Ex-spouse Tax Liability

[equinecpa]

My client is having major issues with tax liabilities incurred while she was previously married. Her ex-husband took care of preparing the returns but filed them late and didn't pay the tax liability. When they divorced part of the divorce decree was that he'd pay the outstanding income taxes. To make a long story short he hasn't.

My client paid the 2000 tax levy this past January because she needed to clear her credit to purchase a house. No sooner had she paid that then out of the blue comes a demand for unpaid taxes for 2003... The IRS just levied on her personal account and nabbed a few thousand dollars but there are still unpaid taxes.

I understand the tax liability on a joint return is joint and that the IRS doesn't honor divorce decree settlements. My client should be able to seek remedy via the legal system shouldn't she ie demand reimbursement from her ex for the amounts paid? But if he doesn't have the means to pay her, she'll just be out attorney fees. How about the unpaid balance -what can she do to prevent future levies?

[Koss]

Innocent Spouse

She may qualify for relief under the Innocent Spouse rules. This is a very complicated area of the law, so you need to do your homework. There is a statute of limitations for seeking the relief, but it has been found unenforceable in some cases by the Tax Court. Nevertheless, the IRS often still denies these requests, and the Tax Court routinely rules in favor of the taxpayer. It's a mess.

Even without the statutory time frame issues, there are very specific criteria that have to be met in order to qualify for Innocent Spouse relief.

If you're not at all familiar with it, the first thing you need to know is that this is totally different from injured spouse.

It's IRC 6015, I believe, and there is an IRS form that is used to request relief. But the form is just that--a form with name, address, SSN, and the tax year in question. The real work is writing a narrative that explains all the facts and circumstances, and makes a coherent argument.

Innocent Spouse is almost, but not quite, as complicated as a an Offer in Compromise. You need to understand what the IRS is looking for.

The concept in a nutshell is that you can argue that it is inequitable, and that it would cause undue hardship, to hold one spouse responsible for the tax liability on a joint return. But there's more to it than that. You still have to meet certain criteria. For example, if some or all of the income was hers... well, good luck. It probably won't fly. But that doesn't mean you shouldn't try.

The bit about the statute of limitations may be critical. The IRS is ignoring certain Tax Court decisions until a higher court sorts it out. But many taxpayers have won this issue without a lawyer. So you have to be prepared to guide your client in that direction. In the most egregious cases, the IRS has actually denied innocent spouse relief on the time limit grounds, while conceding that the person would qualify for the relief they are seeking except for the statutory time limit. This kind of case can be submitted to the court fully stipulated, meaning that the taxpayer and the IRS agree on all the facts, and there's no need for oral argument. And the taxpayer may well win. The Tax Court is not happy with the way the IRS is handling these cases.

But you may not even need to go there. You start with the IRS form...

I'll follow up with some concrete references when I can.

FYI: If she has lots of assets and disposable income, and he doesn't, it probably won't fly.

BMK

[oceanlovin'ea]

Would the taxpayer advocate office be of any help in this matter?

Linda, EA

[Koss]

Taxpayer Advocate

Yes! I thought about that while writing my earlier post, and forgot to mention it.

The Taxpayer Advocate can stop collection action while the request for Innocent Spouse relief is pending. Use Form 911 for this, and attach a copy of the Innocent Spouse form.

References for Innocent Spouse:

Form 8857

Publication 971

IRS FAQ, at the following link:

http://www.irs.gov/individuals/article/0,,id=109283,00.html

In the FAQ, Question #3 says:

A claim must be filed within two years of the first collection activity against you. See the answer to question 35, “What constitutes a collection activity for purposes of starting the two-year statute of limitations the cover the filing of Form 8857?” below.

But see, also, Hall v. Commissioner, 135 T.C. No. 19, at the following link:

http://www.ustaxcourt.gov/InOpHistoric/hallmaj.TC.WPD.pdf

in which the Tax Court held that the two-year statute of limitations contained in the Treasury Regulations is an invalid interpretation of the applicable section of the Internal Revenue Code.

BMK

[Burke]

When they divorced part of the divorce decree was that he'd pay the outstanding income taxes. To make a long story short he hasn't.

