In the recent case of Todisco v. Commissioner of Internal Revenue, the Tax Court granted innocent spouse relief to the taxpayer, finding that it would be inequitable to hold her liable for the taxes at issue.  As a result, the taxpayer was relieved from joint and several liability for the taxes with her spouse, wiping away the taxpayer’s liability.

Our firm’s Insights Blog has covered Innocent Spouse relief in depth.  See, e.g., Innocent Spouse Relief Explained: Tax Relief for Spouses; Do You Qualify for Innocent Spouse Relief?; Innocent Spouse Relief: A Primer.  In this post, we look again at innocent spouse relief and the road map laid out by the Tax Court in Todisco to obtain relief under section 6015(b).

The General Rule of Joint Liability for Joint Federal Tax Returns

In general, married taxpayers can elect to file joint federal income tax returns.  If a joint return is filed, however, each spouse is jointly and severally liable for the entire tax due for that taxable year.

Despite this general rule, a spouse may be relieved from joint and several liability if certain conditions are met.

Innocent Spouse Relief

The Internal Revenue Code provides three potential avenues for innocent spouse relief:

(1) a requesting spouse who satisfies the conditions of section 6015(b) can be relieved of liability from an understatement of tax attributable to the other spouse;

(2) a requesting spouse who satisfies the conditions of section 6015(c) may have his or her liability for a deficiency limited to the portion of the deficiency allocated to him or her under section 6015(d); and

(3) a requesting spouse who satisfies the conditions of 6015(f) may be granted relief from any unpaid tax or any deficiency if relief is not available under section 6015(b) or (c) and it would be inequitable to hold the requesting spouse liable.

This Insight post focuses on innocent spouse relief under section 6015(b), the focus of the Todisco court.

Innocent Spouse Relief under Section 6015(b)

Section 6015(b)(1) provides that a requesting spouse shall be relieved of joint and several liability for a particular year if each of the following requirements is met:

• a joint return was filed for the year at issue;
• the return contains an understatement attributable to an erroneous item of the nonrequesting spouse;
• the requesting spouse establishes that in signing the return he or she did not know and had no reason to know of the understatement;
• taking into account all facts and circumstances, it is inequitable to hold the requesting spouse liable for the deficiency in tax attributable to the understatement; and
• the requesting spouse’s claim for relief is timely.

Failure to meet one of these requirements, however, precludes relief under section 6015(b).

Establishing that Spouse Did not Know or Have Reason to Know under Section 6015(b)(1)(C)

Under section 6015(b)(1)(C), the requesting spouse must establish that in signing the return he or she did not know and did not have reason to know the return contained an understatement.

For these purposes, a requesting spouse is treated as having knowledge or reason to know of an understatement if he or she actually knew of the understatement, or if a reasonable person in similar circumstances would have known of the understatement.  All of the facts and circumstances are considered in determining whether a requesting spouse had reason to know of an understatement.

In the case of an erroneous deduction, knowledge of the item means knowledge of the facts that made the item not allowable as a deduction or credit.

Courts generally apply the standard of whether “a reasonably prudent taxpayer under the circumstances of the spouse at the time of signing the return could be expected to know that the tax liability stated was erroneous or that further investigation was warranted.”

In establishing that she had no reason to know, the taxpayer must show that she was unaware of the circumstances that gave rise to the error and was not merely unaware of the tax consequences.  This standard applies to an understatement of tax resulting from underreporting income and from improperly claiming deductions.

Inequitable to Hold Spouse Liable for Tax under Section 6015(b)(1)(D)

Under section 6015(b)(1)(D), relief applies if it is inequitable to hold a taxpayer liable for the deficiencies in tax attributable to the understatements. Courts look to the same factors used in determining inequity for purposes of section 6015(f).

The IRS has published a list of nonexclusive factors to take into account when determining whether to grant equitable relief under section 6015(f):

• marital status;
• economic hardship;
• in the case of an understatement, knowledge or reason to know of the item giving rise to the understatement;
• legal obligation;
• significant benefit;
• compliance with tax laws; and
• mental or physical health

Marital Status

If the requesting spouse is no longer married to the non-requesting spouse, this factor will weigh in favor of granting relief.

