Innocent Spouse Relief from Interest & Penalty Granted to Sole Earner Despite Contrary Rev Proc

Transcription

1 Innocent Spouse Relief from Interest & Penalty Granted to Sole Earner Despite Contrary Rev Proc Joseph Patrick Boyle, TC Memo The Tax Court, rejecting IRS's contention that Code Sec innocent spouse relief is available only with respect to a tax underpayment and not the additions to tax or interest, has granted such relief to a taxpayer who didn't learn that his wife failed to file their joint return until after her death. The Court found that it wasn't bound by IRS's guidelines set out in Rev Proc , and that the taxpayer was entitled to relief despite the fact that the underpayment was solely attributable to his income. Code Sec. 6015(f) provides for equitable innocent spouse relief under procedures prescribed by IRS if, taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency and relief is not available to the requesting spouse under Code Sec. 6015(b) (regular innocent spouse relief) or Code Sec. 6015(c) (relief for separated or divorced individuals). Rev Proc , IRB 399, sets out a 3-step procedure to be followed in evaluating requests for this equitable relief: (1) Rev Proc , Sec lists seven threshold conditions which must be met. The seventh of these is that the income tax liability from which the requesting spouse seeks relief is attributable (either in full or in part) to an item of the nonrequesting spouse or an underpayment resulting from the nonrequesting spouse's income. If the liability is partially attributable to the requesting spouse, then relief can only be considered for the portion attributable to the nonrequesting spouse. However, IRS will consider granting relief regardless of whether the understatement, deficiency, or underpayment is attributable (in full or in part) to the requesting spouse if an exception (such as abuse or fraud) applies ( Rev 1

2 Proc , Sec. 4.01(7) ); (2) Rev Proc , Sec lists circumstances in which IRS will make streamlined relief determinations; and (3) Rev Proc , Sec sets out non-exclusive equity factors that IRS will consider in determining whether equitable relief should be granted because it would be inequitable to hold a requesting spouse jointly and severally liable (discussed below in the Tax Court's analysis).. During 2003 and for many years before, Joseph Boyle, who was self-employed full time in the business of selling printer cartridges, relied on his wife, Patricia Boyle, to handle the bookkeeping for his business and manage the household finances. Although the Boyles maintained a joint checking account during 2003, Mrs. Boyle managed the account, including writing all checks to cover Mr. Boyle's business expenses and the couple's personal expenses. She also assumed responsibility for having the couple's joint Federal income tax returns prepared and filed. For 2003, as usual, Mrs. Boyle gathered information for their return preparer, and then presented a prepared return to Mr. Boyle for his signature. However, Mrs. Boyle did not in fact mail the signed 2003 return she had him sign. IRS's account transcript for Mr. Boyle's 2003 tax year doesn't indicate that he received any notice with respect to the Boyles' failure to file a return or pay the tax for Mrs. Boyle died on June 14, 2005, as a result of cancer. After her death, at a time not disclosed in the record, Mr. Boyle discovered his wife had not filed the 2003 return he had signed. He thereupon had the couple's long-time return preparer prepare a joint return for 2003, which he signed and filed on Sept. 14, Mr. Boyle, who wasn't seeking relief from the underpayment, but only interest and penalty, argued that such relief was appropriate under Code Sec. 6015(f) because he didn't know that his wife had failed to file the return and pay the tax for that year. He learned of her failure only after her death, at which time he filed 2

3 a return for On the other hand, IRS argued that Code Sec relief was available only with respect to the underpayment and not the additions to tax or interest, and further, that Mr. Boyle failed to meet the requirements in Rev Proc , Sec As a preliminary matter, based on its prior decisions, the Tax Court rejected IRS's contention that Code Sec relief was available only with respect to the underpayment and not the additions to tax or interest. (Kollar, (2008) 131 TC 191 ) It further determined that it would be inequitable to hold Mr. Boyle liable for the unpaid Code Sec. 6651(a)(1) and Code Sec. 6651(a)(2) additions to tax for Although IRS argued that Mr. Boyle failed to satisfy the seventh threshold condition in Rev Proc , Sec because all of the 2003 underpayment was attributable to his own income-the Tax Court concluded that it was not bound by IRS's guidelines in Rev Proc , Sec Allowing this condition to be an absolute bar to relief would run counter to the Tax Court's mandate under Code Sec. 6015(e)(1)(A) "to determine the appropriate relief available." The Court emphasized that Mr. Boyle wasn't seeking relief from the underpayment, he was seeking relief from the additions to tax and interest triggered by his wife's failure to timely file and pay after deceiving him that she had filed and paid. It found that this situation was analogous to the fraud exception in Rev Proc , Sec. 4.01(7). Analyzing the Rev Proc , Sec equitable factors, the Court found: (1) Marital status. If a requesting spouse is a widower, he is treated as no longer married to the nonrequesting spouse unless he is an heir to the nonrequesting spouse's estate that would have sufficient assets to pay the tax liability, in which case the requesting spouse is treated as still married and the factor is neutral. This factor was neutral. (2) Economic hardship if relief is not granted. If denying section Code Sec relief will cause the requesting spouse to suffer an economic hardship this factor favors relief; if not, this factor is neutral. This factor 3

4 was neutral. (3) Knowledge or reason to know that the tax liability would not be paid. Mr. Boyle's credible testimony and his actions in filing the 2003 return after he learned that it hadn't been filed indicated that he was deceived by Mrs. Boyle concerning the filing of the 2003 return. As in the past, he reasonably relied on file their return. This factor favors relief. (4) Legal obligation to pay the outstanding income tax liability. This factor comes into effect when either the requesting or the nonrequesting spouse has a legal obligation to pay the outstanding tax liability pursuant to a divorce decree or other legally binding agreement. This factor was neutral. (5) Receipt of a significant benefit from the unpaid income tax liability. If the unpaid tax is small such that neither spouse received a significant benefit from its nonpayment, as in the Boyles' case, then Rev Proc , Sec. 4.03(2)(e) treats this factor as neutral. However, the Tax Court treats the lack of a significant benefit as a factor favoring relief (see Wang, TC Memo ). This factor favors relief. (6) Compliance with income tax. With respect to 2003, the Court found that Mr. Boyle reasonably believed that his return had been filed and his tax had been paid; and on learning that this wasn't the case, he remedied the failure. The Court also found that compliance failures for 2004 and 2005 were due to extenuating circumstances: in 2004, his wife, the manager of both his household and business finances, died. This factor was neutral. (7) Mental and physical health. The equities for relief may be affected by the requesting spouse's mental or physical health problems at the time the return was filed. This factor was neutral. In sum, the Court determined that all of the Rev Proc , Sec equitable factors were neutral except for two, both of which weighed very heavily in Mr. Boyle's favor. The Court held that it would be inequitable to hold him liable for a penalty. He did not know and had no reason to know the facts that gave rise to the 4

5 penalties. To the contrary, he was misled by his spouse's actions and so reasonably believed that his return had been filed and his tax paid. It also found that it would be inequitable to hold him liable for interest from the due date of the 2003 return through Sept. 14, 2006 (when he knew the liability existed and its amount). During that period, he reasonably believed the 2003 tax had been paid. 5