Southeast Louisiana Legal Services by liuqingyan


									                 Southeast Louisiana Legal Services
                             LOW INCOME TAXPAYER CLINIC
                                 1010 Com m on St., Suite 1400A
                                 New Orlea ns, Louisia na 70112
                                    Phone: (504) 529-1000
                                   Web Ad d ress: w w w

                     AND PRO BONO ATTORNEYS
                         (2009 revised edition)

                                     Mark Moreau 1

       Co-Director, Southeast Louisiana Legal Services, LL.M. (in Taxation), New York
University School of Law, Louisiana and New York bars, 1976.
Rev. December 2009

                                                   TABLE OF CONTENTS

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4



HOW TO GET INFORMATION FROM THE IRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

SENDING INFORMATION TO THE IRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

AUDITS OR EXAMINATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
     Time Limits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
     IRS Automated Adjustment Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
     Types of Audits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
     Preparation for Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
     Handling the Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
     Extending the Audit Time Limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
     The Examination Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
     Audit Reconsideration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

APPEALS WITHIN THE IRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11
    Appealable Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
    Time Limits for Appeal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
    Reasons to Appeal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
    Appeals Officers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
    Face-to-Face Hearings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

TAX COURT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
     Decisions Reviewable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
     Time Limits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
     Filing the Tax Court Petition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
     Revised Tax Court Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
     Pleading Requirements / Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
     Appeals Office Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
     Pre-Trial Settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
     Pre-Trial Procedures and Stipulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
     Qualified Offers . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
     Trial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

            Appeal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21
            Other Judicial Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21
            Review of Pro Se Tax Court Petitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . 21

 REFUND CLAIMS AND LAWSUITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
      Overpayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
      Time Limitations for Refunds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
      How to Claim a Refund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
      The § 6511(b) Look Back Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
      Refund Lawsuits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

 COLLECTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
      Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
      Liens . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
      Levies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
     Collection Due Process Appeals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
     Options for Taxpayers Who Can’t Pay Their Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
      Installment Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
     Offers in Compromise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
     Currently Not Collectible Hardship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
     Bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
     Taxpayer Assistance Orders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
     Innocent Spouse Relief and Separate Liability Election . . . . . . . . . . . . . . . . . . . . . . . . . . 48
     Injured Spouse Relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
     Tax Liability in Community Property States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
     Marital Disputes over Tax Refunds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
     Penalty Abatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
     Statute of Limitations for Collections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
     Designation of Tax Payments . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
     Criminal Penalties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

NONFILERS: OPTIONS? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60

    FILING STATUS AND DEPENDENCY EXEMPTIONS . . . . . . . . . . . . . . . . . . . . . . . 61

EARNED INCOME CREDIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

HEAD OF HOUSEHOLD FILING STATUS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

DEPENDENCY EXEMPTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

EMPLOYEE OR INDEPENDENT CONTRACTOR STATUS . . . . . . . . . . . . . . . . . . . . . . . . . 80

DEBT CANCELLATION INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

LEGAL FEES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82

OTHER TAX ISSUES IN LEGAL AID AND HOUSING PRACTICE . . . . . . . . . . . . . . . . . . . 83

SOCIAL SECURITY BENEFITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

     . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

ETHICS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

TAX LAW RESEARCH . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

APPENDIX: PRE-2005 LAW ON DEPENDENCY EXEMPTION . . . . . . . . . . . . . . . . . . . . . 87



        This guide covers the basics of federal income tax practice for legal services attorneys:
interview information to collect from the taxpayer, Internal Revenue Service procedures, appeal
rights, Tax Court litigation, refunds, innocent spouse relief, the Earned Income Credit, Head of
Household Filing Status and Dependency Exemptions.

       Tax law is important to indigent persons for many reasons:

       !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, and provides a significant portion of a recipient’s annual income. The
poor are frequently audited on the EIC and the closely related issues of dependency exemptions and
head of household filing status. Disallowance of the EIC can result in a large nondischargeable debt
relative to the taxpayer’s financial means. Some taxpayers become homeless when they are denied
the EIC.

