oversight

Need to Amend the Internal Revenue Code to Extend Innocent Spouse Rule to Community Property Situations

Published by the Government Accountability Office on 1977-07-12.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                          DOCUMENT RESUME

02801 -   A1993060]

rNeed to Amend the Internal Revenue C'de t    Exten Iuocent
Spouse Rule to Community Property Situa..iors]. GGD-77-56;
B-137762. Jujy 12, 1977. 2 pp. + enclosure ({ pp.).

Report to Rep. Al Ullman, Chairman, Joint Committee on Taxation;
by Elmer B. Staats, Comptroller General.

Issue Area: Tax Administration (2700).
Contact: General Government Div.
Budget Function: General Governmeat: Central Fiscal Operations
     (803).
Organizaticn Concerned: Department of the Treasury; Internal
    Revenue Service.
Congressional   elevance: Joint Committee on Taxation.
Authority:   (P.L. 91-679: 84 Stat, 2063): Internal Revenue Code,
    sec. 6013(e).   oe v. Seaborn, 282 U.S. 101 (1930). United
    States v. Mitchell, 403 U.S. 190 (1571).

          Unler current law, the Internal Revenue Code grants
relief to a   "'innocent spouse" on a fraudulent joint return
where he or she neither benefits from nor receives income
received by the other spouse and not reported. The applicable
section of the coqe does not apply if separate returns are filel
by two married persons.    Findings/Conclusions: Typically, the
cases lave concerned married individuals living apart but not
 lcgally separated or diJorced, where the husband has
appropriated te entire community income to his own use, and the
wife, filing separately, receives to suppcrt or other financial
assistance from the husband. The Internal Revenue Service (RS)
has proceeded against the wife directly as the person primarily
liable for the Federal income tax on her one-half share,
notwithstanding that the husband has appropriated the entire
community income to his own use. It does not appear that IRS has
ever proceeded against the husband to collect the wife's
one-half share of the community tax liability   in this situation.
Recommendations: Section 6013 of the Internal Revenue Code
should be amended so that, where certain conditions exist, the
separated spouse who does not receive the one-half of community
income to which he or she has a vested right under State law is
relieved of tax liability to the extent that such liability is
attributable to the omission from gross income of the on.-'lalf
of community income not received. (SC)
                         COMPTROLLER GENFRAL OF THE UNITED STATES
                                    WASIINGTUN. G.C.   20948




  fl\
   \{                                                          l    '77
        B-137762

        The Honorable Al Ullman
9-1     Chairman, Joint Committee
          on Taxation
QO)     Congress of the United States

        Dear Mr. Chairman:

            In reviewing the Government's administra+ion of our tax
        laws, we have come across a problem hat we believe can be
        corrected by legislatlon.   The problem relates to a spouse
        in a community property situation who files a separate re-
        +urn from which Is omitted the one-half of community income
        he or she owns but does not receive. Under current law,
        Section 6013(e) of the Internal Revenue Code grants relief
        to an "Innocent spouse" on a fraudulent joint re+u n where
        he or she elther benefits from nor receives ncome received
        by the other spouse and not reported.   Section 6013(e) does
        not apply If separate returns are fired by two married
        persons.

           Typically, +he cases have     concerned married Individuals
        living apart but not. legally    separated or divorced where
        the husband has appropriated     the entire community Income
        to his own use and the wife,     filing separately, receives
        no support or other financial     assistance from the husband.
          Under State community property rules the husband, as
      trustee of the commun:ty, Is legally obligated to pay both
      his and his wife's one-half share of t axes due with respect
      to community property and   ncome out of the proceeds of the
      community property under his managem.ient and control.  Ihe
      Internal Revenue Service (IRS), however, looking to the fact
      that the wife's   nterest In the community property, under thie
      applicable State law, Is a present, vested interest, has
      proceeded against her directly as the person primarily liable
      for the Federal income tax on her one-half share--notwith-
      standing that+ he husband has appropriated the ertire commu-
      nity   ncome to his own use, for other than family purposes or
      use.   It does not appear that IRS ever has proceeded aga;nst
      the husband to collect the wife's one-half share of the com-
      munity tax liability In this situation.    The fact that the
      wife is primarily liable for the tax on her one-half share
      Is not a legal Impediment to IRS's proceeding against +he hus-
      band as rustee of the community and as the one In possession
      of the wife's one-half share.


