Proposed Regs Remove Two-Year Deadline for Filing for Innocent Spouse Relief
(Parker's Federal Tax Bulletin: August 29, 2013)

A recent tug-of-war among the IRS, the Tax Court, and several appellate courts over the appropriate deadline for filing for innocent spouse relief under Code Sec. 6015(f) (i.e., the equitable relief provision) ended when the IRS gave in and published Notice 2011-70, which loosened the deadline. The IRS has now issued proposed regulations (REG-132251-11 (8/13/13)) that formally provide that the two-year deadline applicable to requests for relief under Code Sec. 6015(b) and Code Sec. 6015(c) does not apply to equitable relief requests under Code Sec. 6015(f). The IRS also extended the new rules to certain married taxpayers in community property states. Additionally, the proposed regulations are retroactive to the date Notice 2011-70 was issued.

Background

When spouses file a joint income tax return, both spouses are responsible for the entire tax liability. This is known as joint and several liability, and it applies to the tax liability shown on the joint return, as well as to any additional tax liability the IRS determines to be due. The IRS can collect these taxes from either spouse, even if they later divorce and the divorce decree states that one of the former spouses will be solely responsible for the tax. In some cases, however, a spouse (or former spouse) will be relieved of the tax, interest, and penalties on a joint tax return.

Code Sec. 6015 provides three types of relief from joint and several liability:

(1) full or apportioned relief (i.e., innocent spouse relief) under Code Sec. 6015(b) (¶260,560.10);

(2) proportionate relief for divorced or separated taxpayers (i.e., separation of liability relief) under Code Sec. 6015(c); and

(3) equitable relief under Code Sec. 6015(f) when relief is unavailable under either Code Sec. 6015(b) or Code Sec. 6015(c).

Code Sec. 6015(b) and Code Sec. 6015(c) both have explicit time limits for requesting relief. Absent a request being submitted within two years of the first collection action against the requesting taxpayer, no relief is available.

Additionally, Code Sec. 66(c) provides two avenues for married taxpayers who do not file a joint federal income tax return in a community property state to request relief from the operation of the state community property laws. Under state law, each spouse generally is responsible for the tax on one-half of all the community income for the year. Traditional relief under Code Sec. 66(c) allows the requesting spouse to avoid liability for tax on community income of which the requesting spouse did not know and had no reason to know. If a requesting spouse does not satisfy the requirements for traditional relief, the IRS may grant equitable relief. The IRS uses the same procedures for determining eligibility for equitable relief under Code Sec. 66(c) as it does for equitable relief under Code Sec. 6015(f).

Initially, in Rev. Proc. 2003-61, the IRS spelled out the conditions a taxpayer needed to meet to qualify for the equitable relief election under Code Sec. 6015(f). One of the conditions was that the taxpayer had to request relief no later than two years after the date of the IRS's first collection activity with respect to the taxpayer. This requirement was then incorporated into Reg. Sec. 1.6015-5(b)(1).

Subsequently, in Lantz v. Comm'r, 132 T.C. 131 (2009), the Tax Court held Reg. Sec. 1.6015-5(b)(1) to be invalid. The Seventh Circuit then reversed that decision. In Hall v. Comm'r, 135 T.C. 374 (2010), the Tax Court reconsidered the matter but did not change its position. In Mannella v. Comm'r, 631 F.3d 115 (3d Cir. 2011), the Third Circuit reversed the Tax Court and held the two-year deadline to be valid. Subsequently, in Pullins v. Comm'r, 136 T.C. 432 (2011), the Tax Court again held the two-year deadline to be invalid.

The IRS reconsidered the issue and released Notice 2011-70, in which it announced that the two-year deadline would no longer apply to requests for equitable relief under Code Sec. 6015(f). Instead, under Notice 2011-70, to be considered for equitable relief, a request must be filed within the statute of limitations period for collection of tax or, within the statute of limitations for any credit or refund of tax. Notice 2011-70 specified transitional rules that applied until the IRS amended the regulations under Code Sec. 6015. Under the transitional rules, the two-year deadline did not apply to any request for equitable relief filed on or after July 25, 2011 (the date Notice 2011-70 was issued) or any request already filed and pending with the IRS as of that date.

Deadline for Requesting Equitable Relief under the Proposed Regulations

Under Prop. Reg. Sec. 1.6015-5(b)(2), a requesting spouse must file Form 8857, Request for Innocent Spouse Relief, or other similar statement with the IRS within the statute of limitations period on collection of tax in Code Sec. 6502 or within the statute of limitations period for credits or tax refunds in Code Sec. 6511, as applicable to the joint tax liability. If a requesting spouse files a request for equitable relief under Code Sec. 6015(f) within the statute of limitations period, the IRS will consider the request for equitable relief, but the requesting spouse will be eligible for a credit or refund of tax only if the limitation period for credit or refund of tax is open when the request is filed, assuming all other requirements are met.

