I don't just inflict misery on tax students. I also teach a class in Civil Procedure to first year law students. One recurring lesson there concerns the different standards courts of appeals use when reviewing trial court decisions. I want my students to learn to that the applicable standard of review matters. It not only makes a huge difference in the outcome of the current case, but it also can make a huge difference in the precedential effect of that case on later cases.
We learn today how the different standards of review affect both outcomes and precedential value of old spousal relief cases. We also learn how the Tax Court might be induced to finesse the bastardized administrative record rule in §6015(e)(7). In Pia O. Bacigalupi v. Commissioner, Docket No. 20480-21 (Order of Oct. 27, 2022) (Judge Holmes), the IRS Office of Appeals decided Ms. Baciglupi should be held to the joint liability she had agreed to bear when she signed the joint returns. They were unmoved by her present circumstances and denied her request for §6015(f) equitable relief. Despite the record review rule, Judge Holmes allowed her to testify, and on the basis of that testimony disagreed with the IRS about two crucial factors for spousal relief. Under an abuse of discretion review, that disagreement would not have mattered but under the de novo review, it made all the difference. The de novo review standard also allowed Judge Holmes to ignore certain precedents unfavorable to Ms. Baciglupi. Notice, however, this is just an unpublished bench opinion, so don’t get too excited. For more about that, I recommend Keith Fogg’s excellent post from last week on bench opinions in general and this case in particular. Meanwhile, you will find today's lesson in more detail below the fold.
Law: Standard and Scope of Reviewing IRS Spousal Relief Decisions
When the IRS rejects a taxpayer’s request for spousal relief under §6015, Tax Court review might come up as part of a deficiency petition, or as part of a CDP petition, or as a stand-alone petition. Given that the Tax Court generally reviews IRS deficiency decisions de novo, but reviews CDP decisions for abuse of discretion, it was not always clear how the Tax Court would review an IRS decisions denying spousal relief.
Before 2009, the Tax Court reviewed IRS rejections of spousal relief requests using an abuse of discretion standard. Jonson v. Commissioner, 118 T.C. 108 (2002). This approach was blessed by at least two Courts of Appeals. Mitchell v. Commissioner, 292 F.3d 800, 807 (D.C. Cir. 2002); Cheshire v. Commissioner, 282 F.3d 326 (5th Cir.2002). The basic rationale was that Congress had given the IRS the decision whether to grant equitable relief, therefore the Tax Court should review such decisions for abuse of the granted discretion. What made this awkward, however, was that the Tax Court permitted the introduction of new evidence, and abuse of discretion review does not make a lot of sense when the review encompasses different sets of information.
In 2009 the Court switched to using a de novo standard of review. Porter v. Commissioner, 132 T.C. 203 (2009) (abrogating Jonson). The basic rationale hinged on new statutory language Congress had added in 2006. As modified, §6015(e) said the Tax Court’s job was "to determine the appropriate relief available to the individual under this section." The Tax Court believed the phrase “to determine” meant de novo review, just like in deficiency cases where the Tax Court’s job was to “redetermine” a proposed deficiency. This interpretation was blessed by the only Circuit Court to review it. Wilson v. Commissioner, 705 F.3d 980 (9th Cir. 2013), and the IRS conceded the issue. See Action on Decision (June 17, 2013), IRB 2013-25.
In Porter and Wilson, the courts paired this de novo standard of review with a de novo scope of what information the Tax Court could review. That is, consistent the Tax Court deficiency cases, the idea was that the IRS decision received a presumption of correctness but the taxpayer still was allowed a do-over in Tax Court.
In the Taxpayer First Act of 2017 Congress modified §6015(e) by adding paragraph (7). Paragraph (7) codified the de novo standard of review. Weirdly, however, it modified the scope of review by limiting the scope of information the reviewing court can consider. In effect it created a bastardized administrative record review rule. Here’s the unfortunate statutory text:
“(7) Any review of a determination made under this section shall be reviewed de novo by the Tax Court and shall be based upon—(A) the administrative record established at the time of the determination, and (B) any additional newly discovered or previously unavailable evidence.”
The ABA Tax Section objected to this bastardized record review rule in comments it submitted to the Senate Finance Committee. See Letter from ABA Tax Section, published in 72 Tax Law. 122 (2017). I think this passage is particularly relevant to today’s lesson:
“...we are concerned that the proposed language could lead to burdensome litigation over whether evidence that the taxpayer seeks to introduce qualifies as “newly discovered” or “previously unavailable.” *** The limitations on scope of review also could conceivably restrict the Tax Court from considering the credibility of the parties.... [T]he Tax Court should be able to review all the evidence in making its determination with respect to relief from joint liability, and not be limited by what the Service may have decided without having obtained (or put into the administrative record) all the relevant facts.”
Law: Spousal Relief
Feel free to skip this short summary. But for those not familiar with spousal relief, it will help you understand the lesson. For more in-depth treatment, including the history of this provision in my 100th Lesson From The Tax Court, The Role of Innocence In Spousal Relief, TaxProf Blog (Oct. 21, 2019).