I understand the tax liability on a joint return is joint and that the IRS doesn't honor divorce decree settlements. My client should be able to seek remedy via the legal system shouldn't she ie demand reimbursement from her ex for the amounts paid? But if he doesn't have the means to pay her, she'll just be out attorney fees.

The innocent spouse situation has been covered here; however, to answer the other part of your question, yes, she can seek remedy via the legal system, etc. She may be able to file a judgement in small claims court (depending on the amount) and if she can, she should. A judgement is permanent until satisfied, which will prevent him from buying anything on credit, including a house, car, possibly get a credit card, and so on. She might not get anything now, but it is a good tool that locks in her claim for the future.

[New York Enrolled Agent]

But see, also, Hall v. Commissioner, 135 T.C. No. 19, at the following link:

http://www.ustaxcourt.gov/InOpHistoric/hallmaj.TC.WPD.pdf

in which the Tax Court held that the two-year statute of limitations contained in the Treasury Regulations is an invalid interpretation of the applicable section of the Internal Revenue Code.

BMK

To clarify, the Tax Court has ruled the regulation invalid only for cases involving innocent spouse claims under §6015(f) - equitable relief.

For the other two innocent spouse sections §6015(b) and §6015(c), the two year rule limitation for seeking relief still exists - in both sections it is statutory.

I believe the IRS has prevailed in at least two of the Appeal Circuits on this issue.

[erchess]

One More Word on Innocent Spouse

There is a key point to remember about Innocent Spouse. We are of course always dealing with under reporting of income or over claiming of deductions and credits by the other Spouse. Well, the Innocent Spouse cannot have actually known about nor had any reasonable way to know about nor gotten any benefit from the cheating of the other Spouse. The most common Innocent Spouse is married to someone who has another home and family that was maintained with the monies the Innocent Spouse did not know about, had no way to know about, and did not benefit from.

One of the first cases brought under Innocent Spouse involved a woman who lived with her self employed husband in a mansion in Beverly Hills Ca and shared ownership in several ultra expensive cars, you know Rolls, Bentley, etc. He prepared and they both signed returns showing their only income was about 15K of profit from his Sch C Activity. It was eventually proven that he had under reported revenue and greatly over stated expenses. She asked for Innocent Spouse treatment. The court denied her claim saying that first she had to know that their lifestyle cost way more than $15K to support and second that in any event he had no life of which she was not part so she benefited from his cheating and had to join him in the resultant debt.

[Koss]

Innocent Spouse

Erchess--

While I certainly agree with the general point you are making, I think that each individual case has to be evaluated, by the tax pro, by the IRS, and sometimes ultimately by the Tax Court, on all the facts and circumstances.

I'm not sure I agree that the innocent spouse must have no benefit and no knowledge.

Or perhaps my point is that "knowledge" in this context is a very subjective concept. And even the concept of benefit can have some nuances.

First of all, I think there are a few innocent spouse cases that did not involve underreported income or overstated expenses. The original post in this thread appears to deal with just that scenario. We don't have enough background info on equinecpa's client for me to form an opinion. But the original post suggests that the client is dealing with an ex that simply didn't pay the balance due. He didn't pay it with the return, and he also didn't pay it later, as he was required to do by the terms of the divorce decree.

This taxpayer may not have a very strong claim. Or she may. I think some taxpayers have prevailed by showing evidence that they genuinely believed the tax was getting paid when it was due--even if there was never an audit, and the tax return itself is presumed to be accurate.

In other words, she might have signed a return that showed a very high income and the correct tax liability. If she can show that her husband handled all the financial affairs, and led her to believe that the tax was paid, then she may have a case.

My second point is this: Regardless of whether the IRS made an adjustment to the return, one of the things the Tax Court is known to look at very closely is the educational level, and overall level of sophistication, of the purported innocent spouse.

The archetypal scenario in which the woman has prevailed, even when she clearly benefited from an opulent, wealthy lifestyle, is something like this: Woman with only a high school education, and perhaps a couple semesters of college, in courses like psychology and literature, marries a guy with an MBA. Guy with MBA is already pretty well-off when they marry. She spends her time raising kids. Meanwhile, she is vaguely aware that one year before they married, his mother died, and three years after they married, his father died, and that he inherited a lot of money.

