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									            TAX PRACTICE


              Mark Moreau
    Southeast Louisiana Legal Services
         New Orleans, Louisiana

               March 2005

                        TAX PRACTICE

                       About The Author
Mark Moreau is the Director of Program Services for Southeast
Louisiana Legal Services and the past director of the New Orleans
Legal Assistance. He is a member of the Louisiana and New York
     Mr. Moreau has a LL.M in Taxation from New York University
Law School and has worked as a tax specialist for a national
accounting firm. Mr. Moreau has written tax, landlord- tenant, con-
sumer and domestic violence chapters for the Louisiana Legal
Services and Pro Bono Desk Manual. He is a recipient of the
Louisiana State Bar Association’s Career Public Interest Award.

Special thanks to Susan Morgenstern of the Legal Aid Society of
Cleveland, Kathy Roux and Charles Delbaum of New Orleans Legal
Assistance and Jay Caffrey of McGlinchey Stafford for their contri-
butions to this Manual.

                                                TAX PRACTICE

     This guide covers the basics of federal income tax practice for legal serv-
ices attorneys: interview information to collect from the taxpayer, Internal
Revenue Service procedures, appeal rights, Tax Court litigation, refunds, inno-
cent spouse relief, the Earned Income Credit, Head of Household Filing Status
and Dependency Exemptions.
     Tax law is becoming more important to indigent persons for several
     •     The IRS disproportionately audits the poor.
     •     The Earned Income Credit is now the largest federal anti-poverty
           program. It is larger than SSI, food stamps or TANF. The poor are fre-
           quently audited on the EIC and the closely related issues of depend-
           ency exemptions and head of household filing status. Disallowance of
           the EIC can result in a large nondischargeable debt relative to the tax-
           payer’s financial means. Some taxpayers become homeless when they
           are denied the EIC.
     •     Tax debt can preclude a person from becoming a homeowner.
     •     Recent tax law changes have expanded the opportunities for reason-
           able settlements of tax debts and protection of homes from seizure.
     •     Since welfare reform, there are more working poor who have tax con-
     •     Recent tax law changes allow the IRS to levy welfare benefits.
     •     Innocent spouse relief has been liberalized to provide greater relief.
     Caveat: The Internal Revenue Code is frequently revised. This guide does
not attempt to discuss the tax laws which may have been in effect for prior tax
years under audit. Be sure to research the applicable law for the years involved
in a particular tax dispute.

                                      TAX INTERVIEW CHECKLIST
    1. Identify action taken by IRS and deadline for taxpayer’s reply.
             The taxpayer should have a notice from the IRS. Each IRS notice can
       be identified by its CP number. This number should be in the upper right of
       the first page of the notice. The IRS is redesigning its notices. You can find
       information on how to understand many IRS notices at
       The common IRS notices are:
       •     Notice of proposed changes to tax return, CP-2000 Notice (30 days to
       •     Penalty and interest notices (30 days to reply).
       •     An examination or audit notice (correspondence or office).
       •     Examination Report, Form 4549 or 886-A. (30 days to reply or appeal).
       •     The 30 day letter notifying taxpayer of right to appeal. (Must appeal by
             protest letter within 30 days of date on letter. Taxpayer should not sign
             the Form 870 since it will waive right to petition Tax Court).
    If you need more time, call the IRS for an extension. Generally, the IRS will allow an extension of 30 days beyond the
    response date in the CP-2000 notice.

                                                TAX PRACTICE

        •       Notice of tax deficiency or “the 90 day letter” (check the notice for last
                day to file Tax Court Petition).
        •       Notice and Demand for Payment (10 days to pay to avoid lien).
        •       Notice of Federal Tax Lien (30 days to appeal by Form 12153).
        •       Final Notice of Intent to Levy (30 days to appeal by Form 12153, if
                bank account levy, 21 days before bank remits funds to IRS).
        •       Seizure (10 days to appeal by Form 9423; about 60 days to sale)
        •       Denial of Installment Agreement (30 days to appeal by Form 9423)
        •       Termination of Installment Agreement (30 days to appeal by Form
        •       Nonfiler (penalties may increase for delay in filing).
 2. Copies of all IRS notices and correspondence to/ from the IRS about the
    tax dispute.
 3. Any documents that the taxpayer has to support her case.
 4. Federal and state tax returns for all years in dispute.
 5. Each year that a federal or state tax return was not filed.
 6. All previous tax disputes within last 6 years and how resolved.
 7. Any bankruptcy filings by taxpayer or spouse within last 5 years. Get
    case number if you need for statute of limitation determinations.
 8. Marital status and living arrangements at end of each year in dispute.
 9. Did the taxpayer file for the Earned Income Credit in each of the last 4
    years? (Generally, returns may be amended for up to 3 years after the
    due date of the return, April 15th).
10. If the Earned Income Credit is an issue, you will need to see all the doc-
    uments that the IRS requested from the taxpayer. In addition, you will
    need information from the taxpayer on her household expenses and
    support provided to the dependents.
11. If Innocent Spouse Relief is possible, ascertain 2 year deadline for
    filing Form 8857. 2
12. For installment agreements and offers in compromise, the required
    information on the taxpayer’s income, assets, liabilities and expenses.
    See e.g., Form 433-A and Form 656 (offer-in-compromise).
13. Power of attorney, Form 2848, signed by the client.

                         HOW TO GET INFORMATION FROM THE IRS
      Most low-income taxpayers do not fully understand the status of their tax
liabilities, tax examinations or other actions by the IRS. Therefore, you should
always contact the IRS to get information on the taxpayer’s situation for the tax
years in question.
      Have the taxpayer sign a Form 2848. Immediately fax it to the Central
Authorization File Unit (CAF):
    The 2 year deadline does not apply to traditional innocent spouse relief under IRC § 66 (c).

                                                TAX PRACTICE

                Arkansas, Louisiana & states west of Mississippi River:
                         901-546-4115 (Memphis CAF fax no.)
                                  States east of Mississippi River:
                                  801-620-4249 (Ogden CAF fax no.)
     Filing your 2848 in the CAF enables any IRS employee to speak with you
about your client’s tax account. This will save you time since you will not have
to fax your 2848 every time you want to speak with the IRS.
     Attorneys, who have a signed Form 2848, may call the Practitioner’s Priority
Service at 866-860-4259 to get tax information on their clients. (This phone
number should NOT be used by taxpayers.3 It is reserved for tax professionals).
With a phone call, you can get free tax information on your client, such as:
     • Transcripts of the taxpayer’s tax returns or tax account
     • Forms W-2 and 1099 on the taxpayer
     • Assessment dates for taxes
     • Taxes owed by the taxpayer for each year
     • Activity between the IRS and the taxpayer, e.g., audits, appeals, install-
         ment agreements, settlements, etc.
     The IRS can read this information to you over the phone and can fax or mail
the aforesaid documents or information to you.
     If you need a copy of the taxpayer’s actual tax return (as distinguished from
a transcript of the return), you must send a Form 4506 to the IRS. A copy of the
return currently costs $39.

                               SENDING INFORMATION TO THE IRS
     For information on when documents can be faxed to the IRS, see the IRS
faxing guidelines posted on the Tax Professionals section of

                                       AUDITS OR EXAMINATIONS
1.      Time Limits
        General Rule: Audits barred if 3 years after tax return’s original due date.
        Exceptions:   6 years if income understated by 25%
                      If nonfraudulent return filed late, 3 years after filing
                      No limit if tax return fraudulent or not filed
2.      IRS Automated Adjustment Notices
             The IRS may make some changes to a tax bill without an audit, e.g.,
        math errors, penalty or interest assessment, underreporting amounts
        reported on Form W-2 or 1099. The most common automated adjustment
        form is a CP-2000. 25% to 50% of these notices are wrong. You must object
        to an automated adjustment notice within 30 days of the notice date. Look
        for the deadline on the notice. Send a protest letter by certified mail and
        request abatement of tax, penalties and interest as appropriate. Include the
        IRS notice with your letter.
    Taxpayers can get a free transcript of their tax returns by calling 800-829-1040.

                                                TAX PRACTICE

3.      Types of Audits
             There are three types of audits: correspondence, office and field. The
        correspondence audit is the major audit for salaried and self-employed tax-
        payers. The correspondence audit is conducted by mail and requests docu-
        ments. Don’t send originals. Keep copies of the documents sent.
             The office audit is conducted at the IRS and requests the taxpayer to
        bring certain documents. Primary issues in an office audit will include
        income, exemptions and deductions. Office audits may last from 1 to 4
        hours. Field audits are usually done at the taxpayer’s home or office. You
        should try to have the field audit conducted in your office rather than the
        taxpayer’s home or office.
             A second audit of a taxpayers’s return is prohibited unless the IRS pro-
        vides written notice. IRC § 7605 (b); Rev. Proc. 94-68, 1994-2 C.B. 803. The
        taxpayer must assert this prohibition at the time of the second audit. Rife v.
        Comm’r., 356 F.2d 883 (5th Cir. 1966); Rice v. Comm’r., TCM 1994- 204.
             The Earned Income Credit (EIC) audits are generally done through cor-
        respondence audits.
4.      Preparation for Audit
        •    Review tax return.
        •    Ask client to organize supporting documents for items listed in audit
        •    Research tax law if there are any questionable deductions or tax ben-
        •    If EIC claimed, be prepared to defend EIC, head of household filing
             status, dependency exemptions, and child tax credit.
5.      Handling the Audit
        •    Your goals are to minimize liability and prevent expansion of the audit.
        •    You may negotiate with the auditor, e.g., settle for x%.
        •    Auditors do not have an appeal officer’s “hazards of litigation” settle-
             ment authority.4
        •    Don’t disclose tax returns or documents not requested by the audit.
        •    The representative, not the taxpayer, should attend the office audit.5
6.      Extending the Audit Time Limit
        •   If an auditor has not completed the audit within 28 months after the
            filing of the tax return, he will ask for a Form 872 extension of the
            deadline to assess the tax.
        •   Generally, the best approach is to negotiate a limited extension for spe-
            cific audit items or refuse to consent to an extension.
        •   If you don’t negotiate or sign a Form 872 extension, the auditor will
            issue the Examination Report and Notice of Deficiency simultaneously.
            This will prevent the taxpayer from appealing with the IRS and require
            the filing of a Tax Court petition.6
    An auditor may only resolve issues on a factual basis. He does not have “hazards of litigation” settlement authority.
    The IRS must issue an administrative summons to compel the taxpayer to accompany the representative to the audit.
    IRC §§ 7521 (c), 7602.
    The Tax Court filing fee is $60. A Tax Court proceeding may delay resolution of the dispute.

                                                  TAX PRACTICE

                On the other hand, the auditor may miss the 3 year deadline for assess-
                ment of taxes if you don’t consent to an extension.
7.       The Examination Report
              The auditor will issue an Examination Report that explains the pro-
         posed changes to the tax return. If the taxpayer agrees with the Report’s
         findings, she can sign a Form 870 consenting to immediate assessment of
         the tax deficiency. If the taxpayer does not agree, she should not sign the
         Form 870 since it will waive her right to petition Tax Court.7
              The auditor can authorize payment plans for debts under $10,000 and
         allow up to 3 years to pay. Interest and late payment penalties will continue
         to run on the unpaid balance.
              You can ask the auditor to reconsider. You can ask to meet with his
              Or you can ignore the Examination Report. In this case, you will
         receive a 30 day letter advising you of your right to appeal. The right of
         appeal is discretionary, but the IRS usually allows it. If it does not allow an
         appeal, the taxpayer must receive a letter by certified mail advising that a
         petition may be filed with the Tax Court within 90 days (commonly called
         the “90 day letter”).
              Taxpayers often receive the 90 day letter immediately after the exam-
         ination. This is usually wrong and will deny the taxpayer an IRS appeal
         unless corrected. If the IRS issues a 90 day letter, instead of a 30 day letter
         of appeal, you should write to ask that the 90 day notice of deficiency be
         rescinded and that the taxpayer be granted a right of appeal within the IRS.
         If you do not receive a timely response, ask the IRS Taxpayer Advocate for
         help. If the 90 day notice of deficiency is not timely rescinded, the taxpayer
         must file a petition with the Tax Court before the 90 days runs out.
8.       Audit Reconsideration
              Audit reconsideration can be an excellent tool for taxpayers where
         regular channels for tax relief are closed. Audit reconsideration is available
         1. Reevaluate a prior audit where the taxpayer disagrees with the origi-
              nal determination by providing information that was not previously
         2. Contest a “Substitute for Return” determination by filing an original
              delinquent return; or
         3. Contest the denial of a tax credit as a result of an examination.9
              See IRM §,,; IRS Pub. 3598.
    A Form 870 is not binding on the IRS or the taxpayer. The IRS may still issue a notice of deficiency and the taxpayer
    may file a claim for refund. IRS attempts to enforce a Form 870 on an equitable estoppel theory are generally unsuc-
    cessful. However, unlike Form 870, Form 870-AD contains a statement that a taxpayer is barred from filing a refund
    lawsuit. The courts have taken divergent views of whether a Form 870-AD bars a refund claim or lawsuit. See e.g.,
    Smith v. United States, 328 F.3d 760 (5th Cir. 2003); Whitney v. United States, 826 F.2d. 896 (9th Cir. 1987). Some courts
    hold that a Form 870-AD is binding. Others hold that it is nonbinding, standing alone, but that equitable estoppel may
    bar a refund lawsuit depending on the facts of the case.
    This may also include new information or information that was not viewed in the proper light.
    Thus, audit reconsideration will often be available to review the correctness of an Earned Income Credit denial.

                                TAX PRACTICE

          To request an audit reconsideration, the taxpayer must have filed a tax
     return and the assessment remains unpaid or the IRS has reversed tax
     credits that the taxpayer disputes. IRM § If the taxpayer has paid
     the tax, he should file a formal claim by using a Form 1040X.
          The IRS does not have a form for audit reconsideration requests. Audit
     reconsideration may be requested by a Form 1040X or letter. Some IRS
     offices request both a Form 1040X and a cover letter for audit reconsidera-
     tion. If the taxes have not been paid, a letter requesting audit reconsidera-
     tion may be written. If a Form 1040X is used, state the request for audit
     reconsideration in the cover letter.
          The letter requesting audit reconsideration should include:
     1. Taxpayer’s name, Social Security number, and tax year at issue.
     2. Clear statement of issues and adjustments disputed.
     3. Relief or action desired.
     4. Document the history of the prior audit. (Attach original audit report,
          Form 4549).
     5. Additional information not considered during the original audit. Your
          letter should identify the new information. (Attach new documentation.
          You should provide information on each disputed issue since the IRS
          considers your request issue by issue).
          The request for audit reconsideration should be filed with the IRS
     Service Center where the taxpayer’s return was filed. IRS Pub. 3598.
          In a partially paid assessment, be careful not to miss the time limits
     for refund claims. The Taxpayer Advocate Service can help expedite an
     audit reconsideration. IRM §

                          APPEALS WITHIN THE IRS
1.   Appealable Decisions
         The following IRS decisions may be appealed:
     •   Proposed tax adjustments pursuant to an audit
     •   Denial of innocent spouse relief
     •   Denial of interest or penalty abatement
     •   Liens
     •   Levy
     •   Seizures
     •   Installment agreement denial or termination
     •   Offer in compromise denial
2.   Time Limits for Appeal
          Most protests must be filed within 30 days of the date on the appeal
     notice letter. Seizures must be appealed within 10 days.
          The protest letter should unequivocally appeal the adverse determina-
     tion and request a conference with an Appeal Officer. Some Officers will
     ignore or deny appeals where the protest letter does not clearly request an
     appeal. 26 CFR § 601.106 states the following requirements for a protest:

                                                TAX PRACTICE

              For audit cases under $2,500, a written protest letter is not required.
         (However, you should protest in writing to preserve the record).
              For audit cases between $2,500 and $10,000, a simple letter explain-
         ing why the IRS decision or action is wrong, is all that is required.
         (However, a more detailed written protest letter is recommended).
              Audit cases over $10,000 require a more formal written protest letter
         which includes:
              •    Name and social security numbers of taxpayers.
              •    A statement that the Examination Report is being appealed.
              •    The Report’s findings that the taxpayer disagrees with.
              •    Explanation of why the Report is wrong.
              •    Signature and date under penalty of perjury clause.
              •    Copies of 30 day letter and Examination Report.
              However, IRM and IRS Publication 5 state that Appeals will
         consider matters under its small case procedures if the total amount for any
         tax period is under $25,000. IRS Form 12203 (Request for Appeals
         Review) may be used for small cases under $25,000. However, it is better
         practice to prepare a more formal protest letter.
3.       Reasons to Appeal
              The Appeals Office provides an opportunity for the taxpayer to settle
         her case based on the flexible “hazards of litigation” approach. 85% of all
         appeals cases are settled. The Appeals Office is a favorable and inexpen-
         sive forum.
              In addition, a taxpayer should exhaust administrative remedies
         through Appeals Office review for the following reasons:
              •    Preserve claims for costs. IRC § 7430(b)(1).
              •    Protect against Tax Court sanctions for unreasonable failure to
                   pursue administrative remedies. IRC § 6673(a)(1).
              •    Shift burden of proof to IRS in subsequent judicial proceeding.
                   IRC § 7491.
4.       Appeals Officers
               Appeals Officers are usually senior IRS employees. They are
         instructed to settle cases. 85% of appeals cases are settled. The Appeals
         Officers are aware of the law on common issues. They want to know the
         facts of your case. They are not supposed to develop the facts themselves.10
         Rather, their role is to adjudicate facts and evaluate “hazards of litigation.”
         Procedures for appeals conferences are described in IRM 8.6.
               Convincing the officer that there are hazards of litigation will enhance
         the probability of a favorable settlement. The Internal Revenue Manual
         states that settlements resolve each issue based on the probable result in
         litigation or involve mutual concessions of issues based upon the relative
         strength of the opposing positions when there is substantial uncertainty as
         to the outcome in litigation. IRM Appeals Officers have broad
     Appeal Officers are prohibited from ex parte communications with the auditors. Rev. Proc. 2000-43, 2000-43 IRB 404;
     Robert v. United States, 364 F.3d 989 (8th Cir. 2004).

                                                TAX PRACTICE

       authority to settle cases. Their settlement authority is, however, restricted
       if there is a judicial or revenue ruling directly on point.
             The hearing may be at the Officer’s office or may be conducted by mail
       and telephone.11 Appeal settlements are usually reached orally and then
       written on an IRS Form 870 by the Appeals Officer. At the appeals level, it
       is reasonable to agree to an extension of the 3 year limit for assessing a tax
       liability.12 If a settlement is not reached, the taxpayer will be mailed a
       Notice of Deficiency advising her that she has 90 days to file a petition with
       the Tax Court.
5.     Face-to-Face Hearings?
            Most appeals are effectively handled by correspondence, phone calls or
       conferences. If your case is complex or heavily dependent on credibility
       determinations, you may want to request a face-to-face appeal. Such a
       request must be made early in the appeal process. The appeal will be trans-
       ferred to a local office if you timely request a face-to-face appeal.

                                                   TAX COURT
1.     Decisions Reviewable
            A Tax Court Petition may be used to challenge the following IRS deci-
            •   Tax liability
            •   Denial of separate liability, innocent or injured spouse relief 13
            •   Denial of penalty or interest abatement 14
            •   Liens
            •   Notice of Intent to Levy 15
            •   Certain refund cases
            •   Determination of employee or independent contractor status 16
            The Tax Court’s review is de novo for tax liability and § 6015 (b) or (c)
       innocent spouse relief. The abuse of discretion standard is applied to
       reviews of § 6015 (f) equitable relief. Butler v. Comm’r., 114 T.C. 276 (2000).
       However, review of an adverse § 6015 (f) decision is not limited to the
       administrative record. Ewing v. Comm’r, 122 T.C. 32 (2004). Rather, the Tax
       Court makes its “abuse of discretion” decision after a trial de novo. Id. This
       is the Tax Court’s practice for many issues, not just § 6015 (f) reviews.
       Robinette v. Comm’r, 123 T.C. 85 (2004)(collection due process appeal).17
   Appeals conferences must be available in regular cases within each state. The IRS must consider the use of video con-
   ferences for taxpayers in remote or rural areas. See § 3465 of the IRS Restructuring and Reform Act of 1998.
   Failure to consent to an extension of the statute of limitations does not constitute a failure to exhaust administrative
   remedies for the purposes of shifting the burden of proof. Minihan v. Comm’r., 88 T.C. 492 (1987).
   See Fernandez v. Comm’r., 114 T.C. 324 (2000); Tax Court Rules 320-25. Tax Court review is available regardless of
   how innocent spouse relief is raised.
   IRC § 6404; Tax Court Rules 280-81; Katz v. Comm’r., 115 T.C. No. 26 (2000).
   See Tax Court Rules 330-34. However, no jurisdiction where taxpayer failed to request an IRS appeal. Offiler v.
   Comm’r., 114 T.C. 492 (2000).
   IRC § 7436(a); Tax Court Rules, 290-94; Randolph v. Comm’r., 112 T.C. 1 (1999).
   The IRS disagrees with Robinette and part of Ewing. It may appeal Robinette. IRS litigation strategies in response to
   Robinette and Ewing can be found in Office of Chief Counsel Memoranda CC 2004-031 (Aug. 31, 2004) and CC-2004-
   026 (July 12, 2004).

