I. What the IRS Restructuring and Reform Act Did Not Change

The rules and filing requirements have not changed. Poe v. Seaborn, 282 U.S. 101 (1930) is still good law, and community income, deductions and credits must still be reported on each parties' return 50-50 unless Section 6 reporting is applicable.

II. What is New in the IRS Restructuring and Reform Act.

1. Innocent Spouse Rules

The old innocent spouse rule was very difficult to qualify under, as it required that you meet all the prongs of a multi prong test. In a lot of ways, this was like trying to pass a camel through the eye of the proverbial needle. It did not happen very often. Requirements of the old law were:

• substantial understatement at least $500 or specific percentage (10 or 25%) of adjusted gross income
• must be due to a grossly erroneous item
• spouse has no knowledge or no reason to know of the understatement
• under the facts and circumstances, it is inequitable to hold spouse liable.

The requirement of a "grossly erroneous item" was a daunting one for taxpayers, as there exists a significant body of law on the subject, defining a "grossly erroneous item" as one for which there was no factual or legal basis for the position taken on the return. In practice, it was virtually impossible to meet.

The next largest problem, in my opinion however, was meeting the "knew or should have known" test. If the purported innocent spouse enjoyed a lifestyle that does not match with the reported income, (e.g. private schools, country clubs and River Oaks on $50,000 a year), innocent spouse relief would not be available, because there would be deemed knowledge. One of the few cases granting innocent spouse relief and interpreting the "knew or should have known" standard came in the case of Rebecca Jo Reser, 97-1 U.S.T.C. 50,416 (5th Cir. 1977), where a Texas personal injury defense lawyer was held to be an innocent spouse. Her claim was made based on an erroneous complicated Subchapter S passthrough deduction. In granting innocent spouse relief, the 5th Circuit noted that it was not the knowledge of the transaction itself, but rather whether the spouse knew that the deduction would give rise to a susbstantial understatement. The complexity of the deduction was an important factor. Another important factor in that case was that Ms. Reser did not benefit from the erroneous deduction in a monetary sense; in fact, the marital community has a significant decrease as a result of the corporation's activities, thus, the 5th Circuit felt that equitable ends were met. The equity requirement is related to the substantial benefit problem, with a twist for divorced spouses: if the purported innocent spouse ended up with a substantial portion of the marital property in a divorce, the courts frequently found that he or she had benefitted from the substantial understatement and os innocent spouse relief was denied. There are numerous cases on this point.

In contrast, the requirements of the new law are:

• an understatement (need not be a "substantial understatement," a term of art in the Code)
• both the percentage test and $500 minimum are gone
• must now be an "erroneous item", not "grossly" erroneous
• no knowledge or no reason to know of the understatement
• under the facts and circumstances, it is inequitable to hole spouse liable
• partial innocent spouse relief now authorized

The understatement that is now required need not be a "substantial" understatement. As a practical matter this eliminates a requirement with a significant body of law behind it, and somewhat arbitrary mechanical tests. The new rule also gets rid of the required minimum threshold amounts for relief, a change that is perceived to benefit low income taxpayers.

The real easing of requirements comes from the removal of the grossly erroneous item requirement. The erroneous item standard is an achievable standard, whereas proving that something had no basis in law or fact was virtually impossible to achieve.

Innocent spouse relief may also now be granted on a partial basis. It is no longer an all or nothing proposition. It is presumed that Congress meant to codify cases in some circuits that held that the determination could be made on an item by item basis, and this is the implication that is clear in the Conference Committee Report. For example, just because you know that your spouse is not reporting their income from tips at their waitressing job doesn't mean that you will not be able to qualify for innocent spouse treatment for the income from drug dealing that you didn't know about.

Judicial review of denials of innocent spouse relief will now be heard at the United States Tax Court, unless a refund case is filed in Federal District Court or the Court of Federal Claims in which case the jurisdiction is transferred to the court hearing the refund claim.

2. Joint and Several Liability Changes

A. The IRS Restructuring and Reform Act requires that the IRS advise joint return signers regarding joint liability for taxes on return. The new 1998 Forms 1040 do this by a reference to the instructions on the signature line. Whether anyone will actually read these instructions is an open question.

B. The IRS Restructuring and Reform Act created new separate liability "election" If granted, this "election" can eliminate an unpaid liability but not generate a refund to a taxpayer. The separate liability election is not a true election, as we tend to think of them in the Internal Revenue Code. It is subject to approval by the Internal Revenue Service.