So they are living a lifestyle that obviously reflects spending of a quarter of a million dollars a year. But she has no knowledge and no access to his books and records. What would she possibly know or understand about his income, or about the distinction between income and assets?

So she signs a 1040 that shows an AGI of only $21,000, and a tax liability near zero, due to EIC. Does she have any idea how to interpret what she is signing?

And what if she is sharp enough, and has the testicular wherewithal to ask her husband, "Gee, honey, you only made $21,000 last year? How can we afford to have this house, and the boat, and the horses??"

His answer might be something like, "Well, our living expenses are mostly paid by the trust that was set up by my mom and dad. And the corporation that I own also has a lot more income. That income shows up on the corporation's tax return."

And an answer like that could have some truth to it.

Only after the divorce does she discover that the 1040 returns were audited, resulting in a large unpaid tax liability...

In some cases, the audit may not even commence until after the divorce.

In other cases, the guy might be a working-class dude making $35,000 a year at a factory. No kids. But the guy puts down six exemptions on his W-4.

"Here, honey, you gotta sign the tax return."

"Whoaaaaah... Sweetheart, why do we owe the IRS $3,300??"

"Well, I dunno. They didn't take enough outta my pay, I guess."

"How are we going to pay it?"

"Don't worry. I'll get it taken care of. I'm getting a bonus next month."

And so it goes, for three or four years, with the tax debt accumulating, and never getting paid.

Like I said, it's very fact specific. You gotta think Stanley Kowalski (Streetcar Named Desire), or maybe Archie Bunker. This guy gets his paycheck deposited into a bank account that she doesn't have signature authority over, and even the statements go to a post office box, and she doesn't have a key. These days, you can just go paperless, and the bank stops sending statements in the mail.

She doesn't work, and he gives her a monthly spending allowance.

Really. Some people still live like this, even in 2011. Here in the USA. And in other places. Like Afghanistan.

Women in these kinds of relationships have won their cases, even though they lived off the income, and even though they were vaguely aware, on some level, that there was a balance due on the return.

Is this common? I don't know. It may be more common than you think.

Throw domestic violence into the equation, and the Tax Court may become even more sympathetic.

And yes, I know, in some cases, it's the guy that gets screwed. But it sure seems like most of the time it's the girl.

I don't really think it is common for men to file returns with substantial understatements, fail to pay the tax due, and keep their wives totally in the dark.

But I think it is quite common, in many marriages, for one partner to handle all of the finances, while the other partner is relatively clueless.

Is this a good idea? Probably not. But it happens. And if the other spouse can show that it happened, they may have a shot at innocent spouse relief, even if they benefited from the income. If they reasonably believed that the tax liability was getting paid, then they have a case to argue.

BMK

[Koss]

One MORE word...

Although it is certainly not my intent to have the last word...

Here's an innocent spouse case from about a year ago. It runs 23 pages. But for anyone interested in this issue, it is well worth reading.

This taxpayer prevailed in the Tax Court after the IRS denied innocent spouse relief. She attempted to navigate the system on her own, without representation before the IRS, and without counsel before the Tax Court. When the IRS attempted to schedule a telephone hearing, she blew it, and never followed up. With limited information, the IRS denied her request for relief.

In this particular case, in which she sought equitable relief, the Tax Court's standard of review is de novo. They do not decide whether the IRS made a mistake, and they are not limited to the IRS administrative record. They start over, take new evidence, and make their own decision.

In this case, the Tax Court found no evidence of physical or emotional abuse.

But the Court found the taxpayer to be so naive that when the case got to trial, they put it on hold, and arranged for pro bono counsel for her.

This woman won, even though she made some serious procedural mistakes, and didn't get a lawyer until the very end stage. And she was definitely spending, or benefiting from, a good chunk of her husband's income. And there was no audit. It was all about an unpaid liability on an amended return.