Economic Hardship

An Economic hardship exists if satisfaction of the tax liability, in whole or in part, will cause the requesting spouse to be unable to pay reasonable basic living expenses.

If denying relief from joint and several liability will not cause the requesting spouse to suffer economic hardship, this factor will be neutral.

Knowledge or Reason To Know

If the requesting taxpayer did not know and had no reason to know of the items giving rise to the understatements for the years at issue, this factor weighs in favor or relief.

Compliance With Tax Laws

If the requesting taxpayer filed income tax returns and does not have an outstanding balance for other tax years, this factor will generally weigh in favor of relief.

Legal Obligation

If a divorce decree or mediated settlement agreement provides that the other spouse is liable for tax liabilities, this factor may weigh in favor of relief.

Significant Benefit

The IRS may also look to whether the requesting spouse significantly benefitted from the unpaid income tax liability or understatement. A significant benefit is any benefit in excess of normal support. For example, 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, however, 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 benefitted from the unpaid tax or understatement, 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 understatement was small such that neither spouse received a significant benefit, then this factor is neutral.

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 return or returns for which the request for relief relates were filed (or at the time the requesting spouse reasonably believed the return or returns were filed), or at the time the requesting spouse requested relief. Factors to consider include the nature, extent, and duration of the condition, including the ongoing economic impact of the illness. If the requesting spouse was in neither poor physical nor poor mental health, this factor is neutral.

The Request for Innocent Spouse Relief in Todasco

The taxpayer claimed that she is entitled to relief from joint and several liability on the couple’s  joint returns for the years at issue under all three subsections. The husband, however, opposed relief.

The Tax Court concluded that the taxpayer satisfied the requirements under section 6015(b)(1)(A), (B), and (E). She and the ex-husband filed joint returns for the years at issue. The joint returns for the years at issue contained an understatement of tax attributable to erroneous Schedule A deductions for unreimbursed employee business expenses and for tax preparation fees. The erroneous items were related to the ex-husband’s employment. The ex-husband alone hired and provided information to the C.P.A. for their joint return the wife-taxpayer met with the C.P.A. to sign the return only under duress and was not involved in the preparation of their joint return.

The Tax Court next addressed whether the taxpayer had knowledge or reason to know of the understatements under section 6015(b)(1)(C) and whether it was inequitable to hold her liable for the deficiencies in tax attributable to the understatements under section 6015(b)(1)(D).

The taxpayer was a high school graduate with no education in business, accounting, or finance and no experience in business. During the years at issue she was the primary caregiver for their children and was not involved in the husband’s business activities that resulted in the erroneous items. She was involved in the financial activities of the family; however, the ex-husband maintained financial control over the household and was evasive or deceitful with respect to the family’s finances. A review of the returns would have revealed that the husband claimed unreimbursed employee business expenses; however, the taxpayer credibly testified that she did not review the returns because if she had challenged or questioned the returns, it would have resulted in a confrontation with the husband.

Moreover, a review of these items on the return would not necessarily have revealed that the husband’s expense deductions were overstated or improper.

The taxpayer admitted that, at the time she signed one of the returns, she knew about the existence of the earlier year’s deficiency, but she credibly testified that she did not know the details causing the deficiency and was not involved in process of providing documents to the IRS with respect to the deficiency. When she asked the husband to explain the earlier year’s notice of deficiency, he told her that she was “too stupid” to understand. To the extent that the taxpayer’s knowledge of the earlier year’s deficiency triggered a duty of inquiry with respect to the later year’s return, the Tax Court found that she satisfied her duty by asking the husband to explain the earlier deficiency. On the basis of the facts and circumstances, the Tax Court found that the wife-taxpayer did not have reason to know of the understatements at the time she signed the returns.

Finally, the Court found that four of the factors under section 6015(b)(1)(D)/(f) weighed in favor of granting relief, three factors were neutral, and no factors weighed in favor of denying relief. As a result, the Tax Court found that it would be inequitable to hold her liable for the deficiencies in tax attributable to the understatements for the years at issue. Accordingly, the court granted relief under section 6015(b), providing full relief from joint and several liability on the joint returns for the years at issue.