       !Tax debt can preclude a person from becoming a homeowner.

       !Tax law changes have expanded the opportunities for reasonable settlements of tax debts
and protection of homes from seizure.

       !Since welfare reform, there are more working poor who have tax controversies.

       !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.


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. You can find
information on how to understand and respond to many IRS notices at “Understanding Your IRS
Notice” in The common IRS notices are:

        !Notice of proposed changes to tax return, CP-2000 Notice (30 days to reply)2.

        !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).

        !Notice of tax deficiency or “the 90 day letter” (check the notice for last day to file Tax Court

        !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, CP-90/CP-297, (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, CP-523 (30 days to appeal by Form 9423)

        !Nonfiler (penalties may increase for delay in filing).

          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.

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 documents that the
         IRS requested from the taxpayer. In addition, you may need information from the
         taxpayer on her household expenses.

11.      If Innocent Spouse Relief is possible, ascertain 2 year deadline for filing Form 8857. 3

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

13.      Power of attorney, Form 2848, signed by the client, for all tax years needed.


       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.

            The 2 year deadline applies to § 6015(b) and (c) relief. It may not apply to equitable relief claims under
 IRC § 6015(f). See Lantz v. Comm’r, 132 T.C. No. 8 (2009)(on appeal by IRS);Mannella v. Comm’r, 132 T.C. No.
 10 (2009). In Rev. Proc. 2003-61, the IRS set a 2 year time limit on § 66(c) equitable spouse relief claims. The Tax
 Court has not addressed the issue of time limits for equitable innocent spouse relief under IRC § 66(c).But, it has
 held that Rev. Proc. 2003-61 is an invalid interpretation of § 6015(f). Caldwell v. Comm’r, TCS 2009-96, n.6. The
 time limit for traditional innocent spouse relief under IRC § 66(c) is 6 months before the expiration of the statute of
 limitation on assessment for the nonrequesting spouse.

         Have the taxpayer sign a Form 2848. Immediately fax it to the Central Authorization File Unit

         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.4 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, installment
         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 are an LITC, you should enroll for electronic access to your
clients’ IRS tax records.

        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 $57.


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


             Taxpayers can get a free transcript of their tax returns by calling 800-829-1040.

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.

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 taxpayers. The correspondence audit is conducted
by mail and requests documents. 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 provides 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-

       The Earned Income Credit (EIC) audits are generally done through correspondence audits.

4.     Preparation for Audit

       !Review tax return.
       !Ask client to organize supporting documents for items listed in audit notice.
       !Research tax law if there are any questionable deductions or tax benefits.
       !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 don’t have an appeal officer’s “hazards of litigation” settlement authority.5
         !Don’t disclose tax returns or documents not requested by the audit.
         !The representative, not the taxpayer, should attend the office audit.6

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 specific 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.7

       On the other hand, the auditor may miss the 3 year deadline for assessment of taxes if you
don’t consent to an extension.

7.       The Examination Report

        The auditor will issue an Examination Report that explains the proposed 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.8

              An auditor may only resolve issues on a factual basis. He does not have “hazards of litigation” settlement

            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.

            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 unsuccessful. 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

       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 manager.

          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 examination. 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 to:

           1.         Reevaluate a prior audit where the taxpayer disagrees with the original determination
                      by providing information that was not previously considered.9

           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.10

See IRM §,,; IRS Pub. 3598.

        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.

 lawsuit. See e.g., Smith v. United States, 328 F.3d 760 (5 th Cir. 2003); Whitney v. United States, 826 F.2d. 896 (9 th
 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

        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 reconsideration. If the taxes have not been paid, a letter requesting audit
reconsideration 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

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 § If a case is
accepted for audit reconsideration, and the taxpayer’s request is disallowed in full or part, the taxpayer
may request an appeal. IRM §


        1.      Appealable Decisions

        The following IRS decisions may be appealed:

        !Proposed tax adjustments pursuant to an audit
        !Disallowance of taxpayer’s request in an audit reconsideration (IRM §
        !Denial of innocent spouse relief
        !Denial of interest or penalty abatement
        !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 determination 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

        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 explaining why the IRS decision
or action is wrong, is all that is required. (However, a more detailed written protest letter is

       Audit cases over $10,000 require a more formal written protest letter which includes:

       !Taxpayer’s name, address, and daytime telephone number

       !A statement that the Examination Report is being appealed.

