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Innocent Spouse Relief: Income attribution

Income attribution rule addressed by Tax Court

In Connie L. Minton a.k.a. Connie L. Keeney v. Comm’r, T.C. Memo 2018-15, filed February 5, 2018, the Tax Court was asked to review an IRS Appeals’ decision denying innocent spouse relief based on equitable relief. In this case, taxpayer made application for relief after divorce. The return in question reflected income from a 401(k) withdrawal taxpayer instituted at the request of her former spouse – for the purpose of investing in a business venture that failed. Additionally, the spouse’s income from his business, along with a small amount of interest income was reported on the return. The Appeals officer indicated that the taxpayer’s request for relief failed because the tax was attributed to her income. Thus, it did not meet the threshold condition for relief. The Tax Court reviewed this decision and discussed the exceptions to the attribution rule. Those exceptions include: a) attribution due solely to the operation of community property law, b) nominal ownership, c) misappropriation of funds, d) abuse before the return was filed that affects the requesting spouse’s ability to challenge the treatment of items on the return or question payment of any balance due, and e) fraud committed by the nonrequesting spouse that is the reason for the erroneous item. Ultimately, the Court indicated that the taxpayer did not meet any of the exceptions and failed the threshold conditions as to her 401(k) withdrawal. The Tax Court, however, disagreed with Appeals in that they concluded the liability attributed to the nonrequesting spouse’s business income should not be attributed to the taxpayer because her involvement in the business was nominal only. This is a good discussion of some exceptions to the income attribution rule, not regularly reviewed by the Court.

Passports: Revocation or denial due to tax debt

I.R.C. Section 7345

If a taxpayer has “seriously delinquent tax debt,” the IRS will certify that debt to the State Department for action. The State Department will generally not issue a passport to a taxpayer after receiving certification from the IRS. Further, the State Department may revoke a taxpayer’s passport on certification from the IRS. “Seriously delinquent tax debt” is defined as a tax debt currently in excess of $51,000 (this is inflation adjusted), for which a notice of federal tax lien has been issued and all administrative remedies under I.R.C. section 6320 have lapsed or been exhausted, or a levy has been issued. Some tax debts are not included, even if they meet the above criteria. This includes tax debt that is being paid timely on an IRS approved installment agreement, is being paid timely with an accepted Offer in Compromise, is pending a timely requested Collection Due Process hearing regarding a levy, or for which collection is suspended because of an application for innocent spouse relief. Additionally, a passport won’t be at risk under the program if the taxpayer is in bankruptcy, identified by the IRS as a victim of identity theft, if the taxpayer’s account is in currently not collectible, if the taxpayer resides in a federally declared disaster area, if the taxpayer has a pending request for an installment agreement, if the taxpayer has a pending Offer in Compromise, or if the taxpayer has an IRS accepted adjustment that will satisfy the debt in full. Before denying a passport, the State Department will hold the application for 90 days to allow the taxpayer to resolve any erroneous certification issues, make a full payment of the tax debt, or enter a payment arrangement with the IRS.

Trust Fund Recover Penalty

I.R.C. section 6672

This is a hard fought case on a narrow issue that ultimately went in favor of the IRS. The Tax Court in Scott T. Blackburn v. Comm’r, 150 T.C. No. 9, filed April 9, 2018, was asked to review the verification of compliance rule of I.R.C. section 6751(b), as required by sections 6330(c)(1) and (3)(A). The Appeals officer must “obtain verification from the Secretary that the requirements of any applicable law or administrative procedure have been met.” Sec. 6330(c)(1). The Petitioner did not argue or contest the liability issue relating to assessment of the Trust Fund Recovery Penalty against him. The Revenue Officer in this instance has recommended assessment and said assessment was approved by the Revenue Officer’s manager using Form 4183. The name of the manager was listed on the form, but no signature was present. The taxpayer argued that in creating section 6751(b), Congress could not have meant to require a meaningless, supervisory “rubber stamped” signature. Petitioner asked the IRS many times to provide some evidence that the supervisor’s review was meaningful. Petitioner relies on the Internal Revenue Manual to suggest an argument that the signature of a supervisor in support of a penalty is not in itself a sufficient showing to comply with section 6751(b). The Court indicated that caselaw review applying these code sections has only required the officer to review the administrative steps taken before assessment of the underlying liability. To impose the requirement of a substantive review on the officer would allow the taxpayer to avoid the limitations of pursuing the underlying liability in a review under section 6330 and apply a level of detail in the verification process that has never been previously required, the Court explained.

