previously paid or not.  Thus, even if there was no underpayment, one of the signers of the joint return could come to the IRS later and ask to unwind the return.

The House Ways and Means Committee did not listen to those commentators.  It proposed a straightforward reform of the traditional innocent spouse relief.  While it liberalized the requirements for innocent spouse relief, widened the scope of relief, and introduced the idea of partial relief if a spouse could show ignorance of some of the erroneous items causing the understatement, it still kept both innocence requirements: knowledge and benefit.  And it retained both the presumption and the Monday-morning quarterback rule.

The Conference Committee adopted, with modifications, both proposals.  The Senate proposal because subsection (c), but limited to deficiencies, and the House proposal became subsection (b).

This is just a high-level overview.  For more details I recommend: GAO Report 97-34: Tax Policy: Information on the Joint and Several Liability Standard (March 1997); Svetlana G. Attestatova, Note, The Bonds of Joint Tax Liability Should Not be Stronger Than Marriage: Congressional Intent Behind Section 6015(c) Separation of Liability Relief, 78 Wash. L. Rev. 831 (2003); and, natch, Bryan Camp, Between a Rock and a Hard Place, 108 Tax Notes 359 (July 15, 2005).

Law: Rules for §6015(c)
Section 6015(c) permits a requesting spouse to unwind a joint return, limiting their liability to that portion of the deficiency properly allocable to them under the allocation rules in §6015(d). In general, §6015(d) provides that items giving rise to a deficiency on the joint return are allocated between spouses as if separate returns had been filed. §6015(d)(3)(A).  Importantly for today’s case, omitted income items are allocated to the spouse who was the source of the income. Treas Reg. 1.6015-3(d)(2)(iii).

Under §6015(c) a taxpayer can obtain relief when:

(1) On the date the request is filed, the taxpayer is either (a) no longer married to the non-requesting spouse; or (b) is legally separated from the non-requesting spouse; or (c) was not a member of the same household as the non-requesting spouse at any time during the 12-month period ending on the date the request is filed.  See Treas. Reg. 1.6015-3(b) for definitions; and
(2) The request is made within two years of when the IRS first initiates collection action. §6015(c)(3)(B).  This 2-year rule creates some problems.  For example, it is particularly difficult to tell when the IRS may have performed a setoff of an overpayment, yet that setoff starts the 2-year period.  That is why it is critical to obtain the account transcript for the years the requesting spouse seeks relief. Only a transcript will reveal whether and when the IRS has taken one of the collection actions that trigger the 2-year period.

These are the elements that the taxpayer must prove to request relief.  Notice that the taxpayer does not bear the burden to prove innocence of knowledge of the items of the other spouse that contribute to the deficiency.  However, the IRS can deny relief if the IRS determines that either:

(1) The requesting spouse had actual knowledge of the transactions that gave rise to the erroneous items attributable to the non-requesting spouse (§6015(c)(3)(C); Treas. Reg. 1.6015-3(c)(2)); or
(2) The non-requesting spouse had transferred assets to the requesting spouse to avoid payment of tax (§6105(c)(4); Treas. Reg. 1.6015-3(c)(3)).

Two points to notice here.  First, while §6015(b) relief requires the requesting spouse to not have benefited from the errors leading to the deficiency (here’s a new car for you honey!), §6105(c) relief has no such requirement.  Second, and more importantly, the statute presumes the requesting spouse was innocent of knowledge.  That is, there is still an innocent requirement, but the burden lies on the IRS to show "actual knowledge of the factual circumstances” which created the error.  King v. Commissioner, 116 T.C. 198, 204 (2001).  This is in sharp contrast to the Monday-morning quarterback rule for traditional innocent spouse relief under §6015(b).

Still, the test for knowledge is same for both (b) and (c) in this respect: courts look to what knowledge the requesting spouse had about the factual circumstances, not their knowledge of the law.  For example, in Cheshire v. Commissioner, 282 F.3d 326 (5th Cir. 2002), the IRS proved that the requesting spouse actually knew that her husband had drained his IRA account. That was enough to preclude both (b) and (c) relief, even though the husband had assured his wife that he had consulted with a CPA who told him the withdrawal was not taxable income.

Further, the regulations distinguish between actual knowledge of receipt of income and actual knowledge of a source of income.  Thus, if the requesting spouse has actual knowledge that the other spouse had received stock dividends, that precludes relief.  Treas. Reg. 1.6015-3(c)(2)(i)(A).  But if the requesting spouse had only actual knowledge that the other spouse owned stocks, and did not have actual knowledge of the dividend payments, that would not preclude relief.  Treas. Reg. 1.6015-3(c)(2)(iii).

Mr. and Ms. Tobin lived in California during the years at issue (2013 and 2014) and filed a joint returns for those years.  Mr. Tobin was self-employed in three different businesses: a plastic tubing resupply business, a weight loss sales business run through Amazon, and a multi-level marketing sales business with Nu Skin.  Ms. Tobin had been a wage earner but in early 2013 she “left the workforce and devoted her time to caring for the couple’s growing family.”  Op. at 3.

