Taxpayer First Act changes innocent spouse relief

Editor: Mark Heroux, J.D.

The Taxpayer First Act (TFA), P.L. 116-25, was for the most part an improvement for taxpayer rights. Congress strengthened the Office of the Taxpayer Advocate, mandated new taxpayer protections for IRS third-party contacts, and reaffirmed the independence of IRS Appeals. Despite all of these positive changes, in one area, the TFA was a step backward for taxpayer rights. The TFA changed the Tax Court’s scope of review in innocent spouse petitions filed after July 1, 2019, from de novo to a review of the administrative record, with limited exceptions (Sec. 6015(e)(7)). While this change might sound minor, it significantly affects how an innocent spouse case is prepared and places an increased burden on return preparers who interact with a taxpayer who potentially has an innocent spouse claim.

Prior to the passage of the TFA, it was not unusual for innocent spouse cases to start late in a deficiency proceeding or as part of a collections case. Taxpayers were often three to five years removed from the actual filing of the return and able to use hindsight to evaluate the strength of their case.

The Tax Court’s prior scope of review was a de novo, or “we can consider all of the evidence presented even if it is something new” standard of review that made hindsight extremely valuable. If a taxpayer seeking innocent spouse relief learned of his or her spouse’s gambling winnings years after the return was filed, it made no difference. The taxpayer could discuss the facts surrounding the state of the marriage, the imbalance of financial power, any mental or physical abuse, and the facts surrounding the income at the time of trial. Usually by this point, the marriage had dissolved, and the person requesting innocent spouse relief had a margin of physical and emotional safety that allowed him or her to freely testify.

This is no longer necessarily the case. The Tax Court’s current scope of review is primarily the administrative record. It can only consider facts contained in the administrative record unless the facts presented were newly discovered or previously unavailable. Putting these two exceptions aside for the moment, the change to the scope of review means that innocent spouse cases are built based on information available years earlier, when the taxpayer seeking the innocent spouse relief did not have the benefit of extended hindsight and was likely more inextricably linked to the other spouse.

Beyond those factors, getting facts into the administrative record takes deliberate thought. Preserving the facts and circumstances of the taxpayers’ relationship requires written correspondence with the IRS. There are small windows where the IRS can consider innocent spouse substantiation, such as during the filing of Form 8857, Request for Innocent Spouse Relief, and the leadup to an Appeals hearing, and the innocent spouse must rely heavily on nonobvious terms of art. Despite the best efforts of the IRS to draft forms that educate taxpayers on what type of narrative is necessary, represented taxpayers fare better during the innocent spouse process than pro se taxpayers.

From the tax practitioner’s point of view, the accelerated timeline and limited opportunities to introduce evidence heightens the risk of conflicts. Innocent spouse cases often span several years. A return preparer who files a joint return with a tax balance due for a married couple could potentially still be preparing returns for the couple when a Collection Due Process (CDP) hearing request is submitted. A Form 12153, Request for a Collection Due Process or Equivalent Hearing, contains a checkbox notated “My spouse is responsible,” and the Appeals officer who hears the CDP request can consider whether granting innocent spouse relief is appropriate.

This option to check the box for innocent spouse relief creates a conflict of interest for the return preparer if both spouses are still clients. Since innocent spouse relief is an allocation of tax liability instead of an abatement, the spouse who is making the request has a direct conflict with his or her spouse over who pays what. Under Section 10.29 of Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), practitioners “shall not represent a client before the Internal Revenue Service if the representation involves a conflict of interest. A conflict of interest exists if . . . the representation of one client will be directly adverse to another client.”

However, failing to check the box on Form 12153 when it would be appropriate for the spouse filing the form may cause other problems under the new rules. Under a de novo standard of review, failing to check the innocent spouse box on a CDP hearing request could be considered a harmless error. The requesting taxpayer could independently file a Form 8857. If that was denied, he or she could request a separate Appeals conference, and, if that was denied, the requesting spouse could introduce all the evidence he or she wished during a Tax Court trial. Under the current standard of review, things are different. Innocent spouse cases frequently involve married taxpayers with drastic differences in earnings. It cannot be assumed that each spouse will have access to representation. If the innocent spouse taxpayer is a stay-at-home parent or some other type of nonearning spouse, failure to check the box may deprive him or her of the only chance at being represented at an Appeals hearing. Without representation, taxpayers may not be able to identify and adequately document the innocent spouse factors and are at higher risk for a denial not only at Appeals but at Tax Court as well.

One of the biggest risk factors for an innocent spouse claim creating a conflict for the return preparer is what type of knowledge the preparer has about the client’s relationship and financial activity. For example, a return preparer who knows his or her client is self-employed, gambles, and puts his or her family on a strict allowance is much more likely to have a conflict of interest than a return preparer who knows less about the client’s personal life and completes a simple W-2 tax return. While Circular 230 does require actual knowledge of a client’s omission in Section 10.21 or of an improper solicitation in Section 10.30, it does not have a specific-knowledge standard for conflicts.As such, the mere suspicion that an innocent spouse claim might exist is not enough to trigger a conflict.

The important takeaway for tax return preparers to remember when it comes to potential innocent spouse cases is that the rules have changed. An inchoate innocent spouse claim can no longer be overlooked as in previous years when there was a way for claims to be effectively presented years into the future. If the facts support a claim, there may be an actual conflict that cannot simply be ignored in hopes that it will go away.

EditorNotes

Mark Heroux, J.D., is a tax principal in the Tax Advocacy and Controversy Services practice at Baker Tilly US, LLP in Chicago.

For additional information about these items, contact Mr. Heroux at 312-729-8005 or mark.heroux@bakertilly.com.

Unless otherwise noted, contributors are members of or associated with Baker Tilly US, LLP.