Proper Notice of Deficiency Proceedings

I.R.C. 6212

In Daniel Sadek v. Comm’r, T.C. Memo 2018-174, Filed October 16, 2018, the Tax Court takes up the issue of what is deemed to be an appropriate address for the issuance of a notice of deficiency. The rule is set out in I.R.C. section 6212(b)(1): a deficiency notice sent to the taxpayer’s last known address, shall be sufficient. Treasury Regulation section 301.6212-2(a) elaborates: “A taxpayer’s last known address is the address that appears on the taxpayer’s most recently filed and properly processed Federal tax return, unless the IRS is given clear and concise notification of a different address.” In this case, taxpayer’s most recently filed tax return was for 2005, which was filed October 19, 2009. The IRS issued a notice of deficiency for 2005 and 2006 in excess of $25 million dollars, to his address in both California and Nevada. This notice was issued August 25, 2011. Petitioner filed his petition with the Tax Court on January 4, 2017. From September 2010 through May 2014 Petitioner lived in Beirut, Lebanon. Despite the seemingly straightforward notification provision, Petitioner made a couple of arguments that the IRS should have known where he was living. First, the Petitioner argued that the IRS had used his bankruptcy filings to determine that he also had a home in Nevada. The Petitioner argued that the IRS should have known better as the automatic stay had been lifted during the bankruptcy proceedings to allow both lenders to foreclose – thus he no longer could have lived there. There was no evidence the foreclosure actually took place, and no other address was referenced in any bankruptcy filing. Next, while residing in Beirut, Lebanon, the Petitioner was the subject of an investigation by the FBI relating to his former mortgage business. Petitioner had several communications from Beirut with the FBI during this time. The testifying agent indicated that the FBI never had Petitioner’s address, and even if they did, they would not share the details of an ongoing criminal investigation with non-law enforcement agents of the IRS. The Court declined to “impute to the [IRS] the knowledge of the entire Federal Government.” That simply is not the requirement of the statute referenced above. The Court explained that even if the FBI had the address, and even if the Petitioner had provided the State Department with an address while in Lebanon, “change of address information that a taxpayer provides to another government agency, is not clear and concise notification of a different address,” per Treasury regulation section 301.6212-2(b)(1). Petitioner’s petition was deemed untimely and the deficiency stood.

Innocent Spouse Relief: Relief while married

Taxpayer obtains relief while still married

In Hudson v. Comm’r T.C. Summary Opinion 2017-7, filed February 8, 2017, the Tax Court granted equitable relief from joint and several liability under section 6015(f).  It is a rare case that the IRS grants relief to a taxpayer that requests innocent spouse relief, unless that individual is legally separated or divorced from the jointly liable taxpayer. The taxpayer and her husband remained legally married, but were essentially estranged.  Petitioner remained in the marriage because she “regards the vow of marriage as sacrosanct and does not believe in divorce.” The liability reported on the face of the return was largely from the early withdrawal penalty associated with Petitioner’s husband taking a distribution from his retirement account to finance the purchase of a piece of residential real estate – in his name alone. Though petitioner resided at this residence, the Tax Court did not believe she enjoyed a lavish lifestyle.  Petitioner held a bachelors degree and, while she was out of the workplace caring for their children during the year at issue, she later became employed in her field. At the time of filing the Petition in the Tax Court, she was unemployed and struggled with reasonable living expenses. The Court could not provide “streamlined” relief because the Petitioner remained married.  That triggered a facts and circumstances analysis where economic hardship and lack of significant benefit factored heavily into the Court’s grant of liability relief. 

2016 Inflation Adjustments on Several Tax Benefits and Retirement Adjustments

IRS Announces 2016 Inflation Adjustments on Several Tax Benefits and Retirement Adjustments

The IRS recently announced annual inflation adjustments for several tax provisions, which will apply to the 2016 tax year. Some of the affected provisions include: income tax rate schedules, the estate tax exemption, long-term care adjustments, and retirement adjustments. Below is a summary of those adjustments.