                                                 TAX PRACTICE

       The abuse of discretion, rather than de novo, standard also governs judicial
       review of lien and levy decisions unless there are tax liability issues
       involved. Nield v. Comm’r, 122 T.C. 1 (2004); Joint Committee on Taxation,
       Summary of the Conference Agreement on H.R. 2676, 132 (June 24, 1998).
2.     Time Limits
             The Tax Court Petition generally must be filed within 90 days of the
       mailing date of the Notice of Deficiency or a determination of innocent
       spouse relief.18 IRC §§ 6213, 6015 (e). The IRS notice of deficiency must
       tell the taxpayer the last date to file a petition with the Tax Court. That
       date will be deemed to be timely (even if it is wrong). IRC § 6213 (a).
             The taxpayer may have additional time if she received the deficiency
       notice while a bankruptcy action was pending or if a bankruptcy was filed
       during the 90 day delay for filing a petition with the Tax Court. In such
       cases, the time for filing the Tax Court petition is suspended until 60 days
       after the bankruptcy discharge. IRC § 6213 (f)(1); Zimmerman v. Comm’r,
       105 TC 220 (1995). A bankruptcy debtor is stayed from filing a Tax Court
       petition unless the bankruptcy stay is lifted by the bankruptcy court. 11
       U.S.C. § 362(a)(8); Halpern v. Comm’r, 96 T.C. 895 (1991).
             In such cases, the bankruptcy may control whether bankruptcy court
       or Tax Court decides the tax liability issue.
             The petition must be received within 90 days or mailed in a properly
       addressed envelope with an official U.S. Post Office postmark or by certain
       designated private delivery services19 within the 90 day limit. IRC § 7502
       (a). You must be able to prove a timely postmark. This means that you
       should use certified or registered mail and secure an official postmark if you
       are relying on a mailing date to meet the 90 day deadline. Make sure that
       the Post Office gave you a correct postmark date.
             It is too risky to use privately metered mail for the filing of Tax Court
       petitions. This delivery method only qualifies for the timely filed rule if the
       petition is actually received by the Tax Court within the normal delivery
       delay. If it is not received within that delay, it will be difficult to prove that
       the petition was timely mailed. See Reg. § 301.7502-1 (c)(1)(iii)(b).
             The filing fee is $60, but may be waived for indigents. IRC § 7451; Tax
       Court Rules 20 (b), 173(a)(2). You must be admitted in advance of filing the
       petition or have a member sign the petition and other initial pleadings.
             If the 90 day limit is missed, the taxpayer’s only judicial remedy is to
       pay the tax and sue for refund–usually in United States District Court. This
       is not a realistic option for most indigents.20 If the 90 day limit has been
   It’s 90 days even if the taxpayer didn’t receive her notice until many days after the notice date. A notice properly mailed
   to the taxpayer at her ‘last known address” is valid even if not received. United States v. Ahrens, 530 F.2d 781, 785
   (8th Cir. 1976). For judicial review of a denial of innocent spouse relief or separate liability election, a taxpayer may
   file her petition at any time after 6 months of filing her election provided the 90 day period has not run. IRC § 6015
   Airborne Express, DHL Worldwide Express, Federal Express and UPS. If you use these companies, make sure that
   you use the type of delivery recognized by the IRS. See IRS Notice 97-27, 1997-17 IRB 6 modified by IRS Notice 99-
   41, 1999-35 IRB 325;
   Note, however, it may be meaningful in Earned Income Credit cases since the taxpayer often does not owe any tax.
   Rather, the IRS has denied her the EIC before ever paying it to the taxpayer. Also, consider audit reconsideration as
   a remedy.

                                                 TAX PRACTICE

         missed, you may want to try an Offer-in-Compromise to eliminate the tax-
         payer’s liability if there is “doubt as to liability.” See Reg. § 301.7122.
              Judicial review of a lien or levy decision must be taken within 30 days
         of the Appeals Office decision. IRC §§ 6320 (c), 6330 (c)-(e); McCune v.
         Comm’r, 115 T.C. 114 (2000). The Tax Court will only review proper claims
         presented to the Appeals Office. Goza v. Comm’r, 114 T.C. 176 (2000).
3.       Filing the Tax Court Petition
              Check the current rules at the Tax Court’s webpage, www.ustax- or 26 U.S.C.A. foll. § 7453. The initial filing requirements are an
         original and 2 copies of:
              •    Petition
              •    Notice of Deficiency
              •    Designation of Place of Trial (Tax Court is held in most major
                   cities, including New Orleans, for about 1 to 2 weeks every year)
              •    Motion and Affidavit to Waive Costs (or check for $60) 21
              Send the original and 2 copies to:
                   Clerk, U.S. Tax Court
                   400 Second St., NW
                   Washington, D.C. 20217
             You must decide whether to elect to proceed under the Small Tax Case
         or Regular Tax Case procedures.
             Election of the Small Tax procedure (available for cases under $50,000
         per year) waives the right to appeal the judge’s decision. Trial may be
         sooner under the Small Tax Case procedures. Interest (about 4%-10%)
         does run on taxes while the case is pending in Tax Court. On the other hand,
         90% of all cases are settled without a trial.
4.       Revised Tax Court Rules
             In February 2003, the Tax Court revised its Standing Pretrial Order
              In June 2003, the Tax Court substantially revised its rules. The rules
         for Small Tax Cases were simplified. Other important changes related to the
         expansion of the Court’s declaratory judgment jurisdiction and new author-
         ity to hear actions for redetermination of employment status, actions for
         determination of relief from joint and several liability on joint returns, and
         lien and levy actions.
5.       Pleading Requirements / Considerations
              Check Tax Court Rules 23, 30-41, 50-58 for the general requirements
         for a petition and other pleadings. Some major rules and tips include:
              The form and contents of the Petition in a regular case are specified in
         Tax Court Rules 34, 23 and Form 1 of Appendix I to the Tax Court Rules.
         For Small Tax Court cases, see Rules 173-79 and Form 2 of Appendix I.
     Check Tax Court Rule 23. Motions and pleadings (other than petition) generally require 4 copies in addition to origi-

                                                TAX PRACTICE

               The Petition should clearly state every issue the taxpayer intends to
         litigate. Tax Court Rule 34 (b)(4). The Petition is an opportunity to provide
         the judge with a structured blueprint of your case. See Rule 41 if you need
         to amend the Petition to add issues.
               Affirmative defenses, such as an innocent spouse defense or the
         statute of limitations, should be pleaded in the Petition to avoid waiver.
         Charlton v. Comm’r., 61 TCM 3011 (1991); see also Butler v. Comm’r., 114 T.C.
         276 (2000)
               The prayer for relief should request no deficiency. In addition, “all
         other appropriate relief” should be requested so the Tax Court can grant a
         refund or carry back relief. The Petition should not claim litigation costs
         and administrative fees. See e.g., Tax Court Rules 233, 34 (b). 22
6.       Appeals Office Review
              If the taxpayer didn’t appeal before, the Appeals Office will consider
         the case. Rev. Proc. 87-24, 1987-22 IRB 23. You should participate in the
         Appeals Office conference.
              If taxpayer appealed, but didn’t make a settlement, the IRS District
         Counsel may refer the case to the Appeals Office for review if she thinks
         settlement is possible.
              Cases are usually at the Appeals Office for about 6 months.
              If a settlement is reached with the Appeals Office or District Counsel,
         District Counsel will prepare a Stipulated Tax Court Decision for signature
         by all counsel and the judge.
7.       Pre-Trial Settlement
               90% of all Tax Court cases are settled without a trial. More than 50%
         of all petitions filed in Tax Court result in some tax reduction through set-
         tlement or judgment.
8.       Pre-Trial Procedures and Stipulations
              About 4 to 10 months after the filing of the Petition, you will receive a
         Notice Setting Case for Trial and a Pre-Trial Order.
              The Pre-Trial Order requires you to prepare written stipulations and to
         exchange witness lists and documents at least 15 days before trial. Tax
         Court Rule 91 mandates that the parties stipulate to the fullest extent to
         which complete or qualified agreement can be fairly reached. This rule is
         mandatory, not aspirational. Failure to comply with stipulation, disclosure
         and consultation rules can result in dismissal of the petition for lack of pros-
         ecution. Raquet v. Comm’r., TCM 1996-279. Work cooperatively with the
         IRS attorney and document your efforts to stipulate.
              All documents (except those for impeachment) must be stipulated and
         exchanged. If not, the documents can be excluded from use at trial. Tax
         Court Rules 70, 91. Document stipulations are more helpful to the judge if
         you indicate the relevant pages and language of each document and briefly
     If the parties agree on litigation and administrative costs, an award of costs should be included in the Stipulated
     Decision submitted to the Court. Tax Court Rule 231. If the parties cannot agree, a motion for costs must generally
     be filed within 30 days of the Court’s decision.

                                                  TAX PRACTICE

         summarize what the document means. Stipulations may be confined to the
         relevant portions of the document. Objections to stipulated documents can
         be noted in the Stipulation. Tax Court Rule 91 (d).
              Normally, discovery by the taxpayer is unnecessary. However, if you
         need discovery, you should proceed promptly with consultation and discov-
         ery given tight Tax Court deadlines.
              You must submit a Trial Memorandum at least 15 days before trial.
         Failure to file a memorandum can result in dismissal of the case. Most small
         cases can be tried in 2 to 3 hours. Generally, the IRS does not have any wit-
         nesses in cases involving indigent taxpayers. Many of the case facts will be
         stipulated. See Tax Court Rule 91.
              Postponements of trial are rarely granted. Tax Court Rule 133.
9.       Qualified Offers
              IRC § 7430 now allows a taxpayer to make a qualified offer of settle-
         ment similar to those authorized by Rule 68 of the Federal Rules of Civil
         Procedure. If the IRS obtains less at trial, it could be liable for the taxpay-
         ers’ attorney’s fees.23
10. Trial
          Tax Court’s calendar call starts on Monday. The judge gets a status
    report from each case’s attorneys and then sets the trial schedule for the
    session. It is possible that your case could be tried immediately after the
    calendar call.
          Opening statements may be brief (or unnecessary) if the judge has read
    the pre-trial memorandum. The Stipulations should be filed into evidence.
    You should be prepared to deal with any evidentiary issues relative to the
    stipulated facts and documents at the beginning of the trial.
          The judge’s file will only include the Petition, Answer, Stipulation of
    Facts and Pre-Trial Memorandum. You have to present your case. The
    burden of proof on factual issues may be shifted to the IRS if certain condi-
    tions are met. However, the judge can assign the burden of proof to the tax-
    payer if she did not cooperate with the auditor or did not keep good records.
    IRC § 7491; Tax Court Rule 142. The conditions for shifting the burden of
    proof are difficult to meet. As a practical matter, you should conduct the
    trial as though you have the burden of proof by presenting credible evi-
    dence, i.e., documents and testimony which corroborate the taxpayer’s tes-
    timony. A tax court judge can believe a taxpayer’s testimony, which is not
    corroborated by documents or witnesses, but she does not have to.
          The taxpayer presents her case first. The evidence will usually consist
    of the taxpayer’s testimony and supporting documents and nontaxpayer tes-
    timony. The IRS usually will not have any witnesses and will cross-examine
    the taxpayer’s witnesses. The taxpayer then gets a rebuttal.
          Post-trial briefs are required in regular cases unless the presiding judge
    directs otherwise. Tax Court Rule 151. Summary opinions in Small Tax
    cases should not be cited as precedent in your brief. IRC § 7463 (b), Tax
     LSC regulations currently prohibit legal services attorneys from claiming attorney’s fees.

                                                 TAX PRACTICE

         Court Rule 152 (c). Decisions are made as soon as practicable, but may take
         several months. In Small Tax cases, the judge may rule from the bench.
              For a judge’s perspective on Tax Court trial procedures, see
         T.Tannewald, Tax Court Trials: An Updated View From the Bench, 47 Tax
         Lawyer 387 (1994).
11. Appeal
         A regular Tax Court decision may be appealed to the circuit court of
    appeal of the taxpayer within 90 days of the date the Tax Court decision was
    entered. IRC §§ 7481, 7483; Tax Court Rules 190-93.
12. Other Judicial Remedies
          Taxpayers who pay the disputed tax, may sue for refund in U.S. District
    Court or the Court of Claims. Sometimes, bankruptcy judges will decide tax
    disputes. See 11 U.S.C. § 505, IRM § There is little jurisprudence
    on when a bankruptcy court should exercise its jurisdiction over a tax lia-
    bility issue. See e.g., In re Luongo, 259 F.3d 323 (5th Cir. 2001); In re Hunt,
    95 B.R. 442 (Bankr. N.D. Tex. 1989).

                                   REFUND CLAIMS AND LAWSUITS
     An “overpayment” is a payment of taxes in excess of what is due. IRC §
6401; Jones v. Liberty Glass Co., 332 U.S. 524 (1947). It also includes deficien-
cies asserted by the IRS. A taxpayer may file a claim for the refund of an “over-
payment.” If the refund claim is denied, the taxpayer may sue for a refund.
                         Time Limitations for Refunds
     Three separate time limitations can bar a refund or limit the amount of a
     1. Time Limitation for Filing an Administrative Refund Claim with
         the IRS.
              Under IRC § 6511(a), a refund claim generally must be filed with
         the IRS within (i) 3 years from the date the return was filed, or (ii) 2
         years from the date the tax was paid, whichever is later.24 “Return” in
         § 6511 means the original return for the purposes of the limitation
         period for refund claims. Rev. Rul. 72-311, 1972-1 CB 398. For pur-
         poses of § 6511, an early return shall be considered filed on the last day
         prescribed for filing thereof. IRC § 6513. Additional time may be avail-
         able if there is an agreement to extend the time for assessment. See
         IRC § 6511 (c); Engelken v. United States, 823 F. Supp. 845 (D. Colo.
         2.      Look-Back Limit on Amount of Refund Claim
                      Under IRC § 6511(b)(2), the amount of the refund claim generally
                 will be limited to the portion of the tax paid within either 3 years of the
                 date the return was filed or 2 years from the date the tax was paid. For
                 purposes of § 6511, an early return shall be considered filed on the last
                 day prescribed for filing thereof. IRC § 6513.
     A refund time limitation that expires on a Saturday, Sunday or legal holiday, will be timely if filed on the next suc-
     ceeding day that is not a legal holiday. Rev. Rul. 2003-41, 2003-17 IRB 814.

                                                 TAX PRACTICE

         3.      Time Limit for Refund Lawsuit
                      Under IRC § 6532 (a), a refund lawsuit must be filed within 2
                 years of the mailing of a valid notice of claim disallowance to the tax-
                 payer by certified or registered mail. The IRS may try to get the tax-
                 payer to waive formal notice of disallowance of the refund. Taxpayers
                 should not waive formal notice. Check to see if your client waived
                 notice. If he waived notice, the time limit for filing a lawsuit runs from
                 the date the waiver was “filed”with the IRS. Reg. § 301. 6532-1 (c).
                 The statute and regulation do not define “filed.” Id.
                      An administrative refund claim that is untimely under IRC §
                 6511(a) will defeat a refund lawsuit. The amount recoverable in a
                 refund lawsuit will be limited to the taxes paid during the IRC § 6511(b)
                 look-back period that applies to the administrative refund claim.
                                           How to Claim a Refund
File an Original or Amended Tax Return
      An original or amended tax return (Form 1040X) shall constitute a claim for
refund within the meaning of IRC § 6402 and § 6511 for the overpayment dis-
closed on the return.25 Reg. § 301.6402-3 (a)(5). You should file a separate
amended tax return for each year in which a refund is due. Any return will be a
claim for a refund for the overpayment shown on the return. Ryan v. United
States, 64 F.3d 1516 (11th Cir. 1995). But, the Justice Department will object to
district court jurisdiction if a refund was paid on a Form 1040 and subsequently
disallowed unless the taxpayer has filed an amended return (Form 1040X) after
payment of the alleged taxes.
      A separate claim must be made for each taxable year. Reg. § 301.6402-2
(d). The claim must be verified by the taxpayer by a declaration under penalty of
perjury. Reg. § 301.6402-2 (b). “Overpayments” also include payments of a defi-
ciency asserted by the IRS. IRC § 6401.
      The claim must set forth in detail each ground upon which the refund is
based and facts sufficient to apprise the IRS of the basis of the claim. Reg. §
301.6402-2 (b). Cite to Internal Revenue Code sections supporting the refund
claim. Any subsequent refund lawsuit will be limited to the grounds asserted in
the administrative claim for a refund. United States v. Felt & Tarrant Mfg. Co., 238
U.S. 269 (1931); Ottawa Silica Co. v. United States, 699 F.2d 1124 (Fed. Cir. 1983).
      The amount of the refund must be stated. You should also add the phrase,
“or such greater amount as is legally refundable, together with interest.” This
language should be included on the Form 1040X. You should ask for refund of
underpayment interest and penalties.
      If the IRS acts on a claim as though it were sufficient and disallows it on
the merits, it cannot contend later that the claim was defective. Ford v. United
States, 402 F.2d 791 (6th Cir. 1968).
      Supporting evidence does not have to be attached to the refund claim.
However, for refund claims involving the Earned Income Credit, your chances of
     Informal claims may meet the requirements for a refund claim. See “Informal Claims”,infra. However, a practitioner
     should only use an informal claim if the taxpayer failed to timely file a formal claim through an original or amended
     tax return.

                                TAX PRACTICE

getting relief at the IRS level will be enhanced if you attach documentation that
supports the Earned Income Credit claim. IRS examination procedures for
refund claims are almost the same as in the examination of a tax return.
     Many low-income taxpayers will come to you after they have lost an exam-
ination and after the 90 day period for filing a Tax Court petition. In these cases,
you should consider filing a Form 1040X. Submission of a Form 1040X will
allow you to state the issues correctly and give the taxpayer another chance to
win with either IRS examination or appeals.
     A Form 1040X submitted after an examination should show the IRS adjust-
ments in the “Original amount or as previously adjusted” column. List your
amendments to the IRS adjustments under the “Correct Amount”column on the
Form 1040X. Use the “Explanation of Changes” section or attachments to
explain the basis for the refund claim.
IRS Review or Immediate Judicial Review?
     Exhaustion of IRS administrative review is required for refund lawsuits.
However, if you do not want administrative review within the IRS, you may
request in writing that the claim be immediately rejected. See IRS Publication
556. Generally, it is advisable to seek IRS review since you may win at that level.
     In Earned Income Credit cases, you may want to bypass the IRS where you
don’t have sufficient “paper” documentation of the taxpayer’s claim or don’t want
to wait 6 to 15 months for the IRS to rule. Some taxpayers will lack “paper”
proof for the Earned Income Credit, but may have credible witnesses, e.g., neigh-
bors, relatives, etc., who can establish the child’s residence through testimony.
If you request that the claim be rejected, the IRS should send you a notice of
claim disallowance. You have 2 years after the date of the mailing of the notice
of disallowance to file a refund suit in the United States District Court or in the
United States Court of Federal Claims. IRC § 6532(a). Jurisdictional defects may
be curable by amended and supplemental pleadings if exhaustion of administra-
tive remedies occurs after the filing of the action and before the IRS moves for
dismissal. Tobin v. Troutman, Civ. A. 3:98CV-663-H (W.D.Ky. 2002).
Audit Reconsideration
     If time is not an issue, you may want to ask the IRS for an audit reconsid-
eration of the erroneous assessment of taxes. In your request for audit recon-
sideration, include information that was not considered in the prior audit. In
recent years, the IRS has been more open to reconsideration of assessments,
including denials of Earned Income Credits. If you win in audit reconsideration,
your client will receive his tax refund. For more information, see the prior
section on audit reconsideration procedures.
Informal Claims—Look for an Informal Claim if the Taxpayer Did Not File a
Return for the Refund Claim
     A written letter that meets the requirements for a refund claim (request for
a refund for certain years, the basis of the overpayment and sufficient informa-
tion as to the tax and year for the IRS to examine the claim) may also constitute
an administrative refund claim that can support a refund lawsuit. United States
v. Kales, 314 U.S. 186 (1941); American Radiator & Standard San. Corp., 318 F.2d

                                TAX PRACTICE

915 (Ct. Cl. 1963). However, such informal claims often attract challenges. See
e.g., PALA v. United States, 234 F.3d 873 (5th Cir. 2000). Therefore, you should
always claim a refund through an original or amended tax return that complies
with the Reg. § 301.6402 requirements.
Timely File a Refund Claim with the IRS
     The administrative refund claim should be filed with the Internal Revenue
Service Center where the taxpayer filed his original tax return. For purposes of
IRC § 6511, a refund claim is considered as filed on the date on which the return
(or amended return) is considered as filed. However, if the requirements of Reg.
§ 301.7502-1, relating to timely mailing treated as timely filing are met, the
claim shall be considered filed on the date of the postmark stamped on the enve-
lope in which the return was mailed. If the refund time limitation expires on a
Saturday, Sunday or legal holiday, it will be timely if filed on the next succeed-
ing day that is not a legal holiday. Rev. Rul. 2003-41, 2003-17 IRB 814.
     Be sure to get a proof of postmark or mailing. If a return or claim is filed
after the due date, the return or claim is considered to have been filed when
received by the IRS. Rev. Rul. 73-133, 1973-1 CB 605.
     Warning: A court has held that the § 7502 mailbox rule cannot be applied,
for the purposes of § 6511(b)’s 3 year refund limitation, to a refund claim that
was timely under § 6511(a). Anastastoff v. United States, 223 F.3d 898 (8th Cir.
2000) (§ 6511 (b) barred refund claim timely mailed on April 13th, but not
received until April 16th). However, this decision was subsequently vacated. 235
F.3d 1054 (8th Cir. 2000). In Manka v. United States, 105 F. Supp. 2d 490 (E.D.
Va. 2000), a court held that where the return was untimely filed, § 6511 (b) look
back period begins when IRS receives the return, not when it is mailed.
     Practice Tip: If you are close to a time limit, you should hand deliver the
refund claim to the local IRS office. Get a receipt for the claim.
     Generally, a refund claim must be filed with the IRS within (i) 3 years from
the date the return was filed, or (ii) 2 years from the date the tax was paid,
whichever is later. IRC § 6511(a). For purposes of § 6511, an early return shall
be considered filed on the last day prescribed for filing thereof. IRC § 6513.
Additional time may be available if there is an agreement to extend the time for
assessment. See IRC § 6511 (c); Engelken v. United States, 823 F. Supp. 845 (D.
Colo. 1993).
     A refund claim is timely if filed within 3 years of the applicable tax return
regardless of the due date of the return. Rev. Rul. 76-511, 1976-2 CB 428;
Omohundro v. United States, 300 F.3d 1065, 1068-91 (9th Cir. 2002); Weisbart v.
United States, 222 F.3d 93 (2d Cir. 2000).
      The date of payment for § 6511(a) purposes is the date of receipt by the
Service Center. Quershi v. United States, 75 F.3d 494 (9th Cir. 1996). The 2 year
limit runs as the taxes are paid. After 2 years from the date the taxes are fully
paid, the taxpayer will no longer have a timely refund claim for any portion of the
taxes. Quershi, supra at 496. You should order a transcript from the IRS
Practitioners’ Line so that you will have the official record of when taxes were