                                       .I-                                GGD-77-56
B-137762


    IRS officials Informally advised us that they try to exhaust
available administrative remedies before recommending costly
liigation.    They also noted +hat, to their knowledge, the
Justice Department will not accept IRS recommendations for suit
if administrative recourse Is still available.

   The Tax Court and the United States Supreme Court, when cn-
fronted with +his ax problem, have expressed sympathy for the
wife whose one-haif share ot the community has been misappro-
prlated by the husband but have failed to sustain the wife's
position In the face of what they have regarded as the Impos-
sible weight of the precedent established by Poe v. Seaborn,
282 U.S. 101 (1930).  The United States Supreme Court In United
States v. Mitchell, 403 U.S. 190 (1971) recomme ed that Section
6013 of the Internal Revenue Code be amended o correct this
situation. Desflte the Court's ecommendation, the RS has no+
sought legislative relief and has continued to assess tax, In-
terest, and where applicable, additions to tax and penalties
against '.e wlf3, who on a separate return, falls to include in
gross  ncome her one-half share In community Income In the
possession and control of the husband.
   We recommend that Section 6013 of the Internal Revenue Code
be amended so that, where certain conditions exist, the separated
spouse who does not receive the one-half of community Income to
which he or she has a vested right under State law Is relieved
of tax liability to the extent that such l!abil'ty Is attrlbutable
+o +he omission from gross income of the one-half of community
Income not received.  IRS officials Informally areed +hat legis-
lation along the lines we recommend Is the best solution to he
problem. We explain the Issue In detail In the enclosure to +his
letter.
   We are also roviding a copy of this report to the Vice Chairman
of the Committee, +he Secretary of the Treasury, ths Assistant
Secretary for Tax Policy, the Commissioner of Internal Revenue, and
other Interested parties.  We would be pleased to discuss his
matter fu-ther with you or your staff if you believe It would be
approirliate.

                                       Sincerely yours,




                                       Comptroller General
                                       of the United States
Enclosure


                             2
ENCLOSURE                                                        ENCLOSURE

                        U.S. GENERAL ACCOUNTING OFFICE
                 NEED TO AMEND THE INTERNAL REVENUE CODE TO
        EXTEND INNOCENT SPOUSE RULE TO COMMUNITY PROPERTY SITUATIONS

                              I.   INTRODUCTION
        The proposed amendment extends the "innocent spouse" rule of
   section 6013(e) of the Internal Revenue Code to the spouse who
   files a separate return in a community oroperty situation. Under
   current law, section 6013(e) rants relief to an innocent souse
   on a fraudulent joint return where he or she does not benefit from
   the omitted income; it does not relieve an innocent souse filing
   a separate return from liability for taxes on one-half of community
   income which he or she does not receive, either directly, or indi-
   rectly in the form of support. Typically, the cases have concerned
   married individuals living apart, but not legally separated or di-
   vorced, where the wife, filing separately, receives no support or
   other financial assistance from the husband and where the husband
   has appropriated his earnings and other community income to his own
   use, for other than family purposes or use. On tne authority of
   Poe v. Seaborn 282 US 101 (1930) and companion cases, the Internal
   Revenue Service (IRS) requires the 'wife in this circumstance to in-
   clude in her gross income, reported on a separate return, her one-
   half share of community income apprupriated by the husband. This
   situation cannot arise in a common law s.ate. Since the innocent
   spouse rule of section 6013(e) does not apply if a separate return
   is filed, legislation is required to extend the rule to cover a wife
   who does not report her one-half share of community income which she
   does not receive. arv Lcu Galliher 62 T.C. 760 (1974).1/      -

        The proposed amendment provides that, where crtain conditions
   exist, the separated spouse who does not receive the one-half of
   community income to which he or she has a present, vested rioht under
   state law, is relieved of tax liability to the extent that such lia-
   bility is attributable to the omission from ross income of the one-
   half of community income not received.