Requirements for separate liability elections are:

Either:

• divorces, widowed or legally separated taxpayers OR
• not living in same household as any other joint filer for 12 months prior to election:

  AND

• no actual knowledge of the item causing the understatement.

Note that the actual knowledge requirement is a much easier standard to meet than the "known or should have known" test for innocent spouse relief. The burden of proff however, remains on the taxpayer to show that they did not have actual knowledge of the understatement.

Judicial review of denials of separate liability elections will be heard at the United States Tax Court, unless a refund case is filed in Federal District Court or the Court of Federal Claims in which case the jurisdiction is transferred to the court hearing the refund claim.

3. Miscellaneous Equitable Relief

This is the only form of relief for mere underpayments 0 that is, underpayments that do not result from understatements of income. For example, if the return is correct, there just wasn't any money sent, you have an underpayment without an understatement.

The Internal Revenue Service will now automatically consider this relief in addition to all innocent spouse requests and separate liability elections.

The general equitable relief standard is not defined in the statute. The legislative history indicates that Congress intended for it to apply in "appropriate situations" - whatever that is. As a result, the effectiveness will largely depend on personality of who is handling the file and how the case is presented to them.

Judicial review of denials of this relief will also go to the United States Tax Court, as with the two other forms of relief, subject to transfer to District Court or the Court of Federal Claims if a refund claim is pending.

4. Additional Administgrative Changes

All innocent spouse, separate liability and equitable relief claims will go to one unit in Cincinnati, OH for processing to promote uniformity of application.

New Form 8857 has been created to request this relief (all three are on the same form). You may download and print a copy of form 8857 from the IRS web site. Use of this form is mandatory.

New training has been provided for all IRS employees on innocent spouse rules.

The IRS has initiated an outreach to abused and battered spouses (presumably through service providers and low income taxpayer clinics).

5. Effect on the Day to Day Family Law Practice

Question the Family Case Practice Manual model language - do you really want to allocate the liability for taxes and provide indemnities? You may still want to do so, but it bears thinking about and certainly bears a discussion of the issue with the client. You must now consider what the effect would be under these rules but remember - the separate liability election requires not only an underpayment, but an understatement as well. If you are pretty sure that there are no understatements, or that the indemnity has value, you may want to continue using that language you have all typically used. Be aware, however, that you may be creating a state law claim to reimbursement if the decree says for example, that the parties will share the liability 50-50 and a separate liability election is later obtained. Additionally, there is case law under the old innocent spouse rules that indicates that indemnity agreements in divorce agreements eliminate the need for equitable relief. See, e.g., E.L. Stitler, 69 TCM 2975 (1995) (husband's promise to pay any tax liabilities not held to be unreliable); F.L. Garratt, 73 TCM 2799 (1977).

What is the effect of standard language in a decree stating that parties are "jointly liable" for prior years' taxes? Is it a waiver of the right to seek innocent spouse, separate liability or equitable relief? There are simply no clear answers to these questions. The tax bar and the family law bar will have to work these out together, over time.

5. New notice Requirements

All notices on joint returns now must be sent out tqice 0 once to each spouse. This makes it doubly important that the IRS be notified when a party has moved. IRS Form 8822 may be used. Send it Certified Mail, Return Receipt Requested.

Be aware that the IRS must notify the other spouse when a Form 8857 request for innocent spouse relief, separate liability election or equitable relief is sought. Factor this notification into your game plan.

6. A Word About Dealing with the IRS Administratively and About Appeals in Tax Cases . . .

Most laypersons (e.g., non tax professionals) do not realize that the overwhelming majority of tax disputes are settled at the administrative level, often without face to face contact. This makes to form of the written request very important. If you do not have expertise in this area, you should refer the client to someone who does, whether accountant or tax lawyer. The administrative file (and any admissions or statements contained therein) will be admissible at any later hearing in the Tax Court.

Also, the judicial appeal from an administrative denial of relief for innocent spouse, separate liability and equitable relief must be filed in the United States Tax Court within strict deadlines. These deadlines are the EARLIER of 90 days from the date of mailing of the denial or 6 months from the date of the filing of Form 8857. These deadlines are jurisdictional; no extensions may be granted. If missed, the taxpayer's sole avenue for relief is to pay the tax and sue for a refund in Federal District Court or the Court of Federal Claims.

7. Effective Date.

The IRS Restructuring and Reform Act changes discussed herein are effective for:

• Taxes assessed after July 22, 1998 and
• Taxes assesses before July 22, 1998, but remaining unpaid at that date.