New developments in innocent spouse rules

Academy of Accounting and Financial Studies Journal, Jan, 2008 by John Leavins, Darshan Wadhwa, Charles Smith

An example of separation of liability can be seen in Joan Phyllis Levy v. Commissioner, This case dealt with tax deficiencies for several years and ruled that for the 1979 tax return, Mrs. Levy did not qualify as an innocent spouse under IRC section 6015(b), because she was unable to prove that a reasonable person would not be expected to know there was a tax deficiency. However, the court overruled the IRS and granted separation of liability under section 6015(c). Section 6015(c) applies when the income which accounts for the tax liability would have been properly allocated to the other spouse if they had filed separate tax returns instead of a joint tax return.

During Dr. And Mrs. Levy's marriage, Mrs. Levy was a full-time homemaker and although she knew that her husband did practice medicine, she was not involved with any of the financial dealings of the household. All household bills where paid by her husband, and furthermore, she did not have access to the checking account where her husband deposited the money. She was provided cash by her husband as needed for expenses and did not live a lifestyle that was unreasonable in light of the amount expected by the income reported on their tax returns. The family took no expensive vacations and she did not furnish their house with expensive items. Additionally, she did not have a credit card until 1999. After separating from her husband in 1994, he still paid the household bills for the condominium that she resided in and provided cash or a check for living expenses that she deposited into her own checking account.

The court pointed out that Dr. Levy testified that he invested in a tax shelter and that Mrs. Levy did not participate or have knowledge of the tax shelter. The record also showed that she did not participate in his medical practice and barely had any knowledge of his financial transactions. Even though Ms. Levy did not qualify as an innocent spouse, she qualified for relief under the separation of liability rules. Additionally, with separation of liability, unlike innocent spouse, the burden of proof for actual knowledge is shifted from the taxpayer to the Internal Revenue Service. This case illustrates the difference that can result between asserting the doctrine of innocent spouse versus that of separation of liability.

EQUITABLE RELIEF

An innocent spouse may also qualify for relief under the equitable relief provisions. Under this type of relief, one may request to be relieved of the responsibility of tax, interest, and penalties. This relief applies to any tax liability arising after July 22, 1998 and any tax liability arising on or before the date but remaining unpaid as of that date. Equitable relief differs from innocent spouse relief and separation of liability because it allows an individual relief from an understatement of tax or an underpayment of tax. An underpayment of tax by definition "is an amount of tax one properly reported on a tax return but has not paid." If the taxpayer satisfies the required conditions for equitable relief, then the IRS is obligated to evaluate the positive and negative factors to determine whether full or partial relief should be granted the taxpayer.