Equity and Relief from Joint Return Liabilities

'Abuse of Discretion'

In the Tax Court, determinations under ' 6015(f) are reviewable only for an 'abuse of discretion' by the IRS. Jonson v. Commissioner, 118 T.C. 106, 125 (2002), aff'd on other grounds, 353 F3d 1181 (10^th Cir. 2003) ('whether [the Commisioner] abused his discretion by acting arbitrarily, capriciously, or without sound basis in fact'). As described below, Tax Court review of these determinations generally relies on evaluation of IRS application of the factors described in the Rev. Proc. to each case.

A 'Standalone' Petition

A 'standalone' petition occurs when there is liability to pay an assessed tax in a case where a deficiency has not been asserted (an 'underpayment case'), the taxpayer applies for relief, IRS determines that relief is not available, and the
taxpayer then petitions the Tax Court to review the determination. Underpayment cases occur when a return is filed, the tax is reported but not paid, and the taxpayer relies on his or her spouse to make the payment. Although neither Ewing v. Commissioner, 122 T.C. 32 (2004), rev'd, 439 F.3d 1009 (9^th Cir. 2006), nor Billings v. Commissioner, 127 T.C. 6 (2006), have been reconsidered by the Tax Court following legislative overruling on the jurisdictional point, as have some other cases, each illustrates how these problems can arise. In divorce situations, there is often the financial distress that might lead to (or have been caused by) the tax issues in these cases, and agreeing to sign a joint return may seem like a way to minimize looming tax issues in a stressful time.

Divorce Situations

In Billings, W had embezzled substantial sums from her employer. H was unaware of the embezzlement when he and W filed their original joint return. Later, the embezzlement was disclosed, and H and W were advised to file an amended joint return, reporting the embezzlement in the hope that compliance with income tax laws would result in more lenient treatment in the criminal matter. H also filed for relief as an innocent spouse (his pension may have been the family's only source of income). The IRS denied relief under ' 6015(f), taking the position that H knew (or should have known) that they would not be able to pay the liability at the time he signed the joint return. The Tax Court seemed to find H's position sympathetic, as he could not have elected to file an amended return as an individual, but, in an evenly divided decision, concluded that it did not have jurisdiction. In Billings, the amended joint return was filed for the purpose of dealing with a nontax problem, which may force taxpayers to accept joint liability for the embezzler's tax in a continuing relationship, given the IRS' emphasis on knowledge as a negative factor.

In Beatty v. Commissioner, T.C. Memo. 2007-167, the Tax Court reversed the Commissioner's determination not to provide relief under circumstances very much like those in Billings. H had a gambling problem that he concealed from W, and failed to file returns over a 15-year period. After pleading guilty to state tax evasion, and as a condition of probation (rather than jail time), he was required to file all delinquent returns, which W signed because she believed that doing so was essential to help H escape jail. The opinion in this case, as in van Arsdalen, discussed below, seemed heavily influenced by W's deference to H in financial matters.

Ewing, too, raises a similar problem, where the joint return may be filed to reduce the aggregate tax liability for both parties, even though one spouse had not paid and might never be able to pay his or her liability. At the time, joint filing may seem to be a good idea, but taxpayers in that position should think twice before doing so. Ware v. Commissioner, T.C. Memo. 2007-112, is illustrative. In Ware, H was self-employed and failed to pay either estimated taxes or income tax on the initial joint return, which had been filed late. W was employed and had tax withheld on her wages in excess of the tax liability attributable to her wages. The amount owed was stated on the return, and a partial payment was made. The IRS then began collection by garnishing W's wages. W had apparently been unaware that returns for the two succeeding years had not been filed, and she and H promptly filed joint returns for those years, showing a substantial tax liability which, the court concluded, W knew the parties could not pay. It seems that W must have asked H why her wages were being garnished, and, on being informed of the tax problems, must have participated in tardy compliance with the tax law, but without thinking about what this might mean for her and her ability to enjoy her earnings.

