Widow entitled to equitable spousal relief for some years
Martinez, TC Memo 2008-165
Mike Habib, EA Tax Relief & Tax Problem Resolution
The Tax Court held that a widow was entitled to equitable spousal relief for two of four tax years even though she had knowledge of her and her husband’s tax liabilities, because she took steps to address their tax problems and made significant payments under an installment agreement.
The taxpayer married her husband in 1971 and they remained married until his death on 4/2/01. From 1985, the taxpayer’s husband struggled with serious health issues; he stopped working in July 1995. The taxpayer was working as a secretary during this time. The couples’ bank account was in her name, but her husband decided which bills to pay and when to pay them. The taxpayer did not review monthly banking statements, did not balance the checkbook, and did not pick up or open the mail. The taxpayer’s husband would prepare their tax returns, show her a preliminary draft, and have her sign a blank original that he would complete and mail.
In 1988, the taxpayer and her husband had a balance due for their federal income tax that the IRS collected by levy in 1994. In 1992, they earned equivalent wages and had equivalent withholdings, but began drawing money from the taxpayer’s retirement account. By 1995, they were experiencing significant problems as the taxpayer’s husband stopped working, and the couple began withdrawing larger amounts of money from their retirement plans. Their tax preparer included the withdrawals in their gross income and reported a 10% additional tax for premature distributions from retirement plans.
In 1996, the taxpayer and her family moved from southern to northern California. Shortly after the move, the taxpayer learned that her husband had not filed their 1992 and 1995 tax returns. The couple hired a regional law firm that specialized in taxes to prepare the delinquent returns. By 1998 or 1999, the couple had no financial resources other than the taxpayer’s paycheck, as they had exhausted their retirement accounts and emptied their after-tax investments and savings. The taxpayer’s salary was in the low- to mid-thirty thousands.
Shortly before her husband’s death, the taxpayer discovered shoe boxes filled with unopened letters from the IRS and the tax returns that she signed but her husband had not mailed. The taxpayer re-engaged the law firm that prepared the prior delinquent returns. The firm determined that the couple had outstanding balances for each year during 1992-2000 except for 1996, where a refund was due. The total amount due was $48,684. The firm prepared an offer-in-compromise of $1,000 to settle the entire debt, which was submitted to the IRS during the summer of 2001. The IRS indicated that it was going to reject the offer, so the taxpayer decided to enter into an installment agreement with the IRS, under which she agreed to pay $775 per month to resolve the entire debt.
The taxpayer began making installment payments in May 2002 and continued until November 2005, when she stopped because the IRS stopped sending her monthly payment coupons. In total, the taxpayer paid approximately $35,650 in installment payments. The IRS applied the couple’s 1996 refund to the 1993 underpayment, and applied the installment payments in a “seemingly haphazard manner” that resulted in full payment of the balances owing for 1993, 1994, 1997, and 2000, while leaving balances due on 1992, 1995, 1998, and 1999.
The taxpayer retained a national tax preparation firm to help her prepare her 2004 return. After reviewing her records, the firm suggested that she apply for innocent spouse relief. The taxpayer completed an application, including a Form 12510, Questionnaire for Requesting Spouse, which had a worksheet for monthly income and expenses. The taxpayer reported a monthly net income of $2,636 and expenses of $2,480 (including the $775 monthly installment payment), leaving her a surplus of $156 per month. The IRS denied the taxpayer’s request for innocent spouse relief.
The taxpayer timely appealed the denial to the IRS’ Office of Appeals, where the Appeals officer determined that the taxpayer was in tax compliance and satisfied the threshold requirements for relief on the portion of the liability attributable to her deceased husband. The Appeals officer rejected the taxpayer’s request for relief, because:
(1) The taxpayer had reason to know of the underpayment. (2) In 1999 and 2000 nearly all of the underpayments were attributable to her earnings (the officer did not have the 1998 return for review).
(3) Paying the debt would not cause the taxpayer economic hardship, because she reported a monthly surplus on her worksheet.
(4) The taxpayer’s husband did not abuse her. (5) The taxpayer had no health problems.
