oversight

Tax Policy: Information on the Joint and Several Liability Standard

Published by the Government Accountability Office on 1997-03-12.

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

                United States General Accounting Office

GAO             Report to the Committee on Ways and
                Means, House of Representatives, and
                the Committee on Finance, U.S. Senate


March 1997
                TAX POLICY
                Information on the
                Joint and Several
                Liability Standard




GAO/GGD-97-34
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      General Government Division

      B-271456

      March 12, 1997

      The Honorable William V. Roth, Jr.
      Chairman, Committee on Finance
      United States Senate

      The Honorable Daniel P. Moynihan
      Ranking Minority Member, Committee
        on Finance
      United States Senate

      The Honorable Bill Archer
      Chairman, Committee on Ways
        and Means
      House of Representatives

      The Honorable Charles B. Rangel
      Ranking Minority Member, Committee
        on Ways and Means
      House of Representatives

      When a married couple files a joint federal income tax return, each spouse
      becomes individually responsible for paying the entire amount of the tax
      associated with that return. Because of this joint and several liability
      standard, one spouse can be held liable for tax deficiencies assessed after
      a joint return was filed that were solely attributable to the actions of the
      other spouse. However, when one spouse, independently and without the
      knowledge of the other spouse, incurs the additional taxes, the other
      potentially “innocent spouse” may obtain relief from the additional tax
      liability if certain conditions are met. Because of concerns about the
      effectiveness of the current innocent spouse provisions and other
      perceived inequities caused by the joint and several liability standard,
      section 401 of the Taxpayer Bill of Rights 2 directed us to study and report
      on several issues related to the joint and several liability standard that
      applies to jointly filed federal income tax returns.1 Accordingly, this report
      discusses (1) the potential universe of taxpayers that may be eligible for
      innocent spouse relief, (2) the Internal Revenue Service’s (IRS) practices
      and procedures for handling requests for innocent spouse relief,
      (3) whether the innocent spouse provisions provide the same treatment
      for all taxpayers, (4) the potential effects of replacing the joint and several


      1
       Public Law 104-168, July 30, 1996. The law also directed the Secretary of the Treasury to study and
      report on the same issues discussed in this report. IRS and Treasury staff jointly conducted the study.
      The report had not been issued at the time of our review.



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             liability standard with a proportionate liability standard,2 (5) the potential
             effects on IRS of requiring it to abide by the terms of divorce decrees when
             those decrees allocate tax liabilities, and (6) the potential effects on IRS of
             changing the law so that community income of one spouse cannot be
             seized to satisfy tax liabilities incurred by the other spouse before their
             marriage.3


             A traditional argument for applying a joint and several liability standard to
Background   joint returns is that married couples form a single economic unit, so
             spouses who benefit from each other’s income and assets can be held
             responsible for the total tax liability generated from the income and assets.
             The benefit of joint returns is that married couples are taxed as if their
             combined income were equally split between the spouses. For married
             couples with substantially disproportionate incomes, such
             income-splitting may lower their overall taxes because some of the higher
             earner’s income could fall into a lower tax bracket and be taxed at a lower
             rate than if it had all been taxed as the income of one person.

             The benefits of income-splitting first became available in community
             property states in 1930 as a result of the Supreme Court case of Poe v.
             Seaborn [282 U.S. 101 (1930)]. In that case, the Court held that in
             community property states, the wife is vested with a half-interest in her
             husband’s income. Therefore, for federal tax returns, income was divided
             equally between husband and wife, regardless of who earned it. The
             benefits of income-splitting were denied couples living in common law
             states as a result of another 1930 Supreme Court case, Lucas v. Earl [281
             U.S. 111 (1930]. In that case, the Supreme Court rejected a couple’s private
             agreement assigning one-half of each spouse’s earnings to the other
             spouse for federal income tax purposes. Income-splitting for all joint filers
             was added to the Internal Revenue Code by the Revenue Act of 1948 as a
             means of equalizing the tax rates for married couples in common law
             states with the tax rates for those living in community property states.

             Congress subsequently determined that in some instances, it was
             inequitable to hold taxpayers liable for additional taxes resulting from
             their spouses’ unreported income. A commonly cited example was a
             spouse who, unknown to the other spouse, was engaged in an illegal

             2
              Under proportionate liability, each taxpayer is responsible only for the taxes resulting from his or her
             individual income, even when such income is reported on a joint return. Proportionate liability was
             generally the standard followed before the Revenue Act of 1938, which established joint and several
             liability on joint returns.
             3
              In community property states, the income and assets of each spouse belong equally to the other
             spouse and are available to pay the debts (including taxes) of either spouse.


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    activity, did not report the illegal income, and was subsequently caught
    and assessed the taxes on the illegal gain. In 1971, Congress enacted the
    innocent spouse provisions in the Internal Revenue Code (section 6013(e))
    to recognize the inequity of holding spouses liable for additional tax
    assessments in certain cases. The provisions were broadened in 1984 to
    provide relief from liabilities resulting from grossly erroneous deductions,
    credits, or basis (i.e., the purchase price of an asset), in addition to
    unreported income. The current innocent spouse provisions allow relief
    from the joint and several liability standard when

•   the innocent spouse has filed a joint return with the culpable spouse;
•   the spouse did not know and had no reason to know there was a
    substantial tax understatement (knowledge test); and
•   taking into account all the facts and circumstances, it is inequitable to hold
    the spouse liable for the additional tax attributable to the substantial
    understatement of the culpable spouse.

    In addition, the spouse requesting relief must meet certain dollar
    thresholds that vary depending on the cause of the additional assessment:

•   A tax liability resulting from an omission of gross income must exceed
    $500.
•   A tax liability resulting from a deduction, credit, or basis that has no basis
    in fact or law must exceed $500 and also be in excess of (1) 10 percent of
    the innocent spouse’s adjusted gross income for their preadjustment tax
    year if the taxpayer’s income is less than or equal to $20,000; or
    (2) 25 percent of the innocent spouse’s income if the taxpayer’s income is
    greater than $20,000. If the innocent spouse has remarried, the new
    spouse’s income is included in this calculation.

    IRSgenerally follows state law in regard to ownership of property, and the
    states define ownership of property very differently. In community
    property states, the income and assets (property) of each spouse belong
    equally to the other spouse and can be attached to pay the debts (including
    taxes) of either spouse.4 About 27 percent of all taxpayers live in the nine
    community property states (Arizona, California, Idaho, Louisiana, Nevada,
    New Mexico, Texas, Washington, and Wisconsin). In common law states,
    spouses do not have an inherent right to each other’s income and assets.
    As a result, there is a distinct difference in the application of joint and

    4
     Community property principles apply to the income and assets acquired during the marriage.
    Residents of community property states may own separate property, which generally consists of
    property owned before the marriage or property acquired by gift or inheritance. The laws of the
    individual states govern the treatment of such separate property and the income derived from it.



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                   several liability between the residents of community property states
                   versus common law states. For example, a married couple living in a
                   common law state can avoid joint and several liability by filing a “married,
                   filing separate” return, whereas filing a “married, filing separate” return in
                   a community property state will not necessarily result in a similar
                   avoidance of tax.


                   We estimated that about 587,000, or about 1 percent, of the 48 million
Results in Brief   couples who filed joint returns in 1992, the most recent year for which
                   data were available, had additional tax assessments of more than $500.
                   This estimate represents the maximum number of taxpayers potentially
                   eligible for innocent spouse relief; however, fewer would probably actually
                   qualify. Some taxpayers would also probably have been assessed
                   additional taxes as a result of overstated deductions, credits, or basis,
                   which have other dollar thresholds in addition to the $500 threshold. Some
                   of these taxpayers would also probably have been ineligible for relief
                   because they would not have met the knowledge test of the innocent
                   spouse provision. However, IRS did not have the data that we would need
                   to estimate the number of taxpayers that fell into these categories.
                   Furthermore, although any taxpayer signing a joint return may seek
                   innocent spouse relief, according to IRS officials, divorced taxpayers are
                   more likely to face the most egregious problems because their current
                   assets could be seized to satisfy tax obligations accruing from joint returns
                   filed prior to the divorce. Assuming a 2 percent per year divorce rate, we
                   estimated that about 35,000 of the 587,000 couples with additional tax
                   assessments for 1992 were divorced in the 3 years since the end of the
                   1992 tax year and thus a spouse from these couples may have been more
                   likely to consider applying for relief.

                   The limited information that was available from several operating units
                   within IRS indicated that IRS received few requests for innocent spouse
                   relief and denied most of them. Although information was not available to
                   determine why few requests were made, we observed that IRS publications
                   provide little information on how to request innocent spouse relief and
                   that the publications covering procedures related to the need for relief
                   (e.g., tax examination and appeals) have no information on relief, and IRS
                   has no specific form or process for applying for innocent spouse relief.

                   Critics of the innocent spouse provisions contend that the current
                   provisions do not ensure that all deserving taxpayers receive equivalent
                   relief. For example, they believe that the dollar thresholds for claiming



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innocent spouse relief may preclude some deserving taxpayers from
obtaining relief because of the amount of their liability. Four states
apparently agree because, for state income tax purposes, they have no
dollar thresholds. Assuming a 2 percent per year divorce rate, we
estimated that for tax year 1992, an additional 42,600 divorced taxpayers
might have been eligible for innocent spouse relief if the dollar thresholds
had been eliminated. Since the innocent spouse relief provisions relieve
the innocent spouse of responsibility for a joint liability rather than forgive
the tax obligation, we could not estimate the revenue impacts of modifying
the provisions because data were not available on how successful IRS has
been in collecting from culpable spouses.

