ROBERT E. MCKENZIE, ESQ.

ARNSTEIN & LEHR LLP

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© 2001

INNOCENT SPOUSE - IS ANY SPOUSE TRULY INNOCENT?

Robert E. McKenzie, EA, Attorney

1. INTRODUCTION TO SPOUSAL RELIEF

1.10 Although many taxpayers enjoy substantial tax benefits from filing joint returns, those benefits may be
outweighed when a tax deficiency or unpaid balance is asserted for a return. The general rule is that each spouse
has joint and several liability. The IRS might also offset a current year joint refund to pay a separate obligation of
one spouse. In community property states married individuals face the more onerous duty to pay taxes on ½ of a
spouses income even when they file a married filing separate return. This course will cover three methods to
secure relief from spousal liability. We will cover:

? Innocent spouse relief;

? Injured spouse relief &
? IRC §66, for community property states.

2. INNOCENT SPOUSE RELIEF

2.10 The IRS Restructuring Act of 1998 provided expanded spousal relief for taxpayers who have filed joint
returns. IRC § 6015 provides three types of relief which depend upon whether the tax liability arose as a
deficiency or as a filed joint return with a balance and upon the current marital status of the of the parties. For
the first time parties may seek equitable relief from joint and several liability on joint returns even when the
liability resulted from a return filed with a balance due. [IRS Publication 971]

Innocent Spouse
2.20 The IRS Restructuring Act of 1998 generally makes innocent spouse relief easier to obtain. The Act
eliminates all of the understatement thresholds of prior IRC § 6013 and requires only that the understatement of
tax be attributable to an erroneous (and not just a grossly erroneous as in the past) item of the other spouse. An
individual will be relieved of liability for tax (including interest, penalties and other amounts) for a tax year to
the extent the liability is attributable to an understatement (understatement and tax deficiency are synonymous)
described below:
. 1. A joint return was filed for the tax year [IRC §6015(b)(1)(A)];

2. There is an understatement of tax on the return that is attributable to an erroneous item by the other spouse
[IRC §6015(b)(1)(B)];

3. A taxpayer establishes that in signing the return he/she did not know and had no reason to know of the
understatement; [IRC §6015(b)(1)(C);

4. Taking into account all of the facts and circumstances, it would be inequitable to hold the taxpayer liable for
the deficiency attributable to the understatement; [IRC §6015(b)(1)(D)]; and

5. A taxpayer elects the benefits of this provision, on the form that the IRS prescribes (Form 8857) , no later than
the date that is two years after the date the IRS has begun collection activities with respect to the taxpayer. [IRC
§6015(b)(1)(E)]

Knowledge
2.30 If an individual who otherwise qualifies for innocent spouse relief fails to establish that he/she did not
know or have reason to know of the understatement, but does establish that he/she did not know or have reason
to know the extent of the understatement, that individual may be relieved of liability for tax, penalties and
interest to the extent that liability is attributable to the portion of the understatement that he/she did not know or
have reason to know.

Example: If the husband and wife file a joint return and the IRS determines the deficiency for the year based on
$15,000 of unreported income attributable to the husband. Wife shows she did not know or have reason to
know of $5,000 of the under-reported income. If the wife otherwise qualifies for any spouse relief, she will be
relieved of joint liability for the portion of the understatement attributable to the $5,000 of omitted income. She
will still remain liable for the taxes due on the $10,000 of omitted income.

Election Of Separate Liability

2.40 The Act also provides a separate liability election for a taxpayer who, at the time of the election, is no
longer married to including widowed, is legally separated from, or has been living apart for at least 12 months
from the person with whom the taxpayer originally filed a joint return. [§3201] [IRC §6015(a)] The electing
must show that he did not know of the understatement by the other spouse. The knowledge requirement is lower
than for spouses who remain together where the electing spouse must show that she did not know or have reason
to know in order to receive relief. A taxpayer may elect to have the liability for any deficiency limited to the
portion of the deficiency that is attributable to items allocable to the taxpayer. The election is not available if the
Secretary demonstrates that assets were transferred between individuals filing a joint return as part of a
fraudulent scheme of the individuals or if both individuals had actual knowledge of the understatement of tax.

Divorced, Separated or Living Apart

2.50 An individual is eligible to make the separate liability election only if at the time the election is filed he/she
is no longer married to including widowed, or is legally separated from, the spouse from whom the joint return to
which the election relates was filed; or he/she was not a member of the same household as the spouse with
whom the joint return was filed at any time during the twelve month period ending at the date the election is filed
[IRC §6015(c)(3)(A)(i)]. This provision allows additional relief when the IRS proposes a deficiency against a
taxpayer who is no longer married or living with the person with whom he/she filed the joint return. The
proponent may have had indication of a potential understatement but must have been without actual knowledge.
If the understatement was not attributable to him/her, he/she may elect proportional liability. The provision does
not apply to returns which were jointly filed showing a liability at the time of filing. It only applies to
deficiencies as described in IRC §6662(d)(2)(a).