                                               TAX PRACTICE

      The Fifth Circuit has held that remittance of taxes with a Form 4868 exten-
sion is a “deposit” and not a payment. Harden v. United States, 76 AFTR 2d 95-
7980 (5th Cir. 1995) (unpublished opinion). The IRS and most other courts have
held that such remittances are payments. See e.g., Dantzler v. United States, 183
F.3d 1247 (11th Cir. 1999); Gabelman v. United States, 86 F.3d 609 (6th Cir. 1996).
If no return was filed, the claim must be filed with the IRS within 2 years from
payment of the taxes.
      The person who paid the taxes should file the refund claim. IRC §§ 6402
(a), 6511 (a), 7701 (a)(14). In the case of a joint tax return, both spouses should
claim the refund if possible. However, each spouse can file a claim for refund of
his or her overpayment. Rev. Rul. 74-611; Rev. Rul. 80-8; Gens v. United States,
673 F.2d 366 (Ct. Cl. 1982).
The § 6511(b) Look Back Rule
      IRC § 6511 (b) limits the amount recoverable in a timely refund claim to the
taxes paid during:
      •    the 3 years prior to the filing of the claim where the claim was filed
           within 3 years of the filing of the tax return, or
      •    the 2 years prior to the claim where the claim was not filed within 3
           years of the filing of the return, (i.e., claims filed within 2 years from
           the time the tax was paid). 26
      These limits may be extended if there is an agreement to extend the assess-
ment of the tax.
      IRC § 6511 (c). For purposes of § 6511, an early return shall be considered
filed on the last day prescribed for filing thereof. IRC § 6513.
      The § 6511 (b) look-back rule creates serious problems for taxpayers who
can’t pay the taxes within 2 years. Such taxpayers could be limited to the
portion of taxes paid in the last 2 years. For example, if the taxes were paid in
installments over a 5 year period, the refund claim may be limited to those pay-
ments within the last 2 years.
      Where the taxpayer makes 2 separate refund claims based on the 3 year and
2 year limitations, there may be a pool for 3 year recoveries and a pool for 2 year
recoveries. See Allstate Insurance Co. v. United States, 550 F.2d 629 (Ct. Cl. 1977).
      A taxpayer can recover penalties paid before the look back period as long as
the amount claimed does not exceed the amount of taxes, penalties and interest
paid within the look back period. Carroll v. United States, 339 F. 3d 61 (2d Cir.
2003). A refund may include additional taxes paid by a subsequent assessment so
long as the total refund does not exceed the portion of the tax paid prior to the
administrative claim. Keeter v. United States, 957 F. Supp. 1160 (E.D. Cal. 1997).
Refund Lawsuits
     IRC § 7422 provides a statutory remedy to sue for a refund of taxes, penal-
ties and interest.27 The requirements for filing a refund lawsuit include:

     Taxes can be paid by withholding, estimated tax payments and “credits.”
     Claims for abatement of interest under IRC § 6404 can be brought as refund claims under IRC § 7422. See Beall v.
     United States, 336 F.3d 419 (5th Cir. 2003).

                                 TAX PRACTICE

     •    A timely administrative claim for refund with the IRS. IRC §7422(a);
          Reg. § 301.6402-2(a)(1); United States v. Dalm, 494 U.S. 596, 602 (1990).
     •    Disallowance of the claim by the IRS, or no decision by the IRS within
          6 months of the filing of the refund claim. IRC § 6532 (a).
     •    At least in the 5th Circuit, that an assessment has been made. Ford v.
          United States, 618 F.2d 357 (5th Cir. 1980). Note: this decision is
          subject to attack given that even the 5th Circuit questions the decision
          and most circuits disagree with the 5th Circuit.
     •    Full payment of the taxes, penalties and interests claimed by the IRS.
          Flora v. United States, 362 U.S. 145 (1960); Magnone v. United States,
          902 F.2d 192 (2d Cir. 1990); Smith v Booth, 823 F.2d 94 (5th Cir. 1987).
          However, some circuits may not require payment of the interest and
          penalties if they are not at issue. See e.g., Shore v. United States, 9 F.3d
          1524 (Fed. Cir. 1993); Schmidt v. United States, No. CS-03-130-JLQ
          (E.D. Wash. 2003).
          Warning: The courts are divided as to whether the taxes can be paid
          after filing the refund claim with the IRS and before filing suit in court.
          Compare King v. United States, 949 F. Supp. 787 (E.D. Wash. 1996)
          (payment after administrative refund claim is permissible), aff’d on
          other grounds 152 F.3d 1200 ( 9th Cir. 1998); Carroll v. United States,
          198 F. Supp.2d 328 (E.D. N.Y. 2001), rev’d in part on other grounds 339
          F.3d 61 (2d Cir. 2003) with Nelson v. United States, 727 F. Supp. 1357
          (D.Nev. 1989) (full payment rule of Flora engrafted into “prior claim”
          rule of IRC § 7422a) ; Urwyler v. United States, 1996 WL 87001 (E.D.
          Cal. 1996) aff’d 125 F.3d 860 (9th Cir. 1997); Malkin v. United States, 3
          F.Supp. 2d 493 (D.N.J. 1998); Douglas v. United States, 727 F. Supp.
          239 (W.D.N.C. 1989).
     •     Refund suit filed within the applicable time limitation. IRC § 6532(a).
     A taxpayer, who appeals a deficiency to the Tax Court, loses the ability to
sue for a refund in another court. In such situations, the Tax Court has exclusive
authority to award a refund.
Jurisdiction and Venue
     The district courts and Court of Federal Claims have jurisdiction under 28
U.S.C. § 1346(a)(1). A refund suit should be brought in the judicial district
where the taxpayer resides. 28 U.S.C. § 1402(a)(1). The suit may only be brought
against the United States. IRC § 7422 (f). The local United States Attorney, the
Attorney General, Department of Justice, Washington, D.C. 20530, and the local
IRS official must be served in accordance with Fed. R. Civ. P., Rule 4.
     Precedent at the appellate level is a major factor in choice of forum deci-
sions. If the taxpayer’s circuit has unfavorable precedent, the taxpayer may
want to file in the Court of Federal Claims, whose decisions are appealable to the
Federal Circuit. Also, the Federal Circuit, unlike most circuits, does not require
prepayment of interest and penalties as a prerequisite to a refund lawsuit. Shore
v. United States, 9 F.3d 1524 (Fed. Cir. 1993). Jury trials are not available in the
Court of Federal Claims. It is not clear whether you can get a trial outside of
Washington, D.C. The Court’s rules allow the assigned judge to select the loca-
tion of the trial. See also 28 U.S.C. § 173.

                                                 TAX PRACTICE

Time Limitations for Refund Lawsuits
      A refund suit is barred unless filed within 2 years after the date of mailing
by certified or registered mail of a notice of disallowance of the claim by the IRS.
IRC § 6532 (a). Absent a notice of disallowance, there is no time limitation for
filing a refund lawsuit. Consolidated Edison Co. of NY v. United States, 135 F. Supp.
881 (Ct. Cl. 1955). However, a taxpayer should not delay the filing of a lawsuit.
Another court has ruled that the 6 year limitation in 28 U.S.C. § 2401 applies as
an outer limit. Finkelstein v. United States, 943 F. Supp. 425 (D. N.J. 1997).
     Warning: The taxpayer may have signed a waiver of the notice of claim
disallowance when the IRS originally denied the refund. Many low-income tax-
payers do not know if they signed such a waiver or may forget to tell you. The
2 year period for a refund lawsuit begins running on the date the waiver is filed.
If you are faced with a waiver, you should determine whether it is valid. See Reg.
§ 301. 6532-1(c)(1)-(4); IRS National Office Service Center Advice, Assistant
Chief Counsel Memorandum, No. 200202069 (Release date 1/11/2002).
     IRC § 7422 (a) and § 6511 (a) do allow the filing of a refund lawsuit within
2 years of the payment of taxes. Thus, when a taxpayer pays the last payment
on an installment agreement with the IRS, his right to sue for a refund accrues
and the 2 year time limitation begins running. IRC §§ 7422 (d), 6511 (a). For
example, if the taxpayer finally pays off a 1994 tax obligation in 2003, she will
then be able to sue for a refund of the 1994 “overpayment.” See e.g., Dresser
Industries v. United States, 73 F. Supp.2d 682 (N.D. Tx. 1999) aff’d 238 F.3d 603
(5th Cir. 2001).
     In a low-income tax practice, you may win an Earned Income Credit for a
recent tax year examination. The IRS will offset that refund against taxes owed
for prior years, sometimes 5 to 10 years earlier. If that offset extinguishes the
prior year tax liability, the taxpayer then has the right to sue for a refund. The
date that the IRS applies the offset is considered the date of payment. IRC §
7422(d); Favret v. United States, No. 03-2322 (E.D. La. 2003).
     IRC § 6513, which deems withholdings and credits to have been paid on the
April 15th return deadline, does not apply to situations in which the refund claim
arises from the application of an overpayment from one tax year to an outstand-
ing tax liability for another tax year. Favret v. United States, supra. In such situa-
tions, IRC § 7422(d) applies and the date of offset is considered the date of
payment. Therefore, the taxpayer will have the right to seek refund for the
amount of taxes paid within 2 years of the IRS offset.28
     The §§ 7422(a) and 6511(a) rules can open up many past years for litiga-
tion. For example, you win a 2003 Earned Income Credit. The IRS applies it to
a 1994 tax obligation. You sue for and win the 1994 refund, which is then applied
to and pays off another tax year’s deficiency and sets up the taxpayer for a refund
lawsuit for another tax year.
Special Problems with Earned Income Credits
     In many Earned Income Credit cases, the taxpayer who loses the examina-
tion, does not owe any taxes. Often, these taxpayers have missed the 90 day
     Payment of taxes by IRS offset can be determined from the offset notice or a transcript of the taxpayer’s account.

                                                  TAX PRACTICE

deadline for filing a Tax Court petition to contest the denial. Many low-income
taxpayers have trouble meeting the precondition of full payment of taxes for the
filing of a refund lawsuit. Such taxpayers commonly present as follows:
        Situation 1: Taxpayer did not owe any taxes after the disallowance of the
                     Earned Income Credit.
        Situation 2: Taxpayer owed a few hundred dollars after the disallowance
                     of the Earned Income Credit.
        Situation 3: Taxpayer received the Earned Income Credit before it was
                     disallowed and owes several thousand dollars to IRS.
        Situation 4: IRS freezes the Earned Income Refund immediately upon the
                     filing of the return.
Discussion of Possible Approaches
    Situation 1
          The courts have held that an Earned Income Credit is deemed under
    IRC § 6513(b) to have been paid on April 15th of the year following the tax
    year. See e.g., Israel v. United States, 356 F.3d 221 (2d Cir. 2004).29 This
    means that Earned Income Credit claims in tax returns filed more than 3
    years after the April 15th deadline for the tax return are precluded by the
    “look-back” rule in IRC § 6511 (b)(2)(A), which limits a refund claim to
    amounts paid within 3 years prior to the claim.
          When does a taxpayer, who owes no taxes after disallowance of the
    Earned Income Credit, meet the “full payment” rule for filing a refund
    lawsuit? Under Israel, supra, it would seem that the “overpayment” or “full
    payment” occurs on April 15th of the year following the tax year in ques-
    tion. An IRS memorandum supports this view. See IRS National Office
    Service Center Advice, Assistant Chief Counsel Memorandum, No.
    200202069 (Release date 1/11/2002). Thus, a taxpayer, who owes nothing
    after disallowance of her Earned Income Credit, should meet the “full
    payment” requirement for a refund lawsuit.
    Situation 2
          The taxpayer will have to pay the taxes owed before filing a refund
    suit. Under IRC § 6513(b), the Earned Income portion of the refund will be
    deemed paid on April 15th of the year following the tax year in question. An
    original return claiming the Earned Income Credit should serve as an
    administrative refund claim for the Earned Income Credit portion. The time
    limitation for suing for a refund is 2 years from a valid notice of claim dis-
    allowance. If the taxpayer can’t pay the taxes owed within 2 years of a valid
    notice of claim disallowance, she could lose her right to sue for the refund
    (which is generally worth several thousand dollars).
          The time limitation for suing for a refund remains open indefinitely
    unless the IRS sent the taxpayer a notice of claim disallowance or the tax-
    payer waived the notice of claim disallowance. Interestingly, the IRS gen-
    erally does not mail “notices of claim disallowance” when it disallows
     Note, however, that IRC § 6513 does not apply to situations in which the refund claim arises from the application of
     an overpayment from one tax year to an outstanding tax liability for another tax year. Favret v. United States, No. 03-
     2322 (E.D. La. 2003). In such situations, IRC § 7422(d) applies and the taxpayer will have the right to seek refund of
     the amount of taxes paid within 2 years of the IRS offset.

                                TAX PRACTICE

     Earned Income Credits. This means that if a taxpayer filed a timely original
     or amended tax return claiming the Earned Income Credit, the 2 year time
     limitation for refund lawsuits in IRC § 6532(a)(1) never begins running. It
     remains open indefinitely. Thus, these taxpayers may be able to sue for
     refunds for prior tax years when they ultimately pay the balance owed. See
     IRS National Office Service Center Advice, Assistant Chief Counsel
     Memorandum, No. 200202069 (Release date 1/11/2002).
           It is not uncommon for these taxpayers to have tax deficiencies for
     several years. To set up refund lawsuits, you consider which tax years
     should be paid first. Should the taxpayer expressly designate her payments
     to the tax year in which the least amount of tax is owed? Or is it better to
     designate the payments to a tax year where the time limitation for refund
     suit is running? Make a strategic decision. Do not let the IRS decide which
     tax years are paid first. See Rev. Proc. 84-58, 1984-2 CB 501 (taxpayer has
     right to designate how voluntary tax payments are applied).
     Situation 3
          These taxpayers must pay thousands of dollars before they can file a
     suit for refund. This is often an insurmountable obstacle for many low-
     income taxpayers. In addition, it may take them many years to pay the defi-
     ciency through an installment agreement. Once they have paid the entire
     amount owed, they should file an administrative refund claim. However, if
     the claim is not filed within the 3 year period of IRC § 6511 (b)(2)(A), the
     amount of the refund will be limited to the amount paid during the 2 years
     immediately preceding the filing of the claim. See IRC § 6511(b)(2)(B).
     Thus, if the taxes were paid in installments over a 5 year period, the refund
     claim may be limited to those payments within the last 2 years.
       Situation 4
           The IRS often freezes refunds based on Earned Income Credits. The
     IRS cannot indefinitely freeze an Earned Income Credit. The IRS should
     either grant the claim or issue a deficiency notice which would allow a Tax
     Court petition to contest the denial. You can ask the Taxpayer Advocate for
     relief if the IRS has frozen the refund for a long period.
           If the delay or freeze is more than 6 months, the taxpayer should have
     the right to sue for a refund based on her original return. A taxpayer, who
     has been “frozen”, may owe little or no taxes and therefore may have a more
     realistic chance of suing for a refund.

1.   Introduction
          Generally, the IRS may not assess the tax until 90 days after the Notice
     of Deficiency or until the Tax Court’s decision if a timely petition is filed.
     Notice and demand for payment is usually made within 60 days of the
          The IRS is a powerful creditor. It does not need a judgment to collect.
     State law exemptions don’t apply to the IRS. Most tax debts are nondis-
     chargeable in bankruptcy. The IRS uses liens and levies to enforce collection.

                                              TAX PRACTICE

2.     Liens
             A federal tax lien is the IRS’s legal claim to property as security or
       payment for a tax debt. The claim arises “automatically” under IRC § 6321
       and attaches to every interest in property and rights owned by a taxpayer
       without regard to its location. Drye v. United States, 120 S. Ct. 474 (1999).
       The lien attaches to after-acquired property. Federal tax liens even attach
       to property exempt from seizure under state law. Drye, supra; Medaris v.
       United States, 884 F.2d 832 (5th Cir. 1989). Exemption from levy under
       federal law does not bar a lien on the exempt or non-exempt property.
       Matter of Sills, 82 F.3d 111 (5th Cir. 1990). The IRS may seek to enforce the
       lien against exempt property by a foreclosure lawsuit under IRC § 7403. Id.
       at 114. Discharge of a tax debt in bankruptcy will not extinguish a prepe-
       tition lien. In the Matter of Orr, 180 F.3d 656 (5th Cir. 1999); In re Isom, 901
       F.2d 744 (9th Cir. 1990). It only extinguishes the personal liability.
       However, sometimes the IRS does not bother enforcing liens after a bank-
             If a taxpayer does not pay a bill, the IRS will generally send a Notice
       of Federal Tax Lien which demands payment within 10 days.30 The Notice
       will threaten the filing of a tax lien in the public records office if the bill is
       not paid.31 A tax lien is not self-enforcing. The IRS must administratively
       levy on property or income or bring a foreclosure suit under IRC § 7403.
             A taxpayer may appeal a Notice of Federal Tax Lien by filing a Form
       12153 within 30 days. See Reg. § 301.6320-1. Grounds for appeal include:
             • Whether the law or administrative procedures were followed32
             •     Spousal defenses
             •     Challenges to appropriateness of collection actions
             •     Collection alternatives
             An Offer in Compromise is a “collection alternative” which can be
       heard by the Appeals Officer. Practitioners report higher success rates on
       Offers that are raised in collection due process (CDP) appeals. Offers in
       Compromise raised in a CDP appeal can be judicially reviewed by the Tax
             Lien appeal decisions by the IRS Appeals Officer are reviewable under
       an abuse of discretion standard by the Tax Court. The petition for judicial
       review must be filed within 30 days. IRC § 6320 (c), 6330 (c)-(e). Joint
       Committee on Taxation, Summary of the Conference Agreement on H.R. 2676,
       132 (June 24, 1998).
             A recorded lien can be released if the tax liability is satisfied or
       becomes legally unenforceable. IRC § 6325. A lien becomes unenforceable
       upon expiration of the statute of limitations for collection unless the IRS
       brings timely suit and wins judgment. IRC § 6322; Markham v. Fay, 74 F.3d
       1347, 1353 (1st Cir. 1996). The IRS has 10 years after timely assessment
       to collect taxes. IRC §§ 6502(a), 6322. The IRS may withdraw a lien if the
   IRS personnel are directed to file liens for tax debts that are $10,000 or more and may file for lesser debts.
   Note that the filing of a lien on a taxpayer’s home may trigger a technical default if the mortgage has a “‘no lien”
   In a “CDP” appeal, check for compliance with all applicable IRM procedures.

                                TAX PRACTICE

     filing was premature or in violation of administrative procedures, or the lia-
     bility is being paid through an installment agreement or an Offer in
     Compromise. IRC § 6323. If these conditions are met, a Certificate of
     Release of Lien (Form 668Z) may be obtained from the IRS and filed in the
     public records office. If the lien was filed in error, the IRS Certificate of
     Release should state so to minimize damage to the taxpayer’s credit rating.
     IRC § 6326 (b).
3.   Levies
          The IRS generally seizes property or income through the levy process.
     In any case that the IRS may levy, it may seize and sell such property. IRC
     § 6331 (b). A levy reaches every species of property owned by the taxpayer
     unless exempted by federal law. Drye v. United States, 120 S. Ct. 474 (1999).
     IRS policies discourage levies of houses and retirement plans even though
     they are not exempt. Most commonly, the IRS levies on bank accounts and
     wages. The IRS is not required to file a lien before using the levy process.
          Since 1997, virtually all property and income are subject to levy or
     seizure. Under IRC § 6334, exempt property includes:
     •    Wearing apparel and school books
     •    Fuel, provisions, furniture and personal effects in household up to
          $6,890 (for 2003)
     •    Books and tools of a trade, business or profession up to $3,440 (for
     •    Principal residence up to $5,000
           Weekly wages equal to the standard deduction and the aggregate
     amount of deductions for personal exemptions divided by 52 are exempt.
     IRC § 6334 (d). Thus, exempted wages vary with family size and taxpayer
     filing status. For example, the 2005 exempted weekly wages are:
     Exemptions                    1             2            3             4
     Single                       $158          219          281           342
     Married, Joint Return        $254          315          377           438
          See IRS Publication 1494 (or IRS Notice 2004-81, IRB 2004-51) for
     current exemption amounts. Blind persons or persons over 65 get additional
     exemptions from levy. The taxpayer is required to claim the exemption
     amount if he has a spouse and/or dependents. Generally, as a policy matter,
     the levy only applies to the taxpayer’s usual take home pay, i.e., net wages
     after historical payroll deductions. See IRM Ask for a manager’s
     review if the collection officer applies the levy to gross wages.
          Wages necessary to pay a pre-levy child support order are exempt. IRC
     § 6334 (a)(8). Under IRC § 6331 (h), the IRS can now levy against 15% of
     the exempt wages other than those necessary to pay child support judg-
     ments. In addition, the IRS may levy against exempt wages if it determines
     that the taxpayer has other income that equals or exceeds the exempt
     amount. Reg. § 301. 6334-2(c); Melton v. Teachers Ins. & Annuity Assoc.,
     114 F.3d 557 (5th Cir. 1997).