    1/ Tax writers have pointed out the inherent unfairness of this situ-
       ation and urged legislative relief. See J. Chrys Dougherty, Su-
       preme Court holds wife liable in Mitchell:   A too harsh adherence
       to precedent?' 35 Journal of Taxation 296 (1971); Frederick w.
       Bradley, "Community Property - Federal Inc.,ie Tax Liability of
       Wife During Existence of Community," 46 Tulane Law Review
       329 (1971); Annon.," 'Innocent Spouse' Statute Does Not Eute
       Separate Returns in a Community Proprcty State with Joint Returns
       Filed There or Anywhere Else," 1 Community Propertv Journal
       252 (1974); Mary Jane Boyd, James H. Bovd, "IRC Secs. 6013(e)
ENCLOSURE                                                        ENCLOSURE

                  II.   REASONS FOR TE PROPOSED AMENDMENT


       The general rule in the community property states of Arizona, Cali-
  fornia, Idaho, Louisiana, Nevada, New Mexico, and Texas is that the com-
  munity relationship continues notwithstanding the spouses  re separated
  and living aart. This means that the husband continues as    anaaer of
  the community and each spouse remains  rimarily liable for one-half of
  the total tax due on community income. This rule is uniformly applicable
  in the case of community income derived from earnings of the husband
  living separate from the wife.2/ There is some variation amcna states
  concerning the husband's ownership of, and hence liability for tax on,
  the one-half of community derived from the earnings of the wife living
  separate from the husband.3/
        In the community property state of Washinaton, the community re-
   latiorship can be dissolved by de facto seoaration orior to leaal di-
   vorce. This means that, while lTv'ri-qaoart, each souse is taxable
   upon the total amount of his (her.) earned income and is not taxable on
   one-half of the total income earned by the other spouse. This rule
   applies only if the,spouses "show by affirmative action their intent
   not to maintain the community status." Rev. Rul. 68-66, 1968-1 C.8. 33;
   Knodle v. Warren (D.C.W.D. Wash., 1967) reported in 67-1 U.S.T.C.
   para. 9261; See also, Dalton v. United States, (D.C.W.D. Wash., 1969)
   reported in 69-1 U.S.T.C. para. 9233.
        Numerous cases have arisen in which a husband and wife, living
   apart, have filed separate returns of community income under the mis-
   taken belief that their physical separation was effective to dissolve
   the community. In this circumstance, IRS has recomputed the tax lia-
   bility of both spouses on the basis that each was taxable on one-half
   of the earr.ings of the other spouse, notwithstanding that neither spouse
   in fact received any part of the community income earned bv the other or


   2/ See Jack M. Vaughan, Community ProDerty Civorce:   "Preoarina the    ax
      Returns," Community Property Journal 213 (1975,.
   3/ See references cited in William . de Funiak and Michael J. Vauqhn,
      Principles of Community Prooerty, 2d edition, 1971, sections 56,
      114, 12.




                                        2
ENCLOSURE                                                          ENCLOSURE

  derived income from property over which the other had control.
       IRS' position has been sustained i the Tax Court and on appeal to
  the United States Supreme Court. Christine K. Hill 32 T.C. 254 (1959);
  Carmen Ramos, T.C. Memo 1969-157; CarFo-ete J. Kimes 55 T.C. 774 (1971);
  United States v. Mitchell 403 U.S. 190 (1971). The same rule applies
  even though the wife, after separation, moves to a common law state.
  Marjorie Hunt 22 T.C. 228 (1954).
       In most cases this result has caused considerable financial hard-
  ship to the wife reouired to pay one-half of the much larger tax lia-
  oility attributable to the hiqher income of her husband out of the Tuch
  smaller earnings and separate property from which ' e supoorts herself.
  The fact was noted by   . Featherston in Ramos:

       "We are not unaware that this conclusion roduces a harsh
        result:  It seems unfair to impose liability on Detitioner
        for a tax based on earnings from which she received not the
        slightest benefit.   But, regardless of our sympathies, we
        have no discretion to relieve etitione: of the tax; our
        decision is d'ictated by the inexorable provisions of Texas
        community property law:   .   .