An alternative way to ensure that taxpayers are not held liable for their
spouses’ taxes would be to replace the joint and several liability standard
with a proportionate liability standard. Under such a standard, taxpayers
would be responsible only for the taxes generated by their individual
incomes and assets or, for taxpayers living in community property states,
for the tax associated with one-half of the community income. Options for
administering a proportionate liability standard include (1) eliminating
joint returns and requiring all taxpayers to file separately, (2) retaining
joint returns but modifying them so that each spouse’s income and
deductions would be reported in separate columns, and (3) retaining the
current joint return requirements but applying proportionate liability only
in cases where there are unpaid taxes or subsequent tax assessments.
Each of these options represents a trade-off between clearly establishing
each taxpayer’s liability and the amount of paperwork and administrative
burden created for taxpayers and IRS. The separate and modified joint
return options would increase taxpayers’ filing burden and IRS’
return-processing costs. All three options could increase the costs of IRS’
audit, underreporter, and collection programs.

Divorcing couples may specify in their divorce decrees how future
liabilities resulting from their prior joint returns are handled. IRS officials
at the local level said many taxpayers are surprised to discover that IRS is
not bound by these agreements because it is not a party to the decree.
Requiring IRS to be bound by divorce decrees is impractical for two major
reasons. First, federal tax matters are the exclusive jurisdiction of certain
federal courts, while divorce matters are generally handled by state courts.
Thus, there is currently no legal forum where IRS and the parties to a
divorce could resolve issues relating to both tax matters and divorce
proceedings. Furthermore, this proposal could require IRS to become
involved in every divorce settlement or trial. In 1994, about 1.2 million



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              divorce decrees were granted in the United States. IRS officials also raised
              related concerns, such as whether their interpretation of lengthy and
              complex divorce decrees would increase the number of appeals and
              whether divorce decrees would be manipulated to reduce tax liabilities.

              IRScan treat taxpayers living in community property states differently from
              taxpayers living in common law states when collecting taxes. Unlike in
              common law states, IRS can levy one spouse’s income to satisfy the
              premarital tax debts of the other spouse in community property states
              because of the joint ownership of property in those states. In contrast, IRS
              cannot levy the income of one spouse to pay the premarital tax debts of
              the other spouse in common law states because spouses do not have a
              legal entitlement to each other’s property. Since IRS does not maintain data
              on how often these levy actions occur, we could not assess the potential
              impact on IRS of changing the law to treat everyone the way it treats
              taxpayers in common law states.


              To calculate the potential universe of innocent spouses, we used IRS’
Scope and     Statistics of Income data for tax year 1992 to estimate the number of joint
Methodology   returns filed that year and whether or not the taxpayers lived in
              community property states. We used IRS’ information on the results of its
              1992 underreporter program to estimate the number and dollar amount of
              such assessments made against joint filers. We also used the Audit
              Information Management System (AIMS) database to identify the number
              and amount of audit assessments made against tax year 1992 joint returns.
              Finally, we used data from the Bureau of the Census and the Department
              of Health and Human Services to calculate an annual divorce rate and
              estimate the number of joint filers that divorce each year.

              To determine IRS’ practices and procedures for handling innocent spouse
              cases, we interviewed IRS officials at headquarters, four district offices,
              and three service centers to discuss their procedures for identifying and
              processing innocent spouse cases. We selected the Baltimore,
              Philadelphia, Arkansas-Oklahoma, and San Francisco District Offices and
              the Philadelphia, Austin, and Fresno Service Centers to give a diverse
              geographic perspective. We also reviewed innocent spouse cases at the
              San Francisco District Office and the Fresno Service Center located near
              our San Francisco office. In addition, IRS, as part of its own efforts to
              assess the problems related to divorced and separated taxpayers, had
              requested five Problem Resolution Offices to forward the innocent spouse




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cases handled between January and June 1996 to its Problem Resolution
Office in headquarters. We reviewed the 31 innocent spouse cases.

To determine whether the innocent spouse provisions provide the same
treatment to all taxpayers, we reviewed the literature examining the
provisions and IRS data, and compared the federal innocent spouse
provisions to state innocent spouse provisions.

To determine the potential effects of changing the current joint and
several liability standard to a proportionate liability standard, we used IRS’
Statistics of Income data for tax year 1992, underreporter assessments,5
and the AIMS database to estimate the number of taxpayers who filed using
the “married, filing jointly” status. We also worked with IRS to develop an
estimate of the number of taxpayers who had an assessment made against
a previously filed joint return to estimate the universe of taxpayers who
would have been affected by any changes to the standard. In addition, we
reviewed proposed alternatives to the joint and several liability standard
prepared by the American Bar Association (ABA) and the American
Institute of Certified Public Accountants (AICPA). We also met with North
Dakota state officials, who administer a proportionate liability standard on
joint state income tax returns. To determine the potential tax
administration issues and taxpayer burden associated with establishing a
proportionate liability standard, we developed a stratified probability
sample of 200 joint tax returns from IRS’ tax year 1992 Statistics of Income
file to estimate the amount of income that could be identified as either
joint or separate income. We projected this sample to the universe of
48 million taxpayers who used the “married, filing joint” status at a
95 percent confidence level.

To determine the potential effects on IRS of requiring it to be bound by
divorce decrees, we analyzed the legal ramifications of binding IRS to the
terms of lower court decisions. We also discussed the benefits and
problems associated with following the provisions of divorce decrees with
officials from IRS and officials from California, Wisconsin, and Delaware,
whose state tax agencies are bound by divorce decrees.

To determine the potential effects on IRS of changing the law to limit its
ability to attach community property, we discussed with IRS officials the


5
 In its underreporter program, IRS computers match income shown on information returns (e.g., forms
W-2 and 1099 for interest and dividends) with income that taxpayers report on their tax returns to
determine whether taxpayers reported all their income. When discrepancies are found, IRS contacts
taxpayers to resolve the issue and assess additional taxes, if required.



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                        policies related to the attachment of income and assets of one taxpayer to
                        pay the debts incurred by his or her spouse before the marriage.

                        We performed our review from February 1996 through September 1996 in
                        accordance with generally accepted government accounting standards. We
                        requested comments on a draft of this report from the Commissioner of
                        Internal Revenue, which we received on January 15, 1997. These
                        comments are discussed on pages 23 to 25, and a copy of the comments
                        are included in appendix VI.


                        Because IRS did not have data on the number of innocent spouse requests
Estimated Universe of   filed, we developed an estimate of the potential universe of taxpayers that
Potential Innocent      could qualify under the current innocent spouse provisions. We estimated
Spouses                 that a spouse from up to 587,000 couples may have been eligible for
                        innocent spouse relief in 1992.

                        About 48 million joint tax returns were filed for tax year 1992. From IRS’
                        data on tax year 1992 audit and underreporter programs, we estimated that
                        1.25 million couples filing joint returns were assessed additional taxes
                        under these programs—250,000 were audit assessments and 1 million were
                        underreporter assessments. Of these 1.25 million returns, about 587,000
                        had additional tax assessments exceeding $500, which is the minimum
                        dollar threshold required for innocent spouse relief. Appendix I describes
                        the methodology we used to make these estimates.

                        However, our estimate of 587,000 couples represents the maximum
                        number of taxpayers potentially eligible for innocent spouse relief; fewer
                        would probably actually qualify. Some couples would also probably have
                        been assessed additional taxes as a result of overstated deductions,
                        credits, or basis, which have other dollar thresholds in addition to the $500
                        threshold. Data were not available that we would need to estimate the
                        number of joint taxpayers whose tax year 1992 additional tax assessments
                        resulted from overstated deductions, credits, or basis. Also, some of the
                        587,000 couples may not have qualified for innocent spouse protection
                        because they knew there was a substantial tax understatement. This
                        knowledge would have made them ineligible for relief even if the tax
                        deficiency was solely attributable to the actions of one spouse.

                        Although an unknown number of the 587,000 couples could potentially
                        seek innocent spouse relief, IRS officials told us that the severity of the
                        problem for taxpayers seeking such relief is much greater in the case of



                        Page 8                                         GAO/GGD-97-34 Income Tax Liability
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                        divorced or separated taxpayers. Therefore, we also estimated the number
                        of taxpayers who could potentially be eligible for relief and may have
                        divorced during the 3 years since the 1992 joint returns were filed. Using a
                        2 percent per year divorce rate, we estimated that 35,000 divorced
                        taxpayers might have been eligible for innocent spouse relief for
                        additional tax assessments of more than $500. Appendix I describes how
                        we developed this estimate.


                        IRS did not accumulate data on the number of cases requesting innocent
Limited Data on         spouse relief or the number of cases for which it grants such relief.
Innocent Spouse         Although IRS did not systematically collect data on innocent spouse cases,
Claims Were Available   we found that some IRS operating units we visited maintained some
                        information on the innocent spouse cases they handled. The limited
                        information found on innocent spouse claims indicated that few requests
                        were received, and of these, most were denied. For example, records at
                        the Fresno Service Center indicate it received 90 Offer in Compromise
                        cases requesting innocent spouse relief during the 3 years between March
                        1993 and February 1996.6 The service center denied 48 of these requests
                        because either (1) they dealt with taxes reported as owed on the original
                        return but not paid rather than with subsequent assessments; or (2) the
                        issues causing the assessment had already been resolved by IRS’ Appeals
                        Division or the Tax Court, and the claimant had agreed to the decisions.
                        The remaining 42 cases were referred to district offices for processing. As
                        of September 1996, 26 of these 42 cases had been resolved, with 7 being
                        allowed and 19 being denied.

                        We found that most of the cases handled by IRS’ Problem Resolution Office7
                         were also denied. In fiscal year 1996, the Problem Resolution Office
                        requested information from five offices on innocent spouse cases. We
                        reviewed 31 Problem Resolution Office cases from 4 district offices and 1
                        service center where taxpayers raised the innocent spouse issue between
                        January and June 1996. For the 21 cases where a decision had been
                        reached, IRS granted relief in 10 cases. Appendix II shows our analysis of
                        the Problem Resolution cases we reviewed and summaries of some of the
                        cases.