Bankruptcy must have followed soon after these returns were filed, and resulted in a discharge for the tax liability for the earlier year. Four months after filing the joint returns for the later years, W requested relief under ' 6015(f). W asserted that all tax questions had been handled by H, and she was unaware of the liabilities.

Reason to Know

In the Revenue Procedure, reason to know that the tax would not be paid is a factor weighing against relief, and here it weighed heavily against W's claim. The fact that her wages had been garnished to pay the earlier liability made clear to the court that she was aware of problems in paying the tax at the time she signed the returns, and W did, in fact, testify that she knew they would be unable to pay the tax liabilities. This finding might have been overcome by showing that W did not receive a 'significant benefit' from the failure to pay the tax or that imposing the liability on her would cause economic hardship. The former point was lost because of the size of the unpaid liability, indicating that W must have received a significant benefit from H's failure to pay as his income was shared by the parties, and the latter was simply unproven. On the latter point, hardship must be shown by proof that payment of the liability 'prevent [W] from paying reasonable basic living expenses.'

In van Arsdalen v. Commissioner, T.C. Memo. 2007-48, there was a happier ending for the taxpayer. This case began in circumstances that were similar to those in Ware. H was a self-employed attorney, and W, for the years involved in the case, a homemaker. H and W filed joint tax returns for a number of years on which liability for tax was not paid. As the court observed, this was a pattern for the parties, who were substantially in debt. At the end of this period, the parties sold their home and the proceeds were applied to tax liability for an earlier year.
They then divorced, and subsequently W remarried. The IRS began collection activity against her, and W requested relief under ' 6015(f) (because there was no deficiency). The Commissioner denied relief because, in his view, W had reason to know that the liability would not be paid from the pattern of nonpayment of debts, and that it would not be inequitable to impose liability on W (she had an IRA with substantial accumulation).

The court disagreed with both conclusions. Because H had misled her into thinking that he would pay the liability from future earnings, the court thought that she could reasonably anticipate that he would do so. Moreover, the imposition of liability would cause serious harm to her ability to maintain a decent living. On the latter point, the court concluded that the Commissioner had underestimated her living expenses. Two points seem to distinguish van Arsdalen from Ware; H and W had divorced (and H had agreed to be responsible for the tax liabilities); and the court stressed W's limited education and lack of familiarity with financial issues. That point seems to hark back to the earlier cases under the forerunner to (b), when the more ignorant or helpless the taxpayer requesting relief could be made to appear, the more likely was the taxpayer to be successful, a position which the 1998 legislation was thought to have dispatched.

Banderas v. Commissioner

One cannot leave this topic without a word about Banderas v. Commissioner, T.C. Memo. 2007-129. H was a medical doctor who was sued by a business associate in a dispute over the purchase of his practice and who suffered a substantial adverse judgment in that proceeding. W was apparently a homemaker in the relevant taxable years. As a result of efforts to collect the judgment, H, who had retired, filed a voluntary petition in bankruptcy. All of his assets were tied up in the bankruptcy which, despite the existence of assets of substantial value (and life insurance after H died), consumed all the assets. The following year, H and W filed a joint return for the year in which H filed his petition. In those years, they struggled to stay afloat, but H then died and W filed a joint return for that year as a surviving spouse. Both returns reported substantial income but a large portion of the tax remained unpaid.

Later, W requested relief under ' 6015(f) for both years. She argued that, first, because of the substantial assets in the bankruptcy estate, she had expected the tax to be paid from the estate, but that did not happen, and second, that the financial struggles she had endured made imposition of the tax a financial hardship. The court concluded that at the time she signed the returns, she had reason to know that the tax would not be paid. On this point, the court concluded that 'a reasonable belief that taxes would be paid must at a minimum incorporate a belief that funds would be on hand within a reasonably prompt period of time.' W had not proven that she could have expected that to happen. Nor had she shown that imposition of liability would cause an economic hardship, mainly because of the lack of documentation to support her assertions about her economic situation. Most other facts were neutral. The court made clear that enduring significant financial hardship at some point, as W certainly had, would not justify relief under ' 6015(f).