To return to my original point about how knowledge of the understatement, or underpayment, as the case may be, can be a very complicated issue...

What you will see in this case is that a great deal hinges not just on what she knew, but when she knew it. I know it's kind of a tired cliche, but it's actually very important.

This is a fascinating case.

http://www.ustaxcourt.gov/InOpHistoric/Wilsonopinion.TCM.WPD.pdf

BMK

[Koss]

Benefit Factor

The opinion I cited above also indicates that the Tax Court looks not just at whether the petitioner benefited from the income, but also when she benefited from it...

Remarkably, in this particular case, both the IRS and the Court appear to have determined that the relevant question was whether the Petitioner benefited from the income since she applied for innocent spouse relief.

And although it is not relevant in the case I cited, the IRS and the Court do take into account whether the divorce decree requires one of the spouses to pay the tax liability. This factor is not dispositive, but it is one factor among many that the Court may consider.

BMK

[DaveO]

The first OIC case I handled was similar to the scenario Koss describes only it was the wife who was self employed. She was in charge of the taxes and they timely filed all returns but never paid the balance due. This went on for 10 years, finally the state levied his wages for unpaid sales tax, then for unpaid income tax, then the really big shoe dropped when the IRS came knocking. Seems she had a little gambling problem that he didn’t know about. They could have taken bankruptcy and cleared most of it away but were unwilling to do so. I explained the innocent spouse rules to them both but he was determined they would get through it together. They both worked second jobs and mortgaged the house to the hilt but were able to pay it off through the OIC.

[JohnH]

Sounds like a guy who took his marraige vows seriously.

[New York Enrolled Agent]

FYI - Today, May 5, 2011, the Tax Court released an opinion Pullins, 136 TC No. 20. Once again the Court says the IRS regulation stating that a taxpayer must file for innocent spouse relief under §6015(f) in the two-year period after collections begins is invalid.

The Court noted that the case would be subject to appeal to the 8th circuit and under the Golsen Rule it will rule for the taxpayer even though the Tax Court position has been reversed by both the 7th and 3rd circuits.

[equinecpa]

As the original poster...thanks for all the discussion!

This client did file for innocent spouse relief and was denied -on what basis I'm not sure the response didn't say.

I'd have to say in this case my client knew of the outstanding amounts when they were divorced or it wouldn't be written in the decree that her ex would pay them.

Another question that arises in my mind is what is considered collection activity? Is sending a notice of a balance owed considered collection activity? I ask because my client applied for relief for the 2004 tax year, the levy was on the 2003 tax year. I don't know what notices she has or has not received. But I do have a copy of the transcript showing her ex did apply for an installment agreement on this year-and the balance due for 2003 is now 0. I called practitioners priority line and the agent I talked to said she'd release the levy as there is no balance remaining.

So hopefully this is a done deal -but I don't know what other snakes are laying out there that may raise their ugly head-I have transcripts back to 2003 but not prior to that...

And a little aside just came across this this morning: http://tax.cchgroup.com/downloads/fi...ws050511.htm#2

[equinecpa]

Well the levy hasn't been removed ...this is turning in to a doozy of an issue. Apparently the balance has not been paid but has been moved into a collections account.

My clients ex filed for bankruptcy so apparently the IRS "split" the account -moving 100% to my client (how's that for a fair split??). Her Ex has a job now and has filed an installment agreement covering that year effective Mar 2011. One payment of $50.00 was applied to the account in Mar 2011 paying the $42.00 remaining balance (an amount left after balance moved to collections). Over-payment of $8.00 credited against another year.

So the ex is trying to pay this but the IRS is saying there is nothing due because nothing shows in the original account it's sitting in a collection account in just the wifes name.

So can the IRS levy on an account that is in installment status (though I see they removed that status from the account in April-probably so they could levy!). I'm having a hard time communicating with them on this since I don't have POA for the ex.

I did try taxpayers advocate and they couldn't help me because this is in collections. Agent said my best bet was to write them -but I know how long letters take to get a response.

I'm thinking of doing a conference call with collections, my client and her ex-he really wants to pay this. Do you think that might work?

Thanks for ANY suggestions

Carolyn