Time Deadline
2.60 Expanded innocent spouse relief and the separate liability election must be elected no later than two years
after the date on which the Secretary has begun collection activities with respect to the individual seeking the
relief. The Act provides that the Tax Court has jurisdiction with respect to disputes about innocent spouse relief.

Equitable Relief
2.70 The IRS Restructuring Act further authorizes the Secretary to relieve an individual of liability if relief is
not available under the expanded innocent spouse rules set forth above, if it would be inequitable to hold the
individual liable for any unpaid tax or any deficiency. The expanded innocent spouse relief, separate liability
election, and authority to provide equitable relief apply to liabilities for tax arising after the date of enactment, as
well as any liability for tax arising on or before the date of enactment that remains unpaid on the date of
enactment. A taxpayer who filed a joint balance due return may seek equitable relief.

IRS Notice 98-61 & Rev. Proc 2000-15

2.80 IRS Notice 98-61 1998-51 I.R.B. 13 and Rev. Proc 2000-15 provide interim guidance to taxpayers seeking
equitable relief under section 6015(f) in three areas. First, Section 3.01 of the notice provides threshold
conditions that must be satisfied in order for an individual to be considered for relief under section 6015(f).
Second, Section 3.02 of the notice sets forth the circumstances in which relief under section 6015(f) will
ordinarily be granted in the situation where an individual did not know, and had no reason to know, that funds
intended for the payment of tax were instead taken by the spouse for the spouse's benefit. Third, for all other
requests for relief under section 6015(f), and all requests for relief under section 66(c), Section 3.03 of the notice
provides a partial list of factors to be considered in determining whether it would be inequitable to hold an
individual liable for a deficiency or unpaid liability.

Eligibility to Be Considered for Equitable Relief

2.90 All the following threshold conditions must be satisfied before the Service will consider a request for
equitable relief under S 6015(f). In addition, with the exception of conditions (1) and (2), all of the following
threshold conditions must be satisfied before the Service will consider a claim for equitable relief under S 66(c).
The threshold conditions are as follows:

(1) The requesting spouse filed a joint return for the taxable year for which relief is sought;

(2) Relief is not available to the requesting spouse under S 6015(b) or 6015(c);

(3) The requesting spouse applies for relief no later than two years after the date of the Service's first collection
activity after July 22, 1998, with respect to the requesting spouse;

(4) Except as provided in the next sentence, the liability remains unpaid. A requesting spouse is eligible to be
considered for relief in the form of a refund of liabilities for: (a) amounts paid on or after July 22, 1998, and on
or before April 15, 1999; and (b) installment payments, made after July 22, 1998, pursuant to an installment
agreement entered into with the Service and with respect to which an individual is not in default, that are made
after the claim for relief is requested;

(5) No assets were transferred between the spouses filing the joint return as part of a fraudulent scheme by such
spouses;

(6) There were no disqualified assets transferred to the requesting spouse by the non-requesting spouse. If there
were disqualified assets transferred to the requesting spouse by the non-requesting spouse, relief will be available
only to the extent that the liability exceeds the value of such disqualified assets. For this purpose, the term
"disqualified asset" has the meaning given such term by S 6015(c)(4)(B); and

(7) The requesting spouse did not file the return with fraudulent intent.

A requesting spouse satisfying all the applicable threshold conditions set forth above may be relieved of all or
part of the liability under S 6015(f) or 66(c), if, taking into account all the facts and circumstances, the Service
determines that it would be inequitable to hold the requesting spouse liable for such liability.
 Circumstances under Which Equitable Relief Will Ordinarily Be Granted
2.100 In cases where a liability reported on a joint return is unpaid, equitable relief under § 6015(f) will
ordinarily be granted (subject to the limitations of paragraph (2) below) in cases where all of the following
elements are satisfied:

(a) At the time relief is requested, the requesting spouse is no longer married to, or is legally separated from,
the non-requesting spouse, or has not been a member of the same household as the non-requesting spouse at any
time during the 12-month period ending on the date relief was requested;

(b) At the time the return was signed, the requesting spouse had no knowledge or reason to know that the tax
would not be paid. The requesting spouse must establish that it was reasonable for the requesting spouse to
believe that the non-requesting spouse would pay the reported liability. If a requesting spouse would otherwise
qualify for relief under this section, except for the fact that the requesting spouse had no knowledge or reason to
know of only a portion of the unpaid liability, then the requesting spouse may be granted relief only to the extent
that the liability is attributable to such portion; and

(c) The requesting spouse will suffer economic hardship if relief is not granted. For purposes of this section, the
determination of whether a requesting spouse will suffer economic hardship will be made by the Commissioner
or the Commissioner's delegate, and will be based on rules similar to those provided in § 301.6343-1(b)(4) of the
Regulations on Procedure and Administration.

Limitations
2.110 Relief under this section is subject to the following limitations:

(a) If the return is or has been adjusted to reflect an understatement of tax, relief will be available only to the
extent of the liability shown on the return prior to any such adjustment; and

(b) Relief will only be available to the extent that the unpaid liability is allocable to the non-requesting spouse.

Factors for Determining Whether to Grant Equitable Relief.

