25.18.3  Innocent Spouse Relief and Community Property

25.18.3.1  (03-04-2011)
IRC 6015

  1. Under IRC 6015, a spouse may be eligible for relief from joint and several liability on a joint return. Determinations under this section are made without regard to community property. IRC 6015(a). Therefore, the existence of community property does not impact on IRC 6015 determinations.

25.18.3.2  (02-15-2005)
IRC 66

  1. The Supreme Court, in Poe v. Seaborn, 282 U.S. 101 (1930), held that spouses receiving income that is community property and filing separate returns are each required to report half of each item of community property income. This case required a spouse to report half of community property income even if the spouse had not received or benefited from any of the income. Congress enacted IRC 66 to address this problem. See S. Rep. No. 96-1036, at 8 (1980). IRC 66 grants spouses relief from the community property income splitting requirements in certain circumstances.

25.18.3.3  (03-04-2011)
Effect of Innocent Spouse Relief

  1. The effect of innocent spouse relief is to make a spouse no longer liable for a particular tax. It removes or prevents the assessment of tax against a spouse. It does not, however, affect the ability of the Service to pursue collection remedies against the nonliable spouse’s interest in community property. United States v. Stolle, 2000-1 U.S.T.C. ¶ 50,329, 86 A.F.T.R.2d ¶ 2000-5043 (C.D. Cal. 2000). This is true even if this has an adverse impact on the nonliable spouse who has received the innocent spouse relief. For example, even if a spouse receives innocent spouse relief, if state law would allow a private creditor to garnish the nonliable spouse’s wages for a debt of the liable spouse, the Service could still collect from this property.

  2. IRC 6015(g) does not override the Service’s ability to offset payments made from community property under state law. Subject to other limitations in the Code, IRC 6015(g) allows taxpayers who have received innocent spouse relief to receive refunds of certain payments they have made toward the liability. However, the Service may still be able to retain all or part of the payments that would otherwise be refundable under IRC 6015(g), if they were made from community property and the Service has a state law remedy against the community property. Ordlock v. Commissioner, 126 T.C. 47 (2006).

25.18.3.4  (03-04-2011)
General Provisions of IRC 66

  1. IRC 66 has three subsections that could affect the reporting of community property income. IRC 66(a) provides an exception to the general rule of community property income splitting. IRC 66(b) allows the Service to shift the incidents of taxation to the other spouse if certain requirements are met. IRC 66(c) grants relief to spouses from reporting half of particular items of community property income. IRC 66 applies only to community income, as defined by state law. Some of the requirements of the section can be quite complex. Pro forma workpapers with checksheets and other information concerning IRC 66 and its subsections are included in Exhibit 25.18.3-1.

25.18.3.5  (02-15-2005)
Other Liabilities and Collection Remedies

  1. IRC 66 does not negate liability that arises against a spouse under the operation of other (non-community property) laws. For example, while it might negate a spouse's direct liability for a tax, it will not negate transferee liability if it applies. Treas. Reg. 1.66-1(c). It also does not negate any collection remedies based on state law against community property in the hands of the other spouse. For example, if the Service has a remedy against the liable spouse based on collecting from all community property, the fact that the other spouse received relief under IRC 66 will not eliminate that remedy. Cf. United States v. Stolle, 2000-1 U.S.T.C. ¶ 50,329, (C.D. Cal. 2000) (with respect to IRC 6015 ).

25.18.3.6  (03-04-2011)
Transfer of Liability

  1. Where IRC 66 applies, the items of community property upon which the requesting spouse receives relief are included in the income of the nonrequesting spouse, but only as long as the statute of limitations is open. Requests for relief under IRC 66, except for equitable relief, usually are required to be filed before the statute of limitations on assessment expires with respect to the nonrequesting spouse’s year subject to the request. The time for filing a claim for equitable relief is not tied into the statute of limitations for assessments with respect to the nonrequesting spouse. See IRM 25.18.3.15(2). Consideration should be given to protecting the statute of limitations regarding the nonrequesting spouse if it is still open when the request is received. If the shifting of the income creates a deficiency, then the deficiency procedures apply to assess the additional tax.

