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December 2012

Innocent Spouse Relief in Any Economy Part 2

 
This is the second installment in a series of three newsletters discussing Innocent Spouse Relief. The previous issue covered three alternatives for Innocent Spouse Relief with a detailed explanation of the factors required for each alternative. This issue will continue the discussion of the requirements for receiving equitable Innocent Spouse Relief.

 

The final part of this newsletter series, coming soon, will discuss how to proceed if the IRS refuses to grant Innocent Spouse Relief.

  

If you are interested in finding out more about Innocent Spouse Relief, I will be discussing this topic as part of a panel at the 2012 American Bar Association 29th Annual Institute on Criminal Tax Fraud and the 2nd National Institute on Tax Controversy on this topic. The conference will take place December 6 and 7 at the Wynn Hotel in Las Vegas. Please register here if you are interested in attending.

 

Sincerely,

 

Dennis Brager

(310) 208-6200

Innocent Spouse Relief in Any Economy Part 2

  

Streamlined Determinations. If the threshold conditions are met, the IRS will "consider" granting equitable relief provided that the following additional conditions are met. The requesting spouse:

  1. Is no longer married to the non-requesting spouse.
  2. Would suffer economic hardship if relief were not granted; and
    1. Did not know or have reason to know that there was an understatement or deficiency on the joint return, or did not know or have reason to know that the non-requesting spouse would not or could not pay the underpayment of tax reported on the joint income tax return. This condition does not need to be met if there was abuse by the non-requesting spouse, or the non-requesting spouse maintained control over the household finances by restricting access to the financial information.

Factors in Non Streamlined Determinations. All cases are determined on the facts and circumstances, and the factors are intended only as a guide. No one factor or even a majority of factors necessarily determines the outcome. Nevertheless, the courts and the IRS tend to use the factors as a litmus test, and it is very difficult to obtain innocent spouse treatment simply based upon generalized "equitable grounds." The factors are classified as being favorable, unfavorable or neutral.

1. Marital status: Whether the requesting spouse is no longer married to the non-requesting spouse as of the date the Service makes its determination. If the parties are married this is a neutral factor. No longer married includes divorced, legally separated, living separate and apart during the 12-month period ending on the date relief was requested, or a widow or widower and not an heir to the non-requesting spouse's estate which would have sufficient assets to pay the tax liability.

2. Economic hardship: Whether the requesting spouse will suffer economic hardship if relief is not granted.

a) Whether the requesting spouse will suffer economic hardship is determined based on rules similar to those provided in Treas. Reg. ß301.6343-1(b)(4), and will take into consideration a requesting spouse's current income and expenses and the requesting spouse's assets. Treas. Reg.ß301.6343-1(b)(4) provides little specific guidance other than to say that the inability to maintain a "luxurious or lavish" lifestyle is not an economic hardship. Economic hardship is judged by the IRS based upon the IRS reasonable allowance guidelines. This is contrary to some of the Tax Court cases which have used a more realistic standard for determining economic hardship

b) If the requesting spouse's income is below 250% of the Federal poverty guidelines, or if the requesting spouse's monthly income exceeds the requesting spouse's reasonable basic monthly living expenses by $300 or less, then this factor will weigh in favor of relief unless the requesting spouse has assets out of which the requesting spouse can make payments towards the tax liability and still adequately meet the requesting spouse's reasonable basic living expenses. If the requesting spouse's income exceeds these standards, the Service will consider all facts and circumstances.

c) Lack of economic hardship is a neutral factor.

3. Knowledge or reason to know.

a) Understatement cases: Whether the requesting spouse knew or had reason to know of the item giving rise to the understatement or deficiency at the time the requesting spouse signed the joint return (including a joint amended return). In the case of an income tax liability that arose from an understatement or a deficiency, this factor will weigh in favor of relief if the requesting spouse did not know and had no reason to know of the item giving rise to the understatement. If the requesting spouse knew or had reason to know of the item giving rise to the understatement, this factor will weigh against relief. Lack of knowledge will weigh in favor of granting relief. Actual knowledge of the item giving rise to the understatement or deficiency will not be weighed more heavily than any other factor. If there is abuse or financial control by the non-requesting spouse then this factor will weigh in favor of relief even if the requesting spouse had knowledge or reason to know of the items giving rise to the understatement or deficiency.

b) Underpayment cases. In the case of an income tax liability that was properly reported on a joint return (including a joint amended return) but not paid, underpayment cases refer to whether the requesting spouse knew or had reason to know at the time the requesting spouse signed the joint return that the non-requesting spouse would not or could not pay the tax liability at the time the joint return was filed or within a reasonably prompt time after the filing of the joint return. For example, if prior to signing the return, the requesting spouse knew of the non-requesting spouse's prior bankruptcies, financial difficulties, or other issues with the IRS or other creditors, or was otherwise aware of difficulties in timely paying bills, then this factor will generally weigh against relief.If there is abuse or financial control by the nonrequesting spouse then this factor will weigh in favor of relief even if the requesting spouse had knowledge or reason to know of the items giving rise to the understatement or deficiency.

c) Factors to Consider in determining reason to know.

