Representing the Innocent Spouse in Pre- and Post-Filing Tax Controversies

Transcription

1 Representing the Innocent Spouse in Pre- and Post-Filing Tax Controversies Presented to CPA Academy Lawrence A. Sannicandro, Esq. 1

2 Overview I. Introduction II. Conflicts of Interest III. Overview of Innocent Spouse IV. Step 1: Is There a Joint Return V. Step 2: Is the Spouse Eligible for Relief A. I.R.C. ' 6015(b) B. I.R.C. ' 6015(c) C. I.R.C. ' 6015(f) VI. Procedure and Tips to Request Innocent Spouse Relief VII. Rights of the Nonrequesting Spouse VIII. Innocent Spouse Litigation 2

3 Introduction 3

4 Why Do We Need Innocent Spouse Relief? Spouses may file a joint tax return. I.R.C Both spouses are individually liable for the taxes due on a joint tax return regardless of who earned the income and the IRS can collect from both spouses. I.R.C. 6013(d)(3) May lead to inequitable results Death Separation or divorce Returns filed without consent

5 Innocent Spouse Relief Strategy File an innocent spouse petition as soon you are aware that there is a tax liability owed or an IRS audit Fact-specific determination The IRS determines each party s ability to pay 5

6 Innocent Spouse Common Pitfalls Even if a divorce decree says that one spouse is responsible for paying taxes, the other spouse may still be responsible for the tax due on the return If one spouse fails to pay taxes in accordance with the decree, the IRS can collect taxes from the other spouse If one spouse is discharged from a joint tax liability by bankruptcy or an accepted offer in compromise, the other spouse is still responsible for any unpaid liability 6

7 Polling Question 1 How frequently do you make requests to the IRS for relief from joint and several liability? Frequently Sometimes Rarely Never 7

8 Conflicts of Interest 8

9 Identifying and Resolving Conflicts of Interest Practitioners Generally Circular 230 forbids a tax practitioner from representing a client before the IRS if the representation involves a conflict of interest. 31 C.F.R (a). A conflict of interest exists if, among other situations, the representation of one client will be directly adverse to another. 9

10 Identifying and Resolving Conflicts of Interest Lawyers Rule 1.7 of the Model Rules of Professional Conduct, Conflict of Interest, provides: [A] lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict of interest exists if: (1) the representation of one client will be directly adverse to another client; or (2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer s responsibilities to another client, a former client or by a personal interest of the lawyer. 10

11 Identifying and Resolving Conflicts of Interest Tax Court Rules (applies to lawyers and non-attorneys admitted to the Court) Rule 24(g) of the Tax Court Rules of Practice and Procedure provides as follows: If any counsel of record * * * represents more than one person with differing interests with respect to any issue in a case * * * then such counsel must either secure the informed consent of the client * * *; withdraw from the case; or take whatever other steps are necessary to obviate a conflict of interest. 11

12 Identifying and Resolving Conflicts of Interest Strategies to Resolve Conflicts of Interest Between Spouses: A practitioner may represent a client despite the conflict of interest if the practitioner obtains the informed consent of each affected client. Model R. Prof l Conduct, 1.7(b); 31 C.F.R (b); Tax Ct. R. Prac. & Proc. R. 24(g). Included in the materials is a sample waiver of the potential conflict of interest. 12

13 Polling Question 2 If you represent spouses where there is marital discord, do you obtain the clients informed consent? Yes No 13

14 Overview of Innocent Spouse 14

15 Three Types of Innocent Spouse Relief Classic (i.e., Full or Apportioned) Relief - I.R.C. 6015(b) Separation of Liability (i.e., Proportionate) Relief I.R.C. 6015(c) Equitable Relief I.R.C. 6015(f) Deficiency Deficiency Deficiency, Underpayment 15

16 Applicable Authorities I.R.C Rev. Proc (to evaluate claims for equitable relief under I.R.C. 6015(f)) Rev. Proc superseded Rev. Proc Recently proposed regulations (Nov. 20, 2015) 16

17 Two-Step Approach Step 1: Is there a joint return? Step 2: Is the spouse eligible for relief? 17

18 Step 1: Is There a Joint Return? 18

19 Step 1: Was There a Valid Joint Return? General Rule: The most important factor in deciding whether a return qualifies as a joint return is whether the couple intended to file a joint return. 19