2.120 Rev. Proc 2000-15, 2000-5 I.R.B. 447, 2000 WL 42026 applies to married individuals filing separate
returns in community property states who request relief under section 66(c), and individuals who meet the
threshold conditions of the notice but who do not qualify for relief under the notice. Individuals may qualify for
relief from tax liability for a taxable year under section 6015(f) or 66(c) if, taking into account all the facts and
circumstances, it is inequitable to hold the individual liable for the unpaid liability or deficiency. The following
are partial lists of the positive and negative factors that will be taken into account in determining whether to
grant equitable relief under section 6015(f) or 66(c). The list is not intended to be exhaustive.

(1) Factors weighing in favor of relief:

Factors weighing in favor of relief. The factors weighing in favor of relief include, but are not limited to, the
following:

(a) Marital status. The requesting spouse is separated (whether legally

separated or living apart) or divorced from the non-requesting spouse.

(b) Economic hardship. The requesting spouse would suffer economic hardship (within the meaning of section
4.02(1)(c) of this revenue procedure) if relief from the liability is not granted.

(c) Abuse. The requesting spouse was abused by the non-requesting spouse, but such abuse did not amount to
duress.

(d) No knowledge or reason to know. In the case of a liability that was properly reported but not paid, the
requesting spouse did not know and had no reason to know that the liability would not be paid. In the case of a
liability that arose from a deficiency, the requesting spouse did not know and had no reason to know of the items
giving rise to the deficiency.

(e) Non-requesting spouse's legal obligation. The non-requesting spouse has a legal obligation pursuant to a
divorce decree or agreement to pay the outstanding liability. This will not be a factor weighing in favor of relief
if the requesting spouse knew or had reason to know, at the time the divorce decree or agreement was entered
into, that the non-requesting spouse would not pay the liability.

(f) Attributable to non-requesting spouse. The liability for which relief is sought is solely attributable to the
non-requesting spouse.

(2) Factors weighing against relief:

Factors weighing against relief. The factors weighing against relief include, but are not limited to, the following:

(a) Attributable to the requesting spouse. The unpaid liability or item giving rise to the deficiency is attributable
to the requesting spouse.

(b) Knowledge, or reason to know. A requesting spouse knew or had reason to know of the item giving rise to a
deficiency or that the reported liability would be unpaid at the time the return was signed. This is an extremely
strong factor weighing against relief. Nonetheless, when the factors in favor of equitable relief are unusually
strong, it may be appropriate to grant relief under S 6015(f) in limited situations where a requesting spouse knew
or had reason to know that the liability would not be paid, and in very limited situations where the requesting
spouse knew or had reason to know of an item giving rise to a deficiency.

(c) Significant benefit. The requesting spouse has significantly benefitted (beyond normal support) from the
unpaid liability or items giving rise to the deficiency. See S 1.6013-5(b).

(d) Lack of economic hardship. The requesting spouse will not experience economic hardship (within the
meaning of section 4.02(1)(c) of this revenue procedure) if relief from the liability is not granted.

(e) Noncompliance with federal income tax laws. The requesting spouse has not made a good faith effort to
comply with federal income tax laws in the tax years following the tax year or years to which the request for
relief relates.

(f) Requesting spouse's legal obligation. The requesting spouse has a legal obligation pursuant to a divorce decree
or agreement to pay the liability.

Refunds
2.130 A credit or refund can be obtained under the innocent spouse rules and, under certain circumstances,
under IRS's authority to grant equitable relief to a spouse (amounts paid from 7-22-98 TO 4-15-99). However,
the separate liability election may not be used to create a refund or to direct a refund to a particular spouse.

Tax Court Has Jurisdiction to Review Denial of Equitable Innocent

Spouse Relief in "Stand-Alone" Petition

2.140 Fernandez v. Commissioner, 114 T.C. No. 21; 2000 U.S. Tax Ct. LEXIS 27 (Tax Ct. May 10, 2000).

In a case in which the taxpayer's application was made directly through section 6015, rather than as part of a
section 6213 deficiency proceeding, the Tax Court held it had jurisdiction to review a denial of equitable
innocent spouse relief, assuming the taxpayer made an election under subsections (b) and/or (c).

In March 1999, Diane Fernandez submitted a request for relief from joint and several liability for tax year 1988,
pursuant to section 6015 (b), (c), and (f). The Service denied the request on the ground that she had actual and
constructive knowledge of the capital gains and the tax underpayment. Additionally, the determination letter
advised that Fernandez received a significant financial benefit when she received sales proceeds of more than
$19,000. After Fernandez filed a petition with the Tax Court, the Service moved to dismiss. It argued the Tax
Court had no jurisdiction to review a denial of subsection (f) relief.