Mr. Tobin handled the couple’s finances.  He worked out of a home office, where he kept his hard copy business records.  He kept electronic records on his laptop.  Mr. Tobin had a separate bank account for his business activities, over which he “had sole signatory authority.” Op. at 5.  He used his accounts to pay for all household expenses, including paying off Ms. Tobin’s credit card and other personal expenses.  Ms. Tobin had her own checking account, but it does not appear to have been used much once she left the workforce.  While Ms. Tobin knew about her husband’s three businesses and his bank account, Judge Guy finds that she “was unaware of the cashflows that [Mr. Tobin’s] businesses generated or the amount of cash reserves on hand to pay household expenses.”  Op. at 5.  That’s a crucial fact, as we shall see.

Mr. Tobin also handled preparation of the couple’s tax returns.  He used an accountant and did not include Ms. Tobin in the preparation process.  Judge Guy finds that Ms. Tobin “did not have access to, or review, third-party information returns” nor did she ever meet with Mr. Tobin’s accountant and the accountant did not review the returns with her.  Op. at 5-6.

The IRS selected the 2013 and 2014 returns for audit and, at a time not disclosed in the opinion, sent the Tobins two Notices of Deficiency, asserting deficiencies of tax due to unreported income for both years.  The 2013 return had failed to report about $3,000 of income attributable to Ms. Tobin (wages and unemployment compensation).  It also failed some $97,000 paid to Mr. Tobin by Amazon.  The 2014 return failed to report some $72,000 paid to Mr. Tobin by Nu Skin.  The Tobins did not petition Tax Court to determine the deficiencies.  Thus, again at a point not disclosed in the opinion, the IRS assessed the liabilities and started collection actions.

Mr. and Ms. Tobin legally separated in 2017, and started divorce proceedings that year.  It does not appear that the proceedings had been finalized when Ms. Tobin filed a Form 8857 in June 2019 requesting spousal relief for those two years.  After six months, the IRS had not acted on the request.  That entitled her to petition the Tax Court to review her request.  §6015(e)(1)(A)(i)(II).  After receiving the case, the IRS Chief Counsel attorney agreed to support Ms. Tobin’s request for §6105(c) relief so long as she agreed to waive any claim to (b) or (f) relief for those years.  She agreed.  However, Mr. Tobin intervened, objecting to relief on the grounds that Ms. Tobin was neither innocent of knowledge nor innocent of benefit.

Lesson: Proportionate Relief Does Not Require (Total) Innocence
Judge Guy explains that (c) relief requires only actual knowledge.  Further, “actual knowledge is not to be inferred from evidence that the electing souse merely had reason to know of the omitted income.”  Op. at 10.  So while Mr. Tobin had a decent should-have-known argument, that is not the standard for innocence in §6105(c).  That is likely why the IRS Chief Counsel attorney agreed to allow (c) relief while opposing (b) relief.  Ms. Tobin would not likely qualify for (b) relief.

Applying that modified innocence of knowledge standard, Judge Guy had no difficultly concluding that Ms. Tobin did not have actual knowledge of the transaction giving rise to the unreported income for two reasons.

First, recall that while she knew her husband was running these three businesses, she did not know how much he was paid.  That is, her knowledge of the source of income did not translate to actual knowledge of payments.  Treas. Reg. 1.6015-3(c)(2)(iii).  That degree of knowledge would likely be sufficient to deny traditional innocent spouse relief but was not enough to deny proportional relief.  While Judge Guy does not explicitly invoke the regulations, he does make the crucial finding of fact necessary to trigger them: she knew about Mr. Tobin’s bank accounts but had no way to know what deposits were made to them.

Second, it appears that Mr. Tobin testified that he himself did not have actual knowledge of the payments reported by Amazon and Nu Skin!  Well, gosh.  Judge Guy points out that if that was the case, the “it was doubtful that petitioner had actual knowledge of them.”  Gotta love the understatement.

Finally, although Judge Guy does not address it, I hope readers can see why Mr. Tobin’s claim that Ms. Tobin benefited from the unreported income is irrelevant to the relief provided by §6105(c).  There is simply no requirement that a requesting spouse be innocent of benefit for (c) relief.  That is another difference from (b) relief.  The fact that Mr. Tobin paid all household expenses and Ms. Tobin’s personal credit card using unreported income would quite likely scuttle a (b) request for relief.  But not a (c) request which is simply a request that each spouse be separately responsible for taxes on their own income, regardless of how they chose to spend it.  It’s an unwinding.

Coda: Readers who are familiar with the Tacit Consent rule (that I blogged here a few weeks ago) may wonder why Ms. Tobin did not simply repudiate the jointly filed returns.  It appears from the opinion that she did not tacitly consent to the joint filing.  The answer might be that this couple lived in a community property state and were married at all times during the years at issue.  So it might be that even if she filed a separate return, Ms. Tobin would still have been obligated to report and pay tax on her share of Mr. Tobin’s income.  If that is the case, then §6015(c) relief was definitely to her advantage. 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School Thereof.  He invites readers to develop their actual knowledge of tax law by returning to TaxProf blog each Monday for a new Lesson From The Tax Court.

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@Jonathan, good catch! Thanks!

Posted by: bryan | Feb 8, 2022 10:04:29 AM

6015(c)(3)(C) is a surprising example of 7491(a)(3). Note that 6055(b) should read 6015(b).

Posted by: Jonathan S. Ingber | Feb 8, 2022 10:02:18 AM