In Yiu v. Commissioner, T.C. Summ. Op. 2020-23, the Tax Court holds that the individual who succeeded in obtaining innocent spouse relief could not get back the money she paid on the liability before receiving relief from the liability. This result occurs because she received relief under IRC 6015(c) rather than under one of the other two bases for innocent spouse relief. This outcome does not provide a new or surprising result. Here, she wins the battle of being deemed an innocent spouse but loses the war because she receives no relief in her request to have her payment of the liability created by her ex-husband returned to her.
For anyone who has not previously litigated innocent spouse issues, this case might provide an alert to seek relief under the other provisions if the taxpayer wants a refund. The innocent spouse unit in Covington, Kentucky seems to default to 6015(c) relief perhaps because of its more mechanical application; however, accepting a determination for relief under that subsection can bring less than full relief where the innocent spouse has made payments on the liability. Contesting the grant of relief under 6015(c) also brings significant obsticales.
Petitioner was married to James Neiswonger in 1998. They remained married until after joint returns were filed for the years at issue. As occurs in approximately 95% of innocent spouse cases, the wife seeks relief here. The year at issue is 2011.
The opinion says that the only liability for which she seeks a refund now is a $2,500 education credit attributable to her husband (who had no income in 2011). She says she signed the return without looking at it which is always a bad fact, but the opinion makes no finding that she knew or had reason to know that the credit was erroneous (which would bar relief under (b), but not necessarily under (f)). Because it is necessary to relief under 6015(c), the IRS conceded that she did not have actual knowledge and the opinion makes no finding that she had a reason to know the claim of the credit was wrong. Section 6015(g)(3) provides: “No credit or refund shall be allowed as a result of an election under subsection (c).” For unexplained reasons, she conceded to the court that she was not entitled to relief with respect to this credit under (b) or (f). We don’t have enough facts to be able to see that her concession made sense. If she won under (b), she could get a refund. If she could win under (f) but for the fact that she could also win under (c), then the regulations provide that she can’t get a refund because she has gotten relief under (c) — even though she can’t get the only relief she sought under (c), a refund. Reg. § 1.6015-4(b) (which applies to relief under (f)), states:
This section may not be used to circumvent the limitation of § 1.6015-3(c)(1) (i.e., no refunds under § 1.6015-3) [i.e., the regulations under subsection (c)]. Therefore, relief is not available under this section to obtain a refund of liabilities already paid, for which the requesting spouse would otherwise qualify for relief under § 1.6015-3.
This regulation was controversial when enacted in 2002. In Taft v. Commissioner, T.C. Memo. 2017-66, the IRS conceded that a taxpayer was not liable under (c), but argued that because the taxpayer was getting relief under (c), she could not get a refund under (f). Carl posted on Taft here. In Taft, the taxpayer argued that she should get relief of a refund under (b) or (f), and the court agreed with her that she could get a refund under (b), so it did not have to decide the (f) issue. In order to enhance her chances in case the she might not qualify for relief under (b), the taxpayer argued that the regulation prohibiting a refund under (f) if the taxpayer qualified for relief under (c) is invalid. Carl’s prior post has a link to the brief filed by her pro bono attorney, Joe DiRuzzo. The Harvard clinic also filed an amicus brief arguing that the reg. under (f) is invalid. A copy of the clinic’s brief is attached here.
Because of the decision to allow relief under 6015(b) the Tax Court did not reach the issue of the validity of the regulation. The validity of the regulation has never been decided by a court.
Ms. Yiu essentially ended her chances to succeed when she conceded that she was not entitled to relief under (b) or (f). Someone in her situation should not make such a concession unless it is obvious that the taxpayer can’t possibly win under those subsections. If making that concession, no need to bring a Tax Court case exists. Of course, a person in this position must consider arguing that the regulation under (f) is invalid if it appears that the taxpayer would otherwise qualify for equitable relief under (f) (which can occur even if the taxpayer had reason to know so could not qualify under (b)).
The default to relief under 6015(c) drives knowledgeable taxpayers to avoid paying a tax assessment if they contemplate divorce and a claim of innocent spouse relief. Probably less than 1% of taxpayers have knowledge of this consequence. They need assistance from knowledgeable tax practitioners but they also need to seek assistance early. This situation reminds me of the rules created by the IRS with respect to the Trust Fund Recovery Penalty, viz., if more than one responsible officer exists the one who pays first loses. See a discussion of those rules here. So, clients in this situation must try not to pay the taxes directly or by offset if they intend to seek innocent spouse relief. Trying to do that is hard. Adjustments to withholding to try to avoid having a refund can result in owing tax if not properly calculated. As a result, many people in Ms. Yiu’s circumstance end up paying some or all of the tax from the joint return because of the offset of refunds from later year returns.
This circumstance also argues for seeking innocent spouse relief as soon as possible. If the person seeking innocent spouse relief seeks such relief when the notice of deficiency is sent before there is even an assessment of the additional taxes, they do not have to worry about seeking a refund. Unfortunately, many individuals who might have a valid innocent spouse defense do not raise it at the notice of deficiency stage and only become concerned about it when the IRS moves into the collection phase. Some individuals with this defense may still be in a positive relationship with their spouse at the notice of deficiency phase and not think about their individual responsibility should the marriage dissolve.
Once the assessment occurs a slightly different dynamic can occur. Seeking relief will keep the IRS from beginning to take administrative collection action while the innocent spouse request is pending. Section 6015(c) relief only becomes available if the spouses divorce, separate for 12 months or one dies. It may take some time before the spouse becomes eligible for this relief. In the period before this occurs the spouse would look to relief under 6015(b) or (f). After 6015(c) relief becomes available, the person seeking relief who has made a payment and wants a refund must argue for 6015(b) relief or face a somewhat difficult argument for 6015(f) relief if 6015(c) relief is available.
If the individual can wait for two years after the IRS initiates collection, then 6015(c) relief is no longer available and the individual can seek relief under 6015(f). This two-year rule creates the easiest basis for going directly to 6015(f) relief. Of course, the individual would also attempt to keep from paying during that two-year period if possible in order to avoid having to seek a refund in the innocent spouse case.
In addition to the problem of only receiving a refund under the right subsection of 6015, the individual has to thread the needle of Flora which will prevent the receipt of a refund in situations in which the individual seeks the refund more than three years after filing the return or two years after making payment. Additional hurdles imposed by Flora involve the need for full payment if the taxpayer seeks relief in district court and the position of the trial section of the Department of Justice regarding the use of innocent spouse cases as a vehicle for obtaining a refund discussed here, here and here.
Individuals who desire to use the innocent spouse provisions to relieve themselves of a liability and to obtain the return of money paid on a debt they argue should not be placed on them face numerous challenges. Obtaining a refund in the innocent spouse context is not impossible but is difficult because of default to 6015(c) relief, the regulation barring a taxpayer from seeking a refund through 6015(f) if they qualify for 6015(c), the Flora rule and the unclear jurisdictional situation of seeking a refund in district court. The best outcome for someone seeking innocent spouse relief involves not having paid anything towards the debt but few taxpayers know that money once paid toward the debt will prove difficult to recover. Ms. Yiu joins a long list of taxpayers who while deemed innocent of the liability still end up paying all or part of it and not recovering that payment. Maybe Congress should rethink how the relief works for people caught in this situation.