                            TAX PRACTICE

      A taxpayer may ask for a reduction of the levy if the levy would cause
economic hardship. The IRS will require a Form 433-A before it will con-
sider a reduction of the levy. If you are near a local IRS office, you may get
somewhat quicker action if the request and Form 433-A are filed personally
with the local IRS office.
      All public assistance income, other than service-connected disability
and JTPA assistance, is subject to a 15% levy. IRC §§ 6331 (h), 6334 (f).
Under the 1997 amendments, levies of Social Security benefits are also
limited to 15%. IRC § 6331 (h)(2)(A). Under the Federal Payment Levy
Program (FPLP), the IRS may continuously levy 15% of monthly Title II
Social Security benefits (even if less than $750) and most welfare benefits.
SSI benefits are not levied under the FPLP or by regular levy. IRC §6331
      Note:In general, a levy does not apply to property acquired after the
date of levy. By contrast, a continuous levy is effective until it is fully paid
or is unenforceable. Wages and public assistance are subject to “continuous
      If the IRS levies in excess of what is allowed by law, you must request
a return of the excess amount within 9 months. IRC § 6343 (b) and (d); IRM See also, M. O’Connor, The IRS’s Authority to Garnish a Disabled
Person’s Social Security Benefits to Collect Unpaid Taxes.
      Inheritances are subject to levy. Woods v. Simpson, 46 F. 3d 21 (6th
Cir. 1995). So is alimony. United States v. Rye, 550 F.2d 682 (1st Cir. 1977).
Child support is exempt.
      The IRS can take the entire retirement account if the taxpayer has the
right to withdraw his account funds. All pensions, IRAs and annuities, other
than Railroad Retirement and Railroad Unemployment Insurance, are fully
subject to levy. See e.g., Shanbaum v. United States, 32 F.3d 180 (5th Cir.
1994); In re Tudisco, 183 F.3d 133 (2d Cir. 1999). However, employer plans
must be vested before the IRS can seize them. If retirement income is
levied, the taxpayer will be subject to income tax on the levied amounts, but
not the early withdrawal penalty. IRC § 72 (t)(2)(A).
      For tax debts greater than $5,000, a principal residence is not exempt
from levy if a federal district judge or magistrate approves the levy in
writing. IRC § 6334 (e)(1)(A). Federal district court has exclusive juris-
diction to approve levy of a principal residence. Notice of the hearing must
be given to the taxpayer. At the hearing, the IRS must prove (1) that the
legal requirements for levy have been met, (2) that the liability is owed and
(3) no reasonable alternative for collection of the tax exists. Joint
Committee on Taxation, Summary of the Conference Agreement on H.R. 2676,
18 (June 24, 1998). Jointly owned property can be seized by the IRS.
However, the IRS must compensate the nondebtor for her share. United
States v. Rodgers, 461 U.S. 677, 699 (1983).
      A taxpayer does not have to move out of his house after a levy. The
IRS will not evict a taxpayer after the sale. The buyer at the sale must
bring a state court eviction lawsuit. The buyer does not have full title to the
house. After the sale, the taxpayer has 180 days (not 6 months) to redeem
his property by paying the full bid price plus interest at 20% per annum.

                                               TAX PRACTICE

       IRC § 6337. If the taxpayer plans to redeem, it may be possible to rent
       from the purchaser.
             The district courts have some discretion under IRC § 7403 to deny a
       foreclosure sale where the IRS holds a lien on only part of the house. See
       e.g., United States v. Rodgers, 461 U.S. 677 (1983); United States v. Jensen,
       785 F. Supp. 922 (D. Utah 1992) (harm to terminally ill nondebtor out-
       weighed delay to IRS); United States v. Jones, 877 F. Supp. 907 (D. N.J. 1995)
       (nondebtor wife kept house in return for fi rent payments to IRS).
             If the taxpayer has a levy notice, determine what stage he is at in the
       levy process. Generally, the taxpayer will receive 3 statutory notices before
       the actual levy:
       •     10 day notice and demand for payment [IRC § 6331 (a)]
       •     Final notice before levy [IRC § 6331 (a)]
       •     Notice of intent to levy and CDP hearing opportunity at least 30 days
             before proposed levy [IRC §§ 6330(a), 6331 (d)]
             Generally, levy cannot be made on wages or property until the IRS has
       given the taxpayer a 30 day written notice. IRC § 6331 (d).33 The taxpayer
       has 30 days to appeal a levy to an IRS Appeals Officer. IRC § 6330 (b); Reg.
       § 301.6330-1 (b)(1). If a taxpayer requests an appeal, the IRS may not levy
       while the appeal is pending. IRC § 6330 (e) amended by P.L. 106-554 (eff.
       Dec. 21, 2000). 34 Use Form 12153. Issues at the hearing include:
       • Spousal defenses
       • Challenges to appropriateness of collection actions
       •     Collection alternatives (the Appeals Officer is required to balance the
             need for efficient collection with taxpayer’s concern that collection be
             no more intrusive than necessary)
       •     Challenges to the existence or amount of tax liability if the taxpayer
             did not receive a notice of deficiency or did not otherwise have an
             opportunity to dispute tax liability.35
             An Offer in Compromise is a “collection alternative” which can be
       heard by the Appeals Officer. Offers raised in a CDP appeal may be judi-
       cially reviewed by the Tax Court.
             Judicial review may be obtained by petition to the Tax Court within 30
       days of the Appeals Officer’s decision. IRC § 6330 (d). However, the levy
       is only suspended where the taxpayer is contesting the underlying tax lia-
             In a levy on a bank account, a taxpayer will have 21 days to negotiate
       with the IRS before the bank sends the funds to the IRS. IRC § 6332 (c).
       A levy freezes a bank account. Therefore, unpaid checks may bounce. A
       taxpayer may want to consider an interim agreement to pay the tax in
   However, the IRS has taken the position in temporary regulations that wage levies in place before 7/22/98 are not
   subject to the 30 day notice and due process hearing requirements.
   The Tax Court may enjoin levy actions during the period that the levy action is required to be suspended under the pre-
   levy administrative due process hearing procedures. P.L. 106-554.
   However, if there is “doubt as to liability”, the issue can be raised through an Offer in Compromise filed with the
   Appeals Officer or by Appeal Office review of a rejected Offer in Compromise.

                                 TAX PRACTICE

          Uneconomical levies are prohibited. These are levies where the sale
     expenses exceed the property’s fair market value. IRC § 6331 (f). No levy
     may be made during the pendency of proceedings for refund or the pendency
     of an offer in compromise or installment agreement. IRC § 6331 (I), (k).
     Property essential for a taxpayer’s work may be entirely exempt if the levy
     is under $5,000. levy. IRC § 6334 (a)(13) (B). For tangible personal prop-
     erty or real property essential to a trade or business, the IRS must provide
     an expedited administrative process to determine the existence of § 6343
     (a)(1) grounds for the release of the levy if the levy is likely to prevent the
     taxpayer from carrying on her trade or business. IRC § 6343 (a)(2).
4.   Collection Due Process Appeals–General Tips
           The IRS appeal form for collection due process appeals does not help
     the taxpayer. The IRS appeal form should be supplemented by a more spe-
     cific appeal letter that is similar to a pre-trial memorandum. Use your
     appeal letter to create an administrative record and preserve issues for Tax
     Court review. Your letter should identify any IRS procedures that the IRS
     failed to follow. Be sure to raise all issues at the appeals level that you want
           In a CDP appeal, the Appeals Officer should send a letter that explains
     the appeal procedures, asks for additional information and tells you
     whether he thinks the appeal is a timely CDP appeal or an equivalent
     hearing. If you disagree with any findings in this initial letter, raise your
     issues in writing. Appeals Officers may try to conduct the “hearing” through
     an exchange of correspondence.
           Therefore, it is important to review Appeals Officer correspondence
     and promptly respond to (or challenge) Appeals Officer findings and
           A suspension of the CDP hearing makes sense where the taxpayer is
     in audit reconsideration for a tax liability that he does not owe. Often, this
     situation arises where a taxpayer had an Earned Income Credit claim, but
     failed to respond to a 90 day notice of deficiency. Here, you may want to
     ask the Appeals Officer (or his manager) to suspend the CDP hearing or
     notice of determination so that the taxpayer does not have to file a Tax
     Court petition to contest a CDP determination that may ultimately be
     mooted by a favorable decision on audit reconsideration. You may need to
     ask the Taxpayer Advocate for help to get a suspension for the pendency of
     an Earned Income Credit audit reconsideration.
5.   Options for Taxpayers Who Can’t Pay Their Taxes
         The taxpayer who can’t pay his taxes may have the following options
     when dealing with IRS collections:
         •    Enter an installment agreement
         •    Make an offer in compromise
         •    Taxpayer Assistance Order
         •    Ask for temporary suspension of collection
         •    File for bankruptcy (some taxes may be dischargeable)
         •    Innocent spouse relief

                                TAX PRACTICE

          •    Separate liability election
          •    Divorce spouse if property or wages levied for premarital tax
          •    State law basis for one spouse compromising her share of joint lia-
          •    New audit if never received notice
          •    Challenge assessment if procedures not followed
          •    Collection barred by 10 year statute of limitations
          •    Redemptions of real property
          Many taxpayers won’t qualify for relief through offers in compromise,
     bankruptcy or temporary suspension. An installment agreement is the
     practical option for most taxpayers.
6.   Installment Agreements
          The IRS is now required by IRC § 6159 to enter an installment agree-
     ment if:
          •   The liability is $10,000 or less
          •   The taxpayer, within the previous 5 years, has not failed to file tax
              returns or to pay taxes shown on such returns, nor entered an
              installment agreement
          •   If requested by the IRS, the taxpayer submits financial state-
              ments and the IRS determines that the taxpayer is unable to pay
              in full
          •   Installment agreement provides for full payment within 3 years
          •   The taxpayer agrees to continue to comply with tax laws and the
              agreement for the period (up to 3 years)
          IRS Form 9465 is used to request installment agreements under
          The IRS is required to send every taxpayer in an installment agree-
     ment an annual statement of the initial balance owed, the payments made
     during the year and the remaining balance. IRC § 6159. Penalties and
     interest accrue as long as the taxpayer owes on the installment agreement.
     They can run higher than 20% per year.
          For debt greater than $10,000, the IRS must negotiate an installment
     payment plan in good faith. The taxpayer will have to complete a Form 433-
     A. The taxpayer must offer to make monthly payments equal to line 34
     (income) minus line 45 (expenses) on Form 433-A. Remember to reserve
     enough money to meet payments for state tax debts. If the taxpayer’s pro-
     posal is rejected, he can keep negotiating and ask to speak to the collector’s
         Once approved, the IRS and the taxpayer are bound by the agreement
     unless any of the following happens:
          •    Taxpayer fails to file tax returns or pay taxes arising after agree-

                                                 TAX PRACTICE

                •   Taxpayer misses payment36 ( if there is a good excuse, Taxpayer
                    Advocate or Problems Resolution may be able to help prevent a
              •     Taxpayer’s financial condition improves or worsens
              •     Taxpayer provided inaccurate information as part of negotiation
              A taxpayer may refuse to extend the statute of limitations on collec-
         tions or limit the extension to specific issues or time period. IRC § 6501(c).
         Extensions of the statute of limitations on collections may be made as part
         of an installment agreement. The extension is only for the period for which
         the installment agreement extends beyond the 10 year period, plus 90 days.
         IRC § 6502(a)(2).
              Denials or terminations of installment agreements can be appealed by
         using Form 9423. If line 45 (expenses) exceeds line 34 (income) on the
         Form 433-A, an offer in compromise, suspension of collection or bankruptcy
         may be more promising options.
              Effective October 22, 2004, IRC § 6159 was amended to authorize the
         IRS to enter partial payment installment agreements–installment agree-
         ments which do not provide for full payment over the life of the agreement.
         American Job Creation Act of 2004, Pub. Law 108-357 § 843, 118 Stat.
         1418, 1600. See also House Conf. Rep. 108-755, 636-37. The 2004 amend-
         ment reverses a 1998 IRS Chief Counsel Memorandum that held that partial
         payment installment agreements were not permitted. Taxpayers who
         request partial payment installment agreements will be asked to address
         equity in assets that can be used to reduce the outstanding liability.
7.       Offers in Compromise
              IRC § 7122 authorizes the IRS to settle tax debts through Offers-in-
         Compromise which may substantially reduce the amount a taxpayer must
         pay. Offers may be submitted on the basis of (1)doubt as to collectibility, (2)
         doubt as to liability, or (3) effective tax administration.
              The IRS Restructuring and Reform Act of 1998 required the IRS to
         adopt a liberal acceptance policy for Offers-in-Compromise. The 1998 Act
         prohibited the IRS from rejecting offers by low-income taxpayers solely on
         the basis of the amount of the offer. IRC § 7122(c)(3).
               The IRS charges a $150 user fee for processing offers to compromise.
         26 CFR § 300.3, 68 Fed. Reg. 48785 (8/15/03). A check or money order
         should be made payable to the United States Treasury. The user fee does not
         apply to offers based solely on doubt as to liability and offers made by tax-
         payers whose incomes are below 100% of poverty. Indigent taxpayers must
         file a Form 656-A to request a waiver of the user fee.
              Regulations and procedures for the Offer-in-Compromise program are
         found at Reg. § 301.7122 et seq., 67 Fed. Reg. 48025 (7/23/02), and Rev.
         Proc. 2003-71, 2003-27 IRB 1. The program’s purpose is to settle tax debts
         for the maximum amount that the taxpayer can pay out of his net current
         assets and future income potential. The IRS may allow the taxpayer to pay
     Usually, a defaulted installment agreement can be reinstated once.

                           TAX PRACTICE

off the debt in cash or over a period of time, not to exceed the time remain-
ing on the statutory period for collection. IRM § The taxpayer
will be given a fixed monthly payment amount if an Offer- in-Compromise is
accepted. The compromise should provide the taxpayer with adequate
means for basic living expenses.
      Forms 656 and 433-A must be filed to make a standard Offer-in-
Compromise. The IRS generally requires additional financial documenta-
tion in its evaluation of the offer. Part 5.8 of the Internal Revenue Manual
( has the IRS guidelines for valuation of income, assets
and expenses. You should consult the IRM when preparing an offer in com-
promise. The IRS officer will often battle low-income taxpayers on assets
and expenses.
      The amount of the offer is computed as the sum of (1) net realizable
assets and (2) gross income minus necessary living expenses. “Net realiz-
able assets” equals the Quick Sale Value of an asset (generally 80% of fair
market value) minus the first encumbrance, fix-up costs, broker fees, etc.
      Even if the computed “offer” amount is zero, the taxpayer should still
offer at least $1. (Comments by M. McDermitt, IRS National Program
Manager, OIC, at the 2005 Annual Low-Income Taxpayer Clinic Conference).
      Assets such as nonexempt furniture, appliances and personal effects
can be valued at garage sale prices. Kelly’s blue book values minus appro-
priate adjustments may be used for cars. Retirement funds may be dis-
counted by income taxes due on the withdrawal. Bank accounts (and
similar liquid assets) may not be discounted.
      Future income potential will depend on factors such as the taxpayer’s
age, employability and how much time is left on the 10 year statute of lim-
itations for collection. Generally, this amount will be equal to the amount
the taxpayer would have to pay under an installment agreement.
      Generally, the assets and income of a nonliable spouse are not consid-
ered in determining the amount of an adequate offer for the liable taxpayer.
Reg. § 301. 7122-1 (c)(2)(ii). An exception is where the collection of the tax
liability from the assets and income of the nonliable spouse is permitted by
applicable state law. The IRS may also request information on the nonliable
spouse’s assets and income to verify the expenses claimed by the taxpayer
on his Form 656.
      Many low-income taxpayers live in homes with their extended families
and may have “shared” living expenses. The Internal Revenue Manual,
Part, states the IRS rules for computing “shared” living expenses
when a taxpayer lives with a non-liable person. The rules include:
1. Generally, the non-liable person’s assets and income are excluded from
      the computation of the taxpayer’s ability to pay. The exception is for
      community property states. In these states, the state’s community
      property law will determine what assets or income, if any, are subject
      to collection of the tax.
2. Determine the total income and expenses of the taxpayer’s household
      and the percentage of total household income that the taxpayer con-

                                               TAX PRACTICE

       3.     Determine which expenses are “shared” and which are the taxpayer’s
              sole responsibility.
       4.     Apply the taxpayer’s percentage of total household income to the total
              of “shared expenses” to determine the taxpayer’s share of “shared
              expenses.” To this amount, add the taxpayer’s sole expenses.
            It is helpful to write a letter to the IRS summarizing why the taxpayer
       should be granted a Compromise. If the IRS is unreasonable in its demands
       for documentation that does not exist or cannot be obtained, you should
       consider asking the Taxpayer Advocate to intervene.
             Prior to the 1998 Act, Offers-in-Compromise could be granted if there
       was doubt as to collectibility or liability. The 1998 Act added “effective tax
       administration” as a new ground for compromises. Under this new provi-
       sion, taxpayers may now qualify for Offers-in-Compromise if they have eco-
       nomic hardships37 such as long-term illness or disability where financial
       resources will be exhausted for care and support or where sale of assets
       (e.g., retirement funds) would deprive the taxpayer of the means to pay
       basic living expenses. In addition, an Offer-in-Compromise may be granted
       for exceptional circumstances, such as long-term hospitalization, or inabil-
       ity to manage finances or file tax returns. Taxpayers in these special hard-
       ship situations may be able to settle for less than the maximum collection
             Possible disadvantages to an Offer-in-Compromise include an exten-
       sion of the 10 year statute of limitation by the pendency of the offer plus 1
       year, forfeiture of certain tax refunds, filing of tax liens to protect the IRS’s
       interests, adverse impact on bankruptcy options and reinstatement of the
       full debt, plus penalties and interest, if the taxpayer defaults on the offer.
            Levy is suspended while an Offer-in-Compromise is pending or in
       effect. IRC § 6331(k). The IRS is not required to release a levy upon the
       taxpayer’s filing of an Offer-in-Compromise. However, it will usually release
       the levy if the taxpayer shows economic hardship. “Rejections” of Offers-in-
       Compromise may be appealed to the IRS Appeals Office. IRC § 7122 (d).
       Levy is suspended pending an appeal. IRC § 6331(k). If the IRS “rejects”
       an Offer-in-Compromise, the taxpayer may be able to appeal the collection
       action under IRC §§ 6320 or 6330 or under the Collection Appeals Program.
       Rev. Proc. 2003-71.39
            An Offer in Compromise may be raised in a collection due process
       (CDP) appeal and first heard by an OIC Appeals Officer.40 Practitioners
       report that OIC decisions by Appeals Officers are more accurate than those
       by OIC examiners. OIC decisions by the Appeals Officers in CDP appeals
       may be judicially reviewed by the Tax Court.
   See Reg. § 301.6343-1 and 301.7122-1(c)(3) for meaning of economic hardship.
   For additional guidance on the new “equity or economic hardship” basis for offers in compromise, see the legislative
   history to the 1998 Act.
   Returns of offers for additional information are not “rejections.”
   Offers submitted to the Appeals Officer in a CDP appeal will be forwarded to the Centralized Offer in Compromise site
   for a processability determination and for processing of the filing fee. However, the merits of the Offer are directly
   determined by the Appeals Officer. IRM §

                                                 TAX PRACTICE

               A bankruptcy court has held that IRS policy against consideration of
         Offers-in-Compromise from bankrupt debtors is discriminatory and prohib-
         ited under 11 U.S.C. § 525 (a). Mills v. United States, 240 B.R. 689 (Bankr.,
         S.D. W. Va. 1999). Nevertheless, Rev. Proc. 2003-71 still states that the IRS
         will not process an Offer-in-Compromise for a taxpayer who is in bankruptcy.
8.       “Currently Not Collectible” Hardship
              A taxpayer may be placed in “Currently Not Collectible” status if col-
         lection would cause undue hardship by leaving her unable to meet neces-
         sary living expenses. IRM §,
              CNC status suspends collection, but does not forgive or compromise
         the tax. Also, interest and penalties accrue during CNC status.
              The financial analysis for CNC status focuses on 3 types of necessary
         living expenses: national standards, local standards and other expenses.
         IRM § The taxpayer’s financial information generally must be
         compiled on a Form 433-A or 433-F. The Automated Collection System
         (ACS) and the campuses for individuals owing less than $100,000 use the
         Form 433-F.
              National standards are automatically used for clothing, food, house-
         keeping and personal care expenses. If a taxpayer claims more than the
         national standards, she must substantiate and justify each separate
         expense of the total national standard. IRM §
              For housing and transportation, taxpayers are allowed the local stan-
         dard or the amount actually paid, whichever is less. IRM § On-
         line access to the national and local standards can be found at IRM §
              “Other expenses” may be considered if they meet the necessary
         expense test. The issue is whether they provide for the health and welfare
         of the taxpayer and/or his family or are for the production of income. IRM
9.       Bankruptcy
               A Chapter 7 or Chapter 13 bankruptcy may provide some tax debt
         relief. The rules for determining whether a tax is dischargeable are very
         complex.41 Income taxes are only dischargeable if:
               • No fraud or willful evasion42
               •   Tax return was due at least 3 years before bankruptcy filed
               •   Tax return was actually filed at least 2 years before bankruptcy
               •   Taxes assessed at least 240 days before bankruptcy filed
               These time periods are increased if the taxpayer filed a prior bank-
         ruptcy. The length of the bankruptcy plus 6 months must be added to the
         time periods. Offers-in-Compromise and Taxpayer Assistance Orders may
         also increase the time requirements.
     See National Consumer Law Center Bankruptcy Manual; Borison, Effectively Representing your Client Before the New IRS
     (ABA 2004), Ch. 21.
     See e.g., Matter of Bruner, 55 F.3d 195 (5th Cir. 1995).