The officer did not take into account, or find relevant, the dollar amount and percentage of the overall debt that the taxpayer paid through installment payments. Two years after the taxpayer’s initial submission of Form 12510, the taxpayer submitted a new form that showed a monthly cash-flow shortfall of $322, without provision for the repayment of outstanding taxes. The record showed that the taxpayer’s financial condition worsened due, in part, to the financial arrangement she had with her new husband, who had limited income. Section 6015 provides relief from joint and several liability on a joint return. If a taxpayer does not qualify for innocent spouse relief under Section 6015(b) or 6015(c), the taxpayer may seek an equitable remedy under Section 6015(f). Because the taxpayer did not qualify for relief under Section 6015(b) or 6015(c), her sole avenue of relief was provided by Section 6015(f). The Tax Court began its review by examining Rev. Proc. 2003-61, 2003-2 CB 296, which outlined the new review process IRS employees were to follow when determining whether a spouse qualifies for equitable relief. The process begins with seven threshold criteria that must be satisfied before equitable relief will be considered. The court found that the taxpayer met the threshold requirements of section 4.01 of the Procedure on the portion of the liability that was attributable to her deceased husband for 1992 and 1995, but because the attribution factor was elevated to a threshold fact under the new process, the court could not consider relief for 1998 and 1999 as the liability for those years was her own. Since the taxpayer satisfied the threshold requirements, the court then considered whether her circumstances satisfy all three elements of section 4.02: marital status, knowledge or reason to know, and economic hardship. The court found that the taxpayer satisfied the first element, but failed to satisfy at least one of the other factors. For requesting spouses who fail to qualify under section 4.02, the procedure provides a list of nonexclusive factors that are considered in determining whether to grant full or partial equitable relief. The Tax Court weighed the factors in the instant matter:
(1) Marital status. The taxpayer’s husband died before she requested relief, so this factor favored relief. (2) Economic hardship. The court said that the Appeals officer properly relied on the taxpayer’s Form 12510 in determining that she would not suffer economic hardship if denied relief, because her worksheet showed a monthly surplus after paying basic living expenses and the installment payment and the taxpayer corroborated the determination. The court stated that normally its inquiry would stop there, but because Section 6015(f) required that the court take into account “all facts and circumstances,” it considered the taxpayer’s new Form 12510, which showed a monthly deficit of $322. The court found that the taxpayer, who already had a modest lifestyle, suffered a diminution in her financial circumstances. Considering the combination of age, education, and work situation, the court found that the taxpayer was in a precarious financial circumstance and said that the economic hardship factor was neutral.
(3) Knowledge or reason to know. The relevant standard applied when a couple accurately reported, but did not pay, balances due is whether the taxpayer requesting relief did not know and had no reason to know that her spouse would not pay the income tax liability. The court found that it was improbable that the taxpayer lacked knowledge. Specifically, sometime after the taxpayer’s husband became ill, the taxpayer assumed sufficient responsibility over their delinquent tax filings so as to encourage him to seek help from a law firm. Further, the court noted that the main reason for the balances due for 1992 through 2000 was that the taxpayer had her employer withhold too little tax from her paycheck, adding that only the taxpayer, and not her husband, could have filed the withholding certificate with her employer. Because the court found that the taxpayer knew or had reason to, it found that this factor strongly disfavored relief.
(4) Legal obligation. This factor was inapplicable because the taxpayer and her deceased husband did not divorce. (5) Significant benefit. The court found that during and after her marriage, the taxpayer did not receive jewelry, luxury cars, or designer clothes, nor did she receive or otherwise own a home. Instead, the taxpayer drained her savings and retirement assets trying to support her family and help her dying husband. Thus the court found that this factor significantly favored relief.
(6) Compliance with federal tax laws. Since her husband’s death, the taxpayer was in compliance with federal tax laws, making this factor neutral or in favor of relief.
(7) Abuse. Because the court found that the taxpayer was not abused, this factor was neutral. (8) Mental health. The court believed that the taxpayer was under great mental strain dealing with her dying husband while supporting her family solely on her modest wages and found that this factor strongly favored relief.
(9) Other factors. First, with respect to the 1995 tax return, the taxpayer’s tax preparer included a 10% additional tax on premature retirement plan distributions, but the court believed that the taxpayer’s husband was a good candidate for relief under Section 72(t)(2)(A)(iii), which provides an exception to the additional tax if the distribution was attributable to the employee’s being disabled. The court added that if the original 1995 balance was reduced by removing the 10% additional tax attributable to the taxpayer’s deceased husband, the IRS’s application of the taxpayer’s payments would have paid the entire remaining liability. Second, the court noted that the taxpayer paid $35,650 or 73% of the entire liability for 1992 through 2000, including a portion attributable to her deceased husband, which was more than her share of the liabilities for the 1992 and 1995 tax years. Third, the court noted that the 1992 and 1995 liabilities were old, particularly the 1992 liability where, oddly, the IRS applied less of the payments. Finally, the court review of the conference report accompanying the enactment of Section 6015 showed that the conferees intended to expand the circumstances in which innocent spouse relief could be made available. The court therefore concluded that the other factors strongly favored relief.
In summary, the court found that one factor strongly disfavored relief, three or four factors were neutral, and four or five factors favored or strongly favored relief. Balancing the equities, the court held that for 1992 and 1995 the factors in favor of relief outweighed the factors disfavoring relief, with no single factor being determinative. The court denied relief for years 1998 and 1999 because the taxpayer’s request for relief failed the threshold test of attribution.
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