Innocent Spouse Relief Does Not Apply to Liability for an Erroneous Interest Refund

(Parker Tax Publishing August 2024)

The Tax Court held that a taxpayer was not entitled to innocent spouse relief under Code Sec. 6015(f) with respect to her joint liability for an erroneous refund of interest issued to her and her husband. The court found that such relief is available only for unpaid taxes or deficiencies and an erroneous refund consisting only of interest does not give rise to an unpaid tax or a deficiency. LaRosa v. Comm'r, 163 T.C. No. 2 (2024).

Background

In December 1985, Dominick LaRosa, his brother Joseph LaRosa, and their company International Fuel Co., Inc., were found guilty of tax fraud by the State of Maryland for tax years 1981, 1982, and 1983. The day after the verdict in the State of Maryland case, the IRS made a jeopardy assessment of federal tax against the LaRosas for 1981, 1982, and 1983. The IRS also levied on their assets. Those assets were subsequently placed in escrow pending the determination of the LaRosas' federal tax liabilities.

In November 1990, the Tax Court entered a stipulated decision giving effect to a settlement reached between the IRS and the LaRosas. The agreement stated that the LaRosas underpaid their tax for 1981, 1982, and 1983. The total underpayment, including interest and penalties, was $9,744,587. The parties also agreed that the LaRosas overpaid their tax for 1984 and 1985. The total overpayment, including interest, was $6,120,204. The LaRosas paid the difference between the overpayment and underpayment to the IRS.

After paying the liability, the LaRosas filed a refund claim, asserting that they were owed a refund of interest they had overpaid. The IRS initially denied the claim. But after hearing from the LaRosas' congressional representative, the IRS issued a refund. The refund consisted of Code Sec. 6601 interest (interest on underpayments) and Code Sec. 6611 interest (interest on overpayments) for the years at issue, after taking into account the timing of the various underpayments and overpayments, the jeopardy assessment, and the escrow.

In 1996 the Department of Justice (DOJ) brought a lawsuit on behalf of the IRS to recover the refund issued to the LaRosas, arguing that the refund was erroneous. The district court agreed, holding that the LaRosas were not entitled to the refund they had received and ordering them to repay it. Following the district court's decision, a lien was placed on all of the LaRosas' real property. In October 2019, the DOJ filed an action to foreclose on the judgment lien.

In January 2020, Dominick's wife, Catherine, filed with the IRS a Form 8857, Request for Innocent Spouse Relief, seeking relief pursuant to Code Sec. 6015(f) for among other things, the liabilities for the years at issue. The IRS responded that it could not process her request because no amount was currently owed and there were no additional assessments for years 1981, 1982, and 1986. The letter further stated that "innocent spouse doesn't consider relief for erroneous refunds." Catherine filed a petition in the Tax Court seeking a determination of relief from joint and several liability.

The IRS argued that the Tax Court lacked jurisdiction under Code Sec. 6015(e) to consider Catherine's request for innocent spouse relief relating to an erroneous refund of interest. The IRS further argued that that Catherine not qualify for innocent spouse relief under Code Sec. 6015(f) because an erroneous refund of interest is not an unpaid tax or deficiency. Thus, there was no unpaid tax or deficiency for the years at issue. Catherine contended that the erroneous refund should be considered an unpaid tax because the refund suit filed pursuant to Code Sec. 7405(b) was an action for the recovery of a tax. Additionally, she argued that the erroneous refund was a rebate refund that could have been recovered through deficiency procedures.

Analysis

The Tax Court held that it had jurisdiction over Catherine's petition but concluded that she was ineligible relief under Code Sec. 6015(f).

The court held that in the case of an individual who requests equitable relief under Code Sec. 6015(f), the filing of a timely petition confers jurisdiction on the Tax Court regardless of the merits of the underlying claim for relief. The court found that Catherine satisfied both requirements in Code Sec. 6015(e) for the court's jurisdiction: she submitted to the IRS a request for equitable relief pursuant to Code Sec. 6015(f), and she timely filed a petition with the Tax Court.

The court found that Catherine was ineligible for innocent spouse relief because the erroneous refund did not constitute an unpaid tax or deficiency. The court found that Catherine's reliance on Code Sec. 7405(b) was misplaced because the mere fact that the IRS prevails in an erroneous refund suit does not give rise to an unpaid tax. The court explained that Code Sec. 7405(b) authorizes the IRS to file lawsuits to recover both erroneous rebate refunds, which are based on a substantive recalculation of tax, and erroneous non-rebate refunds, which are the result of clerical or computer errors and are not considered tax.

The erroneous refund paid to the LaRosas was not, in the court's view, a rebate because it did not involve any portion of the LaRosas' underlying tax liabilities for the years at issue. The LaRosas paid their tax liabilities and interest in full for the years at issue. The IRS issued a refund consisting solely of Code Sec. 6601 and Conde Sec. 6611 interest after having (erroneously) concluded that the LaRosas had overpaid interest on the underlying tax. The court noted that the refund did not involve a recalculation of the LaRosas' tax liabilities, but merely corrected a perceived clerical error in computing interest. The LaRosas' underlying tax liabilities were not adjusted, and no portion of their underlying liabilities was refunded.

The court concluded that the erroneous refund paid to the LaRosas was not a rebate and did not give rise to an unpaid tax or a deficiency. Because the erroneous refund did not constitute an unpaid tax or deficiency, Catherine was ineligible for innocent spouse relief under Code Sec. 6015(f).

For a discussion of innocent spouse relief, see Parker Tax ¶260,560.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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