Relying on Butler v. Commissioner, 114 T.C. No. 19; 2000 U.S. Tax Ct. LEXIS 25 (2000), the Tax Court said it
did. Initially, the court looked to the prefatory language in 6015(e)(1)("in the case of an individual who elects to
have subsection (b) or (c) apply") and determined the language did not confine the court's jurisdiction to review
of subsection (b) or (c) elections. Instead, it merely sets forth the procedural requirements necessary to obtain
Tax Court jurisdiction for all seeking innocent spouse relief. The court concluded that "before an individual may
petition this Court for review of innocent spouse relief, including relief under subsection (f), such individual must
make an election under subsections (b) and/or (c)." Statutory authority for its jurisdiction over subsection (f)
could be found in 6015(e)(1)(A) which states: "the individual may petition the Tax Court (and the Tax Court
shall have jurisdiction) to determine the appropriate relief available to the individual under this section." The
court interpreted "under this section" to include all subsections of 6015. As did Butler, the court held that the
legislative history makes it clear Congress did not intend to limit its review of 6015.

Previously in Butler, the Tax Court had held that a taxpayer can seek review of a denial of 6015(f) relief in a
section 6213 deficiency proceeding, if he or she applies for relief under subsection (b) or (c). Fernandez is
noteworthy because of its stance concerning "stand-alone" requests for relief.

2. Distinction Between Should Have Known and Actually Knew Gives Rise to 6015(c) Relief.

Charlton v. Commissioner, 114 T.C. No. 22; 2000 U.S. Tax Ct. LEXIS 29 (May 16, 2000).

A former husband was entitled to section (f) equitable relief where he knew of his wife's self-employment
income, but did not actually know of the amount of the omitted income.

In connection with a 1994 joint income tax return, the IRS determined a $15,000 deficiency arising from denial
of deductions related to rental cabins and reallocation of self-employment income from a physician transcription
service which the wife, Sarah Hawthorne, operated. Hawthorne and ex-husband, Fredie Charlton, who divorced
in 1995, separately asserted that they qualified for innocent spouse relief. The Tax Court consolidated the
petitions.

Citing Butler v. Commissioner, 114 T.C. No. 19 (2000), the Tax Court rebuffed the government's contention that
it lacked jurisdiction to decide whether Hawthorne was entitled to equitable relief pursuant to section 6015(f).
Because Hawthorne and the IRS suspended any activity relating to her claim while Charlton's case is pending,
the court indicated she could file a motion to seek Tax Court review if her application is denied. Meanwhile, the
court would delay entry of decision.

With respect to Charlton, the court held that he did not qualify for relief pursuant to section 6015(b). Though
Charlton asserted that he did not know and had no reason to know of the $22,000 understatement of the
transcription service's income, the court observed that he had prepared the income tax return based on summary
information his wife provided to him, and that he had "unfettered access" to the service's financial records which
were maintained in their home.

Nonelecting Spouse Entitled to Challenge Grant of Innocent Spouse Relief to Former Wife

2.41 Corson v. Commissioner, 114 T.C. No. 24; 2000 U.S. Tax Ct. LEXIS 30 (May 18, 2000).

The Tax Court allowed one former spouse to challenge the other electing spouse's claim for relief under section
6015 where both spouses were before the court in the same deficiency case. Under present law, Tax Court
jurisdiction to review innocent spouse claims arise either as an affirmative defense in a 6213(a) deficiency
proceeding or as review of administrative determination regarding relief (or failure to rule) in a "stand alone"
matter. Because Judith's claim was raised as an amendment to the couple's petition for deficiency
redetermination, the court considered her claim within the framework of deficiency jurisdiction.
Nonelecting Ex-Spouse May Intervene in Deficiency Case Where Other Spouse is Claiming 6015 Relief

2.42 King v. Commissioner, 115 T.C. No. 8; 2000 U.S. Tax Ct. LEXIS 52 (Aug. 10, 2000).

The Tax Court held nonelecting spouses are allowed to intervene in any proceeding in which the other spouse is
claiming section 6015 relief.

"Item Giving Rise to Deficiency" in Omitted Income Case Disputed

2.45 Cheshire v. Commissioner, 115 T.C. No. 16; 2000 U.S. Tax Ct. LEXIS 61 (Aug. 30, 2000).
In a split decision, the Tax Court held that in omitted income cases, section 6015(c)(3)(C) does not require
actual knowledge on the part of the electing spouse as to whether the entry on the return is or is not correct.
Pointing to legislative history, three judges dissented.

6015(c)
Kathryn was also not entitled to section 6015(c) relief. Here, the parties disputed whether she had actual
knowledge, at the time the joint return was signed, of "any item giving rise to the deficiency (or portion
thereof)." With respect to the knowledge component of the analysis, the court held that "the statute mandates
only a showing that the electing spouse knew of the item on the return that gave rise to the deficiency," but not
that knowledge of the tax consequences arising from the item or that the item reported on the return is incorrect.
Further, the knowledge standard is an "actual and clear awareness (as opposed to reason to know)" of the item's
existence. To the extent that legislative history arguably suggests otherwise, the court stressed that nowhere does
the statutory language "explicitly state or reasonably imply that relief is denied only where the electing spouse
has actual knowledge that the item giving rise to the deficiency ... is incorrectly reported on the return."