                        6
                         IRS identified the 90 Offer in Compromise cases by a manual review of Offer in Compromise
                        correspondence files maintained in the Joint Compliance Branch. Although other requests for innocent
                        spouse relief may have been received at the Fresno Service Center during this time period, we were
                        unable to identify any other operating units at the center that maintained such information.
                        7
                         The Problem Resolution Program, administered by IRS’ Problem Resolution Office, is designed to
                        help taxpayers who have been unable to resolve their tax problems after repeated attempts to do so
                        with another IRS unit.



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                            Furthermore, according to IRS officials, the Tax Court denied relief in
                            one-third of the innocent spouse cases decided in 1996.


                            Although innocent spouse relief is clearly established in law and
Information Available       regulation, we observed that little information about the criteria for
on Applying for             granting it or how to apply for it was available from IRS sources. The
Innocent Spouse             innocent spouse relief provisions are described in several IRS publications,
                            including Your Federal Income Tax (Publication 17), Divorced or
Relief Was Limited          Separated Individuals (Publication 504), and Exemptions, Standard
                            Deduction, and Filing Information (Publication 501). However, these
                            publications do not provide any guidance on how to request relief.
                            Furthermore, they are developed to help taxpayers prepare their returns,
                            which is far in advance of the time that taxpayers might need information
                            on the possibility of innocent spouse relief.8 In contrast, Examination of
                            Returns, Appeal Rights, and Claims for Refund (Publication 556) and
                            Understanding The Collection Process (Publication 594) are totally silent
                            about innocent spouse relief, even though these publications are more
                            directly related to the procedures that apply when taxpayers are billed for
                            their spouses’ taxes.


IRS Had No Well-Defined     IRS also lacks well-defined procedures for taxpayers to request innocent
Procedures for Requesting   spouse relief. As noted, in those limited cases where IRS has publicized the
and Processing Innocent     innocent spouse provisions, there is no guidance as to how taxpayers
                            should request such relief. In those innocent spouse cases we were able to
Spouse Claims               identify and review, we found no consistent process for claiming relief. In
                            most cases, we found that either the taxpayers or their representatives had
                            (1) contacted Problem Resolution Offices, which were established to
                            assist taxpayers who cannot resolve their problems through normal IRS
                            channels; or (2) requested relief through an Offer in Compromise, which is
                            used in the cases of taxpayers who cannot pay the full amount of the
                            balance due and decide to offer a lesser amount. The fact that taxpayers
                            are commonly using these two approaches to seek innocent spouse relief
                            may indicate that taxpayers are not provided with adequate guidance for
                            seeking relief by IRS.

                            In contrast, we found a much more taxpayer-friendly approach taken in
                            the case of “injured spouse” claims. Injured spouses are joint filers whose
                            joint refunds have been seized to pay certain of their spouses’ nontax

                            8
                             IRS generally does not begin auditing tax returns until about 6 months after the April 15 return due
                            date. Also, it generally does not begin investigating cases in its underreporter program until 7 months
                            after the April 15 filing date.



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                        debts, such as past-due child or spousal support or a federal loan. Injured
                        spouses can apply for their portion of the joint refund by completing Form
                        8379, Injured Spouse Claim and Allocation. The 1040 instruction booklet
                        provides a clear explanation of the injured spouse provisions, the
                        qualifying conditions to be met, the specific form to be prepared, and how
                        the claim should be filed with IRS. The information is provided under the
                        refund line item instructions and tells taxpayers to attach the Form 8379 to
                        their tax return.

                        We also found confusion within IRS about how taxpayers should request
                        innocent spouse relief. The various IRS units we contacted to determine the
                        procedures they followed in handling innocent spouse cases took different
                        approaches to considering relief. For example, two district offices granted
                        relief using Offers in Compromise based on doubt of liability, while staff at
                        one service center routinely denied such requests as inappropriate. This
                        latter service center staff’s position was that Offers in Compromise based
                        on doubt of liability can be used only to argue that IRS miscalculated the
                        tax assessment, not to argue that a taxpayer is not liable for paying the
                        assessment. An official at one district office said he would advise
                        taxpayers to fill out an injured spouse form, while an official at a service
                        center said he was unaware that innocent spouse relief existed.


                        Critics of the innocent spouse provisions, such as ABA and AICPA, contend
Modifying Tax Code      that the current provisions do not ensure that taxpayers receive equitable
Provisions Could        relief. For example, they said that the dollar thresholds included in the
Allow More Taxpayers    provisions result in eligibility criteria for relief based on income and not
                        strictly on whether the spouse was innocent. Also, under the current
to Qualify for Relief   provisions, spouses can receive relief if deductions have absolutely no
                        basis in fact or law, but not if the deductions are simply erroneous.
                        Furthermore, spouses requesting relief must establish that they did not
                        know and had no reason to know their spouses were cheating on the
                        taxes. Critics note that the concept of “no reason to know” has not only
                        been interpreted differently by various courts, but is difficult for the
                        potential innocent spouse to prove. Appendix II includes several examples
                        that illustrate the issues involved in applying the innocent spouse
                        provisions.

                        According to IRS officials, Congress required innocent spouses to meet
                        certain dollar thresholds to qualify for relief as a way of filtering out
                        insignificant claims. The dollar thresholds clearly exclude some taxpayers
                        from relief and may be inconsistent with the goal of providing relief to



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deserving taxpayers. In the case of a tax assessment related to an
improper deduction, credit, or basis, the amount of the assessment must
exceed 10 percent of the claimant’s adjusted gross income (AGI) for the
claimant’s most recent tax year if such income is $20,000 or less, but the
assessment must exceed 25 percent of AGI if it is more than $20,000. Thus,
if a taxpayer’s AGI is $20,000 or less, relief could be available on
assessments of $2,000 or less, but if the taxpayer’s AGI is more than
$20,000, relief would be available only if the assessment exceeded $5,000.
This distinction appears to be more related to an ability to pay or degree of
hardship than to the innocence of the taxpayer. The logic behind these
dollar thresholds is clouded even more because the potential innocent
spouse’s AGI is based on the tax year ending before the notice of deficiency
(which may be several years after the tax year of the joint return) and
must include the income of any new spouse whether or not a joint return
was filed. Finally, the dollar thresholds prevent taxpayers with smaller
liabilities from obtaining relief, since the minimum understatement of tax
in all cases must be more than $500, which could preclude lower income
taxpayers from obtaining relief.

The 1984 Tax Reform Act extended relief to include deductions but
requires that such items be grossly erroneous, meaning there is no basis in
fact or law for the claim. The distinction between a deduction having no
basis in law or fact versus its just being erroneous is difficult to
comprehend and can lead to various interpretations by IRS and the courts.
This problem is compounded by the fact that IRS’ regulations governing
innocent spouse relief were issued in 1974 and have not been updated
since that time to incorporate the changes to the innocent spouse
provisions resulting from the 1984 Tax Reform Act.

The “knowledge” factor is perhaps the most subjective element in the
current innocent spouse provisions. For someone to prove that they did
not know and had no reason to know of a financial transaction undertaken
by his or her spouse would generally be difficult, if not impossible. IRS and
the courts consider circumstantial factors, such as education, involvement
in the family’s financial affairs, and lifestyle, in assessing this contention.
For example, one indicator that IRS uses to determine if spouses were
aware of the tax avoidance is whether they benefited by living a lifestyle
significantly better than could be supported by the reported income.
However, according to critics, a determination of whether a taxpayer’s
lifestyle was significantly better because of the tax avoidance is fairly
subjective and the courts have interpreted the criteria differently. Some




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                        district offices have designated an employee as the innocent spouse
                        coordinator so that only one employee applies the knowledge test.

                        Some states have decided not to apply the federal innocent spouse
                        provisions and have modified them for state tax purposes. Our survey of
                        the District of Columbia and the 43 states that have personal income taxes
                        showed that 20 do not have innocent spouse provisions, 18 have innocent
                        spouse provisions based on the Internal Revenue Code, and 6 have less
                        restrictive provisions (see app. III for a listing of the states).

                        California, Iowa, Louisiana, and Oklahoma do not apply dollar thresholds
                        when granting innocent spouse relief, while New York applies a $100
                        threshold. Massachusetts does not apply the percentage of income
                        threshold for taxes resulting from grossly erroneous deductions. In
                        addition, California and Oklahoma do not require that deductions have no
                        basis in fact or law, simply that they be erroneous.

                        We estimated that if the federal innocent spouse tax code provisions had
                        been modified to eliminate the dollar thresholds as was done by
                        California, Iowa, Louisiana, and Oklahoma, the maximum number of
                        couples filing tax year 1992 returns potentially eligible for innocent spouse
                        relief would have been 710,000. Assuming a divorce rate of 2 percent per
                        year, we estimate that 42,600 of these couples would have divorced within
                        3 years.

                        Modifying the provisions to allow more taxpayers to qualify for innocent
                        spouse relief would likely result in some revenue loss because IRS might
                        not always be successful in collecting from the culpable spouse. However,
                        since IRS does not maintain data on how often it collects from the culpable
                        spouse, we could not estimate the size of the potential revenue loss. IRS
                        would also incur some additional collection costs associated with
                        pursuing the culpable spouse.


