The Taxpayer First Act of 2019 made several changes that impact how tax cases are handled. We are just now seeing some of these changes play out administratively and in court.
The recent Bacigalupi v. Commissioner, Docket No. 20480-21 (U.S. Tax Court 2022) is an example of this. It is an innocent spouse case that was decided by the court using the new standard of review provided by the Taxpayer First Act. The court specifically notes that the case was a close call–which many innocent spouse cases are–and, given the new standard, it decided the case in the taxpayer’s favor. The court even suggested that it would have reached a different conclusion if it had applied the old abuse-of-discretion standard.
Those submitting requests for innocent spouse relief should take note of this change because, as noted by the court in this case, the unfavorable court cases that apply the old standard are no longer binding on the court. The old court cases have limited precedential value which can open up new arguments and factors for the court to reconsider in cases going forward.
Facts & Procedural History
The taxpayer was 67 years old, divorced, and minimally employed.
During her marriage, the court opinion says that her husband managed the finances and amassed a cash account that the taxpayer did not have access to. The taxpayer and her spouse failed to file timely tax returns and failed to pay their taxes. The divorce decree indicated that the unpaid taxes were solely the husband’s responsibility (which might have been part of the couple’s divorce tax planning).
The taxes went unpaid and, eventually, the IRS tried to collect the taxes from the taxpayer. The taxpayer filed a request for innocent spouse relief to avoid liability for the unpaid taxes. The IRS denied her request and the case ended up in the U.S. Tax Court.
About Innocent Spouse
Innocent spouse relief applies when a taxpayer files a joint income tax return (or in some cases, lives in a community property state). It is intended to be a remedy when it would be inequitable to hold the so-called “innocent spouse” liable for the tax.
As with every remedy provided by the legislature, there are numerous caveats and nuances that can bar relief. The Treasury Department and IRS have issued clarifying guidance that adds additional hurdles. There are factors that have to be considered for his remedy. You can read the more detailed explanation of the innocent spouse relief rules here.
As noted above, this article focuses on the change in the law as to what evidence can be considered in evaluating innocent spouse requests.
The Standard of Review
The Taxpayer First Act of 2019 made a number of changes to the IRS procedural rules. One such change was made to innocent spouse relief.
Section 6015 was amended to change the standard of review by the U.S. Tax Court:
Standard and scope of review Any review of a determination made under this section shall be reviewed de novo by the Tax Court and shall be based upon—
(A) the administrative record established at the time of the determination, and
(B) any additional newly discovered or previously unavailable evidence.
The term “de novo” generally means that the court is to review the evidence with fresh eyes. This is compared to the previous “abuse of discretion” standard. As a general statement, with abuse of discretion cases, the courts usually find for the IRS as there is usually some evidence that could support the IRS’s position. Thus, the change to a de novo standard is a taxpayer-favorable change.
This change was qualified, however. Usually “de novo” review means that the parties can submit any and all evidence for the very first time in court. Subject to the normal rules of evidence, the court is free to consider whatever evidence the parties submit. However, as noted in the quote above, the new “de novo” review for innocent spouse relief is limited to the administrative record plus new evidence. This is unusual. It is not really a true de novo standard, but not really an abuse of discretion standard.
This brings us to the Bacigalupi case and what evidence can be considered.
What Evidence Can Be Considered
In the Bacigalupi case, the court notes that the administrative process did not afford the taxpayer an opportunity to testify or be cross-examined. Based on this and the new standard of review for these cases, the court concluded that the taxpayer’s testimony was new evidence. This means that the taxpayer can still offer testimonial evidence for the first time in court for innocent spouse cases.
As far as records go, the court also dealt with that. The records included a financial statement questionnaire the taxpayer submitted during the IRS review. The questionnaire stated that the taxpayer paid $50,000 for her child’s college education. This type of expense can be a basis for disallowing innocent spouse relief. The IRS produced the actual record. The court considered it, as required by the standard of review.
The court did not just accept the record. The court qualified the record based on the other evidence and testimony in the case:
And here’s what I see when I look at this questionnaire. It is somewhat implausible that a couple with their financial situation being what it is, even if they didn’t reveal their tax problems to the college in seeking financial aid had to cough up $50,000 per year. Ms. Bacigalupi testified also under oath that her son received a considerable scholarship that put a dent into those.
The court went on to note that the prior court cases dealing with college payments no longer apply as they were all decided under the older abuse of discretion standard.
Given the new standard of review for these cases, it seems that the review is limited to the documentary evidence in the record prior to court, but testimony and circumstances can still be presented for the first time during the court process. This hybrid type of review should be factored into how the case is developed at the administrative level and during the court process.
The new standard of review for innocent spouse cases applies to tax court petitions filed after July 1, 2019. This remedy can be used to avoid liability or avoid paying an unpaid tax debt.
The new standard that applies to innocent spouse relief cases is a hybrid de novo review standard. This standard has to be factored into how the case is developed. Those who want to file for innocent spouse relief should put even more effort into building the administrative record while preserving the ability to add testimony later if the court needs to get involved.
Those who pursue this remedy should also know that the prior court cases that apply the old abuse of discretion standard now have little precedential value and, should the IRS cite the old cases, the taxpayer should be quick to point out that they do not apply given this change.
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