Turning to the meaning of the word "item," the court held that "in omitted income situations 'item' refers to the
item of income that should have been reported on the return." This definition is consistent with that used in other
sections of the Code. Additionally, the court was troubled that acceptance of an ignorance of the tax
consequences (aka law) defense would lead to "potentially any spouse who is not a certified public accountant
or tax attorney would be allowed to escape paying income tax."

6015(f)
The petitioner was entitled to section 6015(f) relief with respect to a portion of the accuracy-related penalty. The
court was satisfied that she believed that the portion of retirement distribution proceeds used to pay off the
mortgage on the family residence would be nontaxable. Further, she acted in good faith inasmuch as she trusted
and relied upon her husband when it came to the preparation of the tax returns, she asked him about the
potential tax ramifications, had no reason to doubt the truthfulness of his statements, and in fact believed him.
The court concluded that "[u]nder these circumstances, we do not believe petitioner had an obligation to inquire
further." Accordingly, she was entitled to relief as to the omitted retirement distribution proceeds, but not as to
the omitted interest income.

Concurrences
There were two concurrences. Judge Chiechi concurred in the result only. In his concurrence, Judge Thornton
construed the majority opinion to reject the Service's argument that actual knowledge of an "item" means actual
knowledge merely of the event or transaction giving rise to the deficiency. Five of the majority judges joined in
this concurrence.

Dissents
There were two dissenting opinions. The first, authored by Judge Parr, stressed that 6015 is a remedial statute
intended to provide broader relief than that provided by section 6013(e). Though agreeing that it was not
inequitable to hold the petitioner liable for the deficiency pursuant to section (f), Judge Parr was troubled that
the majority construed both the term "understatement" in 6015(b) and the word "item" in 6015(c) as
synonymous with "transaction."
In a lengthy dissent, Judge Colvin (joined by Judges Marvel and Parr) protested that the majority's construction
of 6015(c)(3)(C) "squarely conflicts" with the legislative history of 6015(c). Unlike the majority, he found the
phrase "item giving rise to a deficiency" to be ambiguous because it could refer to a transaction or activity or to
knowledge that an entry on a tax return was incorrect. Because of the sweeping changes to the innocent spouse
provisions in 1998, Judge Colvin advocated caution in applying interpretations of the prior law to section
6015(c). Under his reading of legislative history (including four separate items for support), "Congress intended
'actual knowledge' to be knowledge that the return is incorrect." Consequently, the majority disregarded this
requirement inasmuch as it held with respect to section (f) relief that the petitioner thought the reporting of the
distributions on her tax return was correct.

Finally, the dissent disparages the majority's treatment of prior authority. First, reliance on Wiksell v.
Commissioner, 215 F.3d 1335 (9th Cir. 2000)(unpub.), was inappropriate inasmuch as that opinion does not
discuss whether the actual knowledge of any item giving rise to a deficiency refers to incorrect reporting.
Second, the majority's failure to reconcile Charlton v. Commissioner (see above) with Cheshire will "inevitably
cause confusion because, both here and in Charlton, we found that the putative innocent spouse knew of the
activity which gave rise to the deficiency." If the majority intends to promulgate a new standard such that
knowledge of an income-producing transaction does not cause a putative innocent spouse to fail to qualify for
the separate liability election unless the putative innocent spouse knew the amount of income involved, then it
should so state.

Form 8857 & Publication 971

2.150 A taxpayer seeking innocent spouse relief should file form 8857 with the IRS. If the taxpayer is the
subject of an on-going audit you should raise the innocent spouse issue as soon as possible with the examining
officer. Review IRS Publication 971 prior to raising an innocent spouse defense. Beware of potential conflicts of
interest which will arise when you represent both parties. You may not be able to represent either if you
originally prepared the return in question.

Notice to Putative Guilty Spouse

2.160 When you file an innocent spouse claim for one taxpayer the IRS will notify the other spouse filing the
joint return. They will send that spouse a letter and ask if he/she will verify the statements of the taxpayer
seeking innocent spouse status. Imagine the response of some ex-spouses after a bitter divorce.

The Tax Court

2.170 To get Tax Court review of a deficiency, a taxpayer must file a petition with the Tax Court at
Washington, D.C., in response to a notice of deficiency (90-day letter, from IRS, within 90 days (150 days if the
notice is addressed to a person outside the U.S.) after the notice is mailed (i.e., postmarked). For 90-day letters
mailed after Dec. 31, '98, a petition is treated as timely if it's filed with the Tax Court on or before the last date
specified by IRS in the 90-day letter for filing it. ( IRC § 6213(a)) The Tax Court's jurisdiction generally is
limited to the review (without a jury) of deficiencies asserted by IRS (and not paid when the 90-day letter is
issued). It can order payment of a refund if it determines the taxpayer overpaid. ( IRC §6512(b)) But it can't
grant equitable relief. The Tax Court has jurisdiction to order a refund of any amount collected while IRS was
prohibited from collecting a deficiency by levy or court proceeding but only if a timely petition for a
re-determination of the deficiency has been filed and only with respect to the deficiency at issue. ( IRC §
6213(a))

Notice and Intervention

2.180 If the IRS denies an innocent spouse claim he/she may file a Tax Court petition pursuant IRC §§ 6320(c)
and 6330(d), added by §3401 of the Internal Revenue Service Restructuring and Reform Act of 1998, but the
statutes provide that upon judicial review of determinations made by IRS appeals, notice must be given the
putative “guilty spouse” as follows:

“(a) Notice: The Commissioner shall serve notice of the filing of the petition on the other individual filing the
joint return.
 (b) Intervention: If the other individual filing the joint return desires to intervene, then such individual shall file
a notice of intervention with the Court not later than 60 days after service of the notice by the Commissioner of
the filing of the petition, unless the Court directs otherwise, and attach to the notice of intervention a copy of
such notice of filing. All new matters of claim or defense in a notice of intervention shall be deemed denied.”