                        An alternative way to ensure that taxpayers are not held liable for their
Potential Impact of     spouses’ taxes would be to replace the joint and several liability standard
Replacing the Joint     with a proportionate liability standard. Under the generally accepted
and Several Liability   definition of proportionate liability, taxpayers would be held responsible
                        only for the taxes generated by their own individual incomes and assets or,
Standard With           for taxpayers living in community property states, for the tax associated
Proportionate           with one-half of the community income. We identified three options for
                        administering a proportionate liability standard that represent trade-offs
Liability

                        Page 13                                       GAO/GGD-97-34 Income Tax Liability
                            B-271456




                            between clearly establishing each taxpayer’s liability on their tax returns
                            and the amount of paperwork and administrative burden created for
                            taxpayers and IRS. Two options in addition to proportionate liability that
                            would limit IRS’ ability to hold taxpayers liable for their spouses’ taxes are
                            to (1) allow taxpayers to amend their filing status after the due date of the
                            return and (2) have each taxpayer identify on the return the percentage of
                            the total liability for which he or she would be responsible.


Comparison of the           Our review of the literature identified three options for administering a
Potential Impact of Three   proportionate liability standard. The options are to (1) eliminate joint
Administrative Options on   returns and require all taxpayers to file separately,9 (2) retain joint returns
                            but modify them so that each spouse’s income and deductions are
Taxpayers and IRS           reported in separate columns, and (3) retain the current joint return
                            requirements but apply proportionate liability only in cases where there
                            are delinquent taxes or subsequent tax assessments. We evaluated the
                            potential effects of these options on IRS’ tax administration processes and
                            taxpayers’ burden. We did not consider how these options would
                            potentially affect tax revenues. Table 1 shows the pros and cons of the
                            three options for taxpayers and IRS.




                            9
                             Married couples currently have the option of filing separately, which in effect proportions their tax
                            liability to their own income, unless the couple lives in a community property state, in which case each
                            taxpayer is liable for the taxes associated with any separate income they may have and one-half of the
                            community income. However, only 5 percent of married taxpayers file separately, because the tax
                            rates are generally lower if they file a joint return.



                            Page 14                                                       GAO/GGD-97-34 Income Tax Liability
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Table 1: Pros and Cons of Different
Methods of Administering a                                     Separate return           Modified joint return Current joint return
Proportionate Liability Standard      Entity                   optiona                   optionb               optionc
                                      Taxpayers

                                      Pros                     If divorced, individual If divorced, individual No additional
                                                               liability is more clearly liability is more clearly paperwork burden.
                                                               established.              established.

                                      Cons                     Must prepare two          Must allocate joint       Must establish
                                                               returns but receive       income, deductions,       individual liability if
                                                               limited or no benefit     and credits but           additional taxes
                                                               while married.            receive limited or no     assessed.
                                                                                         benefit while married.

                                                               May have a higher tax May have a higher tax
                                                               liability under current liability under current
                                                               rate structure.         rate structure.
                                      IRS

                                      Pros                     Individual liability      Individual liability      No additional
                                                               more clearly              more clearly              return-processing
                                                               established.              established.              costs.


                                      Cons                     Increased costs for       Might increase costs      Must establish
                                                               processing up to          for keying additional     individual liability if
                                                               twice as many returns     data into computer        additional taxes
                                                               for married couples.      systems.                  assessed.


                                                               Increased difficulty in   Increased difficulty in
                                                               matching income           matching income
                                                               reported on returns to    reported on returns to
                                                               information returns.      information returns.

                                                               Increased collection      Increased collection      Increased collection
                                                               costs because IRS         costs because IRS         costs because IRS
                                                               would have to collect     would have to collect     would have to collect
                                                               from each taxpayer        from each taxpayer        from each taxpayer
                                                               rather than a couple.     rather than a couple.     rather than a couple.
                                      a
                                          Each spouse files separate return.
                                      b
                                          Income split out separately on joint return.
                                      c
                                          Proportionate income only for returns with unpaid taxes or subsequent tax assessments.

                                      Source: GAO’s analysis of three proportionate liability options.



                                      As shown in table 1, establishing proportionate liability on either a
                                      separate or joint return is of limited or no benefit to married taxpayers




                                      Page 15                                                        GAO/GGD-97-34 Income Tax Liability
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who generally would pay their income tax from joint assets or, if they
prefer, already have the option of choosing the “married, filing separately”
option to limit their liability to their own income. However, such a system
would clearly establish liability so that in the event of a tax shortfall,
divorced taxpayers could more easily establish the extent to which they
are liable for the unpaid taxes or assessments. This clarity, however, is
purchased at the cost of a significant burden for taxpayers. For example,
in tax year 1992, about 48 million couples filed joint returns but only about
4.5 million, or 9 percent, of them had unpaid tax liabilities or subsequent
tax assessments. Thus, under the separate and modified joint return
options, about 43 million more couples would have been burdened by
proportionate liability than would have potentially benefited. These
taxpayers would, at a minimum, have had to allocate their income,
deductions, and credits on a joint return and, if required to file separately,
file an additional return. Under the current joint return option, however,
only the 4.5 million couples with unpaid tax liabilities or additional tax
assessments would potentially have had to proportion their income,
deductions, and credits. Since, according to IRS, married couples are less
likely to request a proportionate split of their joint tax liability even if one
of the spouses is innocent, this number may overestimate how many
taxpayers would have actually benefited. We estimate that about 270,000
taxpayers would divorce during the 3 years after the returns were filed.

Furthermore, as we reported in September 1996,10 most married taxpayers
would pay higher total taxes if they filed separately rather than jointly. As
a result, requiring these taxpayers to file separately could create a higher
tax liability for a significant number of taxpayers under the current rate
structure.

IRS would also face increased return-processing costs under the separate
return or modified joint return-filing options, but not under the current
joint return option. For example, if taxpayers were required to file
separately, IRS would have to process up to 48 million additional returns
since each dual-income couple who formerly filed a single joint return
would have to file two returns. We estimate that if all 48 million joint filers
had to file two returns, it would cost IRS an additional $199 million to
process the additional tax returns. If married taxpayers were allowed to
file jointly but had to report their income and deductions separately on the
return—for example, a tax return column for each spouse—IRS might have
to make twice as many data transcription entries as it currently does. If all

10
 Tax Administration: Income Tax Treatment of Married and Single Individuals (GAO/GGD-96-175,
Sept. 3, 1996).



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48 million joint filers reported two income streams, we estimate that the
additional data entry costs could be about $19 million.11 Appendix IV
describes our methodology for estimating these costs. IRS’ underreporter
program might also face additional computer matches, but we did not try
to estimate these increased costs. There would be no additional
return-processing costs under the current joint return option.

IRS’ tax compliance costs would increase under all three options; however,
it would experience significantly more costs under the separate and
modified joint return options than under the current joint return option.
For example, IRS’ underreporter program costs could increase because it
might have trouble matching proportionate tax returns (i.e., separate
returns and modified joint returns) to information returns. In our review of
a stratified probability sample of 200 joint tax returns for 1992 and the
information returns associated with these returns, we found that
77 percent of the income reported on the returns was separately held and
IRS would have little difficulty allocating this income. About 2 percent of
the income was reported as joint income, and we could not determine
whether 12 percent of the income was jointly or separately held. As a
result, IRS would generally have difficulty allocating this income. (App. V
lists the various income types and whether they were jointly or separately
held.)

For separate returns, IRS would not be able to readily match jointly held
income to determine whether all the income was reported unless it
cross-referenced the return to the spouse’s return. IRS would not have this
problem with the modified joint return because both spouses’ income on
the joint return could be totaled by computer and matched to information
returns. However, under both the separate and modified joint return
options, IRS could not easily determine whether jointly held income was
correctly apportioned without requiring taxpayers to either document the
information provided on the return or to maintain separate information
return accounts for all their income.

The advantage of establishing individual tax liability only if there was a tax
shortfall is that it would create little additional burden for taxpayers or IRS.
The disadvantage is that in the event of a tax shortfall, the taxpayers and
IRS would have to apportion a jointly reported tax liability between the two
taxpayers who signed the return. Since the current information reporting
system shows certain income and deductions jointly, Congress or IRS

11
 If the modified return had separate columns for each spouse and a total column, IRS might need to
key in only the total column, with the other data being used only if a claim for innocent spouse relief
arises.



Page 17                                                        GAO/GGD-97-34 Income Tax Liability
                          B-271456




                          would need to develop guidelines on how such income and deductions
                          should be handled.

                          In addition to increased underreporter costs, IRS would likely face
                          increased collection costs because it would have to collect from each
                          taxpayer rather than the couple or whichever taxpayer it found first.


Proportionate Liability   The least costly and disruptive of the three proportionate liability options
Established Only for      would be to retain the current joint return and proportion income and
Unpaid Taxes or Audit     deductions only in cases where there are either unpaid taxes or additional
                          tax assessments. This option is endorsed by ABA and is practiced by North
Assessments Would Be      Dakota—the only state that has a proportionate liability standard. Each of
Least Costly Option       these entities, however, advocates different methods for proportioning tax
                          liabilities.

                          ABA, which advocates a proportionate liability standard, proposes
                          apportioning the liability reported on the original return by calculating
                          (1) the spouses’ taxes as if they had filed using the “married, filing
                          separately” status; and (2) the percentage of the couple’s combined taxes
                          at the separate rate attributable to each spouse. IRS would then apply each
                          spouse’s percentage to the joint tax to determine each taxpayer’s liability.
                          The burden of proof for calculating the proportionate liability would fall
                          on the taxpayer. If IRS assesses additional taxes through an audit, the
                          deficiency would be the liability of whichever spouse generated the
                          unreported income or disallowed deduction, thus reducing the need for
                          innocent spouse relief. IRS officials believe that innocent spouse relief
                          would still be necessary in certain circumstances, such as when one
                          spouse purchases rental property in both spouses’ names and does not
                          inform the other spouse of the asset or income.