       !A copy of the IRS letter or Examination Report showing the changes proposed by the IRS

       !The tax periods involved

       !The Report’s findings and changes that the taxpayer disagrees with and why

       !The facts and law supporting the taxpayer’s position on any disagreed issue

       !Signature and date under penalty of perjury clause.

        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 inexpensive forum.

        In addition, a taxpayer should exhaust administrative remedies through Appeals Office review
for the following reasons:

        !Preserve Tax Court jurisdiction for review of non-deficiency determinations under IRC §
        6330 (collection due process appeals).
        !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.11
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 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.12
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

            Appeal Officers are prohibited from ex parte communications with the auditors. Rev. Proc. 2000-43,
 2000-43 IRB 404; Adomowicz v. United States, 531 F.3d 151 (2d Cir. 2008); Robert v. United States, 364 F.3d 989
 (8th Cir. 2004); Drake v. Comm’r, 125 T.C. 201 (2005)(case remanded with order that a new, independent Appeals
 Officer be assigned to case).

            Appeals conferences must be available in regular cases within each state. The IRS must consider the use
 of video conferences for taxpayers in remote or rural areas. See § 3465 of the IRS Restructuring and Reform Act of

a tax liability.13 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
transferred to a local office if you timely request a face-to-face appeal.


        1.         Decisions Reviewable

        A Tax Court Petition may be used to challenge the following IRS decisions:

        !Tax liability
        !Denial of separate liability, innocent or injured spouse relief 14
        !Denial of penalty or interest abatement 15
        !Denial of offer-in-compromise, installment agreement or lien relief.16
        !Notice of Intent to Levy 17
        !Certain refund cases
        !Determination of employee or independent contractor status18

         The Tax Court’s review is de novo for tax liability, employment status and § 6015 (b),(c) or
(f) innocent spouse relief.19 In 2009, the Tax Court held that review of § 6015(f) innocent spouse
relief is de novo, not abuse of discretion. Porter v. Comm’r, 132 T.C. No. 11 (2009). The review

          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 Butner v. Comm’r., T.C. Memo 2007-136; 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; IRC § 6330(d). However, no jurisdiction where taxpayer failed to timely
request an IRS appeal. Wilson v. Comm’r, 131 T.C. No. 5 (2008); Offiler v. Comm’r., 114 T.C. 492 (2000).

           See Tax Court Rules 330-34; IRC § 6330(d). However, no jurisdiction where taxpayer failed to timely
request an IRS appeal. Wilson v. Comm’r, 131 T.C. No. 5 (2008); 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).

         If underlying tax liability is at issue in a collection due process appeal, the review is de novo. Murphy v.
Comm’r, 125 T.C. 301, 307 (2005).

standard for § 66(c) equitable claims has not been decided yet. Felt v. Comm’r, T.C. Memo 2009-245.
In a trial de novo, both the taxpayer and the IRS can present evidence in support of their positions on
issues presented, and the Tax Court does not use the deferential abuse of discretion standard to
determine § 6015(f) innocent spouse relief. Haigh v. Comm’r, T.C. Memo 2009-140, n. 13.

         Also, review of adverse § 6015 (f) decisions and collection due process appeals is not limited
to the administrative record. Rather, the Tax Court makes its “abuse of discretion” decision after a
trial de novo. Porter v. Comm’r, 130 T.C. No.10 (2008). This means that the Tax Court may hear
evidence not included in the administrative record. Thus, the Tax Court continues to follow its
holding in Ewing v. Comm’r, 122 T.C. 32 (2004) vacated on jurisdictional grounds 439 F.3d 1009
(9th Cir. 2006), that review of a § 6015(f) decision is not limited to the administrative record. Porter,
supra; see also, Comm’r v. Neal, 557 F.3d 1262 (11th Cir. 2009) aff’g T.C. Memo 2008-08.