25.18.3.7  (02-15-2005)
Relief Not Available If Fraudulent Scheme, Closing Agreement or Offer In Compromise

  1. IRC 66 relief is not available if the spouse transferred assets to the other spouse as part of a fraudulent scheme. Treas. Reg. 1.66-4(f). IRC 66 relief is not available if the spouse entered into a closing agreement (other than an agreement pursuant to IRC 6224(c) as to partnership items) that disposes of the same liability that is the subject of the request for relief. Relief is also not available if the requesting spouse has entered into an offer in compromise with the Service with respect to the liability. Treas. Reg. 1.66-4(h)

25.18.3.8  (03-04-2011)
IRC 66(a) - Treatment of Community Income Where Spouses Live Apart

  1. General Provisions of IRC 66(a). Under IRC 66(a), if spouses meet certain requirements, they do not report most community property income under community property rules.

  2. Requirements. IRC 66(a) has the following requirements:

    1. The spouses are married to each other at any time during the calendar year;

    2. The spouses live apart at all times during the calendar year;

    3. The spouses do not file a joint return with each other for a taxable year beginning or ending during the calendar year;

    4. One or both spouses have earned income that is community income for the calendar year; and

    5. No portion of such earned income is transferred (directly or indirectly) between such spouses before the close of the calendar year.

  3. Effect of IRC 66(a). If IRC 66(a) applies, spouses report their community income in accordance with IRC 879(a). Under IRC 879(a), earned income (other than trade or business income) is taxed to the spouse who earned it. Trade or business (Schedule C) income is treated as the owner spouse's, unless the other spouse exercised substantially all management and control over the business, in which case the income is treated as the other spouse's. IRC 879(a)(2) and IRC 1402(a)(5). Income from a partnership is taxed to the partner spouse. IRC 879(a)(2) and IRC 1402(a)(5). Community income derived from separate property of one spouse is treated as the income of that spouse. IRC 879(a)(3). All other community income is treated as provided under the applicable state community property law. IRC 879(a)(4).

  4. Living apart. For purposes of the requirement of IRC 66(a), living apart requires that spouses maintain separate residences. Treas. Reg. 1.66-2(b). A temporary absence is not living apart as contemplated by this section. Treas. Reg. 1.66-2(d), Example 1.

  5. Transferred income. Transferred income does not include de minimis amounts of earned income that is transferred between the spouses. Amounts transferred for the benefit of the spouses' child are not treated as a direct or indirect transfer of income. Income transferred between spouses is presumed to be a transfer of earned income, although the presumption is rebuttable. Treas. Reg. 1.66-2(c).

25.18.3.9  (03-04-2011)
IRC 66(c) - Traditional Relief

  1. IRC 66(c) is a relief provision that removes the burden of reporting half of specific items of community property income from a spouse. The section 66 regulations refer to it as "traditional relief." Treas. Reg. 1.66-4.

  2. Traditional relief under IRC 66(c) has the following requirements:

    1. The individual did not file a joint return;

    2. The individual did not include in income for the taxable year an item of community property income that, under the rules of IRC 879, would be properly includible in the income of the other spouse ( i.e., if the spouses were not subject to community property laws the item would be reportable by the other spouse);

    3. The individual establishes that he or she did not know, or have reason to know, of the item of community income; and

    4. Taking into account all facts and circumstances it would be inequitable to include the item of community income in such individual's gross income.

  3. Income is Shifted. If the requirements are met, then the unreported item of income will be taxed wholly to the other spouse, and not split. IRC 66(c).