                          North Dakota is the only state that applies a proportionate liability
                          standard to the state income tax return. However, in practice, the North
                          Dakota Tax Commission administers the state tax system as if a joint and
                          several liability standard applied to the state joint returns because it
                          pursues whichever taxpayer it finds first to collect the tax liability. If a
                          divorced taxpayer claims that the tax liability is really attributable to the
                          ex-spouse, the state applies a proportionate liability standard to the joint
                          return. The state uses information returns from IRS to initially apportion
                          reported income and deductions. For income reported in both taxpayers’
                          names, the state assesses 100 percent of the joint income to both
                          taxpayers, and the burden then falls on the taxpayer to document a



                          Page 18                                        GAO/GGD-97-34 Income Tax Liability
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                        different allocation. Joint deductions, such as those for dependents, are
                        allocated in proportion to the amount of income each spouse generated. In
                        other words, if a spouse generated 40 percent of the income, that spouse
                        could claim 40 percent of the deduction. Unreported income is attributed
                        to whoever earned the income.

                        North Dakota Tax Commission officials said that although proportionate
                        liability addresses the problems of some divorced taxpayers, it is not a
                        panacea that produces a just result in all cases. For example, state officials
                        noted that most farm land is held jointly, but the income is claimed only by
                        the farming husband. They questioned the fairness of allowing a wife to
                        disclaim any responsibility for income generated by an asset that was
                        owned by both spouses. State officials said they were also bothered that
                        nonworking taxpayers who are completely supported by their spouses can
                        then disclaim any responsibility for their spouse’s taxes. Such disclaimers
                        are particularly ironic in that nonworking spouses generally establish their
                        claims to assets during divorce proceedings by arguing that they enabled
                        their spouses to generate income. State officials questioned the fairness of
                        allowing taxpayers to make such arguments to bolster their claims to
                        assets and then to escape any tax liability by arguing the income was not
                        theirs.


Other Alternatives to   Two other alternatives to proportionate liability have been proposed or
Proportionate Income    adopted at the state level that would limit IRS’ ability to hold taxpayers
                        liable for their spouses’ taxes. First, IRS could allow taxpayers to amend
                        their filing status after the due date of the return. Nine states give
                        taxpayers the opportunity to do this. Second, AICPA advocates replacing the
                        joint and several liability standard with an allocated liability standard.
                        Under this standard, taxpayers would specify on the return a percentage
                        of the total liability for which they would each be responsible. If the
                        taxpayers failed to specify an allocation, they would each be responsible
                        for one-half of the tax liability.


                        Divorcing couples may specify in their divorce decrees how future
Binding IRS to          liabilities resulting from their prior joint returns are handled, i.e., one
Divorce Decrees         spouse is entirely liable, both spouses are equally liable, or some other
Would Be Impractical    permutation. However, IRS is not bound by these divorce decrees because
                        it is not a party to the decree. IRS officials at the local level said many
                        taxpayers are surprised to discover that IRS is not bound by divorce
                        decrees. According to ABA representatives, many divorce attorneys are not



                        Page 19                                       GAO/GGD-97-34 Income Tax Liability
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well-versed in tax matters and do not realize that divorce decrees do not
provide adequate protection against additional federal taxes. According to
IRS officials and private sector practitioners, IRS’ practices in this regard are
similar to the practices of private sector creditors, such as credit card
companies, which do not feel they are bound by divorce decrees when
collecting on joint debts.

According to certain members of ABA’s Committee on Domestic Relations,
a legislative change to bind IRS to divorce decrees appears to be
impractical for two major reasons. First, current federal law provides no
mechanism whereby IRS can be a party to divorce proceedings. Federal tax
matters are the exclusive jurisdiction of the U.S. Tax Court, federal district
courts, the U.S. Claims Court, and the U.S. Bankruptcy Court. Divorce
matters, however, are generally handled by state courts. Federal courts
have traditionally refused to consider any legal action involving divorce.
Thus, providing a legal forum where IRS and the parties to a divorce could
resolve issues relating to both tax matters and divorce proceedings would
require a fundamental and extensive change in either federal tax law or
state domestic relations law.12

Second, binding IRS to divorce decrees could require IRS to become
involved in every divorce settlement or trial. In 1994, about 1.2 million
divorce decrees were granted in the United States. To be a party to this
many legal proceedings nationwide each year would create a significant
administrative burden for IRS. For example, the California Franchise Tax
Board is bound by divorce decrees if the decree (1) does not reduce
liability for income under the exclusive management and control of the
spouse, (2) does not affect taxes that have already been paid, and (3) has
been cleared by the California Franchise Tax Board when reportable gross
income exceeds $50,000 or the tax liability exceeds $2,500. Once the
California Franchise Tax Board has approved the proposed tax allocation,
the state becomes a party to the decree and is bound by it. State officials
said the requirement has increased demands on administrative resources,
and they had a backlog of about 100 requests for approval of tax
allocations.


12
  The views cited in this paragraph were submitted to the IRS in comments by ABA’s Committee on
Domestic Relations in response to Notice 96-19. The comments specifically noted that the positions
taken represented the individual views of the members who prepared it and did not represent the
position of ABA or of the Section on Taxation. With respect to the specific impact of such a legislative
change on taxpayers or IRS in each state, the comments also noted that to answer the question
definitively would require a law survey of all 50 states, which the Committee had not at that time done.
We also have not done a law survey of the 50 states and, therefore, also cannot answer this question
definitively.



Page 20                                                       GAO/GGD-97-34 Income Tax Liability
                        B-271456




                        The Delaware Division of Revenue is also bound by divorce decrees, even
                        though it is not a party to the decree. As a state agency, the Delaware
                        Division of Revenue considers itself bound by state court decisions.
                        However, most Delaware taxpayers file separately because of the state’s
                        rate structure, so the requirement creates little administrative burden. The
                        Wisconsin legislature recently passed legislation requiring the Department
                        of Revenue to be bound by divorce decrees beginning in the next tax year.
                        Wisconsin officials are just starting to consider the consequences of this
                        legislation on processing returns and revenue collection.

                        IRSofficials also believe the number of appeals would increase because
                        divorce decrees can be lengthy and complex documents that are open to
                        more than one interpretation. Furthermore, IRS officials fear that divorce
                        decrees would be manipulated to reduce tax liabilities. For example, one
                        spouse might retain sole ownership of the couple’s residence, the couple’s
                        major asset, while the spouse without assets takes responsibility for the
                        taxes. Thus, IRS would not be able to place a lien against the residence to
                        force collection action for any delinquent taxes.


                        About 13 million, or 27 percent, of all taxpayers who filed joint returns in
IRS Follows State       1992 lived in community property states. Some of these taxpayers may
Property Laws in        have been faced with tax liabilities incurred by their spouses before their
Collecting Premarital   marriage, which they would not have encountered if they lived in a
                        common law state. This disparate treatment between taxpayers residing in
Tax Debts               community property states versus those living in common law states
                        occurs because IRS, as with other creditors, follows state law in classifying
                        married couples’ rights in property.

                        Because the income, including wages, of taxpayers living in certain
                        community property states is considered community property, IRS can
                        place a levy on the wages or other separate income of either spouse to
                        satisfy an existing tax debt, even if that tax debt was incurred by the other
                        spouse before their marriage. In contrast, IRS cannot place a levy on the
                        separate income of one spouse to pay the taxes due from the other spouse
                        in a common law state. Once the income of either spouse is placed in a
                        joint account it would be subject to IRS seizure in both community
                        property and common law states. However, the placement of wages into a
                        joint account is a matter of choice on the part of the taxpayers and can be
                        avoided if they so choose.




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According to IRS officials, the agency does not have specific procedures for
placing levies on a spouse’s income for premarital taxes incurred by the
other spouse. Officials told us that because community property laws
differ from state to state, it is up to IRS collections personnel in each
community property state to determine whether they will levy a spouse’s
income. Nonetheless, under IRS’ collection procedures, levy action is
generally to be taken against the individually held income, such as wages,
of the taxpayer who incurred the tax debt or any jointly held income, such
as an interest-bearing account, not against the separate income of the
other spouse. In 1994, IRS issued 3 million third-party levies. However, the
agency did not know how many of these levies were placed on the income
of a spouse living in a community property state to pay the premarital tax
debts of the other spouse. As a result, we could not assess the effects of
changing the law to prevent IRS from making these types of levies.

The current tax code contains several provisions that override state
community property laws for noncollection activities. For example, the
innocent spouse provisions, section 6013(e), specifically prevent IRS from
following state community property laws in determining the tax liability
on omission from gross income. Also, under section 879(a), community
property laws do not apply to the earned income of nonresident aliens.
However, making an exemption for this specific collection activity for
premarital debts would set a precedent because it would require IRS to
ignore state community property laws for a collection activity.
Furthermore, unless the states change their community property laws,
such a change would not necessarily protect taxpayers’ assets. Private
sector creditors could continue to pursue community assets to satisfy
community debts even though IRS was precluded from attaching such
assets.

The inequities created by having IRS follow state community property laws
are not limited to levying the income of a spouse to pay the premarital tax
debts of the other spouse. For example, the eligibility criteria for injured
spouse relief on IRS Form 8379, Injured Spouse Claim and Allocation,
specifically state that “Overpayments involving community property states
will be allocated by the IRS according to state law. Claims from California,
Idaho, Louisiana, and Texas will usually result in no refund for the injured
spouse.” Thus, IRS follows state community property laws when
withholding refunds to apply against nontax debts.




Page 22                                      GAO/GGD-97-34 Income Tax Liability
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                     IRS does not track how often innocent spouse relief is requested or
Conclusions          granted; however, we estimate that a relatively small number of taxpayers
                     are eligible for relief under the current innocent spouse provisions. The
                     provisions, with their various qualifying criteria, are complex and difficult
                     to meet, and they require IRS staff to weigh various factors in deciding
                     whether to enforce the joint and several liability standard or to relieve
                     taxpayers of their joint liability. IRS provides limited information to
                     taxpayers about the availability of and criteria for relief and does not have
                     a tax form and procedures for requesting and granting relief.