Here you just need to know about process for taxpayer seeking §6015(f) equitable relief.
The basis for §6015(f) relief is very broadly worded: the statute allows a taxpayer to be relieved of responsibility for an unpaid joint liability when “taking into account all the facts and circumstances, it is inequitable to hold” the requesting spouse liable. The relief applies to both understatements of tax (i.e. deficiency assessments) and underpayments (i.e. assessment based on filed returns that simply did not remit sufficient payment). A taxpayer can seek equitable relief during the entire time that the IRS can collect from the taxpayer. §6015(f)(2).
The IRS has implemented §6015(f) relief through Rev. Proc. 2013-34. While the Tax Court routinely says it is not bound by the Rev. Proc., as a practical matter it always follows the Rev. Proc.’s approach when evaluating the suitability of relief. So let’s see what the Rev. Proc. does.
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 mostly procedural hoops. If a taxpayer does not meet the threshold conditions, the IRS rejects the request without further analysis.
Section 4.02 is the second screen. It kicks in when a taxpayer satisfies the threshold requirements in §4.01. This second screen is called the “streamlined determination” because it takes three of the most important factors used in the third screen and will grant relief if all three favor the requesting spouse: (1) the divorce is final; (2) the taxpayer would suffer economic hardship without relief; (3) the taxpayer did not know or have reason to know of the existence or nonpayment of the tax liability for which relief is sought. While there are additional factors the IRS may consider, these are deemed important enough that if all three favor the requesting spouse, the IRS will not even consider any others. That’s why this is called the “streamlined determination.”
Section 4.03 is the third screen. It applies when a taxpayer passes the threshold requirements but fails one of the streamlined determination factors. Section 4.03 lays out seven non-exclusive factors that the IRS will consider in deciding whether to grant the requested relief. In addition to the three factors listed above (that get used in the streamlined determination), the IRS will consider the following additional 4 factors: (1) who had the legal obligation under any relevant state court order or binding agreement to pay the outstanding tax liability; (2) how much the requesting spouse benefited form the unpaid tax liability; (3) whether the requesting spouses has otherwise complied with income tax laws; and (4) the physical or mental health of the requesting spouse.
Special Role of abuse. Under the former Revenue Procedure the IRS made abuse a separate factor to consider as part of the third screen. However, Rev. Proc. 2013-34 elevates the importance of abuse by allowing a showing of physical or emotional abuse to be considered in each stage. See e.g. §4.01(7)(D), §4.02(3)(a), §4.03(2). If the requesting spouse convinces the IRS that the non-requesting spouse abused them such that the requesting spouse could not, as a practical matter, object or affect the treatment of any item that gave rise to a deficiency, or could not, as a practical matter, question or affect the actual payment of reported taxes, then such abuse or financial control will result in the IRS putting a huge thumb on the scale of fairness in favor of the requesting spouse. Specifically, the IRS will disregard whether requesting spouse knew or had reason to know of the items giving rise to the understatement or deficiency or knew or had reason to know that the non-requesting spouse would not pay the tax liability.
An important idea underlying the abuse inquiry is that it is not fair to hold person responsible for reporting or payment when, even if they knew about the problem, they did not have the ability to control or affect the behavior. Thus, proving abuse can be viewed as a specialized showing of lack of control. Lack of control negates the “knew or had reason to know” factor.
That idea of lack of control is important for today’s lesson. Let’s take a look.
The IRS sought to collect some $300,000 in unpaid taxes from Ms. Bacigalupis from tax years not disclosed in the opinion. She divorced her husband in 2018. So it’s gotta be for some tax years before that. The opinion explains how the joint returns for 2007-2009 were not filed until 2011 and how the 2010-2013, and 2017 returns were late-filed, sometimes by more than a year. But it is not clear whether all of those years or just some are at issue. At any rate, it appears that the unpaid tax liabilies arose from Mr. Bacigalupis’s stock-trading activity. As such, the 2018 divorce decree recited his agreement to be solely responsible for all the outstanding unpaid taxes. Of course, the state court decree does not change the fact that Ms. Bacigalupis had signed the joint returns for the years at issue.
Ms. Bacigalupis asked the IRS for equitable relief. The IRS said no. She petitioned the Tax Court, as provided in §6015(e)(1), to "determine the appropriate relief.”
Judge Holmes walks through the Rev. Proc.’s three screens.
First, he agrees with the IRS that Ms. Bacigalupis passes the threshold tests in §4.01.
Second, he agrees with the IRS that Ms. Bacigalupis does not qualify for the streamlined determination in §4.02. He finds that some of the late-filed returns were not filed until after she had learned (through seeing Notices of Intent to Levy) about the IRS collection efforts for prior years. That meant “she clearly knew that they were going to have payment difficulties.” Op. at 9.
Third, he disagrees with the IRS on how to balance the factors under §4.03. Specifically, Judge Holmes disagrees with the IRS judgment as to two of the factors: (1) whether collecting the $300,000 from Ms. Bacigalupis would create a financial hardship for her and (2) whether she benefited significantly from the unpaid taxes.