  4. Knowledge or Reason to Know. For purposes of the knowledge requirement of IRC 66(c), a requesting spouse has knowledge or reason to know if he or she actually knew of the item of community income or a reasonable person in similar circumstances would have known of the item of community income. Treas. Reg. 1.66-4(a)(2). All the facts and circumstances are considered. Relevant factors include, but are not limited to, the nature of the item of community income, the amount of the item relative to other income items, the couple's financial situation, the requesting spouse's educational background and business experience, and whether the item of community income was reflected on prior years' returns (e.g., investment income omitted that was regularly reported on prior years' returns). Treas. Reg. 1.66-4(a)(2).

  5. The knowledge requirement is interpreted strictly. If a spouse is aware of the source of community income or an income producing activity, the requesting spouse is considered to have knowledge or reason to know of the item of community income even if the spouse does not know the specific amount received. McGee v. Commissioner, 979 F.2d 66 (5th Cir. 1992); Beck v. Commissioner, T.C. Memo. 2001-198; Treas. Reg. 1.66-4(a)(2)(ii). However, if the spouse knows that the earning spouse has some types of income but not other types, he or she may be relieved of tax liability for the latter but not the former. Roberts v. Commissioner, T.C. Memo. 1987-391, aff'd, 860 F.2d 1235 (5th Cir. 1988).

  6. Inequitable. In determining whether it would be inequitable to hold a spouse liable, all the facts and circumstances are considered. An important factor is whether the spouse significantly benefited, directly or indirectly, from the item. This includes transfers of property or rights to property, including transfers several years after the fact. Normal support is not benefit. Other factors include desertion, divorce or separation. Treas. Reg. 1.66-4(a)(3); see also Rev. Proc. 2003-61, 2003-32 I.R.B. 296.

  7. Limitations. Traditional IRC 66(c) relief is not available in underpayment cases, it is only available in understatement cases.

25.18.3.10  (02-15-2005)
Equitable Relief Under IRC 66(c) Generally

  1. The Service may relieve a taxpayer of liability for any unpaid tax or any deficiency or any portion thereof attributable to an item of community income for which relief is not available under IRC 66(c), if taking into account all the facts and circumstances, it is inequitable to hold the taxpayer liable. IRC 66(c). In making this determination, Rev. Proc. 2003-61, 2003-32 I.R.B. 296, should be consulted.

25.18.3.11  (02-15-2005)
Threshold Requirements for IRC 66(c) Equitable Relief

  1. To qualify for equitable relief, a requesting spouse must meet the following threshold requirements:

    1. The requesting spouse must apply for relief no later than two years after the Service's first collection activity after July 22, 1998, with respect to the requesting spouse;

    2. The nonrequesting spouse must not have transferred assets to the requesting spouse as part of a fraudulent scheme, and in addition if disqualified assets were transferred, relief can only be granted to the extent it exceeds the value of those assets;

    3. The requesting spouse did not file or fail to file the return with fraudulent intent;

    4. The income tax liability from which the requesting spouse seeks relief is attributable to an item of the nonrequesting spouse, unless one of the following exceptions apply:
      (1) Operation of community property law. If the item is attributable or partially attributable to the requesting spouse solely due to the operation of community property law, then for this purpose the items will be considered to be attributable to the nonrequesting spouse.
      (2) Nominal ownership. If the item is titled in the name of the requesting spouse, it is presumptively attributable to the requesting spouse. If, for example, the requesting spouse can show that despite the state of title, the item actually belongs to the non requesting spouse, then the item will be attributed to the nonrequesting spouse.
      (3) Misappropriation of funds. If the requesting spouse did not know, and had no reason to know, that funds intended for the payment of taxes were misappropriated by the nonrequesting spouse for the nonrequesting spouse's benefit, the Service will still consider granting equitable relief, although the underpayment may be attributable in part or in full to an item of the requesting spouse.
      (4) Abuse not amounting to duress. If the requesting spouse establishes that he or she was the victim of abuse prior to the time the return was signed, and that, as a result of the prior abuse, the requesting spouse did not challenge the treatment of any items on the return for fear of the nonrequesting spouse's retaliation, the Service will consider granting equitable relief although the deficiency or underpayment may be attributable in part or in full to an item of the requesting spouse. Section 4.01, Rev. Proc. 2003–61, 2003-32 I.R.B. 296.