Tax Rates. Beginning in the 2016 tax year, the following tax rates will apply:

If the Taxable Income Is: The Tax for Married Individuals Filing Jointly is:
Less than or equal to $18,55010% of the taxable income
Over $18,550 but not over $75,300$1,855 plus 15% of the excess over $18,550
Over $75,300 but not over $151, 900$10,367.50 plus 25% of the excess over $75,300
Over $151,900 but not over $231,450$29,517.50 plus 28% of the excess over $151,900
Over $231,450 but not over $413,350$51,791.50 plus 33% of the excess over $231,450
Over $413,350 but not over $466,950$111,818.50 plus 35% of the excess over $413,350
Over $466,950$130,578.50 plus 39.6% of the excess over $466,950
If the Taxable Income Is: The Tax for Heads of Households is:
Not over $13,25010% of the taxable income
Over $13,250 but not over $50,400$1,325 plus 15% of the excess over $13,250
Over $50,400 but not over $130,150$6,897.50 plus 25% of the excess over $50,400
Over $130,150 but not over $210,800$26,835 plus 28% of the excess over $130,150
Over $210,800 but not over $413,350$49,417 plus 33% of the excess over $210,800
Over $413,350 but not over $441,000$116,258.50 plus 35% of the excess over $413,350
Over $441,000$125,936 plus 39.6% of the excess over $441,000
If the Taxable Income Is: The Tax for Unmarried Individuals is:
Not over $9,27510% of the taxable income
Over $9,275 but not over $37,650$927.50 plus 15% of the excess over $9,275
Over $37,650 but not over $91,150$5,183.75 plus 25% of the excess over $37,650
Over $91,150 but not over $190,150$18,558.75 plus 28% of the excess over $91,150
Over $190,150 but not over $413,350$46,278.75 plus 33% of the excess over $190,150
Over $413,350 but not over $415,050$119,934.75 plus 35% of the excess over $413,350
Over $415,050$120,529.75 plus 39.9% of the excess over $415,050
If the Taxable Income Is:The Tax for Married Individuals Filing Separate Returns is:
Not over $9,27510% of the taxable income
Over $9,275 but not over $37,650$927.50 plus 15% of the excess over $9,275
Over $37,650 but not over $75,950$5,183.75 plus 25% of the excess over $37,650
Over $75,950 but not over $115,725$14,758.75 plus 28% of the excess over $75,950
Over $115,725 but not over $206,675$25,895.75 plus 33% of the excess over $115,725
Over $206,675 but not over $233,475$55,909.25 plus 35% of the excess over $206,675
Over $233,475$65,289.25 plus 39.6% of the excess over $233,475
If the Taxable Income Is:The Tax for Estates and Trusts is:
Not over $2,55015% of the taxable income
Over $2,550 but not over $5,950$382.50 plus 25% of the excess over $2,550
Over $5,950 but not over $9,050$1,232.50 plus 28% of the excess over $5,950
Over $9,050 but not over $12,400$2,100.50 plus 33% of the excess over $9,050
Over $12,400$3,206.00 plus 39.6% of the excess over $12,400

Estate Tax Exemption. The Estate Tax is a tax imposed on the transfer of property at a person’s death, for any portion of the decedent’s gross estate that exceeds the Federal Estate Tax Exemption. This year the estate tax exclusion has increased from a total of $5,430,000 to $5,450,000. This means that decedents who die in 2016 have an estate tax exclusion that has increased by $20,000 from the previous year.

Long-term Care. Deductions for Long Term Care Insurance Premiums have increased slightly from 2015. The 2016 deductible limits under §213(d)(10) for eligible long-term care premiums are as follows:

Attained Age Before Close of Taxable YearLimitation on Premiums
40 or less$390
More than 40 but not more than 50$730
More than 50 but not more than 60$1,460
More than 60 but not more than 70$3,900
More than 70$4,870

Retirement Adjustments. The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the government’s Thrift Savings Plan remains unchanged at $18,000. In addition, if you are 50 or over you can contribute an additional $6,000 as a catch-up contribution. The limit on annual contributions to IRA accounts remains unchanged at $5,500 with the catch-up contribution limit remaining $1,000.