It is in these two disagreements that we learn two lessons for today.
Lesson 1: Witness Testimony In Court May Be “Previously Unavailable” Evidence
Judge Holmes acknowledges that the bastardized record review restricts the information he can consider when reviewing the IRS decision. Critically, however, he decides to allow Ms. Bacigalupis to testify in Tax Court. He reasons that her testimony in Court was “previously unavailable evidence” within the meaning of the bastardized rule. Why? Well, because she was giving the evidence under oath and subject to cross-examination! Sure, she might have testified or spoken with an Office of Appeals Settlement Officer, but even if she had, the testimony she gave in Court was not previously available because the previous testimony was neither under oath nor subject to cross-examination.
Ms. Bacigalupis’ testimony gave Judge Holmes two important facts that were not in the administrative record: (1) Ms. Bacigalupis no longer had the car she had when she first asked for spousal relief; and (2) at the relevant times Mr. Bacigalupis had hidden income from Ms. Bacigalupis (Op. at 17) in a separate bank account that only he knew about and could access.
This new evidence contributed to Judge Holmes disagreement with the IRS.
First, the fact that Ms. B. no longer had a car (but instead relied on her son for transportation to her retail clerk job), that was part of what convinced Judge Holmes to “find that she would suffer economic hardship.” Op. at 12. That seemed to have moved the needle on that factor from being against Ms. B. to being in her favor.
Second, the fact that Mr. B. was hiding income from Ms. B. meant she really did not have ability to truly know the amount and extent of the joint liability she had agreed to. And she did not know where the money was coming from that they were living on. Judge Holmes thought that was a “big fact that’s new here.” Op. at 17. It negated control, neutralizing the fact that she knew or had reason to know that the underpayment was not being paid. This fact worked in a way similar to abuse. Judge Holmes explains “it put her in a position where she was not able to reasonably leave the economic community [of marriage] for years after she discovered the problem that her husband was causing.” Op. at 18.
These two critical facts were not in the administrative record. They appeared only because the Court permitted Ms. B to testify and made an independent credibility determination of her testimony. That goes straight to the ABA Tax Section’s concern about the bastardized record review rule that I quoted above.
Lesson 2: Abuse of Discretion Precedent Is...Not Precedent!
The second big disagreement Judge Holmes had with the IRS was whether Ms. B. significantly benefited from the unpaid taxes. That’s one of the factors in the Rev. Proc.’s third screen. It is based on the commonsense idea that it’s not unfair to hold someone responsible when they themselves benefited from the money that should have been used to pay the taxes.
In this case, the big bad fact in the administrative record was that the Bacigalupis’ son attended a college for which the tuition was $50,000 a year. The IRS argued that prior Tax Court decisions had repeatedly held against spousal relief when college tuition was paid for by a couple that was in severe tax debt. In fact, the IRS cited to Jonson, supra, which was on point.
Here’s where the standard of review comes into play. Judge Holmes explains that the Tax Court in Jonson was simply reviewing the IRS decision about tuition payments for abuse of discretion. So those prior decisions were not binding because they had operated under an entirely different legal standard of review. In other words, those precedents just stood for the proposition that it might be entirely reasonable to weigh tuition payment as a benefit. But it was also reasonable to not so weigh it! They did not control a de novo standard of review. Judge Holmes explains:
“So although, I certainly think it would be reasonable, if I was reviewing this for whether the Commissioner had abused his discretion, I'm not bound by those decisions. And I have to look at things with a fresh pair of eyes. And here's what I see when I look....”
Judge Holmes then goes on to explain what he sees and why he does not believe this was a significant benefit to Ms. B. in part because he doubted that college tuition was part of a lavish lifesyle and in part because he thought the record was quite confusing on how much of the $50,000 came from the couple as opposed to scholarships, and whether Ms. B. actually even participated in the decision, again given the hidden bank accounts.
Bottom Line: De Novo review, coupled with a creative reading the §6015(f)(7) bastardized record review rule permitted the Tax Court here to move the needle on two of the equitable relief factors and thus override the judgment of the IRS Office of Appeals.
Comment: Refund Suits?: Notice that the §6015(f)(7) bastardized record review rule applies only to Tax Court review of IRS decisions. I call to your attention the case of Hockin v. United States, 400 F. Supp. 3d 1085 (D. Or. 2019) where the district court permitted the taxpayer there to use the refund suit to challenge the IRS’s prior rejection of her spousal relief claim. The district court was of the opinion that, as with deficiencies, a taxpayer can choose to forgo Tax Court review by paying the asserted tax after being denied spousal relief, and then assert spousal relief in a later refund action. While this option may not be currently available for many taxpayers facing economic hardship, it is something to keep in your research files in case Congress ever modifies the Flora full-pay rule.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return each Monday TaxProf Blog is up and running (or Tuesday if Monday is a federal holiday) for another un-reviewed Lesson From The Tax Court.