                                                 TAX PRACTICE

             A Chapter 13 bankruptcy may secure a more favorable repayment plan.
         A Chapter 7 can be used to discharge old taxes and then supplemented with
         a Chapter 13 to pay nondischargeable taxes over an extended period.
               In Ch. 13 bankruptcies, the plan must provide for priority and secured
         tax debts. Older taxes may be “non-priority” and therefore dischargeable.
         In some cases, you can prevent a tax debt from becoming “secured” by filing
         the bankruptcy before the IRS files its lien. Ch. 13 bankruptcy debtors,
         unlike Ch. 7 debtors, have the right (or standing) to litigate any refund law-
         suits in their own names. See e.g., Cable v. Ivy Tech State College, 200 F.3d
         467, 472-74 (7th Cir. 1999). The trustee will seek to recover tax refunds
         won by the Ch. 13 debtor as “disposable income” that must be included in
         the plan. However, there may be challenges to the trustee’s action depend-
         ing on your jurisdiction and the facts of the debtor’s financial situation. See
         e.g., In re Freeman, 86 F.3d 478 (6th Cir. 1996).
              A bankruptcy stay will apply to IRS collection actions. A Chapter 7
         bankruptcy will even stay nondischargeable taxes for a few months.
         Generally, liens recorded before the bankruptcy will not be canceled.43 If
         they survive, the IRS will be able to seize the liened asset. A bankruptcy
         stay will also stay the commencement or continuation of a Tax Court pro-
         ceeding. 11 U.S.C. § 362(a)(8). The time period to collect taxes is extended
         by the filing of a bankruptcy that does not discharge all of the taxes. The
         balance on the 10 year statute of limitations is extended by the length of the
         bankruptcy plus 6 months. IRC § 6503 (h).
              A bankruptcy court has held that IRS policy against consideration of
         Offers-in-Compromise from bankrupt debtors is discriminatory and prohib-
         ited under 11 U.S.C. § 525 (a). Mills v. United States, 240 B.R. 689 (Bankr.,
         S.D. W. Va. 1999).
10. Taxpayer Assistance Orders
         In 1998, Congress expanded the authority of the Taxpayer Advocate
    (IRS ombudsman) to issue Taxpayer Assistance Orders (TAO) to stop col-
    lection activity. A TAO may be issued if the taxpayer is suffering or about
    to suffer a significant hardship as a result of IRS action or inaction or for
    circumstances set forth in IRS regulations. IRC § 7811 (a). Relief is
    granted in about 75% of TAO applications.
                 Significant hardship includes:
                 •    Immediate threat of adverse action44
                 •    Delay of 30 days or more in resolving a taxpayer’s account prob-
                 •    Incurring of significant costs by taxpayer if relief is not granted
                 •    Irreparable injury or long-term adverse impact on taxpayer if
                      relief is not granted
                 See IRM for further definitions of these hardships.

     Generally, a lien will be valid until the 10 year statute of limitations has run. IRC §§ 6322, 6502 (a).
     Actions that create negative financial consequences because of the taxpayer’s unusual situation or abuse or misuse of
     process by IRS personnel. An action that will occur within 30 days is “immediate.”

                                                TAX PRACTICE

              A TAO is a legal remedy for collection emergencies where the taxpayer
         has exhausted normal appeals or channels. TAOs are most commonly used
         where an actual or threatened seizure of a bank account, pension plan, car
         or wages will cause a taxpayer to lose his home (including eviction), car
         necessary for work, medical care, education, or leave him without enough
         money for basic necessities. A Form 911 is used to apply for a TAO. A TAO
         will suspend the running of any period of limitation. IRC § 7811 (d). For
         more information on TAOs, see IRS Publication 1546 and Reg. § 301.7811.
11. Innocent Spouse Relief and Separate Liability Election
          The IRS Restructuring and Reform Act of 1998 provides 3 forms of
    relief to innocent spouses: (1) innocent spouse relief, (2) separation of lia-
    bility and (3) equitable relief. These 3 forms of relief are discussed below:
    1. Innocent Spouse Relief The Act liberalizes the traditional innocent
          spouse relief under § 6015 (b). It eliminates understatement thresh-
          olds and requires only that the understatement of tax be attributable
          to an erroneous, rather than grossly erroneous, item of the other
          spouse. IRC § 6015 (b). Partial relief is also available if a taxpayer
          can show that she did not know, and had no reason to know, the extent
          of the understatement of tax. IRC § 6015 (b)(2).
                Generally, a taxpayer may be eligible for innocent spouse relief if
          •     Did not know about the unreported income or erroneous items, and
          •     Did not receive benefits from the unreported income or erroneous
                The IRS has a spousal tax relief eligibility explorer on its web
          page to assist with evaluating eligibility for innocent spouse relief.
          These new rules apply to taxes arising after enactment of the 1998 Act
          and any prior tax that remains unpaid on the date of enactment.
                Despite the repeal of former § 6013 (e), the Tax Court, in a divided
          opinion, has reaffirmed its prior case law on what constitutes “knowl-
          edge” for items of omitted income under § 6015 (b). Cheshire v.
          Comm’r., 115 T.C. 183 (2000). According to the Tax Court majority,
          “actual knowledge of the underlying transaction that produced the
          omitted income...” is fatal to 6015 (b) relief.45 In addition, the Tax
          Court barred 6015(c) relief if the spouse learns about income because
          it is reported on the tax return, but was misled about its character. It
          is enough that she had actual knowledge of the “item” giving rise to
          the deficiency.46
                Cheshire was affirmed by the Fifth Circuit, which held that actual
          knowledge of the income producing transaction is fatal to innocent
          spouse relief even if the spouse lacked knowledge of the incorrect tax
          reporting of the transaction. See Cheshire v. C.I.R., 282 F.3d 326 (5th
          Cir. 2002).
     Accord, Jonson v. Comm’r., 118 T.C. 106, 115 (2002).
     The legislative history to P.L. 105-206 stated that “actual knowledge must be established by the evidence and shall
     not be inferred based on indication that the electing spouse had reason to know” and that knowledge of an erroneous
     item will not be imputed to a joint filer.

                                                  TAX PRACTICE

                      Subsequent to Cheshire, a taxpayer was granted §6015 (b) relief
                 despite his knowledge of the receipt of IRA distributions by his wife
                 from her father’s estate where he was misled by the estate’s attorney
                 that the funds were a nontaxable inheritance. Braden v. Comm’r., T.C.
                 Memo 2001-069 (3/22/01).
         2.      Separation of Liability Most significantly, the 1998 Act also provides
                 a separate tax liability election under §6015(c) for a taxpayer who, at
                 the time of election, is no longer married to or has been living apart for
                 at least 12 months from the person with whom the taxpayer originally
                 filed a joint return.
                       The separate liability treatment may be elected by the taxpayer
                 who qualifies for such treatment under IRC § 6015 (c). To get this
                 relief, the taxpayer must prove that a portion of the understatement
                 was attributable to her spouse. The determination of separate liability
                 is made without regard to community property rights. Thus, the elect-
                 ing taxpayer is basically taxed on her own income as though she were
                 filing a separate married return. If she did not have income, her tax
                 liability will be zero.
                       Taxpayers are often successful under § 6015(c). Relief is easier to
                 obtain under §6015(c) than § 6105 (b) since the IRS must prove actual
                 knowledge, as distinguished from “reason to know”, to deny appor-
                 tioned liability under §6015(c).47 See e.g., Culver v. Comm’r., 116 T.C.
                 189 (2001); King v. Comm’r., 116 T.C. 198 (2001); Peters v. Comm’r.,
                 TCS 2003-10. In Culver, the husband was granted 6015(c) appor-
                 tioned liability because he had no actual knowledge of his wife’s
                 embezzlement income even though she channeled funds through their
                 joint account. In King, deductions for the taxpayer’s husband’s activi-
                 ties were disallowed because he lacked a profit motive. The wife knew
                 of her husband’s activity and the deduction appeared on the return.
                 Nonetheless, the wife was granted apportioned liability in King because
                 the IRS failed to prove that she knew her husband’s activity lacked a
                 profit motive. In Peters, the court granted 6015(c) relief with respect
                 to disallowed charitable contribution deductions. The court accepted
                 the taxpayer’s testimony that she did not read the return that she
                 signed, that she was unaware of the deductions and that she was not
                 involved in her husband’s finances. The court held that the IRS did not
                 prove that she actually knew that the charitable contribution deduc-
                 tions were false.
         3.      Equitable Relief Finally, the Act further authorizes the IRS to relieve
                 an individual of liability if relief is not available under the innocent
                 spouse rule or the separate liability election if it would be inequitable
                 to hold the individual liable for any unpaid tax or deficiency. IRC §
                 6015 (f). The IRS automatically considers a taxpayer for equitable
                 relief if innocent spouse and separate liability relief are denied. Note,
                 unlike IRC § § 6015(b) and (c), §§6015(f) and 66(c) permit equitable

     Generally, the burden of proof is on the taxpayer for innocent spouse relief with the exception of the requirement that
     the IRS must prove actual knowledge to deny apportioned liability under §6015(c).

                                                TAX PRACTICE

                relief from an underpayment of income tax. §§ 6015(b) and (c) only
                permit relief from proposed deficiencies. Rev. Proc. 2003-61, §4.04
                may even allow refunds to the requesting spouse in some circum-
                      Even if relief is unavailable under §§ 6015 (b) and (c), the IRS
                may relieve a spouse from liability under §§ 6015 (f) and 66(c) if it
                would be inequitable to hold the spouse liable for any unpaid tax or lia-
                bility. IRC § 66 (c) provides equitable relief in community property
                states where a joint return was not filed.
                      Current IRS guidelines for § 6015 (f) and § 66 (c) equitable relief
                are in Rev. Proc. 2003-61, IRB 2003-32 (eff. Nov. 1, 2003).48 This list
                is not all-inclusive and no single factor is determinative. The following
                factors may be considered:
                •     Current marital status
                •     Abuse experienced during marriage
                •     Reasonable belief of the requesting spouse, at the time she signed
                      the return, that the tax was going to be paid; or in the case of an
                      understatement, whether the requesting spouse had knowledge or
                      reason to know of the understatement.
                •     Current financial hardship or inability to pay basic living expenses
                •     Spouses’ legal obligation to pay the tax liability pursuant to a
                      divorce or agreement to pay the liability
                •     To whom the liability is attributable
                •     Significant benefit received by the requesting spouse
                •     Poor mental or physical health of requesting spouse
                      Tax Court case law has been favorable to taxpayers seeking rever-
                sal of IRS denials of §6015(f) relief. In Gay v. Comm’r., TCS 2003-36,
                the court held that the factors favoring equitable relief outweighed the
                fact that the taxpayer had actual knowledge of his spouse’s unreported
                income. The court found it more important that the taxpayer was
                divorced from his spouse, that a state family court decree required the
                spouse to pay the taxes (or indemnify the taxpayer for his payment)
                and that the liability was solely attributable to the spouse. The court
                said that the most important factor was the obligation created by the
                state court order.49
                      In Wiest v. Comm’r., TCM 2003-91, the court reversed an IRS
                denial upon finding that the taxpayer did not know that his wife, who
                had assumed responsibility for filing the return and paying the taxes,
                would not pay the taxes. A portion of the underpayment was attribut-
                able to the taxpayer. Nonetheless, the court relieved the taxpayer of
                the portion of the underpayment attributable to his spouse. The court
                also cited the factors that the couple was divorced and that the tax-
                payer did not benefit from the underpayment attributable to his spouse.
     Rev. Proc. 2003-61 supersedes Rev. Proc. 2000-15 for requests for relief filed after Nov. 1, 2003.
     The IRS is not bound by state court orders and may seek collection from either spouse. However, Gay shows that such
     orders can be very important to winning §6015(f) relief.

                                                   TAX PRACTICE

                      Ferrarese v. Comm’r., TCM 2002-249, is a good case to read if you
                 are seeking § 6015(f) relief for a taxpayer who will suffer economic
                 hardship if she has to pay the tax on unreported income. In Ferrarese,
                 an elderly taxpayer actually consented to her husband signing a tax
                 return when she knew of unreported embezzlement income. The court
                 found that she would suffer economic hardship, received no significant
                 benefit from the embezzlement income and had complied with tax laws.
                 These factors were held to outweigh the factors against granting relief.
                 The IRS unsuccessfully argued under Rev. Proc. 2000-15 (now super-
                 seded) that the significant benefit factor could only be considered as a
                 factor against relief.
                 Procedures for Asserting Innocent Spouse Claims or Defenses
                       Innocent spouse relief may be sought in deficiency or collection
                 proceedings and as a stand alone 6015 election. However, the Tax
                 Court has held that it does not have jurisdiction to review an IRS
                 denial of a “stand alone” request for equitable relief under IRC § 66 (c).
                 Bernal v. Comm’r, 120 T.C. 102 (2003). Tax Court review is available
                 regardless of how the innocent spouse claim or defense is raised. Joint
                 filers who establish separate addresses after the joint return is filed
                 should consider filing a Form 8822 so that they will receive notices of
                 deficiencies relative to the joint return.
                       A Form 8857 may be filed to raise these claims. A taxpayer may
                 file a Form 8857 at any time after a deficiency for a year is
                 asserted, but no later than 2 years after the IRS first attempts to
                 collect the tax from her. IRC § 6015 (c)(3)(B). P.L. 106-554 (eff. Dec.
                 21, 2000) amended § 6015 (c) to clarify that a taxpayer may elect 6015
                 (b) or (c) relief at any time after the IRS asserts a deficiency. The leg-
                 islative history further states that a deficiency is considered to have
                 been asserted at the time the IRS states that additional taxes may be
                 owed. This most commonly occurs in the Examination process. It
                 does not require an assessment to have been made or administrative
                 remedies to be exhausted prior to the taxpayer requesting innocent
                 spouse relief. Filing a Form 8857 stays collection and tolls the statute
                 of limitations during the collection “stay” period and for an additional
                 60 days. A Form 8857 can also be presented to an IRS collection agent
                 or appeals officer.
                      An innocent spouse relief election must be made not later than 2
                 years after the IRS began “collection activity” with respect to the elect-
                 ing spouse.50 “Collection activity” includes:
                 •       Actual administrative levy or seizure
                 •       Offset of an overpayment of the electing spouse51
                 •       Filing of suit by the United States

     Note, however, that the time limit for a separate filer’s traditional innocent spouse relief under IRC § 66 (c) is 6 months
     before the statute of limitation on assessment on the nonrequesting spouse expires. Reg. 1.66-1(j).
     McGee v. Comm’r, 123 T.C. No. 19 (2004).

                                                 TAX PRACTICE

                 It does not include:
                 •     Notice of deficiency (but you should assert an affirmative defense
                       within Tax Court Petition)
                 •     Demand for payment of tax
                 •     Issuance of notice of intent to levy
                       The collection activity must be specifically directed to the electing
                 spouse in order to trigger the running of the 2 year limit.52 See Reg.
                 §1.6015-5(b)(2). The right to relief under IRC § 6015 must be included
                 in any collection related notice. McGee v. Comm’r, 123 T.C. No. 19
                 (2004); IRS Restructuring and Reform Act of 1998, § 3501, 112 Stat.
                 770. Failure to send this notice will preclude the IRS from applying the
                 2 year limitation if the taxpayer suffered prejudice. McGee, supra.
                       By statute, there is a 2 year time limit for relief under §§ 6015 (b)
                 and (c). However, § 6015 (f) is silent as to any time limit for filing for
                 equitable relief. The IRS has enacted administrative rules that purport
                 to establish a 2 year time limit for § 6015 (f) claims. See Rev. Proc.
                 2003-61, § 4.01 (3); Reg. § 1. 6015-5(b). Rev. Proc. 2003-61 also pur-
                 ports to establish a 2 year time limit for “equitable” innocent spouse
                 relief under IRC § 66 (c) in community property states. There are
                 several possible arguments that the IRS’s establishment of a 2 year
                 time limit is unlawful. Generally, only Congress has the power to
                 establish a statute of limitation. See e.g. United States v. Flores, 135 F.
                 3d 1000 (5th Cir. 1998), cert. denied 525 U.S. 1091 (1999). The 1998
                 amendments to § 6015 created a new § 6015(f) claim as to “under-
                 payment” of tax. 28 U.S.C. § 1658 creates a 4 year statute of limita-
                 tion for “causes of action” arising under an Act of Congress enacted
                 after December 1, 1990. See also, Jones v. Donnelly & Sons Co., 124
                 S.Ct. 1836 (2004). Arguably, 28 U.S.C. § 1658 may govern § 6015(f)
                 underpayment claims.
                       Tax Court review is available for denial of innocent spouse or sep-
                 arate liability relief. IRC § 6015 (e). These claims may also be raised
                 as affirmative defenses in a petition to contest a statutory notice of
                 deficiency. The Tax Court has recently held that it also has jurisdiction
                 to review unfavorable § 6015 (f) equitable relief determinations.53
                 Butler v. Comm’r., 114 T.C. 276 (2000). The abuse of discretion stan-
                 dard is used for IRS denials of § 6015 (f) equitable relief. Id. “Abuse
                 of discretion” is determined by a trial de novo. Ewing v. Comm’r, 122
                 T.C. 32 (2004). The Tax Court will reverse IRS denials of § 6015(f)
                 relief. See e.g., Wiest v. Comm’r., TCM 2003-91. The procedures for the
                 nonrequesting spouse to oppose relief are explained in Rev. Proc.
                      Note that a prior Tax Court decision may not be res judicata as to
                 a petitioning taxpayer for innocent spouse relief if she did not partici-
                 pate meaningfully in the Tax Court case. IRC § 6015 (e)(3)(B).
     You will encounter IRS agents who argue that collection against the other spouse starts the 2 year time limit running.
     However, review of 6015 (f) equitable relief determinations may be precluded for spouses in community property states
     filing separate returns. See Fernandez v. Comm’r., 114 T.C. 324 (2000); IRC § 66 (c).

                                                TAX PRACTICE

               Duress or Forgery Defenses to Joint Liability
                    If warranted by the facts, the first line of defense should be that
               there is no joint return. This defense would include forgery, duress
               (typically a domestic violence victim), or that the taxpayers were not
               married on the last day of the tax year. If a spouse establishes that she
               signed a joint return under duress, the return is not a joint return. Reg.
               §1.6013-4; Rev. Proc. 2003-61, § 2.03.
                    The standard for determining duress is subjective. Long term
               mental intimidation is not required. The taxpayer must prove that she
               was unable to resist the other spouse when she signed the return and
               that she would not have otherwise signed the return.
12. Injured Spouse Relief
          A taxpayer’s tax refund may not be paid to her if her spouse was delin-
    quent on child support or past due federal debts (e.g., student loan, taxes).
    If a joint return was filed and both spouses had income and tax payments
    on the return, the nonliable spouse may request her portion of the tax
    refund by filing a Form 8379. Residents of community property states may
    apply for injured spouse relief if they were not required to pay the past due
    amount that was offset by the IRS. Overpayments are allocated according
    to state law in community property states.
13. Tax Liability in Community Property States
         If separate tax returns are filed by a married couple in a community
    property state, each spouse must report one-half of the community income.
    United States v. Mitchell, 403 U.S. 190, 196- 97 (1971); Reg. § 1.66-1. The
    higher income spouse will want this community property law to apply,
    whereas the lower income spouse will want to argue that an exception to
    this rule exists.
           The Internal Revenue Code establishes 4 exceptions to the rule that a
       spouse has to report one-half of community income:
       (1) The spouses lived apart for the entire year, filed separate returns and
           did not transfer more than a de minimis amount of earned income
           between them.54 IRC § 66 (a); Reg. § 1.66-2.
       (2) The taxpayer was not notified by the other spouse of the nature and
           amount of the income before the due date (including extensions) for
           the filing of the taxpayer’s return and the spouse acted as if solely enti-
           tled to the income.55 IRC § 66 (b); Reg. § 1. 66-3.
       (3) Traditional innocent spouse relief56 from community property laws
           under IRC § 66 (c) for an item of community income if:
   IRC § 66 (a) relief is automatic if the requirements are met. For purposes of § 66 (a), any amount of income trans-
   ferred for the benefit of the spouses’ child is not treated as a transfer to the spouse. Reg. § 1.66-2 (c).
   The IRS may deny a spouse the federal income tax benefits of community property law on items of community income.
   Under the regulations, a spouse will not have acted as solely entitled if the income was “used or made available for
   the benefit of the marital community.” Reg. § 1.66-3 (a). It is not clear whether a small amount of funds paid for family
   support would bar the IRS from invoking IRC § 66 (b) against a taxpayer.
   If a married couple filed a joint return, IRC § 6015 would govern requests for innocent spouse relief. IRC§ 66 (c) does
   not apply to joint filers.