Conclusion

Because these cases turn on their individual facts, often in excruciating detail, it is difficult to draw generalizations from the opinions. The Tax Court will review each case by analyzing the factors that the IRS has identified in Rev. Proc. 2003-61, and although the court has been willing to take a more lenient view than the IRS, a successful outcome depends on how each case is presented. For most, this means that the best time to evaluate one's position is before signing the return, but, as circumstances routinely show, that may be also the worst time for the taxpayer. It is discouraging to think that relief from a spouse's tax liability requires an ability to manage one's financial situation and marshal evidence to prove the 'factors' which the IRS has concluded support relief, which, in turn, supports an inference that the taxpayer is capable of managing finances. That inference makes the relief more difficult to obtain.

Thomas R. White, 3rd is a member of this newsletter's Board of Editors, and a John C. Stennis Professor of Law at the University of Virginia, Law School.

In the first part of this article, I discussed the availability of relief for a taxpayer from liability for tax on a joint return that results from his or her spouse's errors or omissions, focusing on the equitable catch-all provided in IRC ' 6015(f). In December 2006, Congress amended the statute explicitly to provide for Tax Court review of IRS determinations not to grant relief under ' 6015(f). Now, I consider how the Tax Court evaluates these claims in relation to the position of the IRS.

Under subsection (f), the Commissioner is authorized to relieve a taxpayer from liability for tax on a joint return if he or she does not meet the requirements for relief under subsections (b) or (c) and 'taking into account all the facts and circumstances, it is inequitable to hold [the taxpayer] liable ' ' The initial determination is committed to the discretion of the Commissioner. In Rev. Proc. 2003-61, 2003-2 C.B. 296, superseding Rev. Proc. 2000-15, 200-1 C.B. 447, the IRS has set out the 'factors' it applies in deciding whether to authorize relief under ' 6015(f). This Revenue Procedure provides the framework for analyzing requests for relief. Section 4.01 identifies seven factors that must be established before the taxpayer is eligible for relief. The important one for this discussion is the requirement that the 'relief is attributable to an item of the [taxpayer's spouse].' This includes a requirement that, in cases involving the failure to pay an assessed tax, the failure to pay must be from assets of the taxpayer's spouse (called the 'nonrequesting spouse'), unless there is misappropriation by the spouse or other, similar misconduct.

Section 4.02 sets out three elements which, when all are satisfied, will 'ordinarily' justify relief. These elements include a reasonable belief that the taxpayer's spouse would pay the tax (no knowledge or reason to know that the tax would not be paid) and economic hardship, which, in the Service's view, would be caused by the imposition of liability (aggravation of existing hardship would not be a reason to grant relief). If these elements do not justify relief, then ' 4.03 describes additional factors to take into account, including knowledge, economic hardship and the fact that the taxpayer received 'significant benefit' from the failure to pay the liability. Note that if enough of these factors are viewed as supporting relief, they can outweigh knowledge (or reason to know) the liability would not be paid.

'Abuse of Discretion'

In the Tax Court, determinations under ' 6015(f) are reviewable only for an 'abuse of discretion' by the IRS. Jonson v. Commissioner , 118 T.C. 106, 125 (2002), aff'd on other grounds , 353 F3d 1181 (10 th Cir. 2003) ('whether [the Commisioner] abused his discretion by acting arbitrarily, capriciously, or without sound basis in fact'). As described below, Tax Court review of these determinations generally relies on evaluation of IRS application of the factors described in the Rev. Proc. to each case.