20 Step 1: Was There a Valid Joint Return? Paper Returns Not Signed by Spouse: In general, a return must be signed by both spouses to be a valid joint return. Exceptions: Exception 1: Express Consent to File Joint Return: Where one spouse expressly authorizes the other spouse to sign the return, courts have found the requisite intent for a joint return. Exception 2: Tacit Consent to File Joint Return: Where one spouse tacitly consents to the filing of a joint return, courts have found the requisite intent for a joint return. Electronically Filed Returns: For electronically filed returns, whether a requesting spouse signed a return is determined by examining whether he or she signed the Form 8879, IRS e-file Signature Authorization. Did the spouses file separate returns? 20

21 Step 1: Was There a Valid Joint Return? Tacit Consent Did the requesting spouse have a filing requirement? Did the requesting spouse file a joint return for prior years? Did the requesting spouse participate in preparation of return? Did the requesting spouse receive a tax benefit? Did the requesting spouse have a non-tax reason to file a joint tax return? 21

22 Step 1: Was There a Valid Joint Return? Returns Signed Under Duress: A return signed under duress is not a joint return Proving Duress: To prove duress, the spouse must show that he or she: (1) was unable to resists the demands to sign the return, and (2) would not have signed the return but for the constraint applied to his or her will. 22

23 Step 1: Was There a Valid Joint Return? Forged Returns Requesting spouse did not sign the return and there was no tacit consent. There is no ASED for the requesting spouse, until he or she files a return. The ASED for the nonrequesting spouse begins when the joint return was due to be filed, or was filed, whichever occurred later If the signature was forged, but the return is also unlawful or invalid, process as a forgery. 23

24 Step 1: Was There a Valid Joint Return? Invalid and Unlawful Returns Amended return changing to separate filing status filed prior to the due date of the return. The ASED begins when the joint return was due to be filed, or was actually filed, whichever occurred later. All previously issued refunds must be taken into consideration. When it has been determined that the joint election was invalid (e.g., the taxpayers were not married, the IRS will determine each taxpayer s separate liability. 24

25 Polling Question 3 If a requesting spouse does not sign the return, he or she cannot be held jointly and severally liable for any deficiency? True False 25

26 Step 2: Is the Spouse Eligible for Relief? 26

27 Types of Relief and Effective Dates Overview Code prescribes three types of relief under I.R.C. 6015: Full or apportioned relief under I.R.C. 6015(b); Proportionate relief under I.R.C. 6015(c); and Equitable relief under I.R.C. 6015(f). Effective Dates Innocent spouse rules apply to: Liabilities that arise after July 22, 1998, and Liabilities that arose on or before July 22, 1998, but were not paid on or before July 22,

28 Full or Apportioned Relief I.R.C. ' 6015(b) To qualify for relief under I.R.C. 6015(b), the requesting spouse must establish that the following are met: A joint return was filed for the year for which the requesting spouse seeks relief from joint and several liability; On such return, there is an understatement of tax attributable to erroneous items of the nonrequesting spouse; When the joint return was signed, the requesting spouse did not know and did not have reason to know that there was an understatement of tax; and The requesting spouse sought relief under I.R.C. 6015(b) within two years of the first collection activity with respect to the liability giving rise to the deficiency or understatement. 28

29 Know and Reason to Know No Relief if Requesting Spouse Had Actual Knowledge of the Items Giving Rise to the Deficiency: Relief under I.R.C. 6015(b) and (c) is not available if the IRS can prove that, at the time the return was signed, the requesting spouse had actual knowledge of any item giving rise to a deficiency which is not allocable to the requesting spouse. I.R.C. 6015(c)(3)(C). 29

30 Know and Reason to Know INCOME ACTUAL KNOWLEDGE - If taxpayer has knowledge of the transaction or item of omitted income, and not the tax consequences of the transaction, taxpayer will not be eligible for relief OR REASON TO KNOW Whether a reasonable person under the circumstances of the taxpayer at the time of the signing of the return could be expected to know of the omissions DEDUCTION Inquiry is first whether the spouse knew or had reason to know that the deduction would give rise to a substantial understatement of tax. If the spouse knows enough about the underlying transaction that the innocent spouse defense rests entirely upon a mistake of law, he/she has reason to know of the tax understatement as a matter of law. If reason to know cannot be determined as a matter of law, the proper factual inquiry is whether a reasonably prudent taxpayer in the spouse's position at the time she signed the return could be expected to know that the stated liability was erroneous or that further investigation was warranted. 30

