There are often times when different government agencies with different clients and missions are at odds with one another. This is frequently true when it comes to the IRS and the bankruptcy trustee.
The IRS is tasked with protecting the government fisc. The bankruptcy trustee is tasked with protecting the estate for the benefit of creditors–many of whom are not the IRS.
This can lead to some interesting situations and questions. The Kovitch v. Commissioner, 128 T.C. 9 (2007) case is an example. The case considers whether one ex-spouse can prevent the other ex-spouse from obtaining innocent spouse relief by filing for bankruptcy.
The Facts & Procedural History
The Kovitchs were divorced. The IRS issued a notice of deficiency to both spouses for their joint tax liability.
Only the wife filed a petition in the U.S. Tax Court. The wife only sought innocent spouse relief. She did not challenge the underlying tax assessment.
The husband did not file a petition with the tax court. Instead, the husband opted to intervene in the wife’s tax court proceeding. The husband then filed for Chapter 13 bankruptcy after intervening in the tax court case to challenge whether the wife was entitled to innocent spouse relief.
The question before the U.S. Tax Court was whether the bankruptcy automatic stay would preclude the court from determining if the wife was entitled to innocent spouse relief.
Innocent Spouse Relief
The Innocent Spouse Relief program is designed to provide relief to individuals who are innocent of any wrongdoing in cases where their spouse or former spouse failed to report income, reported incorrect income, or claimed incorrect deductions or credits on their joint tax return. The program can also apply if the spouse knew of the inaccuracies but did not benefit from them and did not sign the tax return.
There are three types of relief available under the program:
- Innocent Spouse Relief: This provides full relief from the understated tax liability for taxpayers who did not know and had no reason to know that their spouse or former spouse understated their tax liability.
- Separation of Liability Relief: This provides for the allocation of the understated tax liability between the innocent spouse and the former spouse.
- Equitable Relief: This provides relief for taxpayers who do not qualify for Innocent Spouse Relief or Separation of Liability Relief, but where it would be unfair to hold them responsible for the tax liability.
To be eligible for Innocent Spouse Relief, the taxpayer must meet several criteria, including filing a joint tax return, proving that they did not know about the errors on the return, and showing that it would be unfair to hold them liable for the tax liability. The IRS evaluates each case based on its own set of facts and circumstances.
It’s important to note that the Innocent Spouse Relief program is not automatic, and the taxpayer must apply for it. To apply, the taxpayer must fill out and submit IRS Form 8857, Request for Innocent Spouse Relief, along with any supporting documents that prove their entitlement to relief.
You can read more about innocent spouse relief here.
Intervention in the U.S. Tax Court
The U.S. Tax Court has jurisdiction to hear cases in which the IRS denies innocent spouse relief.
Rule 325(a) refers to a rule of procedure in the U.S. Tax Court that governs the filing of a petition and the right to intervene in a case.
Section 6015(e)(4) of the tax code applies to situations where one spouse has filed a joint tax return with another spouse, but the other spouse did not elect to seek relief from joint and several liability. It requires that the “other spouse” who did not make the election must be given notice of any stand-alone proceeding involving a claim for relief under Section 6015. The notice must provide the non-electing spouse with an opportunity to become a party to the proceeding.
King v. Commissioner, 115 T.C. 118 (2000), is the leading case for the right of a non-requesting spouse to intervene in the tax court proceeding. According to this case, a notice of intervention filed by a nonpetitioning spouse under Section 6015(e)(4) is sufficient to make the nonpetitioning spouse a party to the case. This right is triggered by notice of the tax court proceeding.
It is up to the U.S. Tax Court to determine how to best provide notice and an opportunity to participate, but it must do so in a way that is reasonable and fair to the non-electing spouse.
The Bankruptcy Automatic Stay
The Automatic Stay provision is an important protection for debtors in bankruptcy cases. It allows them to focus on resolving their financial difficulties without interference from creditors or other parties.
The Automatic Stay is a legal provision that is triggered by a bankruptcy filing, which temporarily bars certain actions against or concerning the debtor or property of the debtor or the bankruptcy estate. The actions subject to the Automatic Stay are set out in 11 U.S.C. Section 362(a). Specifically, paragraph (8) of 11 U.S.C. Section 362(a) provides that U.S. Tax Court proceedings concerning the debtor are stayed.
In a bankruptcy case, the Automatic Stay is generally lifted only when a discharge is granted or denied, which occurs at the end of a Chapter 13 bankruptcy case.
The Automatic Stay vs. Innocent Spouse Relief
This brings us to the question in this case. Does the Automatic Stay for the husband suspend the U.S. Tax Court case for his ex-wife’s innocent spouse claim?
The U.S. Tax Court concluded that it does not. The court reasoned that the husband will still owe the tax even if the wife is granted innocent spouse relief. As such, the court was not determining the husband’s tax liability and the bankruptcy rules did not halt this type of decision.
The result may have been difficult if Mr. Kovitch filed his own petition contesting the deficiency and the trials were consolidated or had Ms. Kovitch opted to contest the deficiency in her tax court petition. Ms. Kovtch did not take these actions, and, therefore, the Automatic Stay did not suspend the U.S. Tax Court case.
The U.S. Tax Court has jurisdiction to hear cases in which the IRS denies innocent spouse relief, and a non-requesting spouse may also intervene in the tax court proceeding. The Automatic Stay provision in bankruptcy cases is an important protection for debtors, but, as shown in this case, it may not prevent a U.S. Tax Court case from proceeding in certain circumstances. This case shows how important it is for taxpayers to understand their rights and options when seeking relief from joint tax liability.