Attorney Seeks Changes to Innocent Spouse Relief Guidance

I am happily retired from being the Director of the Benjamin N. Cardozo School of Law Tax Clinic, but I am still following developments in the tax law and doing pro bono tax work. I am writing this letter to you to ask that you initiate a process to modify Rev. Proc. 2013-34, 2013-2 C.B. 397, by deleting two sentences that have recently been rejected by the Tax Court as inconsistent with the court's own precedent. The sentences deal with the "significant benefit" factor for equitable innocent spouse relief. The offending sentences discuss "small" tax liabilities whose non-payment was of little benefit to either spouse.

Background

In 1971, by § 1 of Pub. L. 91-679, Congress enacted the first innocent spouse provision at § 6013(e). There were various requirements to get relief, one of which was that the requesting spouse establish that "taking into account whether or not the [requesting] spouse significantly benefited directly or indirectly from the items omitted from gross income and taking into account all other facts and circumstances, it is inequitable to hold the [requesting] spouse liable for the deficiency. . . ." § 6013(e)(1)(C). This language is the original source for equitable innocent spouse relief under current § 6015(f).

In 1984, Congress made significant changes to § 6013(e), including expanding its applicability to deficiencies arising from some improper tax deductions. When rewriting § 6013(e), Congress moved subparagraph (C) to (D) and shortened it -- by removing the mention of "significant benefit" -- to read that the requesting spouse must establish that "taking into account all the facts and circumstances, it is inequitable to hold the [requesting] spouse liable for the deficiency. . . ." But, the courts held that the elimination of the "significant benefit" wording from the statute was not intended to change anything substantively. Significant benefit was still one of the facts and circumstances that the courts had to consider in making the "inequitable" determination. Indeed, since "significant benefit" had been the only fact or circumstance ever specifically mentioned in the statute, even after 1984, some courts, like the Fifth Circuit, held that "[t]he most important factor in determining 'inequity' is whether the taxpayer seeking relief 'significantly benefitted' from the understatement of tax." Buchine v. Commissioner, 20 F.3d 173, 181 (5^th Cir. 1994).

Cheshire v. Commissioner, 282 F.3d 326 (5^th Cir. 2002), was the first Circuit court opinion after § 6015 was enacted to interpret the new section. In that case, the Fifth Circuit held that "[b]ecause the wording of § 6015(f)(1) is virtually identical to that of former § 6013(e)(1)(D), case law construing former § 6013(e)(1)(D) is helpful in determining whether the Commissioner abused his discretion in denying equitable relief to [a taxpayer] under current § 6015(f)(1)." Id., at 338 n.29. Relying on Buchine, the Fifth Circuit in Cheshire held that significant benefit is the most important factor under § 6015(f)(1), as well. Id., at 338.

After initially issuing a notice to explain how it would decide equitable innocent spouse relief, the IRS replaced the notice with Rev. Proc. 2000-15, 2000-1 C.B. 447. There, the IRS listed various factors it would consider when deciding whether it would be inequitable to hold a requesting spouse liable for the tax. The Rev. Proc. indicated that a spouse's receiving a significant benefit was a factor disfavoring relief, but the Rev. Proc. implied that the lack of a significant benefit was a neutral factor toward relief. In Ewing v. Commissioner, 122 T.C. 32, 45 (2004), the Tax Court overrode Rev. Proc. 2000-15 and held that, consistent with the Tax Court's prior precedents under § 6013(e)(1)(D), the lack of significant benefit was a factor favoring relief, not a neutral factor. By the time Ewing was decided, however, the IRS had already replaced Rev. Proc. 2000-15 with Rev. Proc. 2003-61, 2003-2 C.B. 296, in which the IRS took a position consistent with the Tax Court's Ewing holding -- i.e., that lack of significant benefit is a factor favoring relief under § 6015(f).

In the summer of 2011, the IRS decided that it would make equitable innocent spouse relief under § 6015(f) easier to obtain. After some internal discussion, in Notice 2012-8, 2012-1 C.B. 309, the IRS put out for public comment a draft Revenue Procedure to replace Rev. Proc. 2003-61. Some clinicians and I gave comments to the IRS on the proposed Revenue Procedure -- lauding its many improvements, but criticizing it at some places where it fell short. One of the areas that clinicians disagreed with Notice 2012-8 was as to significant benefit.