  2. Assuming the threshold requirements are met, the Service will then consider other factors in determining whether to grant IRC 66(c) relief.

25.18.3.12  (02-15-2005)
Other Factors Considered With Respect to Equitable Relief

  1. Assuming the threshold requirements are met, the following is a partial list of the positive and negative factors listed in Rev. Proc. 2003-61 that will be taken into account in determining whether to grant full or partial equitable relief under IRC 66(c). No single factor will be determinative of whether equitable relief will or will not be granted in any particular case. Rather, all factors should be considered and weighed appropriately. The list is not intended to be exhaustive:

    1. Marital status. The Service will consider the requesting spouse is separated (whether legally separated or living apart) or divorced from the nonrequesting spouse. Separation does not include a temporary absence.

    2. Economic hardship. The Service will consider the requesting spouse would suffer economic hardship if relief from the liability is not granted.

    3. Knowledge or reason to know:
      (1) Underpayment cases. In the case of an income tax liability that was properly reported but not paid, the Service will consider the requesting spouse did not know and had no reason to know that the nonrequesting spouse would not pay the income tax liability.
      (2) Deficiency cases. In the case of an income tax liability that arose from a deficiency, the Service will consider the requesting spouse did not know and had no reason to know of the item giving rise to the deficiency. Reason to know of the item giving rise to the deficiency will not be weighed more heavily than other factors. Actual knowledge of the item giving rise to the deficiency, however, is a strong factor weighing against relief. This strong factor may be overcome if the factors in favor of equitable relief are particularly compelling. In those limited situations, it may be appropriate to grant relief under IRC 66(c) even though the requesting spouse had actual knowledge of the item giving rise to the deficiency.
      (3) Reason to know. For purposes of determining knowledge or reason to know, the Service will consider the requesting spouse's level of education, any deceit or evasiveness of the nonrequesting spouse, the requesting spouse's degree of involvement in the activity generating the income tax liability, the requesting spouse's involvement in business and household financial matters, the requesting spouse's business or financial expertise, and any lavish or unusual expenditures compared with past spending levels.

    4. Nonrequesting spouse's legal obligation. The Service will consider whether the nonrequesting spouse has a legal obligation to pay the outstanding income tax liability pursuant to a divorce decree or agreement. This factor will not weigh in favor of relief if the requesting spouse knew or had reason to know, when entering into the divorce decree or agreement, that the nonrequesting spouse would not pay the income tax liability.

    5. Significant benefit. The Service will consider whether the requesting spouse received significant benefit (beyond normal support) from the unpaid income tax liability or item giving rise to the deficiency. Treas. Reg. 1.6015-2(d).

    6. Compliance with income tax laws. The Service will consider whether the requesting spouse has made a good faith effort to comply with income tax laws in the taxable years following the taxable year or years to which the request for relief relates.

    7. Other factors. There are other factors that, if present in a case, will weigh in favor of equitable relief, but will not weigh against equitable relief if not present in a case, including, but not limited to, the following:
      (1) Abuse. The Service will consider whether the nonrequesting spouse abused the requesting spouse. The presence of abuse is a factor favoring relief. A history of abuse by the nonrequesting spouse may mitigate a requesting spouse's knowledge or reason to know.
      (2) Mental or physical health. The Service will consider whether the requesting spouse was in poor mental or physical health on the date the requesting spouse signed the return or at the time the requesting spouse requested relief. The Service will consider the nature, extent, and duration of illness when weighing this factor.