31 Know and Reason to Know Reason to Know All the facts and circumstances are relevant to determine whether a spouse had reason to know of an understatement including the following: The nature of the erroneous item and the amount of the erroneous item relative to other items; The couple s financial situation; The requesting spouse s educational background and business experience; The extent of the requesting spouse s participation in the activity resulting in the erroneous item; Whether the requesting spouse failed to inquire, at or before signing the return, about items on the return or omitted from the return that a reasonable person would question; and Whether the erroneous item represented a departure from a recurring pattern reflected in prior years returns. 31

32 Know and Reason to Know Constructive Knowledge Constructive knowledge may be imputed to a spouse who signs the joint return without reviewing it because she fails to satisfy a duty to take reasonable steps to determine its accuracy. A court may find that the spouse had reason to know of the error on the return, but not actual knowledge. 32

33 Know and Reason to Know Duty of Inquiry (Example): Requesting spouse was aware that her husband earned income from his dental practice, although she did not know the exact amount. She was aware of her husband s irresponsible behavior in financial matters, yet never questioned him regarding the amounts he earned from his dental practice of whether tax returns were being timely filed. She made no effort to review tax documents before signing them. Taxpayer testified that she could have determined her husband s income for the years at issue by asking her accountant. McGee v. Comm r, 979 F. 2d 66 (5th Cir. 1992) 33

34 Know and Reason to Know Ignorance of the Law Not a Defense (Example) Wife knew the amount of the retirement proceeds, the account where the proceeds were deposited and drawn upon, the amount of interest earned on the proceeds, and the manner in which the proceeds were spent. Wife had reason to know of the improper deduction as a matter of law. Wife s defense was her mistaken belief that the money spent to pay off the mortgage is properly deductible from retirement distributions. Cheshire v. Commissioner, 282 F.3d 326 (5th Cir. 2002) 34

35 Proportionate Relief I.R.C. ' 6015(c) To qualify for relief under I.R.C. 6015(c), the requesting spouse must show that the following elements are met: The spouses filed a joint return for the year at issue; At the time the election for relief was made the spouses were legally separated or divorced or had not been members of the same household at any time during the previous 12 months; and The election for relief was made after a deficiency was asserted but no later than two years after the Commissioner began collection activities. 35

36 Not Members of the Same Household What does it mean to not be members of the same household? A husband and wife who reside in the same house are presumed to be members of the same household However, legal separations may be recognized under State law that can overcome this presumption: New York: A NY requesting spouse can obtain a decree of divorce or enter into a legal separation by agreement of the parties, which should each be regarded as sufficient to satisfy the legal separation or divorce requirements New Jersey: A NJ requesting spouse can obtain a judgment of divorce or a judgment of divorce from bed and board, which should each be regarded as sufficient to satisfy the legal separation or divorce requirements Work with family law and controversy counsel 36

37 Effect of Assets Transferred to Avoid Payment of Tax Assets Transferred to Avoid Tax Payment? I.R.C. ' 6015(b): Equitable factor I.R.C. ' 6015(c): The portion of the deficiency for which a requesting spouse is liable is increased (up to the entire amount of the deficiency) by the value of any disqualified asset that was transferred to the requesting spouse. 37

38 Equitable Relief I.R.C. ' 6015(f) Available if, Under the facts and circumstances, it is inequitable to hold the person liable for any unpaid tax or any deficiency, and Relief is not available to such individual under I.R.C. ' 6015 (b) or (c) Equitable relief under I.R.C. 6015(f): Guidelines Established: The IRS has prescribed guidelines for determining whether an individual qualifies for equitable relief These guidelines are set forth in Rev. Proc , which modified and superseded Rev. Proc Courts considers these guidelines in the light of the surrounding facts and circumstances but are not bound by them 38

39 Equitable Relief I.R.C. ' 6015(f) Approach: Step 1: Determine if threshold conditions are met (relief cannot be granted if they are not). Step 2: Determine if streamlined determination available. If not, proceed to Step 3. Step 3: Balance equitable factors to determine whether equitable relief is available 39

40 Threshold Factors Threshold Factors for Relief Under Rev. Proc , 4.01: Valid joint return filed No relief available under I.R.C. ' 6015 (b) or (c) Claim is timely (before CSED or refund SOL) No assets were transferred in a fraudulent scheme Nonrequesting spouse did not transfer disqualified assets to requesting spouse (i.e., assets were not transfer to avoid tax or the payment of tax) Requesting spouse did not knowingly participate in the filing of a fraudulent joint return The liability from which the requesting spouse seeks relief is attributable to an item of the nonrequesting spouse There are 5 exceptions 40