3. INJURED SPOUSE

3.10 Injured Spouse--a person filing a joint return with an overpayment of taxes which is offset by the spouse's
taxes, non-tax debt such as a student loan or back child-support. A claim may be filed to protect the injured
spouse's share of the joint overpayment.

Past-due Support
3.20 A taxpayer who

(a) files a joint return with a spouse who has a past-due tax obligation or support obligation and

(b) has income, prepaid credits from withholding, estimated tax payments, or refundable credits such as the
earned income credit, can recover his portion of a joint overpayment applied against the past-due child support
owed by the other spouse.

Form 8379
3.30 The taxpayer uses Form 8379—not Form 1040X —to file this injured spouse claim. If the joint return
hasn't yet been filed, he should attach Form 8379 to the joint return and write "Injured Spouse" in the upper left
corner of the return. If the joint return has already been filed, he should mail Form 8379 by itself to the Internal
Revenue Service Center where the joint return was filed. If the non-debtor spouse takes appropriate action and
secures his or her proper share of a tax refund from which the offset was made, IRS must request that the
Treasury Department's Financial Management Service (FMS) deduct that amount from amounts payable to HHS
or the state.

Offsets To Non-tax Federal Agency Debts

3.40 If a taxpayer filing a joint return with the debtor owing a past-due legally enforceable debt to a federal
agency takes appropriate action to secure his or her proper share of a tax refund against which an offset was
made, IRS must pay that person his or her share of the refund and request that the Treasury Department's
Financial Management Service (FMS) deduct that amount from amounts later payable to the creditor agency.
FMS and the creditor agency must adjust their debtor records accordingly. IRS must pay that person his or her
share of the refund. IRS must deduct the amount of the payment from amounts that are derived from later
reductions in refunds and are payable to the appropriate trust fund.

Community Property States

3.50 In a community property state (Texas), IRS was entitled to offset half of the refund due on a joint return
against a debt owed by the husband to a federal agency, even though all of the refund was related to the wife's
personal earnings, the husband's debt was incurred before the marriage, and then applicable Texas law provided
that a spouse's personal earnings were under her "sole management, control..." and that community property
under one spouse's sole management, control, etc. wasn't subject to any liabilities incurred by the other spouse
before the marriage. State law exemptions of this sort don't prevent the federal offset.

Award Of Fees
3.60 A refund due the taxpayer and her ex-husband (H) was applied to a past due child support obligation of
H. Taxpayer filed an Injured Spouse Claim (Form 8379) requesting her portion of the refund. IRS denied
taxpayer's request. The taxpayer was awarded fees because IRS's actions, after the suit was filed, were
"substantially unjustified" because they unnecessarily increased taxpayer's litigation costs by focusing on issues
of jurisdiction and venue rather than examining the merits of the taxpayer's substantive position.

4. IRC § 66 - TREATMENT OF COMMUNITY INCOME

Community Property and Community Income
4.10 Federal income tax law recognizes the principle of community income in community property states,
under which community income is treated as going half to each spouse even if one spouse earns all the
community income and the couple files separate returns. Under specified conditions, however, the Code relieves
a "separated," or "innocent" spouse from the above 50-50 allocation rule by allocating all the community income
to the earner-spouse. IRS may also disallow the benefits of community property laws to certain spouses. The
laws of the taxpayer's state (or country) of domicile (generally referred to as "local law," determine whether two
individuals are married and thus subject to a state's or country's community property laws. Local law also
determines whether a taxpayer has community property or community income. However, while local law
determines a person's rights to income or property, federal tax law determines the tax on those rights. Federal
taxes are affected by community property laws only if married taxpayers file separate returns while living in a
community property state.

California Community Property

4.20 Income of married taxpayers domiciled in California is generally taxed as community income—i.e., one
half to each spouse when filing separate returns. However, income from separate property, income from
property in non-community property jurisdictions treated by California as separate property, income that the
spouses previously agreed would be treated as income from separate property, and income after divorce or legal
separation is taxed as separate income from the spouse's separate property. A wife domiciled in California has a
vested interest in community property. For tax purposes, community property income is divided equally between
husband and wife. This is true even if the community income is derived from illegal sources (e.g., drug
trafficking) by one spouse without the knowledge of the other. Otherwise allowable deductions paid out of
community income are generally deductible one-half by each spouse.

Earnings Included as Community Income.