  Indeed, if the wife does not work and owns no separate oropertv, it is
  not clear how, as a practical matter, she can be forced to ay such
  personal statutory obligation. See Edward H. Mitchell, "Federal Tax-
  ation in Recent Contact with Californ.a Community Property,"
  14 So. Calif. Law. Rev. 390, 391 (1941).
       IRS has not sought to collect the tax from the husband in such
  cases. Ample legal authority exists, both under state community oro-
  perty law;, and under federal tax law rules, for IRS, as a creditor of
  the c.itmunity, to proceed against the husband as agent or trustee of
  the community and to collect the full amount of the community tax lia-
  bility out of the proceeds of the entire community in his possession
ENCLOSURE
                                                                       ENCLOSURE
  and   contro.   Depending upon the
  the   husband who has appropriated facts of the case, tax liability of
  own                                the entire community income
        use can be based on misappropriation,                     to his
  his   position as a transferee.4/           on unjust enrichment, or on

         IRS officials informally advised
     feasible alternative to oroceed        us that they do not consider
                                        in court 3aainst te husband           it
  basis that he is the trustee                                          on  the
  the Service should exhaust      for the comruit, oroert,.
                               available administrative remedies Theyv     lieve
  commending costly litigation.                                      before    re-
  the Justice Department wilh       They also noted ttat, to their
                                not  acent                             kncwlede,
  administrative lacourse is                 iS   recom.endations for sit
                               still available.                                if
        However, without discussing
  have, proceeded aainst tne          whether or not IRS should
                                husband                           have, or could
  sonal tax liability out                 in Mitchell to collect the
                            of ner one-halfsn3hreof                     wife's cer-
  his possession, thBE Supreme                          te commrunity income in
  the problem:                 Cocrt recommended      leeisl.tive   oltion

        "The remedy is in legislation.
         January 12, 1971, 84 Stat.       An example is Pub. L. 91-679
                                     2063,                               of
                                             addin' to the Code subsection
         of 6013 and the final sentence                                     (e)
         afford relief' to an innocent    of  665I(b).  These amendments
         return, with respect to omittedspouse, who was a arty to
                                                                    a joint
                                           income and fraudulent underoay-
         ment. Relief of that kind
         situation."                 is  the  answer to the respondent's

      Despi.e the Supreme Court's
 amended, the Internal Revenue      recommendation in 1971 that
                                 Service                         the law be
 and ht :Continued to assess             has not sought legislative
 tions to tax and penalties   tax,  interest, and where aDDlicable, relief
                                                                     addi-
 rate return fails to includeagainst the unsupoorted wife who, on a seDa-
                               in gross income her one-half
                                                             share of

 4/ William Q: de Funiak 1
                             PrinciDle. of Comuni tv Prorty
    edfition (1943), section-ra4                                 Law, 1t
     "The Ownership of Community nd authorties cited; Alvhn E. Evans,
                                   Property," 35 arvard Law
     (192i). The general                                       Review 47
    of the husband, in hisrule   is that the liabity
                             capacity               -ad      aounabilitv
    and of personalty acquired         as administrator
                                  out of such earnings, cf  his own earnings,
                                                         ;.sidentical to
    those of a common law agent
    one-half share of the communityor tenant in common. Where
                                                                 the wife's
    in fact satisfies her oersonal is in the hands of the husband, she
    income through the agency         tax liability with resDect
                                of her husband.                     to such
    240 P. 803, 807 (S.C. N. ex.,                  aca v. Villae of 9elen
   and Vaugha, op. cit., Sections 1925) and ai        L'ties cited-; de Funiak
   ties cited.                        100, 102, 103, 113, 126, and
                                                                      authori-