                                                TAX PRACTICE

             (a) the requesting spouse did not file a joint return for the tax year;
             (b) the income item omitted from the gross income of the requesting
                  spouse’s income would be treated as the other spouse’s income
                  under IRC § 879(a);
             (c) the requesting spouse proves that she did not know of, and had no
                  reason to know of, the item of community income; and
             (d) taking into account all of the facts and circumstances, it is
                  inequitable to include the item of community income in the
                  requesting spouse’s individual income.
         (4) Equitable relief for spouses who don’t meet the requirements for tradi-
             tional innocent spouse relief under IRC § 66 (c). See Rev. Proc. 2003-
             61, IRB 2003-32.
               Warning: The time limitation for requesting traditional innocent
         spouse relief under IRC § 66 (c) is different from the time limitations for
         IRC § 6015 innocent spouse relief or IRC § 66 (c) equitable innocent spouse
         relief. Reg. § 1. 66-1 (j) states that traditional innocent spouse relief under
         IRC § 66 (c) must be requested no later than 6 months before the statute of
         limitation on assessment expires for the nonrequesting spouse. By compar-
         ison, the other forms of innocent spouse relief must be brought within 2
         years of the first collections activity against the requesting spouse.
               Some community property income may be excludable from a spouse’s
         income by other laws. For example, the spouse who does not receive an IRA
         distribution is not taxed on her community property share of the IRA dis-
         tribution. Bunny v. Comm’r, 114 T.C. 259, 262 (2000). Similarly, this spouse
         would not be liable for the IRC § 72 (t) additional tax on an IRA distribu-
         tion. Morris v. Comm’r, TCM 2002-17. Some state laws may treat income
         acquired during the marriage as “separate” and that classification will
         govern for federal tax purposes.
14. Penalty Abatement
        Penalties can be abated for reasonable cause.
15. Statute of Limitations for Collections
         The IRS has 10 years57 after a timely assessment to collect taxes. IRC
    § 6502. An “assessment” is the timely recording of a taxpayer’s liability in
    accordance with IRS rules. IRC § 6203. The taxpayer has a right to the
    IRS’s record of assessment. Id. Transcripts of a taxpayer’s records may be
    ordered by tax professionals from the Practitioner’s Priority Service, 866-
         Generally, assessments must be made within 3 years. IRC § 6501.
    This period may be waived. The assessment period does not begin if a tax
    return was fraudulent or not filed. Substitute returns filed by the IRS do
    not start the assessment or collection periods. IRC §§ 6020, 6501(b)(3).
         The limitation periods may be extended by deficiency notices, Tax
    Court proceedings, Offers-in-Compromise, bankruptcy and Taxpayer
     The statute of limitations was extended to 10 years from 6 years on November 5, 1990. Collection of taxes assessed
     before November 5, 1990, and for which the 6 year limitation had already run, are barred. IRC § 6502 (a).

                                              TAX PRACTICE

         Assistance Orders. If the suspension action was taken by a separated
         spouse, determine whether that action also suspends the limitation period
         as to your client.
16. Designation of Tax Payments
          The taxpayer has the right to designate how his tax payments are
    applied to interest or tax for specific periods. Rev. Proc 84-58, 1984-2 C.B.
    501.58 Generally, it is advantageous to have payments made to the most
    recent years and interest first. Recent years are paid first to move the older
    taxes to the end of the statute of limitations.
          A common problem for low-income taxpayers is the denial of the
    Earned Income Credit. If you have a taxpayer who has missed his deadlines
    for contesting an Earned Income Credit internally with the IRS or by Tax
    Court lawsuit, you may want to have tax payments applied to a tax year in
    which the taxpayer was eligible for the Earned Income Credit. This will pay
    off that tax year so that the taxpayer can file a refund lawsuit for his Earned
    Income Credit. See discussion in the section on “Refund Claims and
    Lawsuits”, supra.
          If one spouse is liable for a particular tax year and the other is not,
    there may be other considerations. For example, one spouse may own a
    home and it may be advantageous to protect that asset by paying off a tax
    year for which that spouse is liable, rather than for a tax year in which she
    is not liable.
17. Criminal Penalties
         False statements to the IRS in the collection process are subject to
    criminal prosecution. IRC § 7206 (1); 18 U.S.C. § 1001.

                                        NONFILERS: OPTIONS?
      How do you advise a person who has failed to file tax return(s)? The bad
news is that nonfiling is a crime if the taxpayer owes taxes. The statute of lim-
itations for criminal prosecution is 6 years.59 The good news is that 30% of non-
filers don’t owe taxes and may be worrying about prosecution for nothing. Many
of them may even be entitled to refunds.
      The IRS may prosecute crimes that are still within the statute of limita-
tions. However, the IRS generally does not prosecute the average citizen for
nonfiling. In FY 2002, only 233 taxpayers were indicted for failing to file a
return. Voluntary filing may avoid a criminal investigation. It also starts the 3
year limitation on assessment, and in turn, the 10 year limitation on collections
running. The IRS is looking for nonfilers.
      Civilly, the IRS can go back more than 6 years if no return was filed.
However, it generally does not go back more than 6 years. The interest and
penalties on old back taxes can be enormous. Interest will be about 4%-10% per
annum. Civil penalties could equal about 47.5% of the principal tax. Penalties
for late filing are rarely waived. The failure to file penalty is 5% per month up
     Some taxpayer designations which do not meet the requirements of Rev. Proc. 84-58 have been upheld. See e.g.,
     Perkins v. Comm’r., 92 T.C. 749 (1989), acq. in result in part 1990-2 C.B. 1.
     A 3 year statute of limitations may apply to some tax crimes. IRC § 6531.

                                TAX PRACTICE

to a maximum of 25%. An installment agreement can reduce the late payment
penalty to 1/4 % per month and issuance of a Levy notice can increase the
penalty to 1% per month. The taxpayer is entitled to a PINEX report if he does
not understand the computation of penalties. A delinquent taxpayer’s right to a
tax refund is denied if he didn’t file a return within 2 years.
     What assets and income can the IRS seize to collect old taxes? Social
Security, SSI and public assistance levies are capped at 15%. Most retirement
funds can be fully seized. Houses can be seized for debts greater than $5,000 if
approved by a federal court. However, the IRS generally won’t seek to force the
sale of a house.
     Late filing may require that you find tax returns for old years. The IRS
webpage has downloadable forms for the 1992 to 2003 tax years. The IRS
cannot consider an installment agreement or Offer-in-Compromise until all tax
returns have been filed.

1. Overview
        Generally, the Earned Income Credit (EIC) is a tax credit for workers
   who have earned income and adjusted gross income (AGI) below the appli-
   cable limits for the tax year in question.
          Those who qualify for the EIC pay less federal tax, no tax or even get
     a tax refund. Currently, the average EIC refund is about $1,700. In 2004,
     the maximum EIC was $4,300.
         The EIC can result in a tax refund even if the worker paid no tax what-
     soever. A taxpayer who did not apply for an EIC in any of the last 3 years
     may be eligible for EIC payments by filing amended returns for those years.
2.   Eligibility Rules for Earned Income Credit
          IRC §32 provides the statutory rules for the EIC. The easiest way to
     understand all the EIC rules is to consult IRS Publication 596, chapters 1
     to 3. This IRS publication cogently summarizes the various EIC rules in 3
     sets of rules:
     •    Rules for Everyone
     •    Rules If You Have a Qualifying Child
     •    Rules If You Do Not Have a Qualifying Child
         Chapter 4 of IRS Publication 596 explains the income limits for the
     EIC. You can quickly assess your client’s EIC eligibility by reference to
     Publication 596. If you are preparing a tax return, you should also consult
     Form 8867, Paid Preparer EIC Checklist.
          That said, the basic rules for the EIC are the income limits, earned
     income, ineligibility of persons who legally must file as “married filing sep-
     arately”, and the relationship, age and residency tests for a qualifying child.

                                              TAX PRACTICE

3.     Income Limits
             In 2004, the applicable AGI limits for the EIC were:
             •    $34,458 ($35,458 for married filing jointly) if taxpayer has more
                  than 1 child
             •    $30,338 ($31,338 for married filed jointly) if taxpayer has 1 child
             •    $11,490 ($12,490 for married filing jointly) if taxpayer has no
             Historically, the AGI limits have increased each year.60
4.     Earned Income Tax Credit
             Beginning in 2002, “earned income” includes wages, salaries, tips and
       other employee compensation, if includible in gross income61, plus net earn-
       ings from self-employment. Earned income may also include an employer’s
       disability retirement plan benefits until the worker reaches minimum retire-
       ment age. Beginning in 2004, a taxpayer may elect to include nontaxable
       combat pay as “earned income” for the Earned Income Credit.
             Earned income does not include pensions, annuities, unemployment
       compensation, social security, welfare, alimony, child support, inmate com-
       pensation, nontaxable workfare payments or, in community property states,
       income earned by the spouse of a married taxpayer who is qualified to file
       as head of household. IRC § 32 (c)(2). Proof of “earned income”, e.g., W-
       2 or 1099 Forms, may be required.
5.     Filing Status Cannot Be “Married Filing Separately”
             Taxpayers who are married on December 31 of the tax year and who
       cannot file as “married filing jointly” face special problems. These taxpay-
       ers will not qualify for the EIC unless they meet the requirements for head
       of household filing status. IRC §32(d), Mischel v. Comm’r., TCM 1996- 553.
       About 11% of EIC errors involve married taxpayers who could not legally
       file as single or head of household.
             If a married taxpayer did not live with her spouse at any time in the
       last 6 months of the year, she may be able to file as the head of household
       if she furnished more than half of the cost of maintaining the household.
       IRC §§ 2(b)(1); 7703(b). Unmarried taxpayers do not have to be the head
       of household in order to get the EIC.
             If married taxpayers incorrectly filed as head of household or single,
       they may be able to file an amended tax return to get the allowable EIC for
       their income level. However, they are precluded from filing a joint return
       after a notice of deficiency has been issued and a Tax Court petition filed.
       See e.g., IRC § 6013(b)(2); Pelayo-Zabalza v. Comm’r., TCS 2002-134; Benitez
       v. Comm’r., TCS 2002-12. Therefore, a joint return claiming an EIC should be
       filed before either spouse files a Tax Court petition if this is a feasible option.
   The modified AGI limits for married taxpayers filing jointly for prior years were:
                         >1 child         1 child         0 child
             2003         $34,692         30,666          12,230
             2002         $34,178         30,201          12,060
             2001         $32,121         28,281          10,710
             2000         $31,152         27,413          10,380
             1999         $30,580         26,928          10,200
   Prior to 2002, earned income included nontaxable earned income, e.g, voluntary salary reductions, 401 (k) contribu-
   tions, mandatory contributions to a state or local retirement plan, etc.

                                                  TAX PRACTICE

6.       Relationship, Age and Residency Tests for Qualifying Child
               The Working Families Tax Relief Act of 2004 (WFTRA) has changed
         the definitions of “qualifying child” for tax years beginning in 2005. Thus,
         you will first face these new rules in audits for the 2005 year, which would
         not begin until 2006. Generally, the definition of “qualifying child” will be
         uniform for Earned Income Credit, head of household, dependency exemp-
         tion, child tax credit and dependent care credit.
         Highlights of the WFTRA which will first become effective in 2005 are:
         •       Uniform definition of “qualifying child” for the Earned Income Credit,
                 head of household, dependency exemption, child tax credit and depend-
                 ent care credit.
         •       Uniform definition of “qualifying child” is generally based on the resi-
                 dence, relationship and age tests.
         •       Current tiebreaker rules for EIC used to determine who can claim the
                 “qualifying child” when more than one taxpayer claims the child.
         •       Elimination of the “cared for as own child” requirement for siblings,
                 step siblings (and their descendants), and eligible foster children.
         •       Support tests for dependency exemption replaced by the residence
         •       Waiver for dependency exemption by custodial parent does not apply to
                 Earned Income Credit, dependent care credit or head of household.
         Note: This manual will discuss the pre-2005 laws for Earned Income
         Credit, head of household filing status and dependency exemption. The
         2005 changes made by WFTRA may be noted in said discussion.
                                      Pre-2005 Law
              Only taxpayers with a “qualifying child” get the large EICs. A “quali-
         fying child” must meet 3 tests: relationship, age and residency.
              A qualifying child is a child who is the taxpayer’s:
         1. Child, stepchild, adopted child or grandchild, or
         2. Sibling, step-sibling or his or her child or grandchild, and the taxpayer
              cared for the individual as he would his own child, or
         3. Eligible foster child62 and the taxpayer cared for the individual as he
              would his own child,
     An eligible foster child is a child placed by an authorized placement agency, i.e., a court, state or local government
     agency or a tax exempt organization licensed by the state. Hegwood v. Comm’r., TCS 2002-156.
     Caveat: The definition of “eligible foster child” has changed several times since 1991. Make sure you have the right
     definition for the tax year in question. The history of the changes is set forth below:
         Tax Years                                                    Definition
          1991-99          A child that taxpayer cared for as her own and who lived with the taxpayer for whole year, except
                           for certain temporary absences. IRC §32(c)(3)(B)(iii); Conf. Rept. No. 106-478, p. 127
          2000-01          Cousins and unrelated children eliminated as “eligible foster children” unless placed with taxpayer
                           by an authorized placement agency. P.L. 106-170, §412, 113 Stat. 1917.
          2002             Residency requirement decreased from 1 year to 6 months.
          2005             Placement can also be by court order. Also eliminated the “cared for as own child” requirement.

                                                TAX PRACTICE

       Age AND was at the end of the tax year:
       1. Under the age of 19, or
       2. Under the age of 24 and a “full-time” student, or
       3. Permanently and totally disabled at any time during the year, regard-
           less of age,
       AND who lived with the taxpayer in the United States for more than half of
           the tax year.
7.     Issues That Arise Under Qualifying Child Tests
       A. Cared for as Her Own Child
           Note: The Working Families Tax Relief Act of 2004 eliminates the
           “cared for as own child” requirement for tax years beginning 2005.
                    A taxpayer, other than a parent, step-parent or grandparent, must
              prove that she treated the child as her own. Domingo v. Comr., TCM
              1998-442. A household resident who financially contributed to the
              household, but did not play a significant role in the child’s day-to-day
              life did not qualify for the EIC. Mares v. Comr., TCM 2001-216; Smith
              v. Comr., TCM 1997-544. However, even relatively little time acting as
              a parent may qualify. See e.g,. Barajas v. Comr., TCS 2002-59; see also,
              Gilmore v. Comr., TCS 2004-38 (19 year old held to care for his nieces
              as his own children even where children’s mother and grandmother
              also lived in the house).
                   IRS Publication 596 alternatively refers to the statutory test,
              “cares for as her own child” as acting as a parent or sharing in parental
              responsibilities. Taxpayers may meet the relationship test for some
              children in the household, but not for others.
                   Publication 596 suggests that a parent’s child may also be an “eli-
              gible foster child” of the parent’s same sex relatives or friends who live
              with her.63 In a recent Tax Court case, a taxpayer was held to care for
              his younger siblings as his own children even though their mother lived
              with them and also performed some parental duties. See e.g., Barajas v.
              Comr., TCS 2002-59; see also Gilmore v. Comr., TCS 2004-38.
       B.     Residency Test
                    The majority of issues that arise under the “qualifying child” def-
              inition involve the residency test. Generally, the contested issues
              involve documentation of the child’s residency, and not legal issues.
                    The child must have lived with the taxpayer in the United States
              for more than half of the year.64 If a child was born or died in the tax
              year, she is considered to meet the residency test if she lived with the
              taxpayer for the entire time she was alive in that year. Note that for
   Note, however, that the 11/99 revision of the definition of “foster child” for the EIC precludes friends and lovers from
   meeting the relationship test for tax years beginning in year 2000 unless there is an authorized placement. P.L. 106-
   170 § 412, 113 Stat. 1917.
   Prior to 2002, an “eligible foster child” had to live with the taxpayer for the whole year in order to be a qualifying
   child for the taxpayer’s EIC claim.

                                                  TAX PRACTICE

                 the EIC, there is no “support” or “household maintenance” test if the
                 taxpayer can properly file as single or married filing jointly.
                      A home is anywhere the taxpayer regularly lives and can include
                 nontraditional homes such as homeless shelters. A taxpayer can
                 meet the residency test even if the other parent has custody under
                 a court decree and provided more than 1/2 the support. Webb v.
                 Comr., TCM 1990-581.
                      Temporary absences can count toward the half year or whole year
                 requirements if the taxpayer or child is away from home due to special
                 circumstances such as:
                      •    Illness
                      •    School attendance65
                      •    Business or military service
                      •    Vacation
                      Although not listed in IRS Publication 596, custody agreements
                 where the child is absent for less than 6 months may also count. Cf.
                 Reg. § 1.2-2 (c)(1)(temporary absence pursuant to custody agreement
                 is “special circumstance”). Closely equal joint or shared custody
                 arrangements may present some residency test problems for divorced
                 or separated parents.
                      EIC legislative history indicates that determinations of an individ-
                 ual’s principal abode should be made under rules similar to those for
                 the head of household filing status. H.R. Conf. Rept. 964, 101 Cong. 2d
                 Sess. 1037 (1990).
                      Note: Tax preparation services often counsel a taxpayer not to
                 claim her resident child if someone else has already filed for the EIC
                 based on that child. The IRS will deny an electronic return where
                 someone else has already filed for the EIC. The tax preparation service
                 counsels the taxpayer to file an incorrect return so the taxpayer can
                 get a quick refund through an electronic return. Then, the tax prepa-
                 ration service can make a hefty profit on a refund anticipation loan. In
                 this situation, the proper procedure is to file a paper return which will
                 prompt an IRS examination to determine which taxpayer is entitled to
                 claim the child for the EIC. This conduct by tax preparation services
                 may necessitate an amended return, Form 1040X, which correctly
                 reports the taxpayer’s qualifying children.
         C.      AGI Tiebreaker
                      Sometimes, a child is the “qualifying child” of more than one
                 person. However, only one taxpayer (or a married couple filing jointly)
                 can claim the EIC for the child. Prior to 2002, only the “eligible indi-
                 vidual” with the higher modified AGI could claim the EIC. IRC § 32
                 (c)(1)(C); Jackson v. Comr., TCM 1996-54. Under the prior rules, rela-
                 tives or friends with a higher modified AGI, but no earned income and
                 therefore ineligible for the EIC, could defeat the parent’s EIC claim.
     If the child has a residence in her college’s city and does not intend to return, her college attendance cannot count as
     a “temporary absence.” Schatz v. Comr, TCM 1981-341.

                                                TAX PRACTICE

                     Beginning with 2002, the AGI tie breaker rules change substan-
               tially. See IRC § 32(c)(1)(C). If 2 eligible persons claim the EIC, the
               following tie breaker rules apply:
                      1.      Parent wins over non-parent66
                      2.      Where parents lived apart, but each lived with child for at
                              least 6 months, parent who lived with child longer wins
                      3.      Where child lived with each parent same amount of time,
                              parent with higher AGI wins
                      4.      If neither parent is eligible claimant, caretaker with highest
                              AGI wins
                    These 2002 tax law changes present new planning opportunities
               for unwed parents who live together, but cannot file as “married.” If
               both unwed parents are the biological parents of a child, they can
               decide who claims the child for the EIC. If they have more than 1 child
               together, they can split their children. If both claim a child, the first tie
               breaker favors the parent who lived longer with the child. If residency
               is equal, the parent with the higher AGI wins.
                    Note: The Working Families Tax Relief Act of 2004 retains the
               current tiebreaker rules for tax years beginning 2005.
8.     IRS Audits of the EIC–What to Expect
            The IRS audits many Earned Income Credit (EIC) returns due to the
       high error rates.67 Audits occur when more than 1 taxpayer claims a child
       for the EIC. Only 1 taxpayer may legally claim a child for the EIC.68
       Correspondence audits are used to examine EIC claims. The average EIC
       pre- refund audit takes 225 days to resolve.69
            Typically, an EIC disallowance will be accompanied by a disallowance
       of the head of household filing status, dependency exemptions and child tax
            To get an EIC for a child, the taxpayer must claim a child who meets
       certain residency, relationship and age tests.
            Income or filing status errors are responsible for about half of EIC erro-
       neous payments. Qualifying child errors account for at least 31% of EIC
       errors. The vast majority of qualifying child errors occur because the resi-
       dency test is not met.70

   A parent should win over a “step-parent.”
   The EIC rules are complex. This complexity leads to errors by both the IRS and taxpayers. In prior years, the esti-
   mated EIC error rate has been about 30%. Compliance Estimate for Earned Income Tax Credit Claimed on 1999 Returns
   (IRS, Feb. 28, 2002). The error rate remains high despite the fact that many low-income workers have their tax returns
   prepared by paid tax return preparers. The IRS error rate in its audits of EIC claimants is also high. You will find that
   some IRS auditors do not follow fairly basic EIC rules that are published on the IRS webpage.
   Often, paid tax preparers erroneously tell taxpayers that they cannot file for the EIC because someone else already
   filed for their children. While it is true that the IRS won’t accept an electronic return, the taxpayer can file a paper
   return claiming the EIC for his child. The IRS will then review the tax returns of both taxpayers and determine which
   taxpayer, if any, is entitled to the EIC.
   IRS FS-2003-14 (June 2003).
   IRS FS-2003-14 (June 2003).