41 Streamline Determination Entitlement to Streamline Determination: Marital Status Is no longer married to the nonrequesting spouse or has not lived together for 12 months; Economic Hardship Would suffer economic hardship if relief were not granted (under 250% poverty or excess of income over expenses $300); and Lack of Knowledge 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 nonrequesting spouse would not or could not pay the underpayment of tax reported on the joint return. 41

42 Balancing Test Where a requesting spouse meets the threshold conditions, but does not qualify for a streamlined determination, the courts and IRS balance various factors to determine if the equities favor a grant of equitable relief. Factors: Marital status; If the couple is no longer married, this the factor favors relief. If the couple is married, then the factor is neutral. Economic hardship (measured at the time of trial); If denying relief will cause economic hardship to the requesting spouse, then this factor favors relief. If denying relief will not cause economic hardship to the requesting spouse, then this factor is neutral. Knowledge or reason to know; If the requesting spouse did not know and did not have reason to know, then this factor favors relief. If the requesting spouse knew or had reason to know, then this factor weighs against relief. 42

43 Balancing Test Factors (continued): Significant benefit (in excess of normal support); If there was no significant benefit to the requesting spouse, then this factor favors relief. If there was a significant benefit to the requesting spouse, then this factor weighs against relief. **Abuse or financial control may outweigh the significant benefit. Legal obligation; If a nonrequesting spouse must pay the liability pursuant to a divorce decree or other instrument, then this factor weighs in favor of relief. If both spouses must pay the liability pursuant to a divorce degree or other instrument, then this factor will be neutral. If a requesting spouse must pay the liability pursuant to a divorce decree or other instrument, then this factor will weigh against relief. Compliance with tax laws; and If the requesting spouse is compliant for years after the year at issue, then this factor favors relief. If the requesting spouse is not compliant for years after the year at issue, then this factor disfavors relief. Mental or physical health. If the requesting spouse suffers from poor mental or physical health, then this factor favors relief. If the requesting spouse does not suffer from poor mental or physical health, then this factor will weigh against relief. 43

44 Summary - Equitable Relief 44

45 Changes as a Result of Rev. Proc Gives greater deference to the presence of abuse than Rev. Proc Petition must be filed before the expiration of the collection statute or before the expiration for a refund under I.R.C. ' Relief will not be precluded for an item attributable to the requesting spouse if the nonrequesting spouse s fraud gave rise to the understatement of tax or deficiency. 45

46 Abuse Separate factor in Rev. Proc Not a separate factor in Rev. Proc , but abuse can affect multiple factors Knowledge Significant benefit (neutral, even if lavish lifestyle) Definition of abuse expanded to include abuse of other family members 46

47 Effect of Abuse Abuse can negate knowledge or significant benefit if: Nonrequesting spouse abused the requesting spouse or maintained control over the household finances by restricting the requesting spouse s access to financial information, and Because of the abuse of financial control, the requesting spouse was not able to Challenge the treatment of any items on the joint return, Question the payment of the taxes reported as due Challenge the nonrequesting spouse s assurance regarding payment of the taxes, for fear of the nonrequesting spouse s retaliation 47

48 I.R.C. 6015(g) Res Judicata In the case of any election under subsection (b) or (c) or of any request for equitable relief under subsection (f), if a decision of a court in any prior proceeding for the same taxable year has become final, such decision shall be conclusive except with respect to the qualification of the individual for relief which was not an issue in such proceeding. The exception contained in the preceding sentence shall not apply if the court determines that the individual participated meaningfully in such prior proceeding. 48

49 Procedure and Tips to Request Innocent Spouse Relief 49

50 Procedure and What to Expect File Form 8857 (revised Jan. 2014) Mail and fax to Innocent Spouse Unit, or file with a CDP hearing request (Form 12153) Centralized in Cincinnati Centralized Innocent Spouse Operation IRS makes and issues a preliminary determination Copy will be given to nonrequesting spouse Nonrequesting spouse will be asked to complete Form (Questionnaire) Determination Letter Denial of innocent spouse can be appealed to IRS Office of Appeals Further appeal to United States Tax Court Can be raised as a defense to a notice of deficiency 50

51 Before Preparing the Form 8857 Know what the IRS knows Request IRS Account and Wage & Income Transcripts Conduct asset searches Request credit reports Conduct adverse judgment searches Conduct Google search Freedom of Information Act (FOIA) Request 51

52 Form 8857 Complete and file IRS Form 8857 Attachments to Form 8857 Supporting documents (divorce decrees, separation agreements, etc.) Statement that tells requesting spouse s story Innocent Spouse Statement completed by third parties who have knowledge or information supporting the request for innocent spouse relief (IRS Form 12507) Be sure to obtain conflict of interest waiver from H- W taxpayers if representing both spouses Declarations by taxpayer and return preparer 52