The deduction for taxpayers making contributions to traditional IRA accounts is phased out gradually starting at an Adjusted Gross Income (AGI) of $61,000 for single taxpayers and heads of households, $98,000 for married couples filing jointly (when the spouse who makes the IRA contribution is covered by a workplace retirement plan).  These amounts are unchanged in 2016.  The phase out moves from a starting point of $183,000 to $184,000 for an IRA contributor not covered by a workplace retirement plan but who is married to someone who is covered. 

The deduction for taxpayers making contributions to a Roth IRA is phased out gradually starting at an AGI of $184,000 for married couples filing jointly and $117,000 for singles and heads of households.

Lastly, the AGI limit for the saver’s credit (retirement savings contribution credit) for low and moderate income workers has also increased slightly for 2016. The credit is now $61,500 for married couples filing jointly, $46,125 for heads of household, and $30,750 for singles and married couples who file separately.

If you have any questions about how these adjustments might affect your tax situation, please feel free to contact our office for further assistance.

Increased collection activity against federal employees’ Thrift Savings Plans (TSP)

The National Taxpayer Advocate has reported in its Fiscal Year 2016 Objectives report to Congress that a proposal by the IRS to expand collection efforts against retirement plans of federal employees “infringes on taxpayers’ rights to a fair and just tax system.” Federal employees have the ability to participate in the Thrift Savings Plan (TSP), which is similar to a private sector 401(k) plan in that employee savings are tax deferred and qualify for some level of employer, (in this case the federal government), matching.

Taxpayers, including federal government employees, who owe taxes are subject to IRS levy on their property and rights to property.  This power extends to retirement accounts, including the TSP.  However, given the importance of retirement savings to an individual’s welfare during old age, the IRS has historically regarded a levy on retirement funds as a special case that requires additional scrutiny and a manager’s approval. 

Essentially, before a field Revenue Officer can levy a retirement benefit, the agent would determine what property is available to levy – both retirement and non-retirement, determine if the taxpayer has acted in a flagrant manner, and finally determine if the retirement funds are required for necessary living expenses. There are distinct problems with these factors, but that has been partially mitigated by other requirements prior to issuance of the levy.  The field Revenue Officer must either secure the signature of the Area Director of Field collections, or secure a manager’s approval.

In order to obtain a collection manager’s approval in this instance, the field Revenue Officer is required to draft a detailed memo that sets out a summary of all information provided to the agent by the taxpayer, whether the taxpayer has exhibited any flagrant behavior, and more importantly, other collection alternatives that have been considered and rejected.  In other words, the retirement account falls into a secondary level of collection after the field Revenue Officer reviews other property or income to levy. 

Recent activity at the IRS has created a pilot program to levy TSP accounts.  Most importantly, and of greatest concern, this program will be administered by ACS employees.  ACS is the Automated Collection System unit.  When a taxpayer’s account is in ACS, it is not assigned to a single employee for collection, rather, there are various employees in functions and units that work on similar matters.  These employees do not receive the same level of financial analysis training as a field Revenue Officer. 

In addition to the reduced training received by ACS employees, the pilot program calls for ACS employees to document any information that a retirement is impending and that the taxpayer will be relying on funds from the TSP for necessary living expenses.  This lacks any analysis regarding other property the taxpayer may have that would be available to collect from, or if the taxpayer acted in a flagrant manner, all requirements of a field Revenue Officer. 

Finally, the pilot program requires managerial approval prior to levy on retirement accounts – but that is a requirement of many collection actions by ACS employees – hardly elevating these situation to a special case status.  What is not referenced is the required memo to the manager detailing information provided by the taxpayer and collection alternatives considered and rejected before proposing levy to the retirement account – all requirements of the field Revenue Officer.

In summary, the IRS is targeting one type of retirement account, the TSP, for increased collection activity, over all others. ACS does not have the ability to levy any other retirement accounts at this time.  The National Taxpayer Advocate believes that this pilot program undermines both taxpayer rights and retirement security policy.  As such, the National Taxpayer Advocate is going to continue to push the IRS to abandon the Thrift Savings Plan levy pilot program  If the IRS adopts the program, the National Taxpayer Advocate is prepared to accept all TSP levy cases coming from ACS.  Taxpayers should take advantage of this opportunity to protect their retirement income.  Additionally, where possible, taxpayers should seek assistance from the Appeals division in order to entertain collection alternatives through Appeals’ Collection Due Process hearing procedures.  Feel free to contact Caraker Law Firm, P.C. with any questions you may have.