                                TAX PRACTICE

          Common reasons for disallowance of the EIC are:
          •    The child’s residency with taxpayer was not documented
          •    The child’s relationship with taxpayer was not documented
          •    The taxpayer incorrectly filed as head of household, and legally
               could have only filed as married filing separately
          •    For tax years prior to 2002, the qualifying child was also the qual-
               ifying child of another person with a higher AGI
          •    The taxpayer’s EIC was reduced or denied by the IRS for 1997 or
               a later year and a Form 8862 has not been filed
          •    The taxpayer was not a U.S. citizen or resident alien for the entire
          Failure to document or meet the child residency and relationship tests
     accounts for at least 31% of the errors in EIC claims. Thus, documentation
     of the child’s residency and relationship is essential to defending the tax-
     payer’s EIC claim. Many indigent taxpayers find the IRS demands for docu-
     mentation daunting and are unable to satisfy the IRS without a tax profes-
     sional’s assistance.
9.   Documentation and Proof of Residency and Relationship
     A.   Tax Return Preparation or Review
               In the past, low-income taxpayers and their paid tax preparers
          have not developed documentation to support EIC claims as part of the
          tax return preparation. If the tax return is selected for audit, the IRS
          will demand documentation. It can be more difficult to obtain such
          documentation when the audit occurs. Taxpayers throw out or lose
          documentation. Agencies, that may have documentation, go out of
          business, have a difficult time locating older records, or are unwilling
          to cooperate. Witnesses may move. Therefore, if you have the oppor-
          tunity to prepare the return, you should advise the taxpayer to obtain
          and maintain documentation of residency, household and dependent
          support, as relevant to the return.
              In 2003, the IRS plans to implement a new pre-certification
          process as to high risk EIC claimants. This process will require these
          taxpayers to produce documentation of the child’s residency and
          submit it with a Form 8836. The documentation requested by the Form
          8836 is similar to that requested by the IRS in EIC audits.
               Remember to review the tax return with the taxpayer if the
          Earned Income Credit is being contested. Tax preparation services
          often counsel taxpayers to omit qualifying children, who live with
          them, if someone else has already incorrectly claimed the child for the
          Earned Income Credit.
               Tax preparation services do this to get profitable refund anticipa-
          tion loans from the taxpayers rather than have them file a correct
          paper tax return claiming the child who resided with them.

                           TAX PRACTICE

B.   How to Document and Prove an EIC Claim in an Audit or Appeal
          Residency is commonly contested in an EIC audit. IRS Forms 886-
     H-EIC and 8836 reflect the kind of documentation that the IRS wants
     for the verification of residency, age and relationship at the audit or
     examination level.
          The key is to provide third party records that show the names,
     common addresses and dates of common addresses of the taxpayer and
     any qualifying children. Low-income people frequently change apart-
     ments. This can make the documentation quite burdensome.
     Nonetheless, the taxpayer can generally find some records to establish
     her own address, e.g., leases, rent receipts, utility bills, other bills,
     public assistance notices, driver licenses, pay stubs, etc.
          On the other hand, it can be difficult to find third party records
     that establish the address of a child, particularly a young child. The
     IRS suggests school records, day care records, medical records and
     social service agency or community based organization records to
     establish the children’s addresses. Records submitted to the IRS
     should show a common residency of more than 6 months. For example,
     get a record in the beginning of the year and a record at least 6 months
     later that has the same address.
          If these records do not exist, the taxpayer should try to get a
     letter on official letterhead from the child’s school, medical provider,
     child care provider, or the taxpayer’s clergy, employer, or landlord. If
     possible, the letter should state that the taxpayer and children lived at
     the same address for 6 months or more during the tax year in question.
     This can be difficult since these third parties may not know the exact
     duration of the common residency.
          IRS examiners are less impressed by letters and affidavits from
     relatives, friends and neighbors. You should try to get another letter
     or some corroborating documents if the taxpayer must rely on letters
     from relatives, friends and neighbors. As a practical matter, relatives,
     friends, neighbors, school bus drivers, or lawyers handling divorce or
     custody matters are often more competent witnesses on the issue of
     common residency than the affiants preferred by IRS auditors.
     Fortunately, the IRS Appeals officers and the Tax Court, unlike the IRS
     examiners, can and do give weight to affidavits or testimony by such
          Tax Court judges can and do rule in favor of the taxpayer based
     primarily or exclusively on the credible testimony of the taxpayer. Of
     course, testimony by other credible witnesses is also helpful. As a
     practical manner, the IRS generally will not have any witnesses on the
     EIC issues with the possible exception of a competing claimant. The
     Tax Court has even ruled in taxpayers’ favor when the testimony as to
     the child’s address is contrary to the address in school records. The
     taxpayer’s credible testimony can be given more weight than “official”
     records. See e.g., Coats v. Comm’r., TCM 2003-78; Sliwinski v. Comm’r.,
     TCS 2003-49; Gingrich v. Comm’r., TCS 2002-158.

                                                  TAX PRACTICE

                     Never send original documents to the IRS. They routinely lose
                 documents. You should write the taxpayer’s Social Security number on
                 each document that you send to the IRS.
                     If a married taxpayer needs head of household status to qualify for
                 the EIC, she will need to document expenses for the household and
10. Defense of an EIC Claim–Know The Big Picture
          There are several “big picture” principles that you should know for the
    defense of a typical EIC audit or disallowance.
          For most low-income taxpayers, the disallowance of the EIC will
    account for most, if not all, of the tax adjustment or deficiency proposed by
    the IRS. Therefore, your primary goal is to protect the EIC.
          The taxpayer can get a large EIC even if she has 1 qualifying child.
    The IRS wrongly denies the entire EIC claim when it finds that any of the
    claimed children does not meet the residency, relationship and age tests.
          Single and head of household filers get the same EIC. The amount of
    the EIC is based on the taxpayer’s AGI. Therefore, the head of household
    filing status and dependency exemptions generally don’t affect the amount
    of the EIC.
           In 2003, even “married filing jointly” taxpayers would get the same
    EIC as a “single or head of household” taxpayer until their adjusted gross
    income (AGI) exceeds $13,750. For higher income taxpayers, the “married
    filing jointly” status generally increases the EIC by less than $200.
          For many low-income taxpayers, the head of household filing rate does
    not lower their taxes. For example, a 2003 EIC taxpayer’s tax refund or tax
    owed will be virtually the same for single or head of household for incomes
    below $13,750. The head of household filing status (versus single filing
    status) would only lower the tax refund of an EIC taxpayer with an AGI of
    $20,000 by about $400. By comparison, the EIC would provide a refund of
    about $1,600 to $3,000 for a 2003 taxpayer with $20,000 AGI.
          In summary, the head of household filing status can be irrelevant for
    income tax purposes. It may not be worth fighting over the head of house-
    hold filing status or dependency exemptions if those items have little or no
    effect on the taxpayer’s tax refund.71 Run a tax return for the taxpayer
    without the head of household filing status to see how much money is at
          An unwed or divorced taxpayer can qualify for the EIC since she can
    legally file as “single.” It is amazing how many IRS agents and paid tax pre-
    parers do not know this. Instead, they take the position that a single tax-
    payer has to meet the head of household filing status to get the EIC. They
    are wrong.
          The head of household status is, however, absolutely crucial for tax-
    payers who are married on December 31 of the tax year and who cannot file

     Each tax year stands on its own. A concession in one year does not bind the taxpayer in another year. Pekar v. Comm’r.,
     113 T.C. 158, 166 (1999).

                                              TAX PRACTICE

       as “married filing jointly.” These taxpayers will not qualify for the EIC
       unless they meet the requirements for head of household filing status as to
       at least 1 child.72
            For such low-income taxpayers, who are married on December 31, the
       major EIC audit issues are whether:
       •    their spouse lived with them during the last 6 months of the year73
       •    they paid more than half the cost of maintaining the household
       •    they qualify for a dependency exemption as to at least 1 child74
            Many low-income taxpayers receive money from third parties, e.g.,
       Social Security, welfare. or subsidized housing assistance. These funds do
       not count as support by the taxpayer.75 Therefore, they may not qualify for
       the head of household filing status if their earned income is less than their
       income from third parties.
            Fortunately, most EIC claims do not depend on winning the head of
       household filing status and dependency exemption issues. A single or
       married filing jointly taxpayer does not have to meet the various support
       tests for head of household filing status or dependency exemptions to
       qualify for the EIC.
11. A Taxpayer May Be Eligible for an EIC Even If He Does Not Have a
    Qualifying Child
         The IRS seems to deny any EIC when it finds that the taxpayer does
    not have a qualifying child. However, a taxpayer without a qualifying child
    may qualify for an EIC as to herself if her income is low enough. Chandler v.
    Comm’r., TCS 2002-74. The other EIC requirements for taxpayers without a
    qualifying child are:
    •    Taxpayer or spouse, if filing jointly, is at least 25 but under 65.
    •    Taxpayer is not dependent or qualifying child of another person.
    •    Taxpayer lived in the United States more than half of the year.
12. A Form 8862 Is Required for Taxpayers Who Have Been Denied an EIC
         A taxpayer, whose EIC was reduced or denied by the IRS for 1997 or
    a later year, must file a Form 8862 with a subsequent return in order to
    claim the EIC. Reg. § 1.32-3.
13. IRS Disallowance Procedures For Fraud or Reckless Disregard of EIC
         If the EIC was denied for tax returns (beginning in 1997) and the IRS
    determines that the error was due to reckless or intentional disregard of the
    EIC rules, the taxpayer cannot claim the EIC for the next 2 years. If the
    error was due to fraud, the taxpayer cannot claim the EIC for 10 years. IRC
   Taylor v. Comr., TCS 2002-25
   Married , but separated taxpayer denied EIC because husband lived in household at some time during last 6 months
   of year. Becker v. Comr., TCM 1995-177.
   Beginning with the 2005 tax year, the dependency exemption requirement has been eliminated by the Working
   Families Tax Relief Act of 2004.
   See e.g., Huynh v. Comr., TCM 2002-237 (HUD rental assistance); Gulvin v. Comm’r., 644 F.2d 2 (5th Cir. 1981) aff’g
   TCM 1980-111; Lutter v. Comr., 514 F.2d 1095 (7th Cir. 1975); Rev. Rul. 74-543, 1974-2 C.B. 39; IRS Pub. 501.

                                                TAX PRACTICE

         § 32 (k). Such disallowance could cost the taxpayer several thousand
         dollars per year in tax refunds. IRS determinations of reckless disregard or
         fraud are reviewable through the Tax Court deficiency procedures. IRC §
         6213 (g)(2).
14. Death and the EIC
         A representative may file for the EIC refund if the decedent was eligi-
    ble at the time of his death. If a child was born or died in the tax year, she
    is considered to meet the residency test if she lived with the taxpayer for
    the entire time she was alive in that year.
15. Earned Income Credits and Bankruptcy
         State law determines whether an EIC is exempt from seizure by credi-
    tors. See e.g., In re Collins, 170 F.3d 512 (5th Cir. 1999).76 Some states
    exempt EICs; others don’t. In states where the EIC is not exempt, the
    timing of the tax return and bankruptcy can be critical to maximizing the
    amount of EIC that the client may retain. In jurisdictions where the EIC is
    exempt, a debtor keeps the EIC in a Ch. 7 bankruptcy. However, many
    bankruptcy courts will treat an exempt EIC as “disposable income” in a Ch.
    13 bankruptcy
16. Impact of EIC on Welfare and Subsidized Tenant Rents
         The EIC does not count as income for Medicaid, Food Stamps, SSI or
    federally subsidized housing. See IRC §32 (l). States can set their own rules
    for how the EIC is treated for TANF eligibility. So far, no state has counted
    EIC refunds as income for TANF eligibility.
              By federal statute, states are prohibited from counting the EIC refund
         as an asset for Medicaid, SSI, food stamps or federally subsidized housing
         unless it is unspent by the end of the month after the month of receipt. A
         state may have rules that are more favorable than the minimum federal rule
         against counting EICs as assets.

                              HEAD OF HOUSEHOLD FILING STATUS
1.       Overview
              Individuals filing as head of household pay taxes at rates lower than
         single persons. More importantly, a separated married individual cannot
         claim the EIC unless she qualifies for head of household filing status.
                Generally, the requirements for head of household filing status are:
         •      Unmarried [or considered unmarried under IRC §7703 (b)] on the last
                day of the year.
         •      “Qualifying person” lives with taxpayer in her home for more than half
                of the year. (However, a dependent parent may not have to live with the
         •      Paid more than half the cost of keeping up the home for the year.

     Collins found that the Earned Income Credit was not exempt under Louisiana law. In 2004, the Louisiana legislature
     amended La. R.S. 13:3881 to exempt Earned Income Credits.

                                              TAX PRACTICE

            IRC § 2(b); §7703 (b); IRS Publication 501 (2004). A chart for evalu-
       ating who is a “qualifying person” for filing as head of household is found in
       the Publication 501.
2.     Unmarried
            Persons who are single or divorced on the last day of the year are
       “unmarried.” They can qualify for head of household filing status even if
       they don’t qualify for a dependency exemption for their child, stepchild or
3.     Considered Unmarried
             IRC § 7703 (b) treats a married individual as “unmarried” if two
       requirements are met:
       •     Spouse does not live in home for the last 6 months of the year (note:
             spouse is considered to live in home if he is temporarily absent due to
             special circumstances).
       •     Able to claim dependency exemption77 for her child, grandchild or
             stepchild (note: other relatives don’t count and rule is inapplicable
             where taxpayer is custodial parent who has released exemption to non-
             custodial parent).
             Generally, the above two rules do not apply to persons who were actu-
       ally unmarried at the end of the year. For unmarried taxpayers, the depend-
       ency test only applies to (1) relatives other than children, stepchildren or
       grandchildren78 and (2) foster children.
4.     Lived With Qualifying Person
            A taxpayer’s household is the home that she lives in. She must have
       lived there with a qualifying person.79 Reg. § 1.2-2(c)(1). A household is
       considered occupied during temporary absences due to “special circum-
       stances.” The regulations expressly list the following as special circum-
       stances: illness, education, business, vacation, military service or a custody
       agreement under which the child is absent for less than 6 months. Reg. §
       1.2-2(c)(1). It must be reasonable to assume that the person will return to
       the household after the temporary absence. A stay in a hospital is tempo-
       rary even if the dependent’s chance of recovery is remote. Hein v. Comm’r.,
       28 TC 826 (1957). Absence for marital difficulties has been held to be tem-
       porary. Petlow v. Comm’r., 34 TCM 51, 54 (1975).
            The IRS and Tax Court require the household to be the taxpayer’s prin-
       cipal residence. McDonald v. Comm’r., TCM 1991-242. However, the 9th
       Circuit has held that it must be one of the taxpayer’s homes, but not neces-
       sarily her principal residence. Smith v. Comm’r., 332 F.2d 671 (9th Cir. 1964).
            A household is not determined by physical boundaries. A single house
       may contain more than one household. Fleming v. Comm’r., 33 TCM 619,
       621-22 (1974); SCA 1998-041 (12/21/98)(2 unmarried individuals each
       living with her own dependent children in shared house can both claim head
   She should be able to claim the dependency exemption if she is the custodial parent under a court decree or provides
   more than half of the child’s support.
   The dependency test will apply to some married children.
   Special rules apply for dependent parents.

                                TAX PRACTICE

     of household status if each furnishes more than half of her household’s
           However, the IRS may argue against head of household status if
     married taxpayers still live under “one roof.” See e.g., Lyddan v. Comm’r.,
     721 F.2d 873 (2d Cir. 1983), Dawkins v. Comm’r., TCM 1991-225 (spouses
     living under same roof are not treated as living “separate and apart”).
           You should also expect a challenge to head of household status when
     the taxpayer claims a separate household within a larger household occu-
     pied by his extended family. See e.g., Francisco v. Comm’r., TCS 2004-4.
     Taxpayers in extended families should be prepared to prove that their
     household was “separate.”
           There is a difference between qualified persons for unmarried taxpay-
     ers under IRC § 2 and qualified persons for “married, but deemed unmar-
     ried” taxpayers under IRC § 7703 (b). “Married but deemed unmarried” tax-
     payers are only entitled to head of household status if they live in a home
     with their children, step children or descendants of their children. On the
     other hand, a broad range of occupants, including many relatives (but not
     all) and foster children, may entitle an unmarried taxpayer to head of house-
     hold status under IRC § 2. Note that, beginning in 2000, a “foster child”
     for IRC § 2 purposes may, in many cases, not meet the IRC §32 definition
     of “foster child” for the EIC.
5.   Furnishing More Than Half of Cost of Household
         The cost of maintaining a household is the expense incurred for the
     mutual benefit of its occupants as the occupants’ principal abode for the
     taxable year, and no other expenses. Reg. § 1.2-2(d).
         Expenses of maintaining a household include:
         •     Property taxes and insurance
         •     Mortgage interest
         • Rent
         •     Utilities (including telephone and cable TV)
         •     Upkeep and repairs (but not those in prior years)
         •     Food consumed on premises
         The following are not expenses of maintaining the household:
         •   Clothing
         • Education
         •   Medical treatment
         •   Vacations
         • Life insurance
         •   Transportation
         •   Services rendered to the household by the individual or dependent
         •   Rental value of home
         An individual is considered as maintaining a household only if over
     half the cost of maintaining the household is “furnished by such individual.”
     IRC §§ 2 (b)(1), 7703 (b)(2). Only 1 unwed parent in a household can

                                TAX PRACTICE

     qualify as head of household. The regulations use the word “pays” instead
     of “furnishes.” Reg. § 1. 2-2 (d). This inquiry focuses on the costs of main-
     taining the household for the mutual benefit of its occupants, not the
     amount of support provided to an individual dependent.
           Support from public assistance, including HUD rental subsidies, can
     defeat head of household filing status if it contributes to the taxpayer fur-
     nishing less than half the cost of maintaining the household. See e.g. Huynh
     v. Comm’r., TCM 2002-237.
5.   Absence of Spouse
          A married taxpayer cannot qualify for unmarried status if her spouse is
     a member of the household at any time during the last 6 months of the year.
     IRC § 7703 (b)(3); Reg. § 1.7703- 1(b)(5). Occasionally allowing an estranged
     spouse to sleep in the living room may result in a denial of head of house-
     hold status. Hopkins v. Comm’r., TCM 1992-326. Geographic separation is
     necessary to achieve status of living separate and apart. Lyddan v. Comm’r.,
     721 F.2d 873 (2d Cir. 1983), Dawkins v. Comm’r., TCM 1991-225 (spouses
     living under same roof are not treated as living “separate and apart”).

                          DEPENDENCY EXEMPTION
1.   Overview
          Note: The Working Families Tax Relief Act of 2004 amends IRC §
     152 and 151 (c) for tax years beginning in 2005. The WFTRA defines
     a dependent as a “qualifying child” or “qualifying relative.” The “qual-
     ifying child” test eliminates the support test (other than for a child who
     provides more 1/2 his own support) and replaces it with a residency
     test. The sections below discuss pre-2005 law.
          An exemption is allowed for each dependent. Special rules apply for
     divorced and separated parents. Social Security and welfare may impact
     some indigent taxpayers’ rights to claim the dependency exemption. A
     helpful IRS flow chart for evaluating dependency exemptions is included in
     IRS Publication 501.
          The dependency exemption may affect other tax issues. Some taxpay-
     ers may need the dependency exemption to qualify for the head of house-
     hold status. Some may need the head of household status to qualify for the
     EIC. A married child will not be a “qualifying child” for EIC unless she is
     the taxpayer’s dependent.
2.   Special Rules for Divorced and Separated Parents
           The special rules for divorced and separated parents are discussed
     first since these issues commonly arise as family and tax law issues for indi-
           IRC § 152(e)(1) permits the “custodial parent” to claim her child as a
     dependent if the child:
     •     Receives over half of her support from both parents, and
     •     Is in the custody of one or both of the parents for more than half of the
           calendar year, and
     •     The parents are divorced under a divorce decree, or

                                                TAX PRACTICE

       •     The parents are living separate and apart at all times during the last 6
             months of the year.
             If these requirements are satisfied and no IRC § 152 (e) exceptions
       apply, the custodial parent gets the dependency exemption even if the non-
       custodial parent actually provided more than half the child’s support. Thus,
       IRC § 152 (e) eliminates the proof of support battles between divorced
       parents by allocating the exemption to the “custodial parent.”80 Note: In
       2003, the Tax Court held that IRC § 152(e) also applies to unwed parents
       who were never married. King v. Comm’r., 121 T.C. 245 (2003).
             “Custodial parent” is the “parent having custody for the greater part of
       the calendar year.” IRC § 152(e)(1).81 “Custody” for purposes of IRC §
       152(e)(1) is determined by the divorce decree or subsequent custody
       decree. Reg. § 1.152-4 (b). Generally, the parent who had legal custody for
       the greater portion of the year will get the dependency exemption. Reg. §
       1.152-4 (c).
             If no decree governs custody, or the decree provides for split custody82,
       custody is deemed to be with the parent who has physical custody for the
       greater portion of the year. Reg. § 1. 152-4(b). The “greater portion of the
       year” test can be problematic for joint custody situations. It may be diffi-
       cult to calculate which parent had greater custody. For parents divorced or
       separated for only a portion of the year, Reg. § 1.152-4(c) treats the parent
       having custody more than 1/2 the remaining post-divorce or separation
       period as the custodial parent under IRC § 152 (e)(1).
             Designation of legal custody may not control under IRC § 152 (e)(1) if
       the children actually resided with the noncustodial parent. See Dumke v.
       Comm’r., TCM 1975-91 aff’d 524 F. 2d 1230 (5th Cir. 1975); Nieto v. Comm’r.,
       TCM 1992-296 (no exemption for custodial father who gave physical custody
       to ex-wife); but see Stanford v. Comm’r., TCM 1971-192 (mother deemed cus-
       todial parent under § 152 (e) even though child lived with grandmother for
       10 mos.); Stanford v. Comm’r., TCM 1995-78 (custodial mother entitled to
       exemption even though child lived with friends for more than 1/2 year).
             There are 3 exceptions to the § 152 (e)(1) rule that the custodial
       parent is deemed to provide over 1/2 the child’s support:
       •     The custodial parent releases the exemption to the noncustodial
             parent, 83
       •     A multiple support agreement is in effect,
       •     A pre-1985 divorce decree is in effect that has not been modified to
             apply the current rules.
   However, if other persons or public agencies contribute to the child’s support, the parent claiming the exemption must
   be prepared to prove that the parents met the support test.
   Effective January 1, 2005, IRC § 152(e) rule for divorced or separated parents is amended. Under new IRC § 152 (e)(2)
   a custodial parent is the parent with whom the child shared the same principal place of abode for the greater portion
   of the year.
   Split custody refers to splitting the children (e.g., 1 with each parent) or situations where legal custody is changed in
   Oral agreements will not suffice. Brown v. Comm’r., TCM 1992-548. Express conditions on granting release can be
   enforced. Flatt v. Comm’r., TCM 1986-495. An executed Form 8332 (releasing the dependency exemption) can only be
   rescinded with both parties’ consent. Note: if domestic violence involved, there may be an issue as to whether the
   8332 was forged or signed under duress.