25.18.3.13  (02-15-2005)
IRC 66(b) - Denial of Community Property Benefits Where Spouse Not Notified

  1. IRC 66(b) may be used by the Service to require one spouse to report 100% of an item of community property income.

  2. Under this section, the Service may disallow the benefits of any community property law (i.e., place the entire incidence of tax for a community property item on a particular spouse) if:

    1. The item was treated by that spouse as if he or she were solely entitled to the income, and

    2. That spouse failed to notify the other spouse by 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.

  3. Effect of IRC 66(b). If the Service disregards the community property allocation pursuant to section 66(b), the effect is to shift the item of income to that spouse. SeeIRC 66(b); Treas. Reg. 1.66-3(b). The tax must be assessed against that spouse in accordance with IRC 6212 (deficiency procedures).

  4. IRC 66(b) not a relief provision. Only the Service can invoke IRC 66(b). It is not a relief provision that can be invoked by a taxpayer to escape liability. Hardy v. Commissioner, 181 F.3d 1002 (9th Cir. 1999); Drummer v. Commissioner, T.C. Memo. 1994-214, aff’d without published opinion, 68 F.3d 472 (5th Cir. 1995)

  5. Solely entitled to income. Whether a spouse has acted as if he or she was solely entitled to the income is a facts and circumstances determination focusing on whether the spouse used, or made available, the item of income for the benefit of the marital community. Treas. Reg. 1.66-3(a). Where the community property at issue is deposited into a joint account or an account over which both spouses have signature authority, the spouse who deposited the funds did not act as though he or she was solely entitled to the funds. Cox v. Commissioner, T.C. Memo. 1993-559; Drummer v. Commissioner, T.C. Memo. 1994-214, aff’d without published opinion, 68 F.3d 472 (5th Cir. 1995). Similarly, where a spouse sends a portion of the funds to the other spouse, that spouse has not acted as though he or she was solely entitled to the funds. Mischel v. Commissioner, T.C. Memo. 1997-350; Treas. Reg. 1.66-3(c), Example 1(ii). On the other hand, if the community income is retained by one spouse and spent at his or her discretion, that spouse has acted as though he or she was solely entitled to the income. Treas. Reg. 1.66-3(c), Example 1(i).

  6. Notification of nature and amount of income. Providing a copy of a Form 1099 or Form W-2 satisfies the notification of the nature and amount of income requirement. If this is done before the due date of the return (including extensions), it makes IRC 66(b) inapplicable. Treas. Reg. 1.66-3(c), Example 2.

  7. If a notice of deficiency is being issued shifting the incidence of tax from one spouse to the other in reliance on IRC 66(b), this should be stated in the notice. The determination must be supported by evidence that IRC 66(b) applies. If the notice fails to do this, the burden of proof may be shifted to the Service. Shea v. Commissioner, 112 T.C. 183 (1999).

25.18.3.14  (02-15-2005)
Filing Requests for Relief Under IRC 66

  1. A request for relief under IRC 66 should be made by filing a Form 8857, Request for Innocent Spouse Relief, or equivalent form. The form must be signed under the penalties of perjury, indicate why relief is appropriate, and include the nonrequesting spouse's name and taxpayer identification number. The requesting spouse must also comply with the Service's reasonable requests for information that will assist the Secretary in identifying and locating the nonrequesting spouse. Treas. Reg. 1.66-4(j).

25.18.3.15  (03-04-2011)
Time for Filing Requests for Relief Under IRC 66

  1. Earliest time for filing a request. The earliest time for submitting a request for relief under IRC 66 (other than a request for equitable relief from unpaid tax) is the date the requesting spouse receives notification of an audit or a letter or notice from the Service stating that there may be an outstanding liability with regard to that year. Request for equitable relief from unpaid tax can be filed with the tax return or after the return is filed. Treas. Reg. 1.66-4(j). Premature claims will not be considered. Treas. Reg. 1.66-4(j)(2)(iii).