        The abuse of discretion, rather than de novo, standard governs judicial review of collection
due process appeal determinations on lien, levy, installment agreement or offer-in-compromise
decisions unless there are tax liability, § 6015 (b), (c) or (f) issues involved. See Murphy v. Comm’r,
125 T.C. 301, 307 (2005), aff’d 469 F.3d 27 (1st Cir. 2006); Montgomery v. Comm’r, 122 T.C. 1
(2004); see also N. Zotos, Service Collection Abuse of Discretion: What is the Appropriate Standard
and Scope of the Record in Collection Due Process Appeals, 62 Tax Lawyer 223 (Fall 2008). An
abuse of discretion occurs when the exercise of discretion is arbitrary, capricious or without sound
basis in fact or law. Freije v. Comm’r,125 T.C. 14, 23 (2005).

        In Robinette v. Comm’r, 123 T.C. 85 (2004) rev’d 439 F.3d 455 (8th Cir. 2006), the Tax Court
held that it makes the “abuse of discretion” decision in collection due process appeals after a trial de
novo. In Porter v. Comm’r, 130 T.C. No. 10, n. 6 (2008), the Tax Court stated that it still follows its
Robinette rule for review of lien and levy cases despite the 8th Circuit’s ruling that judicial review is
limited to the administrative record.20 See also, Murphy v. Comm’r, 125 T.C. 301 (2005)(court
considered external evidence); Holliday v. Comm’r, 57 Fed. Appx. 774 (9th Cir. 2003), cert. denied
540 U.S. 1112.

        New evidence in “abuse of discretion” cases must be relevant and admissible. Murphy v.
Comm’r, 125 T.C. 301, 307 (2005), aff’d 469 F.3d 27 (1st Cir. 2006) Also, absent special
circumstances, the Tax Court will not consider new evidence in an “abuse of discretion” case that is
not related to an issue raised in the appeal hearing. See Giamelli v. Comm’r, 129 T.C. 107 (2007);
Magana v. Comm’r, 118 T.C. 488 (2002). The accuracy of an administrative record may be
challenged. Giamelli, supra.

             The IRS will continue to oppose evidence not included in the administrative record. The 1 st Circuit has
 also held that tax court review of a collection due process appeal is generally limited to the administrative record.
 Murphy v. Comm’r, 469 F.3d 27 (1 st Cir. 2006). The 9 th Circuit has affirmed the Tax Court’s de novo consideration
 of external evidence in a collection due process appeal. Holliday v. Comm’r, 57 Fed. Appx. 774 (9 th Cir. 2003) cert.
 denied 540 U.S. 1112.

         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.21 IRC §§ 6213, 6015 (e). Petitions
to review collection due process appeal decisions must be filed within 30 days of the notice of
determination. IRC § 6330 (d).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

        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 of the notice of deficiency22 or mailed in a
properly addressed envelope with an official U.S. Post Office postmark or by certain designated
private delivery services23 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

             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 (8 th 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 (e)(1)(A).

           For discussion of situations where the notice was sent to wrong address or not received by the taxpayer,
 see Pollock v. Comm’r, 132 T.C. No. 3 (2009); Kuykendall v. Comm’r, 129 T.C. 77 (2007).

             Federal Express and UPS. If you use these companies, make sure that you use the type of delivery
 recognized by the IRS. See Gibson v. Comm’r, 264 Fed. Appx 760 (10th Cir. 2008)(petition untimely because UPS
 store sent by US mail rather than by approved UPS delivery service).

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.24 If
the 90 day limit has been missed, you may want to try an Offer-in-Compromise to eliminate the
taxpayer’s liability if there is “doubt as to liability.” See Reg. § 301.7122.