                     Several proposals have been made to modify innocent spouse relief. More
                     taxpayers might qualify for relief if Congress eliminated or modified the
                     dollar thresholds to allow IRS to consider relief for taxpayers with
                     liabilities less than $500. Replacing the joint and several liability standard
                     with a proportionate liability standard may also provide additional relief to
                     taxpayers, but this alternative could create a significant administrative
                     burden for taxpayers and IRS. Requiring IRS to be bound by divorce decrees
                     appears to be impractical because of the legal and administrative hurdles
                     that would have to be resolved. Finally, if the law were changed to prevent
                     IRS from levying the income of one spouse to pay the premarital tax debts
                     of the other spouse, the inequities between taxpayers in community
                     property states and common law states might be reduced. However, no
                     data were available to assess the impact of such a change.


                     To improve IRS’ administration of the innocent spouse provisions of the tax
Recommendations      code, we recommend that the Commissioner of Internal Revenue
                     (1) develop new or modify existing publications to better inform and
                     educate taxpayers about the availability of and criteria for innocent
                     spouse relief and, as part of that effort; (2) develop a tax form and
                     procedures for requesting and either granting or denying innocent spouse
                     relief. We also recommend that the Commissioner provide additional
                     internal guidance to IRS employees so that greater consistency in
                     processing innocent spouse cases can be achieved, establish a
                     cost-effective process for monitoring the consistency being achieved, and
                     update IRS’ regulations to reflect current requirements.


                     In written comments on a draft of this report (see app. VI), the
Agency Comments      Commissioner of Internal Revenue generally agreed with our conclusions
and Our Evaluation   and recommendations and said that the findings in our report present a
                     real possibility for imminent legislative reform of the innocent spouse



                     Page 23                                       GAO/GGD-97-34 Income Tax Liability
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provisions. She said that, thus, it would be preferable to determine if the
current legislative session of Congress produces such reforms before
devoting the resources necessary to carry out our recommendations.

With this overall caveat, the Commissioner agreed with our first
recommendation that IRS should modify existing publications to better
inform taxpayers about the availability of innocent spouse relief. Likewise,
the Commissioner agreed with our second recommendation that IRS
develop a tax form and procedures for taxpayers to request innocent
spouse relief and for IRS to either grant or deny such relief. She pointed
out, however, that implementation of this recommendation would require
approval and clearance of such a form from the Office of Management and
Budget.

The Commissioner also agreed with our third recommendation that IRS
provide additional internal guidance to employees so that greater
consistency in processing innocent spouse cases can be achieved. She said
that the form and accompanying procedures developed under our second
recommendation would also largely meet the intent of the third
recommendation.

The Commissioner said that she understood the concern that prompted
our fourth recommendation to establish a cost-effective process for
monitoring consistency in processing innocent spouse cases. She said,
however, that existing management and information systems do not have
the capability to track issues on specific cases and that the only alternative
way to accomplish the recommendation, manual tracking of such cases,
would be cost prohibitive and less reliable.

It appears that the Commissioner misinterpreted the intent of our
recommendation. We fully agree with her points about the capability of
existing systems and the cost of manual tracking for such cases, and in
fact, we considered these issues in arriving at the wording of our
recommendation. Recognizing the problems with its existing systems and
manual tracking, our intent was to have IRS explore process options that
would not be cost prohibitive but would facilitate a greater level of
consistency in innocent spouse decisions. We thought that such
exploration was needed because we found a substantial amount of
inconsistency and subjectivity, both within and among IRS districts, on
how to interpret the knowledge factor in the current innocent spouse
provisions.




Page 24                                       GAO/GGD-97-34 Income Tax Liability
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As an example of the kind of option that we thought IRS might explore in
response to our recommendation, we noted that some districts had
designated an employee as the innocent spouse coordinator, so that only
one employee in each of those districts applied the knowledge test. This
caused us to think that IRS could explore this as an option by first
determining whether the districts with such coordinators have achieved
greater consistency than those without coordinators. If this proves to be
so, IRS could then explore the cost effectiveness of establishing innocent
spouse coordinators in the remaining districts. By serving as focal points
and monitors in their respective districts, these coordinators might
facilitate more consistent decisions within districts, and by networking
with each other, they might facilitate consistency among the districts.
There may well be other options that IRS could explore before reaching a
final decision on the best approach and it was to that end that we worded
our recommendation to provide IRS with latitude to decide how it goes
about achieving a greater level of consistency in its administration of the
innocent spouse provisions.

Finally, the Commissioner agreed in principle that IRS should update its
innocent spouse regulations to reflect current law, but said that such
action would be premature until Congress determines whether to reform
the existing provisions. We agree with the Commissioner’s position on this
recommendation as well as with her overall statement that it makes sense
to wait until Congress decides whether to modify the existing law in the
current legislative session before devoting the resources necessary to
carry out most of our recommendations.


We are sending copies of this report to various other congressional
committees, the Secretary of the Treasury, the Commissioner of Internal
Revenue, and other interested parties. Copies will be made available to
others upon request.

Please contact me at (202) 512-8633 if you or your staff have any questions.
Major contributors to this report are listed in appendix VII.




Lynda D. Willis
Director, Tax Policy
  and Administration Issues


Page 25                                      GAO/GGD-97-34 Income Tax Liability
Contents



Letter                                                                                          1


Appendix I                                                                                     30
                      Estimated Number of Innocent Spouse Cases That Could Result              30
Estimated Number of     From an Audit
Potential Innocent    Estimated Number of Innocent Spouse Cases That Could Result              31
                        From the Underreporter Program
Spouse Cases          Estimated Number of Married Taxpayers Who Divorce Each Year              32

Appendix II                                                                                    33
                      Cases Between January and June 1996                                      33
Information on        Case Histories                                                           33
Problem Resolution
Office Innocent
Spouse Cases
Appendix III                                                                                   36

State Efforts to
Address Joint and
Several Liability
Issues
Appendix IV                                                                                    38
                      Estimated Cost of Processing Separate Returns                            38
Estimated Costs for   Estimated Cost of Processing Modified Returns                            38
Processing Separate
or Modified Joint
Returns




                      Page 26                                   GAO/GGD-97-34 Income Tax Liability
                         Contents




Appendix V                                                                                            39

Distribution of Joint,
Separate, and
Unknown Income for
1992 Joint Income Tax
Returns
Appendix VI                                                                                           41

Comments From the
Internal Revenue
Service
Appendix VII                                                                                          43

Major Contributors to
This Report
Tables                   Table 1: Pros and Cons of Different Methods of Administering a               15
                           Proportionate Liability Standard
                         Table I.1: Tax Year 1992 Closed Audit Cases for “Married, Filing             30
                           Joint” Returns
                         Table I.2: Estimates of Tax Year 1992 Taxpayers Who Could Be                 31
                           Eligible for Innocent Spouse Relief Based on Underreporter
                           Assessments
                         Table II.1: Characteristics of Problem Resolution Cases                      33
                         Table III.1: State Liability Standards, Innocent Spouse Provisions,          36
                           and Use of Divorce Decrees
                         Table IV.1: Estimated Cost of Processing an Additional 48 Million            38
                           Tax Returns
                         Table IV.2: Estimated Additional Data Entry Costs for Modified               38
                           Joint Returns
                         Table V.1: Percentage of Income Reported Jointly, Separately, or             40
                           Could Not Determine




                         Page 27                                       GAO/GGD-97-34 Income Tax Liability
Contents




Abbreviations

ABA        American Bar Association
AGI        Adjusted Gross Income
AICPA      American Institute of Certified Public Accountants
AIMS       Audit Information Management System
IRS        Internal Revenue Service


Page 28                                     GAO/GGD-97-34 Income Tax Liability
Page 29   GAO/GGD-97-34 Income Tax Liability
Appendix I

Estimated Number of Potential Innocent
Spouse Cases

                                        This appendix describes how we derived the potential universe of
                                        taxpayers that could be covered by the current innocent spouse provisions
                                        in the Internal Revenue Code. The innocent spouse provisions cover
                                        certain taxpayers who are assessed additional taxes of more than $500
                                        after they file a “married, filing joint” tax return. Additional tax
                                        assessments generally result from an IRS audit or from underreported
                                        income detected in IRS’ underreporter program. We used tax year 1992
                                        audit and underreporter results to estimate the potential innocent spouse
                                        universe because that was the latest tax year for which most tax
                                        assessments had been completed.


                                        To determine the number of married couples filing joint returns that had
Estimated Number of                     subsequent audit assessments, we used IRS’ Audit Information
Innocent Spouse                         Management System (AIMS) database of tax year 1992 audit cases that were
Cases That Could                        closed during fiscal years 1993, 1994, 1995, and the first 9 months of fiscal
                                        year 1996. The AIMS data showed that for tax year 1992, 441,224 “married,
Result From an Audit                    filing joint” returns were audited and closed by IRS’ Examination Division.
                                        However, 190,393 of the 441,224 audits resulted in either no change to the
                                        tax liability or in a refund. The remaining 250,831 audits resulted in
                                        additional tax assessments. Table I.1 shows the number of tax year 1992
                                        “married, filing joint” return audit cases with additional tax assessments
                                        that were closed each fiscal year and shows whether the assessments
                                        were for amounts of $500 and less or for more than $500.

Table I.1: Tax Year 1992 Closed Audit
Cases for “Married, Filing Joint”                                                    Returns with tax assessments
Returns                                 Fiscal year closed                  $500 or less         More than $500                   Total
                                        1993                                        1,277                    2,604                3,881
                                        1994                                        8,876                   40,407               49,283
                                        1995                                       17,426                  138,395              155,821
                                        1996                                        4,785                   37,061               41,846
                                        Total                                      32,364                  218,467              250,831
                                        Source: IRS’ AIMS file on tax year 1992 closed audit cases.