(1)  requesting spouse's level of education,

(2)  any deceit or evasiveness of the nonrequesting spouse,

(3)  the requesting spouse's degree of involvement in the activity generating the income tax liability,

(4)  the requesting spouse's involvement in business and household financial matters,

(5)  the requesting spouse's business or financial expertise, and any lavish or unusual expenditures compared with past spending levels. Potential Abuse by the nonrequesting spouse is considered here. Notice 2012-8 states: "Abuse comes in many forms and can include physical, psychological, sexual or emotional abuse, including efforts to control, isolate, humiliate and intimidate the requesting spouse, or to undermine the requesting spouse's ability to reason independently and be able to do what is required under the tax laws." The impact of a non-requesting spouse's alcohol or drug abuse is also considered in determining whether a requesting spouse was abused.

 

4. Legal obligation. Whether the requesting spouse or the non-requesting spouse has a
 
legal obligation to pay the outstanding Federal income tax liability arising from a divorce decree or other legally binding agreement. This factor will weigh in favor of relief if the non-requesting spouse has the sole legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement. It will weigh neutral if the requesting spouse knew or had reason to know, when entering into the divorce decree or agreement, that the non-requesting spouse would not pay the income tax liability. It will weigh against relief if the requesting spouse has the sole legal obligation. The fact that the non-requesting spouse has been relieved of liability for the taxes at issue as a result of a discharge in bankruptcy is disregarded in determining whether the requesting spouse has the sole legal obligation. If, based on an agreement or consent order, both spouses have a legal obligation to pay the outstanding income tax liability, the spouses are not separated or divorced, or the divorce decree or agreement is silent as to any obligation to pay the outstanding income tax liability, this factor is neutral.

 

5. Significant benefit. Whether the requesting spouse received a significant benefit (beyond normal support) from the unpaid income tax liability or item giving rise to the deficiency. See Treas. Reg. ß 1.6015-2(d). If the requesting spouse enjoyed the benefits of a lavish lifestyle, such as owning luxury assets and taking expensive vacations, this factor will weigh against relief.

 

If the non-requesting spouse controlled the household and business finances or there was abuse such that the non-requesting spouse made the decision on spending funds for a lavish lifestyle, then this mitigates this factor so that it is neutral. If only the non-requesting spouse significantly benefited from the unpaid tax or item giving rise to an understatement or deficiency, and the requesting spouse had little or no benefit, or the non-requesting spouse enjoyed the benefit to the requesting spouse's detriment, this factor will weigh in favor of relief. If the amount of unpaid tax or understated tax was small such that neither spouse received a significant benefit, then this factor is neutral.

 

6. Compliance with income tax laws. Whether the requesting spouse has made a good faith effort to comply with the income tax laws in the taxable years following the taxable year or years to which the request for relief relates. If the requesting spouse is compliant for taxable years after being divorced from the non-requesting spouse, then this factor will weigh in favor of relief. If the requesting spouse is not compliant, then this factor will weigh against relief. If the requesting spouse made a good faith effort to comply with the tax laws but was unable to fully comply, then this factor will be neutral.

 

7. Mental or physical health. Whether the requesting spouse was in poor physical or mental health. This factor will weigh in favor of relief if the requesting spouse was in poor mental or physical health at the time the requesting spouse signed the return or returns for which the request for relief relates or at the time the requesting spouse requested relief. If the requesting spouse was in neither poor physical nor poor mental health, this factor is neutral.

 

Find out more about Innocent Spouse Relief at the 2012 American Bar Association 29th Annual Institute on Criminal Tax Fraud and the 2nd National Institute on Tax Controversy. I will be discussing this topic as part of a panel. The conference will take place from December 6-7 at the Wynn Hotel in Las Vegas, NV. 

 

Please register here if you are interested in attending.  

 

 

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Dennis N. Brager, Esq.
Nationally Recognized California State Bar Certified Tax Specialist
Upcoming Speeches
 
2012 American Bar Association 29th Annual Institute on Criminal Tax Fraud and 2nd National Institute on Tax Controversy
Wynn Hotel
Las Vegas, NV
December 6-7, 2012 
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California Society of CPAs, Los Angeles Chapter Discussion
"Quiet Voluntary Disclosures, Noisy Voluntary Disclosures, and Opting Out"
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