Alternatively, if a requesting spouse files a request for equitable relief after the statute of limitations has expired on collecting tax but while the statute of limitations on the credit or refund of tax remains open, the IRS will consider the request for equitable relief insofar as tax was paid by or collected from the requesting spouse, and the requesting spouse will be eligible for a potential credit or refund of tax. If neither limitations period is open when a requesting spouse files a request for equitable relief, the IRS will not consider the request for equitable relief.

Example: Harry and Wendy timely filed a joint federal income tax return for tax year 1999. The IRS selected the 1999 return for audit and determined a deficiency in tax of $10,000. The IRS assessed the tax on December 1, 2001. Harry and Wendy were divorced in 2005. On her separate federal income tax return for 2005, Wendy reported an overpayment of $2,500, which the IRS applied on May 3, 2006, to the joint liability for 1999. On her separate federal income tax return for tax year 2009, Wendy reported an overpayment of $1,750, which the IRS applied on May 15, 2010, to the joint liability for 1999. On May 1, 2012, Wendy filed Form 8857 with the IRS requesting relief under the innocent spouse provisions of Code Sec. 6015. The IRS will not consider whether Wendy is entitled to any relief under Code Sec. 6015(b) or Code Sec. 6015(c) because Wendy's election is untimely, as her Form 8857 was filed after the end of the two-year period running from the offset of Wendy's overpayment from her 2005 return. Although the collection period expired on December 1, 2011, the IRS will consider whether Wendy is entitled to equitable relief under Code Sec. 6015(f) for 1999 because Wendy filed Form 8857 within the two-year period for claiming a credit or refund of tax under Code Sec. 6511(a). Under Code Sec. 6511(b)(2), the amount of any refund to which Wendy might be entitled is limited to $1,750 (the amount paid within the two years preceding the filing of Wendy's Form 8857), and the $2,500 collected in May 2006 is not available for refund.

Example: The facts are the same as in the previous example, except that Wendy's separate federal income tax return for 2009 did not report an overpayment, and there was no offset against the joint liability for 1999. The IRS will not consider whether Wendy is entitled to any relief under Code Sec. 6015(b) or Code Sec. 6015(c) because Wendy's election is untimely, as her Form 8857 was filed after the end of the two-year period running from the offset of Wendy's overpayment from her 2005 return. Further, as the collection period expired on December 1, 2011, and the period for claiming a credit or refund of tax under Code Sec. 6511(a) expired on May 3, 2008, IRS will not consider whether Wendy is entitled to equitable relief under Code Sec. 6015(f) for 1999.

Premature Elections Will Not Be Considered

As provided for in the current regulations, the proposed regulations state that the IRS will not consider any election or request for relief from joint and several liability that is premature. A premature election or request for relief is an election or request, other than a request for relief for a liability that is properly reported on a joint federal income tax return but not paid, that is filed for a tax year prior to the receipt of a notification of an examination or a letter or notice from the IRS indicating that there may be an outstanding liability with regard to that year.

Additional Relief Provided for Married Taxpayers in Community Property States

Because the IRS uses the same procedures for determining eligibility for equitable relief under Code Sec. 66(c) as it does for equitable relief under Code Sec. 6015(f), the proposed regulations also add a rule similar to Prop. Reg. 1.6015-1(b) to Reg. Sec. 1.66-4 for claims for equitable relief under Code Sec. 66(c).

Prop. Reg. Sec. 1.66-4(j)(2)(ii) provides that the earliest time for submitting a request for equitable relief from the federal income tax liability resulting from the operation of community property law is the date the requesting spouse receives notification of an audit or a letter or notice from the IRS stating that there may be an outstanding liability with respect to that year. A request for equitable relief from the federal income tax liability resulting from the operation of community property law for a liability that is properly reported but unpaid is properly submitted with the requesting spouse's individual federal income tax return, or after the requesting spouse's individual federal income tax return is filed.

Compliance Tip: To request equitable relief under Prop. Reg. Sec. 1.66-4, a requesting spouse must file Form 8857, Request for Innocent Spouse Relief, or other similar statement with the IRS within the statute of limitations period for collection of tax or within the statute of limitations for any credit or refund of tax, whichever applies.

If a requesting spouse files a request for equitable relief under Prop. Reg. Sec. 1.66-4 within the applicable period, the IRS will consider the request for equitable relief, but the requesting spouse will be eligible for a credit or refund of tax only if the statute of limitations period for credit or refund of tax is open when the request is filed. Alternatively, if a requesting spouse files a request for equitable relief after the period of limitation on collection of tax has expired but while the limitation period on credit or refund of tax is still open, the IRS will consider the request for equitable relief insofar as tax was paid by or collected from the requesting spouse, and the requesting spouse will be eligible for a potential credit or refund of tax. If neither statute of limitations period is still open when a requesting spouse files a request for equitable relief, the IRS will not consider the request for equitable relief.

Parker Tax Publishing Staff Writers

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