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Individual Can Ask Bankruptcy Court for Innocent Spouse Relief; Relief Not Limited to Tax Court

(Parker Tax Publishing April 2017)

The U.S. Bankruptcy Court for the Southern District of Texas held that it had jurisdiction over an individual's claim for innocent spouse relief, rejecting the IRS's contention that the issue could only be decided in the Tax Court. However, the individual first had to file a Form 8857, Request for Innocent Spouse Relief, and wait for the earlier of a final IRS determination or the passage of six months before the court could decide the issue. In re Pendergraft vs. U.S., 2017 PTC 141 (Bankr. S.D. Tex. 2017)

Jane Pendergraft was married to Robert Pendergraft. Before getting married, Ms. Pendergraft bought a house and treated it as her homestead. The day before the marriage she transferred a one-half interest in the house to her future husband in exchange for a promissory note. Mr. Pendergraft assumed the mortgage on the house and executed a deed of trust in favor of Ms. Pendergraft to secure the note.

The Pendergrafts split their household responsibilities. Mr. Pendergraft took exclusive responsibility for the financial activities, including preparing and paying taxes. Ms. Pendergraft subsequently learned that her husband failed to file the couple's income tax returns for 2001-06 and did not pay any of the taxes the couple owed for those years. Ms. Pendergraft had signed the tax returns and had no reason to know that the returns had not been filed or that the taxes had not been paid. In 2008, the IRS had levied several of Ms. Pendergraft's bank accounts. Mr. Pendergraft told her that he had reached an agreement with the IRS to pay $10,000 per month toward the accrued tax balance and that he would file their tax returns on time going forward. All IRS correspondence continued to be sent to Mr. Pendergraft's office address, including all notices of tax liens. In 2016, Ms. Pendergraft discovered, for the first time, that her husband had not paid their income or property taxes for the last 15 years, that they owed over $2 million in taxes, and that they faced possible criminal prosecution. The couple filed a joint chapter 11 bankruptcy petition in 2016 and Ms. Pendergraft began divorce proceedings.

The IRS filed a proof of claim for approximately $2.5 million in taxes, penalties and interest owed. Of the total, approximately $653,000 was secured by tax liens. Ms. Pendergraft filed an adversary proceeding to determine the validity, priority and extent of the IRS's lien against her homestead and to object to the IRS's proof of claim. In response, the IRS moved to dismiss her complaint on the basis that the bankruptcy court lacked jurisdiction to determine whether she was entitled to innocent spouse relief under Code Sec. 6015. According to the IRS, the determination of innocent spouse relief is vested strictly in the IRS and Tax Court.

The bankruptcy court held that it had jurisdiction to review Ms. Pendergraft's taxes, penalties and interests under Code Sec. 6015(e)(1)(A) and 11 U.S.C. Section 505. However, the court ruled that before it could consider the innocent spouse issue, Ms. Pendergraft first had to file a Form 8857, Request for Innocent Spouse Relief, and wait until either the IRS ruled on her request or six months passed.

Under Code Sec. 6013, co-debtors and spouses that file joint tax returns may be jointly and severally liable for their tax liabilities. However, Code Sec. 6015(f) authorizes the IRS to relieve an individual of such liability if, under the facts and circumstances, it is inequitable to hold the individual liable for an unpaid tax or deficiency. Only the IRS can grant innocent spouse relief under Code Sec. 6015(f).

If the IRS denies a claim for innocent spouse relief or fails to make a determination within six months, the Tax Court can grant innocent spouse relief under Code Sec. 6015(e)(1)(A), which provides that the remedy available in the Tax Court is in addition to "any other remedy provided by law." Another remedy provided by law is contained in 11 U.S.C. Section 505(a)(1), which gives bankruptcy courts the power to determine the legality of taxes and tax penalties.

Based a review of the legislative history, the court interpreted 11 U.S.C. Section 505(a)(1) as granting a bankruptcy court the ability to review an IRS grant or denial of equitable relief. The court found that the legislative history showed Congress's intent to give bankruptcy courts the power to determine certain tax issues for the benefit of the bankruptcy estate and to provide a forum for the swift determination of claims (including tax claims). It also showed that Congress did not intend bankruptcy courts to be a forum for tax issues when no need exists for determining the amount of the tax for bankruptcy estate administration purposes. The court found that a determination of Ms. Pendergraft's tax liability under Code Sec. 6015 and 11 U.S.C. Section 505 directly affected the administration of her bankruptcy estate because the IRS filed such liability as a proof of claim in her bankruptcy case.

The court also found that Fifth Circuit precedent and other sources supported its determination that it had jurisdiction. The Fifth Circuit ruled in In re Luongo, 259 F.3d 323, 327 (2001), that 11 U.S.C. Section 505 gives the bankruptcy court broad jurisdiction to determine the legality of any debtor tax liability, limited only by the statute's express limitations and the court's discretion. The court cited the decisions of several other courts outside the Fifth Circuit that also ruled in support of a bankruptcy court's authority under 11 U.S.C. Section 505(a)(1) to determine and remedy a debtor's tax liability.

The court found unpersuasive the IRS's cited authorities in support of its argument against bankruptcy court jurisdiction over innocent spouse relief. First, in the court's view, none of the cited cases definitively invalidated or even acknowledged the Fifth Circuit precedent interpreting 11 U.S.C. Section 505(a)(1) as allowing bankruptcy courts to determine the legality of a tax, fine or penalty. Second, a finding that bankruptcy courts have jurisdiction over innocent spouse relief follows the plain language of Code Sec. 6015(e), which permits an individual to petition the Tax Court or use any other remedy provided by law to review an IRS determination of relief or lack thereof. Third, the court reasoned, finding that bankruptcy courts have jurisdiction over innocent spouse claims under Code Sec. 6015(e)(1)(A) would not lead to inconsistent judgments, be contrary to basic principles of judicial economy, or provide a result contrary to Congress's intent. The IRS argued that if bankruptcy courts can decide innocent spouse claims, a situation could arise where the bankruptcy courts and Tax Courts resolve the same issue at the same time. The court found that this was not the situation in this case because there was no Tax Court proceeding and further that this issue, if it existed, should be left to Congress to resolve.

Finally, although the court decided that it had jurisdiction over Ms. Pendergraft's innocent spouse claim, it found that it could not yet rule on the issue because Ms. Pendergraft had not satisfied the procedural requirements in Code Sec. 6015(f). Under that provision, an individual must first file a Form 8857 or submit an equivalent signed written statement to the IRS. Under Code Sec. 6015(e)(1)(A), the individual may request relief from the Tax Court, in addition to any other remedy provided by law, either (1) at any time after the earlier of the date the IRS mails its final determination or six months after the IRS request is made; and (2) no later than 90 days after the date the IRS mails the final determination.

For a discussion of innocent spouse relief, see Parker Tax ¶260,560.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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