A 'Standalone' Petition

A 'standalone' petition occurs when there is liability to pay an assessed tax in a case where a deficiency has not been asserted (an 'underpayment case'), the taxpayer applies for relief, IRS determines that relief is not available, and the
taxpayer then petitions the Tax Court to review the determination. Underpayment cases occur when a return is filed, the tax is reported but not paid, and the taxpayer relies on his or her spouse to make the payment. Although neither Ewing v. Commissioner , 122 T.C. 32 (2004), rev'd , 439 F.3d 1009 (9 th Cir. 2006), nor Billings v. Commissioner , 127 T.C. 6 (2006), have been reconsidered by the Tax Court following legislative overruling on the jurisdictional point, as have some other cases, each illustrates how these problems can arise. In divorce situations, there is often the financial distress that might lead to (or have been caused by) the tax issues in these cases, and agreeing to sign a joint return may seem like a way to minimize looming tax issues in a stressful time.

Divorce Situations

In Billings, W had embezzled substantial sums from her employer. H was unaware of the embezzlement when he and W filed their original joint return. Later, the embezzlement was disclosed, and H and W were advised to file an amended joint return, reporting the embezzlement in the hope that compliance with income tax laws would result in more lenient treatment in the criminal matter. H also filed for relief as an innocent spouse (his pension may have been the family's only source of income). The IRS denied relief under ' 6015(f), taking the position that H knew (or should have known) that they would not be able to pay the liability at the time he signed the joint return. The Tax Court seemed to find H's position sympathetic, as he could not have elected to file an amended return as an individual, but, in an evenly divided decision, concluded that it did not have jurisdiction. In Billings, the amended joint return was filed for the purpose of dealing with a nontax problem, which may force taxpayers to accept joint liability for the embezzler's tax in a continuing relationship, given the IRS' emphasis on knowledge as a negative factor.

In Beatty v. Commissioner, T.C. Memo. 2007-167, the Tax Court reversed the Commissioner's determination not to provide relief under circumstances very much like those in Billings. H had a gambling problem that he concealed from W, and failed to file returns over a 15-year period. After pleading guilty to state tax evasion, and as a condition of probation (rather than jail time), he was required to file all delinquent returns, which W signed because she believed that doing so was essential to help H escape jail. The opinion in this case, as in van Arsdalen, discussed below, seemed heavily influenced by W's deference to H in financial matters.

Ewing, too, raises a similar problem, where the joint return may be filed to reduce the aggregate tax liability for both parties, even though one spouse had not paid and might never be able to pay his or her liability. At the time, joint filing may seem to be a good idea, but taxpayers in that position should think twice before doing so. Ware v. Commissioner, T.C. Memo. 2007-112, is illustrative. In Ware, H was self-employed and failed to pay either estimated taxes or income tax on the initial joint return, which had been filed late. W was employed and had tax withheld on her wages in excess of the tax liability attributable to her wages. The amount owed was stated on the return, and a partial payment was made. The IRS then began collection by garnishing W's wages. W had apparently been unaware that returns for the two succeeding years had not been filed, and she and H promptly filed joint returns for those years, showing a substantial tax liability which, the court concluded, W knew the parties could not pay. It seems that W must have asked H why her wages were being garnished, and, on being informed of the tax problems, must have participated in tardy compliance with the tax law, but without thinking about what this might mean for her and her ability to enjoy her earnings.

Bankruptcy must have followed soon after these returns were filed, and resulted in a discharge for the tax liability for the earlier year. Four months after filing the joint returns for the later years, W requested relief under ' 6015(f). W asserted that all tax questions had been handled by H, and she was unaware of the liabilities.

Reason to Know

In the Revenue Procedure, reason to know that the tax would not be paid is a factor weighing against relief, and here it weighed heavily against W's claim. The fact that her wages had been garnished to pay the earlier liability made clear to the court that she was aware of problems in paying the tax at the time she signed the returns, and W did, in fact, testify that she knew they would be unable to pay the tax liabilities. This finding might have been overcome by showing that W did not receive a 'significant benefit' from the failure to pay the tax or that imposing the liability on her would cause economic hardship. The former point was lost because of the size of the unpaid liability, indicating that W must have received a significant benefit from H's failure to pay as his income was shared by the parties, and the latter was simply unproven. On the latter point, hardship must be shown by proof that payment of the liability 'prevent [W] from paying reasonable basic living expenses.'