       Judicial review of a collection due process 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. Wilson v. Comm’r,
131 T.C. No. 5 (2008); 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, or 26 U.S.C.A. foll.
§ 7453. The initial filing requirements are an original and 2 copies of:

       !Statement of Taxpayer Identification Number25
       !Notice of Deficiency
       !Designation of Place of Trial (Tax Court is held in most major cities, including New Orleans
       and Shreveport for about 1 to 2 weeks every year)
       !Motion and Affidavit to Waive Costs (or check for $60)26

       Send the signed 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. On the Tax Court website, there are sample petitions. Form 1 is recommended for regular
cases. Form 2 may be used for small tax cases. Either form can be used for both types of cases.

           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. If the taxpayer’s claim is disallowed in an audit reconsideration, he may appeal to an
IRS appeals officer.

             Tax Court Rule 20(b), Form 4 (01/08)

           Check Tax Court Rule 23. Motions and pleadings (other than petition) generally require 4 copies in
addition to original.

         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. Also,
small tax cases are heard in more cities than regular tax cases are. 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 March 2008, the Tax Court revised its rules. The court implemented a new privacy policy
which requires a new form, “Statement of Taxpayer Identification”, to be filed with the petition. Rule
27 requires certain sensitive information to be redacted from filings with the court. Other changes
include relaxing restrictions on use of unreported orders and oral opinions.

        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.

        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). If the taxpayer lives in a community property state and seeks
§ 66(c) innocent spouse relief, pleading this claim as an affirmative defense may be essential for Tax
Court jurisdiction.

        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). 27

        6.       Appeals Office Review

        If the taxpayer didn’t appeal before, the Appeals Office will consider the case. Rev. Proc. 87-

            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.

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 settlement 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 prosecution. 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 within the
standing order deadlines. 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 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 discovery given tight Tax Court deadlines. Under
Branerton Corp. v. Comm’r, 61 T.C. 691 (1974), the parties should make reasonable informal efforts
to obtain information voluntarily before seeking formal discovery. See also Tax Court Rule 70(a).

        You must submit a Pre-Trial Memorandum at least 15 days before trial. Failure to file a pre-
trial memorandum can result in dismissal of the case. A Final Status Report should be sent to report
subsequent settlements. The Final Status Report is due by 3 pm of the last business day before
calendar call and may be submitted electronically at Most small cases can be

tried in 2 to 3 hours. Generally, the IRS does not have any witnesses 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 settlement 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 taxpayers’ attorney’s fees.28

       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 conditions are met. However, the judge can assign the burden of proof to the
taxpayer 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
evidence, i.e., documents and testimony which corroborate the taxpayer’s testimony. 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 testimony. 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 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:

              LSC regulations currently prohibit legal services attorneys from claiming attorney’s fees.

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

       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 liability 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). A bankruptcy court may be able to decide a tax liability even if the tax has
not been fully paid. If a bankruptcy court accepts jurisdiction, the trial may occur in 2 to 3 months.

       For more information on choice of forum considerations, see Choice of Forum in Federal
Civil Tax Litigation, 62 Tax Lawyer 311 (Winter 2009).

       13.     Review of Pro Se Tax Court Petitions

        Pro se tax court petitions may have jurisdictional or substantive problems. Here is a short list
of things to check when you review a pro se tax court petition:

       G Is there a notice of deficiency or notice of determination
       G Was the petition timely filed
       G Was the taxpayer or spouse in bankruptcy (at a time that would preclude Tax Court
       G Is the taxpayer seeking review of a stand alone § 66(c) innocent spouse claim
       G Does the petition need amendment to plead an innocent spouse claim
       G In Earned Income Credit cases, the taxpayer’s marital status and whether she qualifies as
       head of household
       G Does the taxpayer need to file an original or amended return

       Don’t assume that jurisdiction exists for a tax court petition filed by a pro se litigant or that
a married taxpayer correctly claimed head of household status for the Earned Income Credit.