4.21 Under then applicable California law, there was a statutory presumption that a husband's earnings were
community property. Clear and satisfactory proof was required to contradict this presumption. That proof
included persuasive evidence of the existence of an agreement between a husband and wife changing the status
of the earnings from community property to separate property.

Tax Advantage
4.30 The tax advantage in filing separate returns, where it exists, is seldom large. Many tax cases on community
status in recent years involve separate returns of husband and wife living apart rather than united couples filing
separately for a tax benefit. In one case, married taxpayers who had always filed joint returns tried
unsuccessfully to take advantage of the community property laws. The issue involved cancellation of debt
(COD) income that passed through from a partnership interest that was community property. Taxpayers
excluded most of the COD income under the insolvency exception, Sec. 108, but maintained that the wife
shouldn't have to reduce her allocated portion of an NOL carryover by any of the excluded income because
COD income wasn't considered "income" under local (TX) community property law. The Tax Court rejected the
argument, pointing out that federal law defines what is "income" for federal tax purposes.

§ 66 Treatment of Community Income

4.40 The IRS may disallow the benefits of any community property law to any taxpayer with respect to any
income if the taxpayer acted as if solely entitled to the income and failed to notify the taxpayer's spouse before
the due date (including extensions) for filing the return for the taxable year in which the income was derived of
the nature and amount of the income.

§ 66 Standards
4.50 A married individual who doesn't file a joint return, and omits from his or her gross income his or her share
of community income (determined under the allocation rules of IRC § 879(a), is relieved from income tax
liability on the omitted income if both of these two requirements are met:

(1) The individual must establish lack of knowledge or reason to know of the omitted item,
(2) Under all the facts and circumstances it would be inequitable to include the item of community income in the
individual's gross income. In this case, the item will be included only in the other spouse's gross income (and not
in the gross income of the individual).

Benefit From Income

4.60 In determining whether it would be inequitable to include the item in the gross income of the spouse
lacking knowledge, the determination may include whether that spouse benefited from the untaxed income, and
whether the defense was promptly raised to prevent the statute of limitations from running on the other spouse.
Congress is concerned about the inequity of taxing an individual on community earned income of the other
spouse where the individual received no benefit from the earnings.

Example Of Benefitting From Income

4.70 A taxpayer benefitted from the income that was paid to and/or earned by her spouse during the years at
issue where at least a portion of that income was used to pay at least some of the couple's living expenses for
those years. These living expenses included expenses for groceries, gasoline, maintenance of the trailer house
where they lived, utilities, and meals at restaurants, as well as expenses attributable to their respective children,
and taxpayer's parents, who lived with them at various periods during the years at issue. Thus, the Tax Court,
affirmed by the Ninth Circuit, concluded it would not be inequitable for the taxpayer to include one-half of that
income in her gross income.
Proving Lack Of Benefit
4.80 Where a California housewife didn't benefit from her former husband's income beyond normal support, the
Tax Court determined that it would be inequitable to include unreported community income in her gross income
to the extent that she lacked knowledge of her husband's income. When she lived with her former husband, she
rented her dwellings, drove an old car, and had no credit cards. She took nothing away from the marriage except
an older, used car. Moreover, 16 years passed between the time that she and her former husband separated and
the time that she received a notice of deficiency from IRS about his earnings, of which she knew little or nothing
even at the earlier date.

Knowledge Of Amount
4.90 A taxpayer's knowledge of an item of community income must be determined with reference to her
knowledge of the particular income-producing activity. The exact amount of the item isn't determinative. Thus, a
claim that the innocent spouse didn't know the specific amount of the unreported community income was
irrelevant in meeting the above two requirements.

No Reason to Know
4.100 The "no reason to know" prerequisite wasn't met where the taxpayer-wife actively participated (as a
bookkeeper) in her husband's businesses that generated the unreported community income. The requirement also
wasn't satisfied where a music teacher knew and participated in her husband's real estate activities. Her
participation consisted of acting as a nominee on her husband's behalf in various real estate transactions,
attending real estate closings, and signing various documents. The couple's move from a moderate residence to a
home costing more than $300,000 should have made the wife aware of the improvement of their living
conditions and therefore the income from the community real estate.

Lack of Knowledge
4.110 The lack of knowledge requirement also wasn't met where the taxpayer-wife knew that the husband was
a full-time employee, or was engaged in income-producing business activities. Thus, where a taxpayer/wife
knew about her husband's income from his steel business, the requirement wasn't met. Contrary to her testimony
that she believed that the business was having financial difficulties, the wife knew that her husband, whose sole
source of income was his steel business, was able to make $2,000 a month child support payments to her and
mortgage payments on her property during the entire year in issue.

Illegal Income
4.120 However, where the taxpayer-wife believed that her husband was only in a legitimate occupation but the
husband's unreported community income was derived from illegal activities (such as narcotic trafficking or
embezzlement), the Tax Court won't attribute knowledge of the illegal activity or a portion of the income from
the illegal activity to the taxpayer-wife without evidence that either the marital community or the taxpayer-wife
benefitted from the unreported community income. The same rule was applied to relieve a taxpayer-wife from
tax liability on unreported interest income from secret certificate of deposits of her husband.