                                        As shown in table I.1, the 218,467 taxpayers with tax assessments of more
                                        than $500 potentially meet the eligibility criteria for innocent spouse relief.
                                        Thus, this is the maximum number of taxpayers that could request
                                        innocent spouse relief because of an audit assessment.




                                        Page 30                                                       GAO/GGD-97-34 Income Tax Liability
                                        Appendix I
                                        Estimated Number of Potential Innocent
                                        Spouse Cases




                                        Of the 1.8 million tax year 1992 underreporter cases, 89 percent (about
Estimated Number of                     1.6 million) were assessed additional taxes in fiscal year 1995. The
Innocent Spouse                         remaining 11 percent (about 200,000 cases) were assessed additional taxes
Cases That Could                        in either 1994 or 1996.

Result From the                         Since almost 90 percent of 1992 underreporter cases were assessed in
Underreporter                           1995, we estimated the number of potential tax year 1992 innocent spouse
                                        cases by evaluating a stratified probability sample of 463 underreporter
Program                                 cases assessed in 1995. Based on the tax year 1992 returns in this sample,
                                        we estimated how many of the 1.6 million tax year 1992 returns assessed
                                        in 1995 were “married, filing joint” returns and, of those, how many had
                                        assessments under $500 and assessments of $500 or more. Although we
                                        did not have data to make similar estimates for the 200,000 tax year 1992
                                        returns assessed in 1994 and 1996, we assumed that the filing status and
                                        assessed amounts for these returns would be similar to the returns in the
                                        1995 sample where the assessments occurred either 2 years or 4 years
                                        after the tax year. We could not directly test this assumption, but our
                                        analysis of the data indicates that various characteristics of the returns,
                                        such as the amount assessed and the complexity of the underreporting
                                        problem, determined when IRS processed the case. We weighted the
                                        sample of 463 underreporter cases to represent the number of 1992 tax
                                        year returns processed in 1995 and other years and then estimated the
                                        potential innocent spouse cases for tax year 1992. We accounted for the
                                        stratified sample design and unequal weights for the sample cases when
                                        calculating the sampling errors.

                                        The point estimates and sampling errors for 1992 are given in table I.2.

Table I.2: Estimates of Tax Year 1992
Taxpayers Who Could Be Eligible for                                                                        Point estimates and
Innocent Spouse Relief Based on         Data used to calculate underreporter cases                             sampling errors
Underreporter Assessments               Estimated number of tax year 1992 assessments for                     993,536 ± 150,469
                                        “married, filing joint” returns
                                        Estimated number of tax year 1992 joint filer cases with              624,734 ± 151,703
                                        assessments of $500 or less
                                        Estimated number of tax year 1992 joint filer cases with               368,802 ± 55,822
                                        assessments of more than $500
                                        Source: GAO’s analysis of IRS’ underreporter data



                                        Adding the tax year 1992 joint filer underreporter cases with tax
                                        assessments of more than $500 in table I.2 to the 218,467 joint filer audit
                                        cases in table I.1 results in an estimated potential universe of innocent



                                        Page 31                                               GAO/GGD-97-34 Income Tax Liability
                      Appendix I
                      Estimated Number of Potential Innocent
                      Spouse Cases




                      spouse cases of approximately 587,000 that is bounded by a confidence
                      interval of between 531,447 and 643,091 returns. Additional uncertainty
                      about this estimate comes from our previously mentioned assumption
                      about the characteristics of the 11 percent of the 1992 returns that were
                      not assessed in fiscal year 1995.


                      To estimate the number of taxpayers who divorce each year, we obtained
Estimated Number of   data from the Bureau of the Census and the Department of Health and
Married Taxpayers     Human Services. Census’ report, entitled Marital Status and Living
Who Divorce Each      Arrangements: March 1993, shows that there were 114,602,000 married
                      individuals in the United States at that time. A Monthly Vital Statistics
Year                  Report, dated October 1995 and prepared by the National Center for
                      Health Statistics within the Department of Health and Human Services,
                      states that approximately 1,191,000 divorces were granted in the United
                      States in 1994. Therefore, an estimated 2,382,000 individuals who were
                      married in 1993 had divorced in 1994. Dividing this number of individuals
                      by the total number of married individuals in 1993 results in an annual
                      divorce rate of 2.0784 percent, which we have rounded to 2 percent for the
                      calculations in our study. To estimate how many of the potential innocent
                      spouse cases would involve divorced couples over a 3-year period, we
                      multiplied 583,410 by the annual divorce rate of 2 percent and then
                      multiplied by 3.




                      Page 32                                      GAO/GGD-97-34 Income Tax Liability
Appendix II

Information on Problem Resolution Office
Innocent Spouse Cases

                                         As part of IRS’ efforts to address the problems of divorced and separated
Cases Between                            taxpayers, the headquarters Problem Resolution Office asked the Problem
January and June 1996                    Resolution Offices at four district offices and one service center to identify
                                         all cases where the taxpayer raised the issue of innocent spouse relief
                                         between January and June 1996. The offices identified 51 cases and
                                         forwarded them to headquarters, where we reviewed them.

                                         Of the 51 cases, 20 were not innocent spouse cases—for example, the
                                         taxpayer was actually an injured spouse13 or was requesting relief for
                                         taxes reported as owed on the original return. Of the remaining 31 cases, 4
                                         involved taxpayers who had already been granted innocent spouse relief
                                         but IRS had not correctly transferred the tax liability to the culpable
                                         spouse. We did not include these cases since the files contained
                                         information only on the processing problem, not the innocent spouse
                                         issues. Table II.1 describes the characteristics of the remaining 27 cases.

Table II.1: Characteristics of Problem
Resolution Cases                                                                                                                    Number of
                                                                                                                                    cases with
                                         Characteristic                                   Average          Range                         dataa
                                         Years elapsedb                                   7 years          2 years to                          27
                                                                                                           17 years
                                         Amount of assessment                             $12,000          $900 to $50,000                     23
                                         Annual income                                    $37,000          $7,000 to                           13
                                                                                                           $77,000
                                         a
                                             The Problem Resolution Office case files did not always include all these data .
                                         b
                                          Years elapsed between the tax year assessed and the taxpayer’s contact with the Problem
                                         Resolution Office.

                                         Source: IRS’ Problem Resolution Office case files.



                                         For the 24 cases where we could find data, all of the taxpayers began
                                         requesting help because of collection activity, such as having their wages
                                         levied by IRS. For the 24 cases where we could determine marital status, 20
                                         taxpayers were divorced and 4 were separated. For the 21 cases where a
                                         decision had been reached, IRS granted relief in 10 of the cases.


                                         The following cases histories illustrate some of the issues involved in
Case Histories                           innocent spouse cases.


                                         13
                                          Injured spouses are joint filers whose joint refunds have been seized to pay certain of their spouses’
                                         nontax debts, such as past-due child or spousal support or a federal loan.



                                         Page 33                                                         GAO/GGD-97-34 Income Tax Liability
                            Appendix II
                            Information on Problem Resolution Office
                            Innocent Spouse Cases




Confusion Over              According to IRS’ records, a taxpayer learned of an assessment of over
Procedures and              $3,000 against a 1985 joint return when IRS levied her wages in 1992. The
Documenting Deductions      assessment was generated primarily by her ex-husband’s disallowed
                            business and moving expenses, although he also had some unreported
                            income. The taxpayer contacted the Problem Resolution Office about
                            innocent spouse relief. Problem Resolution Office staff initially could not
                            explain how to apply for relief but provided assistance during subsequent
                            contacts. The taxpayer submitted documentation demonstrating that the
                            unreported income was generated by her husband and received relief for
                            about $200. According to an IRS official, she could not substantiate her
                            husband’s disallowed business expenses and was held liable for the
                            remainder of the tax.


Impact on New Spouses       A taxpayer whose ex-husband was a wanted fugitive had outstanding tax
and Original Return         liabilities because her ex-husband had failed to report income on their
                            joint return for 1 tax year and had not paid the tax reported for 2
                            subsequent tax years. The taxpayer remarried, and IRS placed liens against
                            her new husband’s property. IRS denied innocent spouse relief, in part
                            because the liability for 2 years was for taxes reported as due on the
                            original return. IRS did accept an Offer in Compromise for all 3 years.


Relief on Original Return   In 1995, a taxpayer wrote to IRS to protest a balance due on joint returns
and Knowledge Test          for 3 tax years. The taxes were attributable to income derived from her
                            ex-husband’s fraudulent activities. In 1996, IRS informed the taxpayer she
                            was not eligible for innocent spouse relief for 2 tax years because these
                            balances were for taxes reported as due on the original returns but not
                            paid when the returns were filed. However, IRS staff informed the taxpayer
                            they would consider innocent spouse relief for 1 year if the taxpayer could
                            demonstrate she had no knowledge of the unreported income.

                            IRSdenied her request for innocent spouse relief because she could not
                            meet the knowledge test. Subsequently, she submitted third-party
                            statements that she did not live a lavish or enhanced lifestyle as well as
                            copies of police records on her ex-husband’s arrest and trial. IRS eventually
                            granted innocent spouse relief for that 1 year.


Knowledge Test              A taxpayer learned of an assessment of over $12,000 on a joint 1991 return
                            when IRS levied her wages. The couple had legally separated and sold their
                            residence. Although she had reinvested her half of the capital gain on the



                            Page 34                                       GAO/GGD-97-34 Income Tax Liability
                           Appendix II
                           Information on Problem Resolution Office
                           Innocent Spouse Cases




                           sale, her ex-husband had not done so within the 24 months required to
                           defer taxes. IRS denied innocent spouse relief because the taxpayer could
                           not meet the knowledge test. According to IRS, she knew of the possibility
                           of the additional tax when she signed the return.