                                             TAX PRACTICE

            Many unwed parents (never married) have custody decrees. Until
       2003, the IRS argued that the custodial parent’s exemption entitlement
       under IRC § 152 (e) only applies to divorced or separated married parents,
       and not to unwed parents. See e.g., Radin v. Comm’r., TCM 1987-348; Dillard
       v. Comm’r. TCM 1984-26, n.3. This meant that an unwed parent with
       “custody” under the decree would have to show that she paid more than half
       her child’s support in order to qualify for the dependency exemption.
            In 2003, the Tax Court declined to follow prior decisions and held that,
       under the plain language of the statute, IRC § 152(e) also applies to unwed
       parents who were never married. King v. Comm’r., 121 T.C. 245 (2003).
       Thus, unwed “custodial” parents can now qualify for a dependency exemp-
       tion under the IRC § 152 (e) test.
            A custodial parent, whether married, divorced or unwed, can release
       the exemption to the noncustodial parent by signing IRS Form 8332.84 The
       exemption can be released for the current year, specified future years or all
       future years. According to the IRS, the only way that a custodial parent can
       void Form 8332 is to get the noncustodial parent to forgo his claim for the
       dependency exemption.85 Thus, custodial parents should be advised to sign
       a Form 8332 on an annual basis only, and not for all future years.
            A stipulation as to the release of a dependency exemption in a divorce
       or custody decree will not substitute for a signed Form 8332 unless it meets
       the IRC § 152 (e) requirements, including the written declaration require-
       ment. In Cramer v. Comm’r., TCS 2003-2, the court denied a dependency
       exemption to a noncustodial parent who relied on a divorce decree stipula-
       tion that failed to meet all of the IRC § 152 (e) requirements. Even a state
       court order granting a dependency exemption to the noncustodial parent
       will not support a dependency exemption claim if there is no written decla-
       ration by the custodial parent as required by IRC § 152 (e). Miller v.
       Comm’r., 114 T.C. 184 (2000), aff’d on other grounds, Lovejoy v. Comm’r., 293
       F.3d 1208 (10th Cir. 2002).
2.     General Rules for Dependency Exemptions (IRC §§ 151-52)
              The following tests must be met for a dependency exemption:
       •      The dependent’s gross income must be less than the exemption
              amount.86 The gross income test does not apply to a child who is under
              19 or a full-time student under 24 at the end of the year.
       •      Over 1/2 of the dependent’s total support for the year must have been
              furnished by the taxpayer87 (with exceptions for divorced or separated
              parents and multiple support agreements)

   In King v. Comm’r., 121 T.C. 245 (2003), held that an unwed parent could release the exemption by signing a Form
   8332. Since King, the IRS has revised its Form 8332 to remove any marriage requirement.
   IRS Legal Memorandum 200007031. Of course, fraud or duress, if provable, could also void a Form 8332. See King v.
   Comm’r., 121 T.C. 245 (2003).
   The “gross income” test will not apply to a “qualifying child” under the WFTRA of 2004, which becomes effective on
   January 1, 2005.
   This support test is eliminated for tax years beginning in 2005.

                                            TAX PRACTICE

      •      The dependent must be one of the following relationships to the tax-
             1. Child, grandchild, stepchild or adopted child
             2. Sibling, full or half-blood
             3. Step-sibling
             4. Parent, ancestor or either
             5. Step-parent
             6. Child of taxpayer’s sibling
             7. Child-in-law, parent-in-law, sibling-in-law88
             8. Person (other than taxpayer’s spouse) who lives in house and is
                  member of household for entire year89
      •      Dependent must not have filed a joint return with his spouse (unless
             neither required to file)
      •      Dependent must be a citizen, national or resident of the United States,
             a resident of Canada or Mexico at some time during the year or an alien
             child adopted by and living with a U.S. citizen or national as a member
             of his household for the entire year.
3.    The Support Test (for pre-2005 years)
           Note: The Working Families Tax Relief Act of 2004 eliminates the
      support test for a taxpayer’s child (other than for a child who provides
      more than fi his own support) for tax years beginning in 2005.
           Generally, a taxpayer must furnish more than half of the total support
      provided to a dependent in the tax year in order to claim the exemption. As
      discussed above, there are exceptions for divorced and separated parents.
      Since many indigent parents receive public assistance or child support from
      an unwed parent, the issue of what counts as “support” becomes important.
           If funds from other sources are used for a dependent’s support, deter-
      mine the total support from all sources and allocate support payments
      among the various payers. Total support for the tax year will include:
      •      Fair Rental Value of Lodging
                  Lodging must be measured in terms of its fair rental value. Reg.
             § 1.152-1(a)(2)(I). This value is different from the rent for an apart-
             ment or house or the costs of home ownership. It can include a rea-
             sonable allowance for the use of furniture and appliances, and for heat
             and utilities. IRS Publication 501. Also, if the house is renting for
             $350, but the fair market rental value is $500, then $500 is the amount
             counted as support. This rule may adversely affect subsidized housing
             tenants since their rent is less than the fair market rental value.90
             Similarly, the fair market rental value of a home owned by a taxpayer
             may be higher or lower than the monthly mortgage payment.

   The relationship of affinity is not destroyed by the divorce or death of a spouse.
   Note that this category is broader than the EIC definition of “foster child.”
   Note also that housing assistance payments allocable to a child may count as support provided by another payer.
   Huynh v. Comm’r., TCM 2002-237 (HUD rental assistance); IRS Pub. 504, Divorced or Separated Individuals.

                           TAX PRACTICE

          If real estate taxes, utilities and repairs are reflected in the fair
    market rental value of lodging, they cannot be counted as support.
    Abbot v. Comm’r., 13 TCM 113 (1954). The cost of home improvements
    is not countable as support. Rev. Rul. 77-282, 1977-2 C.B. 52.
    However, the amortized cost of furniture or appliance for a dependent
    may count as support. Brandes v. Comm’r. 29 TCM 1436 (1970), IRS
    Publication 501.
          The amount of lodging and household expenses attributable to an
    individual dependent is per capita or proportionate share. Reed v.
    Comm’r., 40 TCM 1048 (1980). Proportionality may be altered if some
    household members are present for a longer period. If divorced parents
    jointly own a residence, but the occupying parent has exclusive use of
    the residence pursuant to a decree, the occupying parent is deemed to
    provide the child’s entire lodging.
•   Share of Food
•   Costs of Direct Expenses For Dependent For Necessities
          “Support” includes expenses for a dependent’s clothing, educa-
    tion, medical and dental care (including health insurance premiums)
    recreation, transportation and similar necessities. IRS Publication
    501; Reg. § 1.152-1(a)(2)(I). While the Regulation uses the term,
    “necessities”, both the IRS and the Tax Court have allowed expenses
    which exceed a parent’s duty to provide. Examples of allowable
    expenses include a car for the child, summer school classes, private
    school tuition, music lessons, allowances, toys, hair styling, entertain-
    ment, gifts, vacations, etc. The benefits paid by a health insurance
    policy, Medicaid or Medicare are disregarded as support. See Turecamo
    v. Comm’r. 554 F.2d 564 (2d Cir. 1977); Archer v. Comm’r. 73 T.C. 963
    (1980). Support received from a noncustodial parent’s spouse is
    treated as received from the noncustodial parent. IRC § 152 (e)(5).
•   Public Assistance Disregarded As Support
          Public assistance, e.g., Social Security, SSI, welfare, food stamps,
    housing, will be regarded as support provided by either the state or the
    dependent, and not the “parent”, unless it is shown that part of the
    payments were not used for the dependent’s support. See Lutter v.
    Comm’r., 514 F.2d 1095 (7th Cir. 1975); Rev. Rul. 74-543, 1974-2 C.B.
    39; IRS Pub. 501. Food stamps, welfare and housing should be allo-
    cated per capita among the recipients of the assistance as support pro-
    vided by others.
          The support test applies to each dependent. Thus, it is possible
    that some household members will qualify as dependents and that
    others will not. See e.g., Alisobhani v. Comm’r., TCM 1994-629.
    Qualifying even one person as a dependent may protect head of house-
    hold status. Id. You should also consider whether dependents may be
    treated as a “unit” for the allocation of support. See e.g., Abel v.
    Comm’r., TCM 1962-192. The IRS now has access to state welfare
    records. There do not appear to be any rulings on whether a parent’s
    unemployment compensation benefits or subsidized workfare would
    count as support by the parent.

                                TAX PRACTICE

4.   Worksheet for Determining Support
          The IRS Worksheet for Determining Support included in Publication
     501 is very helpful for determining whether the taxpayer provided more
     than half of a person’s support.

     Many employers take advantage of low-income workers by treating them as
independent contractors rather than employees. You can file a Form SS-8 with
the IRS to get a determination as to whether the taxpayer is an employee or inde-
pendent contractor. For a detailed discussion of the tests for employee status,
see Borison, Effectively Representing Your Client Before the New IRS, Ch. 17 (ABA
     An IRS Form 4137 can be used to report employment income and pay
payroll taxes if the employer won’t issue a Form W-2. Once the employee has
paid his payroll taxes, he should file for a correction of his wage earnings with
the Social Security Administration. See 20 CFR § 404.801 et seq. This should
be done promptly since there is a time limit for correcting earnings records. 20
CFR § 404.802.
     In some states, there may be a tort claim against the employer for failure to
correct an information return. See, e.g., Clemens v. USV Pharmaceutical, 838 F.2d
1389, 1395 (5th Cir. 1988) (tort action under Louisiana law). IRC § 7434
creates a private cause of action against any person for fraudulent filing of infor-
mation returns. § 7434 specifies damages as the minimum of $5,000 or actual

                        DEBT CANCELLATION INCOME
     Debt cancellation, Truth-in-Lending rescission and foreclosure may have
income tax consequences. Attorneys for low-income consumers need to know
the tax consequences of these events and plan to minimize them.
     Income from debt cancellation is generally includible in gross income. IRC
§ 61 (a)(2). However, this income is excluded from income if the debt cancella-
tion occurs in (1) a bankruptcy or (2) when the taxpayer is insolvent. IRC § 108.
“Insolvent” means that the liabilities exceed the fair market value of the assets.
IRC § 108 (d)(3). Income in excess of insolvency is includible in a partially insol-
vent taxpayer’s income. IRC § 108 (a)(3).
     The Tax Court has recently held that exempt assets, e.g., a homestead
exemption for the family home, must be included in determining whether a tax-
payer is “insolvent.” Carlson v. Comm’r, 116 T.C. 87 (2001). Some consideration
should be given to challenging Carlson since it has been criticized.
     Another exception to the general rule is that a settlement or “forgiveness”
of a disputed or unenforceable debt does not result in income to the taxpayer.
Zarin v. Comm’r, 916 F.2d 110, 115 (3d Cir. 1990). Since the amount of the dis-
charged debt was void ab initio due to the underlying illegality or fraud, no
taxable income results from the settlement.
     To avoid tax consequences to the debtor, the settlement should include an
agreement by the parties that the settlement agreement reflects settlement of

                                               TAX PRACTICE

disputed claims, does not represent a discharge of indebtedness for purposes of
IRC § 61 (a)(12) and that the lender will not report the transaction as resulting
in income to the debtor to any taxing authority. Lenders rarely agree to the last
of these conditions, but that disagreement does not make the cancellation
taxable income.
      A foreclosure is treated as a sale. Income from a sale is computed as the
difference between the amount realized and the taxpayer’s basis in the asset.
The amount realized by the debtor generally includes the liabilities from which
the debtor is released because of the sale. Reg. § 1-1001-2 (a)(1); Frazier v.
Comm’r, 111 T.C. 243 (1998). An exception exists for “recourse” debt.91 Gain
for “recourse” debt is bifurcated into gain from the sale and gain from debt can-
cellation. Here, the amount realized is the fair market value of the asset.92 The
difference between the fair market value and the house’s basis will be capital
gain. In addition, the debtor has ordinary income from the debt cancellation
computed as the difference between the debt and the fair market value of the
asset. Reg. § 1-1001-2 (a)(2); Frazier, supra. The taxpayer may exclude the debt
cancellation income if he is insolvent when the foreclosure occurs. Frazier, supra.
If the house was the taxpayer’s main home, he may be able to elect the lifetime
exclusion of $250,000 from income.
      What are the tax consequences if the taxpayer successfully rescinds a
transaction pursuant to the Truth-in-Lending Act or another consumer protec-
tion law? The IRS will argue that the difference between the loan principal and
the amount paid by the taxpayer for rescission is debt cancellation income. See
Schlifke v. Comm’r, 61 TCM 1697 (1991). The taxpayer can argue that there was
no debt cancellation income under Zarin v. Comm’r, supra, since the debt was dis-
puted. This may be a successful argument, at least to the extent the taxpayer did
not deduct interest in prior tax returns.
      However, if the taxpayer took deductions for interest in prior tax years, the
IRS will argue that recovery of the same is taxable income under the tax benefit
rule. In Schlifke v. Comm’r, the Tax Court ruled that there was income from a
rescission under the tax benefit rule to the extent that the taxpayer had taken
deductions for interest on the rescinded mortgage.
      Statutory attorney fees may also trigger tax liability. In Commissioner v.
Banks, 03-892 (U.S., Jan. 24, 2005), the Supreme Court held that attorney fees
are includible in the taxpayer’s gross income even though she never receives the
fees. Before Banks , the circuits were split on this issue. Thus, Banks exposes
many taxpayers to significant new liabilities.93 The attorney fees may be par-
tially deducted (i.e., the amount in excess of 2% of adjusted gross income) on
Schedule A of the Form 1040 if the taxpayer can itemize. For large attorney fee
awards, the taxpayer may even suffer alternative minimum tax liability.
      In the American Jobs Creation Act, Congress amended the Internal Revenue
Code to preclude taxation of attorney fees in most civil rights and employment
   Recourse debt is a loan where the debtor is personally liable for the entire amount of the debt, not just the amount of
   the collateral.
   The sale price of property at a foreclosure sale is presumed to be its fair market value. This presumption can be
   rebutted by clear and convincing evidence to the contrary. Community Bank v. Comm’r, 79 T.C. 789, 792 (1982) aff’d
   819 F.2d 940 (9th Cir. 1987).
   The 5th, 6th, 9th and 11th Circuits had held that attorney fees were not included in the client’s gross income.

                                TAX PRACTICE

law actions. Pub. Law. 108- 357, § 703, 118 Stat. 1546-48. However, the new
law only applies to fees and costs paid after October 22, 2004 with respect to any
judgment or settlement after such date. Also, it appears that attorney fees under
consumer protection laws and in certain personal injury cases (contingency fees)
are still taxable to the client. For strategies to minimize taxes on attorney fees,
see NCLC Reports, Deceptive Practices and Warranties (Jan./Feb. 2005)

     Many legal services clients are domestic violence victims. What are some
of the tax issues and considerations that affect them?
1.   Stop Filing Joint Returns
           The economic advantages of a joint return will probably be outweighed
     by the economic disadvantages and the threat to your client’s security. A
     joint return makes the victim jointly liable for taxes. She is unlikely to have
     access to the financial information necessary to sign a joint return.
           If your client has been separated for the last 6 months of the year, she
     may be able to claim the favorable head of household tax rates and the
     earned income credit. The additional tax refunds could help the victim’s
     plan for financial independence.
           After separation, a victim should file a Form 8822 to receive deficiency
     notices relative to joint returns.
2.   Divorce and Custody
          Resolution of divorce and custody litigation before the end of a tax year
     may strengthen a victim’s rights to head of household tax rates, the earned
     income tax credit and dependency exemptions. A court decree allowing the
     victim use of the marital home may help her qualify for these tax benefits.
          Generally, the custodial parent is entitled to the dependency exemption
     under IRC § 152(e). However, Louisiana courts have held that they have
     jurisdiction to order a reallocation of the dependency exemption. See e.g.,
     Rovira v. Rovira, 550 So. 2d 1237 (La. App. 4th Cir. 1989). Any change in
     the dependency exemption allocation should be considered with respect to
     the child support award. Zatzkis v. Zatzkis, 632 So.2d 307 (La. App. 4th Cir.
     1994). See La. R.S. 9:315.18 B. Restrictions, e.g., timely payment of child
     support, can be placed on the reallocation of an exemption. See e.g.,Flatt v.
     Comm’r., TCM 1986-495. Under federal law, the parent who meets the rela-
     tionship, age and residency tests should still get the EIC.
3.   Innocent Spouse Relief, Separate Liability Limitation and Equitable
           A victim may be able to avoid or minimize liability for a past tax return
     through either innocent spouse relief or separate liability limitation. See
     discussion supra, under “Collections.” Abuse and threats of violence are
     factors that may strengthen a Form 8857 application for innocent spouse or
     equitable relief. See Kistner v. Comm’r., 18 F. 3d 1521 (11th Cir. 1994); Rev.
     Proc. 2003-61. A divorce decree requiring the other spouse to pay the tax
     helps a claim for equitable relief. Rev. Proc. 2003-61. Be sure to file for
     relief within the applicable deadline.

                                TAX PRACTICE

          The IRS has taken steps to protect domestic violence victims who
     apply for innocent spouse relief. IR-2001-23. A domestic violence victim
     who fears that filing a claim for innocent spouse relief would result in retal-
     iation should write “Potential Domestic Abuse Case” at the top of the Form
     8857. The IRS will not release to a current or former spouse information
     relative to a new name, employer phone number or other information that
     could endanger the safety of domestic violence victims.
4.   Threats By Batterer
          A batterer may threaten to hurt a victim in order to get her to forgo a
     dependency exemption. Explore this with your client. If she has been
     threatened, advise her of any available civil or criminal remedies.
          If a spouse establishes that she signed a joint return under duress, the
     return is not a joint return. Reg. §1.6013.4; Rev. Proc. 2003-61, §2.03.

     Treasury Department Circular 230 (31 CFR Subtitle A , Part 10) prescribes
additional ethics rules for attorneys who practice before the IRS. As a national
court, the Tax Court follows the ABA Model Rules.

                                TAX PRACTICE

                             TAX LAW RESEARCH
IRS Web page
    IRS web page has great resources for tax practitioners at
    Here, you can find:
    •   Tax forms and publications
    •   IRS contact information
    •   Internal Revenue Manual
    •   Weekly Internal Revenue Bulletin (new regulations, Revenue rulings,
        Revenue Procedures)
    •   Private letter rulings, technical assistance memoranda

Other Web pages
         Tax Court rules, forms and searchable opinions
         American Bar Association, Section of Taxation’s tax links index
         National web site for pro bono and public interest advocates. Plans for
         national tax law practice site for advocates to share their pleadings,
         documents. Also, there are about 30 states that have state web sites for sharing practice documents.
         Georgia State University low-income tax clinic site has tax clinic
         manual, forms, references and summaries of major tax practice issues.
         Commercial site that has tax links.
         Online resources for tax relief

    Borison, Effectively Representing Your Client Before the New IRS (ABA 2004)
    King, Discharging Taxes in Bankruptcy, (KingsPress 2001)
    National Taxpayer Advocate’s Annual Report to Congress (includes helpful
         information on litigated cases)
    Standard Federal Tax Reporter (Commerce Clearinghouse)
    RIA Federal Tax Coordinator 2d.
    Bureau of National Affairs: Tax Management Portfolios:
         Marmoll, 391-2d T.M., Employment Status: Employee or Independent
         Shattuck, 465-2d T.M., IRS Appeals, Audits & Appeals

                            TAX PRACTICE

        Maule, 501-2d T.M., Gross Income, Overview of Conceptual Aspects
        Maule, 503 T.M., Deductions: Overview & Conceptual Aspects
        Maule, 506 T.M., Tax Credits: Concepts & Calculation
        Maule, 507 T.M., Income Tax Liability: Concepts & Calculation
        Wofford, 515 T.M., Divorce and Separation
        Alexander, 623 T.M., IRS Procedure: Examinations & Appeals
        Peyser, 627-2d T.M., Limitation Periods, Interest on Underpayments &
             Overpayments, & Mitigation
        Peyser, 630-2d T.M., Tax Court Litigation
        Tarr, 634 T.M., Civil Tax Penalties
        Starczewski, 638 T.M., Federal Tax Collection Procedure

List serves and newsletters
     The Low-Income Tax Practice Newsletter, edited by Robert Nadler,

     Community Tax Law Project Newsletter
     Professor Jerome Borison’s list serve,


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