In van Arsdalen v. Commissioner, T.C. Memo. 2007-48, there was a happier ending for the taxpayer. This case began in circumstances that were similar to those in Ware. H was a self-employed attorney, and W, for the years involved in the case, a homemaker. H and W filed joint tax returns for a number of years on which liability for tax was not paid. As the court observed, this was a pattern for the parties, who were substantially in debt. At the end of this period, the parties sold their home and the proceeds were applied to tax liability for an earlier year.
They then divorced, and subsequently W remarried. The IRS began collection activity against her, and W requested relief under ' 6015(f) (because there was no deficiency). The Commissioner denied relief because, in his view, W had reason to know that the liability would not be paid from the pattern of nonpayment of debts, and that it would not be inequitable to impose liability on W (she had an IRA with substantial accumulation).

The court disagreed with both conclusions. Because H had misled her into thinking that he would pay the liability from future earnings, the court thought that she could reasonably anticipate that he would do so. Moreover, the imposition of liability would cause serious harm to her ability to maintain a decent living. On the latter point, the court concluded that the Commissioner had underestimated her living expenses. Two points seem to distinguish van Arsdalen from Ware; H and W had divorced (and H had agreed to be responsible for the tax liabilities); and the court stressed W's limited education and lack of familiarity with financial issues. That point seems to hark back to the earlier cases under the forerunner to (b), when the more ignorant or helpless the taxpayer requesting relief could be made to appear, the more likely was the taxpayer to be successful, a position which the 1998 legislation was thought to have dispatched.

Banderas v. Commissioner

One cannot leave this topic without a word about Banderas v. Commissioner, T.C. Memo. 2007-129. H was a medical doctor who was sued by a business associate in a dispute over the purchase of his practice and who suffered a substantial adverse judgment in that proceeding. W was apparently a homemaker in the relevant taxable years. As a result of efforts to collect the judgment, H, who had retired, filed a voluntary petition in bankruptcy. All of his assets were tied up in the bankruptcy which, despite the existence of assets of substantial value (and life insurance after H died), consumed all the assets. The following year, H and W filed a joint return for the year in which H filed his petition. In those years, they struggled to stay afloat, but H then died and W filed a joint return for that year as a surviving spouse. Both returns reported substantial income but a large portion of the tax remained unpaid.

Later, W requested relief under ' 6015(f) for both years. She argued that, first, because of the substantial assets in the bankruptcy estate, she had expected the tax to be paid from the estate, but that did not happen, and second, that the financial struggles she had endured made imposition of the tax a financial hardship. The court concluded that at the time she signed the returns, she had reason to know that the tax would not be paid. On this point, the court concluded that 'a reasonable belief that taxes would be paid must at a minimum incorporate a belief that funds would be on hand within a reasonably prompt period of time.' W had not proven that she could have expected that to happen. Nor had she shown that imposition of liability would cause an economic hardship, mainly because of the lack of documentation to support her assertions about her economic situation. Most other facts were neutral. The court made clear that enduring significant financial hardship at some point, as W certainly had, would not justify relief under ' 6015(f).

Conclusion

Because these cases turn on their individual facts, often in excruciating detail, it is difficult to draw generalizations from the opinions. The Tax Court will review each case by analyzing the factors that the IRS has identified in Rev. Proc. 2003-61, and although the court has been willing to take a more lenient view than the IRS, a successful outcome depends on how each case is presented. For most, this means that the best time to evaluate one's position is before signing the return, but, as circumstances routinely show, that may be also the worst time for the taxpayer. It is discouraging to think that relief from a spouse's tax liability requires an ability to manage one's financial situation and marshal evidence to prove the 'factors' which the IRS has concluded support relief, which, in turn, supports an inference that the taxpayer is capable of managing finances. That inference makes the relief more difficult to obtain.

Thomas R. White, 3rd is a member of this newsletter's Board of Editors, and a John C. Stennis Professor of Law at the University of Virginia, Law School.