Knowledge Test, Divorce    A taxpayer learned of an assessment of about $1,200 on joint returns for 2
Decree, Dollar Threshold   years when IRS seized her 1995 tax refund. The assessment was generated
                           by her ex-husband’s unreported income. The taxpayer argued that the
                           couple had maintained separate checking and savings accounts, and
                           therefore she did not know of the unreported income. Furthermore, the
                           divorce decree specified that she would assume outstanding credit card
                           debts and her ex-husband would be responsible for all other debts
                           incurred during the marriage. IRS denied innocent spouse relief for 1 year
                           because the assessment for that year was less than the $500 threshold. IRS
                           denied innocent spouse relief for the other year because the taxpayer did
                           not meet the knowledge requirement. Because the unreported income was
                           more than 75 percent of the ex-husband’s total income, IRS staff believe
                           she should have been aware of the income earned even though the
                           spouses had separate accounts.


Dollar Thresholds          A taxpayer was assessed over $3,000 on joint returns filed in 4 tax years
                           generated by her husband’s disallowed deductions for gambling losses.
                           She was denied innocent spouse relief for 1 year because the assessment
                           for that year was less than the $500 threshold. She was denied innocent
                           spouse relief for the other 3 years because the assessment in each of those
                           years was less than 25 percent of her adjusted gross income.




                           Page 35                                      GAO/GGD-97-34 Income Tax Liability
Appendix III

State Efforts to Address Joint and Several
Liability Issues

                                           We contacted the state tax agencies to discuss how they handle various
                                           issues surrounding joint and several liability when administering the state
                                           income tax system. Seven states—Alaska, Florida, Nevada, South Dakota,
                                           Texas, Washington, and Wyoming—do not tax personal income. Since the
                                           tax agencies for these states do not administer any joint income tax
                                           returns, we excluded them from our review. The remaining 43 states and
                                           the District of Columbia do administer joint returns; however 2
                                           states—New Hampshire and Tennessee—tax only interest and dividends.

                                           Table III.1 provides information by state on the type of liability standard
                                           the states apply to joint returns, the type of innocent spouse relief they
                                           administer, and whether they are bound by divorce decrees.


Table III.1: State Liability Standards, Innocent Spouse Provisions, and Use of Divorce Decreesa
                                                       Innocent spouse relief
                               Joint return with       based on Internal       Less restrictive         Bound by divorce
State                          proportionate liability Revenue Code            innocent spouse relief   decrees
Alabama                                              X
Arizona                                              X
Arkansas
California                                                                    X                         X
Colorado
Connecticut
Delaware                                                                                                X
District of Columbia                                 X
Georgia                                              X
Hawaii                                               X
Idaho                                                X
Illinois                                             X
Indiana
Iowa                                                                          X
Kansas
Kentucky                                             X
Louisiana                                                                     X
Maine                                                X
Maryland                                             X
Massachusetts                                                                 X
Michigan                                             X
Minnesota                                            X
Mississippi
                                                                                                                     (continued)



                                           Page 36                                            GAO/GGD-97-34 Income Tax Liability
                                  Appendix III
                                  State Efforts to Address Joint and Several
                                  Liability Issues




                                            Innocent spouse relief
                 Joint return with          based on Internal            Less restrictive              Bound by divorce
State            proportionate liability    Revenue Code                 innocent spouse relief        decrees
Missouri
Montana
Nebraska                                    X
New Hampshire
New Jersey
New Mexico
New York                                                                 X
North Carolina                              X
North Dakota     X
Ohio
Oklahoma                                                                 X
Oregon                                      X
Pennsylvania
Rhode Island
South Carolina                              X
Tennessee
Utah                                        X
Vermont
Virginia
West Virginia
Wisconsin                                   X                                                          X
Total            1                          18                           6                             3

                                  a
                                    Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not tax personal
                                  income and we excluded them from our review.




                                  Page 37                                                   GAO/GGD-97-34 Income Tax Liability
Appendix IV

Estimated Costs for Processing Separate or
Modified Joint Returns

                                         This appendix describes how we estimated the increased
                                         returns-processing costs IRS would face if a proportionate liability standard
                                         were administered by either (1) eliminating joint returns and requiring all
                                         taxpayers to file separately; or (2) retaining joint returns but modifying
                                         them so that each spouse’s income, deductions, and credits are reported in
                                         separate columns.


                                         To estimate the cost of processing up to 48 million additional returns, we
Estimated Cost of                        determined the distribution of the returns among the standard forms 1040,
Processing Separate                      1040A, and 1040PC in the 1992 Statistics of Income data. We then
Returns                                  estimated the cost of processing these returns using IRS’ Document 6746,
                                         Cost Estimate Reference for Service Center Returns Processing for Fiscal
                                         Year 1994. The calculation is shown in table IV.1.

Table IV.1: Estimated Cost of
Processing an Additional 48 Million                                                                    Returns
Tax Returns                                                                    Number         processing cost
                                         Type of return                    (thousands)           per thousand                        Cost
                                         1040                                    37,802               $4,231.89          $159,973,906
                                         1040A                                     8,092               3,690.48             29,863,364
                                         1040PC                                    2,126               4,231.89              8,996,998
                                         Total                                                                           $198,834,268
                                         Source: IRS’ 1992 SOI data and Document 6746, Cost Estimate References for Service Center
                                         Returns Processing for Fiscal Year 1994.




                                         To estimate the additional data entry costs for 48 million tax returns if the
Estimated Cost of                        returns were modified to show two income streams, we also used the
Processing Modified                      distribution of the returns among the standard forms 1040, 1040A, and
Returns                                  1049PC in the 1992 Statistics of Income data and IRS’ Cost Estimate
                                         Reference for Service Center Returns Processing Fiscal Year 1994. The
                                         calculation is shown in table IV.2.

Table IV.2: Estimated Additional Data
Entry Costs for Modified Joint Returns                                         Number          Data entry cost
                                         Type of return                    (thousands)          per thousand                         Cost
                                         1040                                    37,802                 $412.64           $15,598,617
                                         1040A                                     8,092                 263.54              2,132,566
                                         1040PC                                    2,126                 412.64                877,273
                                         Total                                                                            $18,608,456
                                         Source: IRS’ 1992 SOI data and Document 6746, Cost Estimate References for Service Center
                                         Returns Processing for Fiscal Year 1994.




                                         Page 38                                                  GAO/GGD-97-34 Income Tax Liability
Appendix V

Distribution of Joint, Separate, and
Unknown Income for 1992 Joint Income Tax
Returns
              The extent to which adopting a proportionate liability standard would
              create an administrative burden for IRS depends partly on how easily IRS
              could use an automated reporting system to allocate income and mortgage
              interest payments between the two spouses. We reviewed a stratified
              probability sample of 200 joint tax returns selected from IRS’ 1992 Statistics
              of Income database to determine how much income was reported
              separately for each spouse or jointly for the married couple. We projected
              the results to the universe of 48 million couples who filed using the
              “married, filing jointly” status at a 95 percent confidence level.

              Of all the income in our sample, 77 percent was reported separately. About
              2 percent of the income was reported as joint income, and we could not
              determine whether the income was separate or joint for 12 percent. As
              shown in table V.1, some types of income were generally reported
              separately. For example, IRA distributions and unemployment
              compensation were always reported separately, as was most farm income
              (Schedule F). As a result, IRS would have little difficulty allocating this
              income under a proportionate liability standard.

              In contrast, state and local tax refunds are generally reported in both
              spouses’ names. As a result, IRS could have difficulty allocating this income
              between the two taxpayers.

              We had difficulty determining whether other income categories were
              separate or joint. For example, we generally could not determine which
              taxpayer earned the profit or loss reported on Schedule E, supplemental
              net gains or losses, or net operating losses.




              Page 39                                       GAO/GGD-97-34 Income Tax Liability
                                          Appendix V
                                          Distribution of Joint, Separate, and
                                          Unknown Income for 1992 Joint Income Tax
                                          Returns




Table V.1: Percentage of Income Reported Jointly, Separately, or Could Not Determine
                                                                                                       Could not
Income source                                              Joint income       Separate income          determine               Totala
Wages, salaries, tips                                                    0%             96±2 %               4±2%                100%
Taxable interest income                                            24±10               36±12               40±17                 100
Tax-exempt interest income                                               0                    0              100                 100
Dividend income                                                    26±17               68±17                 5±3                 100
Taxable state and local tax refunds                                82±15                     4±4           15±13                 100
Schedule C Net Income or Loss                                            0             82±29               18±29                 100
Supplemental net gains or losses                                         0                    0           100±.1                 100
Taxable IRA distributions                                                0                   100                0                100
Taxable pensions and annuities                                           0             100±.1                   0                100
Schedule E Profit or Loss                                            9±14                    4±5           87±16                 100
Schedule F Profit or Loss                                                0               97±5                3±5                 100
Unemployment compensation                                                0                   100                0                100
Taxable Social Security benefits                                         0             83±21               17±21                 100
Net operating loss                                                       0                    0              100                 100
                                          a
                                              Rows may not total due to rounding.

                                          Source: IRS, 1992 Statistics of Income database.




                                          Page 40                                                  GAO/GGD-97-34 Income Tax Liability
Appendix VI

Comments From the Internal Revenue
Service




              Page 41         GAO/GGD-97-34 Income Tax Liability
Appendix VI
Comments From the Internal Revenue
Service




Page 42                              GAO/GGD-97-34 Income Tax Liability
Appendix VII

Major Contributors to This Report


                        Ralph Block, Assistant Director, Tax Policy and Administration Issues
General Government      Nancy Peters, Assignment Manager
Division, Washington,   Elizabeth Scullin, Communications Analyst
D.C.
                        Jack Erlan, Evaluator-in-Charge
San Francisco/Seattle   Jonda Van Pelt, Senior Evaluator
Field Office




(268711)                Page 43                                     GAO/GGD-97-34 Income Tax Liability
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