Notice 2012-8 contained a sentence partially backtracking on the significant benefit position that the IRS took in Rev. Proc. 2003-61, since the proposed Rev. Proc. added a sentence excepting "small" items from these rules: "If the amount of unpaid tax or understatement was small such that neither spouse received a significant benefit, then this factor is neutral." We clinicians had objected to this sentence as inconsistent with case law, which never made any distinctions between "big" and "small" underpayments or understatements. Indeed, by anyone's standards, the $1,070 § 72(t) deficiency in dispute in the case of Porter v. Commissioner, 132 T.C. 203 (2009) (which was from unreported IRA distributions) was small, but the court took no notice of the smallness of the tax amount in reaching its holding that the lack of significant benefit to the requesting spouse in the case was a positive factor for relief. Id. at 212-13. Further, we clinicians noted that "small" in Notice 2012-8 was undefined in amount, making the sentence unadministrable. The only response to our comments was that at section 4.03(2)(e) of the final Revenue Procedure, Rev. Proc. 2013-34, the IRS added another sentence reading: "Whether the amount of unpaid tax or understatement is small such that neither spouse received a significant benefit will vary depending on the facts and circumstances of each case."

Tax Court's application of Rev. Proc. 2013-34 significant benefit factor

One of the first Tax Court cases to apply Rev. Proc. 2013-34 was Howerter v. Commissioner, T.C. Summary Op. 2014-15, where Judge Kerrigan cited Tax Court precedent to reject these sentences providing that small underpayments or understatements rendered the significant benefit factor neutral. See slip op. at *18-*19. Of course, summary opinions do not bind the Tax Court as precedent. So, I waited to write to you until there was a court opinion that I could cite to other judges.

This letter is to report that in Hollimon v. Commissioner, T.C. Memo. 2015-157 (Aug. 12, 2015), Judge Buch issued a memorandum opinion that comes to the same conclusion as Judge Kerrigan had in Howerter. In Hollimon, Judge Buch wrote (slip op. at *13-*14):

So, I ask you to initiate the process within the IRS to issue a modification to Rev. Proc. 2013-34 that explicitly deletes the two offending sentences within the significant benefit factor that discuss "small" amounts. Doing so publically would notify IRS employees, taxpayer lawyers (if any), and judges, so that this particular mistake is never made again.

There is urgency to my request. The error in the Rev. Proc. on significant benefit likely is disproportionately more harmful to the working poor, who either may have claimed improper business deductions or education credits or owe reported taxes. Poor people are more likely to have what CCISO employees will be inclined to think are small liabilities that fall within the exception for making the significant benefit factor neutral. Compounding the problem for the working poor is that another factor -- economic hardship if forced to pay the tax -- is going to be hard to prove for small liabilities, so will also become a neutral factor, rather than a factor favoring relief. After all, if a working poor taxpayer could afford to pay a mere $60 a month (say, over 72 months under a streamlined installment agreement), then a deficiency of, say, $4,000 -- like that involved in Hollimon -- would not impose an economic hardship to pay. Ms. Hollimon herself was not working poor, but she reported that her monthly income exceeded her monthly expenses by about $1,000, so the judge found the hardship factor neutral. In my experience, in most innocent spouse cases, the taxpayer is in good health and there is no divorce or separation agreement that allocates the tax liabilities between the parties, so these two factors (health and legal obligation) are usually neutral. The more neutral factors there are, the more important the few remaining factors become in tipping the equity determination either way. Since many other of the seven factors end up neutral, it will thus be particularly harmful in cases of the working poor to deny them of one of the few factors -- significant benefit -- that should always be either favorable or unfavorable.

I would be happy to discuss with you any issues raised in this letter.

Andrew Roberson, Esq. (Chair, ABA Tax Section Pro Bono and Tax Clinics Committee) (by e-mail)

National Taxpayer Advocate Nina E. Olson (by e-mail)

Tax Analysts (by e-mail)