NewsNotes

Lesli S. Laffie, J.D., LL.M.

Innocent Spouse Relief • Offers in Compromise • International Tax Treaties (Box)

Regulations

Innocent Spouse Relief

The IRS has issued final regulations (TD 9003) on Sec. 6015 relief from joint and several liability (i.e., innocent spouse relief). The final rules reflect law changes made by the Internal Revenue Service Restructuring and Reform Act of 1998 and the Community Renewal Tax Relief Act of 2000, and provide guidance to married individuals filing jointly who are seeking relief from joint and several liability.

Under the final regulations, if a requesting spouse only asks for equitable relief under Sec. 6015(f) and does not elect Sec. 6015(b) or (c) relief, the IRS cannot grant such relief. However, if the IRS determines that the requesting spouse may be eligible for this relief, it will contact the requesting spouse to see if he or she wants to elect the additional relief.

Sec. 6015 relief is not available if the requesting spouse has signed a closing agreement or offer in compromise disposing of the same liability or if one spouse transferred assets to the other spouse as part of a fraudulent scheme. Further, the IRS may allocate any item between the spouses if it establishes that such allocation is appropriate, due to fraud by one or both spouses.

The regulations define an "item" as that which is required to be listed separately on a return or any required attachments; an "erroneous item" is any item resulting in a tax understatement or deficiency, to the extent the item is omitted from or improperly reported on a return. Penalties and interest are not erroneous items.

The final regulations (1) list factors for determining whether holding a requesting spouse liable for an understatement would be inequitable and (2) contain rules for allocating a deficiency under Sec. 6015(c) for spouses who are divorced, legally separated or not members of the same household.

Finally, the regulations provide rules on the nonrequesting spouse's right to notice and to participate in the administrative determination of whether the requesting spouse is entitled to Sec. 6015 relief.

Offers in Compromise

Final regulations (TD 9007), effective July 23, 2002, discuss offers in compromise (OICs) and explain various changes made by previous legislation.

Sec. 7122 requires the IRS to develop guidelines for determining whether a compromise offer is adequate to resolve a dispute. Factors such as equity, hardship and public policy are critical to this determination.

A "compromise" is an agreement between a taxpayer and the IRS that settles a tax liability for less than the total amount determined and assessed. If payment in full is not achievable immediately, the IRS can allow taxpayers to pay over time through installment agreements.

Under the final regulation, compromise is permitted when there is no doubt as to liability or collectibility, and compromise would promote effective tax administration because (1) collection of the liability would create economic hardship or (2) compelling public policy or equitable considerations would provide a sufficient basis for compromising the liability. However, a compromise on hardship and public policy/equity bases may not be authorized if it would undermine tax compliance.

Economic hardship: The final regulation refers to Regs. Sec. 301.6343-1's economic hardship standard–the inability to pay reasonable basic living expenses. The IRS must consider a taxpayer's age, employment status and history, number of dependents and other "unique circumstances."

The final regulation includes a nonexclusive list of factors that support a finding of economic hardship, and examples.

Businesses cannot argue economic hardship. According to the IRS, an economic hardship standard for non-individuals does not necessarily promote effective tax administration. However, even if a business or other nonindividual is unable to compromise on liability or collectibility grounds, compelling public policy/equity considerations may allow for compromise.

Facts such as the number of dependents and the age and health of the taxpayers and their dependents must be considered under Regs. Sec. 301.6343-1 in making economic-hardship determinations. One factor supporting an economic-hardship finding may be that all available funds are used for dependent care.

Policy and equity: The regulation clarifies the types of cases that may qualify for a compromise on the ground that collection of the full liability would adversely affect the overall tax system. A taxpayer seeking compromise on that basis must identify compelling public policy/equity considerations for compromise, even though a similarly situated taxpayer may have paid his liability in full on that basis. Before accepting such an offer, the IRS must conclude that collection of the full liability would undermine public confidence in the tax laws.

According to the regulations, in rare cases, a taxpayer's belief that a liability was caused (in whole or part) by IRS delay or third-party actions may be appropriate for compromise.

Amount of compromise: The final regulation sets forth the permissible reasons for compromise, one of which must be established to accept a compromise. However, it does not prescribe the amount that must be offered. The IRS has the discretion to determine the amount payable, future compliance or other conditions precedent to satisfy a liability for less than the amount due.

Further, the regulation provides for the development and publication of national and local living allowances that allow taxpayers entering into offers to cover their basic living expenses. The determination of whether the published standards should be applied in any particular case must be based on individual facts and circumstances. The IRS will continue to determine the appropriate means for publishing these standards.

Miscellaneous: The regulation expands the Sec. 7122(c)(3)(A) rule that bars rejection of an offer by a low-income taxpayer based solely on the amount offered. This rule now applies to all taxpayers, regardless of income level. Offers will be rejected only when the IRS determines that no basis for compromise is present or that the offer is unacceptable under applicable policies and procedures.

All proposed rejections of OICs will receive independent administrative review prior to final rejection; taxpayers may appeal any rejection to the IRS Office of Appeals. However, the IRS's return of an OIC because the taxpayer (1) submitted it solely to delay collection or (2) failed to provide requested information, does not constitute a rejection and cannot be appealed.