  2. Latest time for filing a request. Requests for relief under section 66, except for requests for equitable relief under IRC 66(c), can be filed no later than 6 months before the statute of limitations on assessment expires with respect to the nonrequesting spouse’s year subject to the request. If, however, the examination begins during that six month period, the request must be filed within 30 days of the commencement of the examination. Treas. Reg. 1.66-4(j)(2)(i). Requests for equitable relief for unpaid tax must be filed 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. Treas. Reg. 1.6015-5(b)(1). The Court of Appeals for the Seventh Circuit in Lantz v. Commissioner, --- F.3d ----, 2010 WL 2267046 (7th Cir. Jun 08, 2010) (NO. 09-3345) has held that the 2-year limitation period on claims for equitable relief under Treas. Reg. 1.6015-5(b)(1) is valid. Collection activity means an IRC 6330 (levy) notice; an offset of an overpayment of the requesting spouse against a liability under IRC 6402; the filing of a suit by the United States against the requesting spouse for the collection of the joint tax liability; or the filing of a claim by the United States in a court proceeding in which the requesting spouse is a party or which involves property of the requesting spouse. Collection activity does not include a notice of deficiency, the filing of a notice of tax lien or a demand for payment of the tax. Treas. Reg. 1.6015-5(2)(i).

  3. When the Secretary receives a request for relief from Federal income tax liability resulting from the operation of community property law under this section, the Service must send a notice to the nonrequesting spouse's last known address that informs the nonrequesting spouse of the requesting spouse's request for relief. The notice must provide the nonrequesting spouse with an opportunity to submit any information for consideration in determining whether to grant the requesting spouse relief from the Federal income tax liability resulting from the operation of community property law. The Service will share with each spouse the information submitted by the other spouse, unless the Service determines that the sharing of this information will impair tax administration. Treas. Reg. 1.66-4(k). As to what information might impair tax administration, coordinate with the Disclosure Office.

25.18.3.16  (03-04-2011)
Refunds Under IRC 66

  1. There are no limitations on refunds within IRC 66. Other limitations in the Code, such as IRM 6511, may apply. See, e.g., IRM 28.18.3.3, Effect of Innocent Spouse Relief.

  2. With respect to equitable relief, the allowability of refunds depends on whether the equitable relief involves an underpayment or a deficiency.

    1. Deficiency Cases. In a case involving a deficiency, a requesting spouse is eligible for a refund of certain payments made pursuant to an installment agreement that the requesting spouse entered into with the Service, if the requesting spouse has not defaulted on the installment agreement. Only installment payments made after the date the requesting spouse filed the request for relief are eligible for refund. Additionally, the requesting spouse must establish that he or she provided the funds for which he or she seeks a refund. A requesting spouse is not in default if the Service did not issue a notice of default to the requesting spouse or take any action to terminate the installment agreement.

    2. Underpayment Cases. In a case involving an underpayment of income tax, a requesting spouse is eligible for a refund of separate payments that he or she made after July 22, 1998, if the requesting spouse establishes that he or she provided the funds used to make the payment for which he or she seeks a refund. A requesting spouse is not eligible for refunds of payments made with the joint return, joint payments, or payments that the nonrequesting spouse made. See Rev. Proc. 2003-61, 2003-32 I.R.B. 296.

25.18.3.17  (02-15-2005)
Judicial Review of Denial of IRC 66 Relief

  1. Denial of IRC 66 relief (including equitable relief) in a deficiency proceeding is subject to judicial review. Beck v. Commissioner, T.C. Memo. 2001-198. The standard is abuse of discretion. Bernal v. Commissioner, 120 T.C. 102 (2003).

  2. IRC 66 does not contain a specific grant of Tax Court jurisdiction similar to IRC 6015(e). The Tax Court cannot review denial of IRC 66 relief in a "stand alone" proceeding. A stand alone case is one where the issue is raised in connection with the denial of IRC 66 relief without a determination of a deficiency. An erroneous statement in an IRS notice that the Tax Court can review a determination will not give the Tax Court jurisdiction. Bernal v. Commissioner, 120 T.C. 102 (2003).

Exhibit 25.18.3-1 
IRC 66 Pro Forma Checksheets and Workpapers for Examiners

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