53 IRS Notices and How to Respond Preliminary determination 30 days to file a protest and request an Appeals hearing. Final Determination Generally, 90 days to file Tax Court petition 30 days in collection due process case 53

54 Preliminary Determination 54

55 55

56 56

57 Rights of the Nonrequesting Spouse 57

58 Rights of Non-Requesting Spouse File a protest to the IRS s preliminary determination to grant full or partial relief to the requesting spouse. Must be filed within 30 days The IRS must hold an Appeals conference with the nonrequesting spouse after timely filing of the protest After the conference, the Appeals office will issue its final determination Both spouses will be notified of the final decision Nonrequesting spouse has the right to intervene in the Tax Court proceeding 60 days to intervene from date of notice Notice of the proceeding provided by IRS counsel 58

59 Polling Question 4 Agostino & Associates, P.C. publishes a monthly journal that discusses tax, audit, and controversy issues. Would you like to be added to our mailing list? Yes No 59

60 Innocent Spouse Litigation 60

61 Litigating Innocent Spouse Cases in Tax Court and Beyond Standalone Innocent Spouse Cases A requesting spouse may separately petition the Tax Court for relief from joint and several liability on a joint return following the Commissioner s denial of a request Deficiency Cases Court may consider innocent spouse as an affirmative defense in a deficiency proceeding Collection Cases A requesting spouse may request relief from joint and several liability on a joint return in connection with a lien or levy action 61

62 Appealing to the US Tax Court Standalone Under I.R.C. 6015(e), the requesting spouse may petition the Tax Court to review a denial of relief under I.R.C Must be filed within 90 days after the date of the IRS s Notice of Determination If the IRS does not mail the requesting spouse a final determination letter within 6 months of the date the requesting spouse files an election under I.R.C. 6015, the requesting spouse may petition the Tax Court to review the election at any time after the expiration of the 6-month period, and before the expiration of the 90-day period. 62

63 Filing a Petition in Tax Court (con t) Notice of Deficiency Taxpayer may petition the Tax Court in response to a notice of deficiency and raise innocent spouse as a defense to the additional tax Must be filed within 90 days after the date of the IRS s Notice of Deficiency 63

64 Filing a Petition in Tax Court (con t) Notice of Determination Taxpayer may petition the Tax Court in response to a collection due process notice of determination Taxpayer must raise innocent spouse as a defense to the tax in the collection due process hearing or else the claim is waived Must be filed within 30 days after the date of the IRS s Notice of Determination 64

65 Sample Petition 65

66 Filing a Petition in Tax Court (con t) An action for relief from joint and several liability is commenced by filing a petition with the Tax Court. Title: Petition for Determination of Relief From Joint and Several Liability on a Joint Return. 66

67 Contents of Petition The petitioner s name, State of legal residence, and mailing address; A statement of the facts upon which the petitioner relies to support the Court s jurisdiction; A statement of the facts upon which the petitioner relies in support of the relief requested; A prayer setting forth the relief sought by the petitioner; The name and mailing address of the other individual filing the joint return (if available); The signature, mailing address, and telephone number of the petitioner or the petitioner s counsel, as well as the counsel s Tax Court bar number; and A copy of the notice of determination, or if not issues, a copy of the election for relief the petitioner filed with the IRS. To the extent the requesting spouse intends to argue that there was no valid joint return, he or she must affirmatively plead that argument in the petition. 67

68 Deficiency Cases Must be Pleaded in Petition: Must clearly and concisely plead the claims relied upon to support their case. This requirements generally means that request for relief from joint and several liability must be pleaded, if at all, in the petition. A claim for relief from joint and several liability must be pleaded in the petition or else it will be waived. Best Practice: Plead that all subsections apply because of the prospects for divorce during the proceeding 68

69 Ability to Amend Pleadings Failure to plead innocent spouse in the petition does not preclude litigation of the issue because pleadings may be amended if it becomes apparent later on that the petition should have raised innocent spouse as an affirmative defense. As a matter of right within 30 days after it is served May otherwise be amended only by leave of Court (filing a motion to amend with the Tax Court) or by written consent of the adverse party. 69

70 Burden of Proof and Standard of Review Standard of Review De novo Burden of proof Requesting spouse generally bears the burden of proving entitlement to relief Can the burden of proof be shifted to the IRS? 70

71 Questions? Lawrence A. Sannicandro, Esq. Agostino & Associates, P.C. (201) , x