Income of Separated Spouses Under Community Property Laws.

4.130 Separated couples treat their income according to the statutes of their state, unless they meet the
conditions of spouses living apart all year, In some states, income earned after separation continues to be
community income before a decree of divorce. In other states, it's separate income. Depending upon the state, a
decree of separate maintenance may not dissolve community interest. On the other hand, the court in the state
issuing the decree may terminate the marital community and divide the property between the spouses.

Separation Agreement vs. Separation

4.140 A separation agreement dividing the community property between the spouses and providing that this
property along with future accumulations and the earnings of each spouse is to be separate property might, in
some states, end the marital community. In other states, the marital community will end when the husband and
wife permanently separate, even without a formal agreement Even if a taxpayer cannot qualify under § 66,
he/she might qualify for innocent spouse protection.

Denial of Community Property Law Benefits to Certain Spouses

4.150 If a spouse acts as if he or she is solely entitled to the community income and fails to notify the other
spouse of the nature and amount of the income before the return due date (including extensions), IRS may deny
any benefit of community property laws to such spouse. In other words, IRS may charge the spouse with the tax
on his or her entire income. The Tax Court applied this rule to attribute to (and thus tax) a husband the entire
community investment income where the wife wasn't notified of her share of such income and the husband
treated the entire investment income as his own. However, the rule didn't apply where taxpayer hand-delivered
to his wife (from whom he was separated) various tax documents, including his Forms W-2 and 1099, before the
due date of her return. And the Tax Court refused to permit IRS to disallow the benefits of the (Arizona)
community property laws to a married taxpayer who didn't act as if she were solely entitled to her wage income,
and didn't fail to notify her husband of that income, and where IRS was unable to offer any persuasive reason for
disregarding those community property laws. Thus, taxpayer, who didn't file a joint return (but whose return as
filed reflected "a fanciful approach to her Federal income tax responsibilities," including a negative number for
wages) was taxed on only one-half of her actual wages, not the entire wages that IRS asserted in its deficiency
notice. The Tax Court also rejected IRS's attempt to disallow the benefits of Arizona community property laws to
another taxpayer who lived separate from his wife, but who had provided substantial income for the benefit of
the marital community and had done so despite the fact that he wasn't under a court order compelling him to. It
didn't matter that the amounts he sent to his wife had fluctuated; the fluctuations were due to the changing
employment situations of the taxpayer and his wife.

IRC § 66(b) Only Available To IRS

4.160 IRC § 66(b) (footnote 42) can be used only by IRS in order to disallow the benefits of community
property laws to a taxpayer under certain prescribed conditions. By its plain language, it's not a relief provision
that can be used by a taxpayer to avoid his or her liability for tax on community income paid to and/or earned by
the taxpayer's spouse. IRC § 66(b) doesn't afford an "innocent spouse" remedy; a taxpayer can't rely on it to
claim innocent spouse relief. Where a taxpayer argued that because IRS had previously determined deficiencies
and assessed tax against her spouse with respect to income earned by and/or paid to the spouse, IRC § 66(b)
relieved her from including any part of that income, the Ninth Circuit affirmed the Tax Court's decision that her
argument was misdirected.

Theft loss deduction for appropriated spouse's community income share.

4.170 Where a spouse—usually the wife—has no control over her husband's community income and the
husband appropriates his wife's share of the community income, may the wife take a theft loss deduction for the
share she never received but nevertheless was required to report on her separate return? The Tax Court and the
Fifth Circuit say "yes" but the wife must first prove that her share was stolen (i.e., that the husband was a thief).
This wasn't proven in a case arising under the then Louisiana law where the husband was deemed "head and
master" of the marital partnership, and in a case arising under the then Texas law.

Observation: Because of the current Code relief provisions: one for spouses living apart; the other for "innocent
spouses", the much harder-to-prove theft loss deduction issue is little used. However, in appropriate cases it is
still available.

Texas Community Property.

4.180 Under the community property laws of Texas, spouses have an equal interest in the marital community.
Texas marital community includes income from most separate property. Where separate federal income tax
returns are filed, each spouse is taxed on one-half of their community income. A wife domiciled in Texas has a
present vested interest in community property, equal and equivalent to that of her husband, and one half of the
Assertion of spousal relief in refund claim. The spouse of a partner can assert the spousal relief rules of IRC §
6015, i.e., innocent spouse relief, the separate liability election, and equitable relief), in a claim for refund on the
ground that IRS failed to relieve the spouse from liability for an adjustment of a partnership item, including
liability for a penalty relating to such an adjustment. The refund claim has to be filed within six months after the
day on which IRS mails to the spouse the notice of computational adjustment. If the claim is not allowed, the
spouse can file a refund suit. The suit must be brought within the refund suit limitations period specified in IRC
§ 6532(a). For purposes of any claim or suit under this provision, the treatment of the partnership items (and the
applicability of any penalties) under the settlement or administrative or judicial determination (whichever is
appropriate) that gave rise to the liability in question is conclusive.

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