                                       4
ENCLOS.U RE                                                        ENCLOSURE
   community income which she does not receive. See, for example,
   Aimee D. Baar 66 T.C. 3.7 (1976); Bettie Jayne Coffman, T.C. Memo
   I974-308e'3ee R. Williams, T.C. Memo 197-48; Mary Ellen
                                                              Brent,
   T.C. Dkt.   7T6-74; Audrevy L. Eardin, T.C. Dkt. 45--.    And the Tax
   Court has continued to decide ?or the    overnment althcah recoanizina
   that, in a real sense, the wife is an innocent victim of
                                                              wroncdoina
   in this circumstance. MavV Lou Galliher, sucra, at 764.
   Tannenwa'd for tne Tax Court in Marlene Quinn, T..          Tnus, Judqe
                                                         Memo 1972-£i2 stated:
        "We sympathize fully with  etitioner, but we are unfortu-
         nately unable to ameliorate the li-ht .n which she finds
         herself. The SuDreme Court of the United States has de-
         clared that, under the circumstances described herein, she
         must include one-half of her husband's earnings in her in-
         come, notwithstanding the fact that she at no time had any
         dominion or control over such income.   United States v.
         Mitchell, 403 U.S. 190 (27 AFTR 2d 71-1457) (1971)/ re-
         versing 430 F. 2d 1 (26 AFTR 2d 70-5127) (C.A. 5, 1970),
         which, in turn, reversed 51 T.C. 641 (1969).   See also
         Christine K. Hill, 82 T.C. 254 (1959)."

        The joint-return requirement of section 6013(e) is an absolute
   to relief under the "innocent spouse" rule of section 6013(e)       bar

        "We realize that given the eual income interests vested
                                                                   in
         each spouse under the community orooertv laws, certain in-
         equitable situations that section 6 0 13(e) was designed to
         eliminate may very well arise if the spouses elect to file
         separately in community roperty states.     However, we have
         previously held that, regardless of the ineouities that
         might result, the intent of Congress was clear that a joint
         return must be filed before an otherwise "innocent soouse"
         ctn be acccrded the benefits of section 6013(e).    Mary Lou
         Galliher, supra.  Therefore, we find this section inaopli-
         cable in the instant case."   (J. Forrester in Mildred L.
         Pehland, T.C. Memo 1975-300).

       In view of the fact that the Mitchell decision may now oreclude
  from proceeding against the husband as administratcr of                 RS
                                                            the community in-
  come for payment of income taxes due with respect to t'ie
                                                             wife's one-half
  share, we recommend that relief be sought by amendment
                                                          to section 6013
  of the Code for those circumstances where the married individuals
                                                                      are
  living apart but not legally separated or divorced.

       IRS officials informally agreed that legislation aonq the
                                                                 lines
  we recommend is the best solution to the problem.




                                       5
ENCLOSURE                                                        ENCLOSURE

                          Ill.   GENERAL EXPLANATION


     Our proposed amendment adds a new subsection (f) to sectJin 6013.
The amendment orovides that when four conditions exist, a mar-ied indi-
vidual is to be relieved of tax liability (including interest, penalties,
and ther amounts) tou he extent that such liability is attributable to
the omission from gross income of the one-half of community income attri-
butab.e to the married individual under apolicable state commuity oro-
perty laws and not received by such individual.
     The four conditions which rust exist are:

(1) a separate r-"r has been riled by an individual who is married; (2)
there is omitted rom ross income reDprted o, the separate return com-
munity ;ncome derived from income earned by the other soouse or derived
from community rpetrtv; (3) the married individual filing the separate
return lives separate and apart from the other spouse for the entire tax-
able year, whether nr not such individual maintains a separate home or
has as a principal place of abode the hone of a third erson; (4) the in-
dividual filing the separate return establishes that h or she has not re-
ceived, directly or indirectly, the one-half of community income omitted
from gross income.
      The first equirement, that a separate return be filed by a person
entitled to file a joint return, is irtended to limit the relief rovided
in the bill to those cases where    married individudi, living aart from
a spousti resident in a community property state, files a separate return
covering his or her own earnings or income from separate earnings. The
second require:ment, that there is omitted from gross income reported on
the separate return the one-half of community income, is intended to
grant relief in situations where the married individual has no realistic
alterna.ive to filing a separate return from which one-half of community
income is omitted.
     Typically, the litigated cases have involved an unsupported wife who
does not know, and has no way of knowing, the financial status and affairs
of the community or even the whereabouts of her husband.  In many cases,
no return has been filed or tax aid by the absent husband. In such situ-
ations the wife has no control over her statutory income tax liability and
no means to compel her husband to divulge information for tax filina ourDose
concerning the community's assets, liabilities, or income. As a practical
matter, the wife filing separately can neither prepare a return showing the
community income ror pay the tax on such income. Further, she has no
power to guarantee that the community will be sufficiently solvent to satis-
fy the tax liability with respect to the one-half community income out of
her separate property. Despite the availability in most community oroverty
states of a suit for separation of property or a suit against the husband's
heirs after the community is dissolved by death, the wife is, as a practical
matter, helpless if the husband cannot be located for service of process.
ENCLOSURE                                                       ENCLOJURE

  Further, while the wife may be relieved of obligations to contract cre-
  ditors and of obligations created y state law under a state exemption
  statute if she renounces :he community, such renunciation does not re-
  lieve her of liabiiitv for federal income taxes due on the one-half of
  community, income attributed to her.
       The third and fourth conditions reauire a factual determination
  (bv the Internal Renue Service or the courts) as to whe-:er the Idi-
  vidual filing separately (1) liver '-parate and apart from tne other
  spouse for the entire taxable year     (2) has not received, directly
  or indirectly, ny benefit from the    :-half of community incor  omit-
  ted fror gross income. It is intenced that such individual will have
  the usual burden of proof (preponderance of the evidence) on these two
  issues and not the higher burden required of the government in civil
  fraud cas:s.

        With respect to the third and fourth conditions, factors to be
  taken into account include the ¢'    uf
                                        - whether the individual in aues-
  tion is deserted or abandoned,     receives alimony, separate main-
  tenance or child support payments during the taxable year from the souse.
  It is not necessary that the individual filing separately maint-in a
  separate home which would qualify as a household under section 2(b) (re-
  lating to definition of head of household) but for the fact that such
  individual is considered as married under section 143(b) (relating to
  certain married individuals living apart). All that is reuuired is that
  such individual not be a member of a household maintained by the other
  spouse. For purposes of determining whether the individual filing
  separately has received any amount of the community income, any amount
  received as alimony, separate maintenance, or child support ayment
  froma the spouse shall be regarded as an amount of community income re-
  ceived, and shall reduce dollar-for-dollar the amount of the one-half of
  community income with respect to which tax liability does not attach.
ENCLOSURE                                                         ENCLOSURE

                         IV.   CHANGES IN EXISTING LAW


Section 6013 of the Intarnal Reverue Code of 1954

Section 6013 Joint Returns of Income Tax By Husband and Wife

     (f) Separate Return after Filina Joint Return

         (1) In General - Under regulations orescribed by the Secretary
     or his delegate, if

           (A) a se.arate return has been made for a taxable year by an
         individual who is married and on such return there was omitted
         from gross icome an amount includable therein nder aolicable
         community oroperty laws,

           (B) the spouse filing the separate return lives aoert from the
         other spouse for the entire taxable  ear, and

           (C) the spouse filing the seDarate return establishes that he
         (she) has not received directly or indirectly any amount of the
         community income omitted from gross income
     then such spou:e shall be relieved of iiability for tax (including
     interest, penalties, and other amounts) for such taxable vear to
     the extent that such liability is attributable to omission of the
     community income from gross income.