        Outside the 10th Circuit, a taxpayer may file a subsequent tax return despite an IRS deficiency
assessment by a Substitute for Return. The SFR can’t deny the taxpayer’s right to contest the
deficiency and the IRS’s choice of filing status in a Tax Court proceeding. See Milsap v. Comm’r, 91
T.C. 58 (1988); Smallridge v. Comm’r, 804 F.2d 125 (10th Cir. 1986).



        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 deficiencies asserted by the IRS. A taxpayer
may file a claim for the refund of an “overpayment.” 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 refund:

        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.
   “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 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).

        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.

        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 taxpayer by certified or registered mail. The IRS may try to get
the taxpayer 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

          A refund time limitation that expires on a Saturday, Sunday or legal holiday, will be timely if filed on the
next succeeding day that is not a legal holiday. Rev. Rul. 2003-41, 2003-17 IRB 814.

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 disclosed on the return.30 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).

       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 deficiency 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 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 examination 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.

            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.

        A Form 1040X submitted after an examination should show the IRS adjustments 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., neighbors, 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 administrative 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 reconsideration of the
erroneous assessment of taxes. In your request for audit reconsideration, 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

       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 information 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 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 envelope in
which the return was mailed.31 If the refund time limitation expires on a Saturday, Sunday or legal
holiday, it will be timely if filed on the next succeeding 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. These cases conflict with Weisbart v. United States,
222 F.3d 93 (2d Cir. 2000). The IRS has said that it will no longer argue that the § 7502 mailbox rule
does not apply under facts such as in Weisbart. See IRS AOD-2000-09, 2000 WL 1711554 (Nov. 13,

        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).

            Note that there is a split in the Circuits as to whether the § 7502 statutory mail box rule preempts the
 common law mail box rule. Phila. Marine Trade Ass’n Intl., 523 F.3d 140 (3d Cir. 2008). The 3d, 8 th, 9 th and 10 th
 Circuits have held that a taxpayer can use either the statutory or common law mail box rule to show timely filing,
 whereas the 2d and 6 th Circuits have held that the taxpayer may only use the statutory mail box rule.

        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 paid.

        The Fifth Circuit has held that remittance of taxes with a Form 4868 extension 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

          ! 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). 32

        These limits may be extended if there is an agreement to extend the assessment 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 payments 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).

                Taxes can be paid by withholding, estimated tax payments and “credits.”

        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, penalties and interest.33
The requirements for filing a refund lawsuit include:

        !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). A bankruptcy court may have jurisdiction to
determine a tax liability where the taxpayer has not fully paid the tax

        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).

           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 (5 th Cir. 2003).

       !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 decisions. 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 location of the trial. See also 28 U.S.C. § 173.

       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 taxpayers 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) 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 outstanding tax liability for another tax year. Favret v. United
States, supra. In such situations, 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.34

        The §§ 7422(a) and 6511(a) rules can open up many past years for litigation. 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 examination, does not owe
any taxes. Often, these taxpayers have missed the 90 day 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

        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

        Discussion of Possible Approaches

        Situation 1

                 Payment of taxes by IRS offset can be determined from the offset notice or a transcript of the taxpayer’s

        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).35 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 question.
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 disallowance. 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 taxpayer waived the notice of claim disallowance.
Interestingly, the IRS generally does not mail “notices of claim disallowance” when it disallows
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

       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

           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.

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 deficiency 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 assessment.

        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 nondischargeable in bankruptcy. The IRS uses liens and
levies to enforce collection.

       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, 528 U.S. 49 (1999).
The lien attaches to after-acquired property (unless property acquired after bankruptcy where taxes

discharged). 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 prepetition 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 bankruptcy.

       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.36 The Notice will threaten the filing of a tax lien in the
public records office if the bill is not paid.37 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 followed38
        !Spousal defenses
        !Challenges to appropriateness of collection actions
        !Collection alternatives
        !Tax assessed and lien filed while bankruptcy stay in effect
        !Time to collect tax expired before lien filed
        !Taxpayer did not have opportunity to dispute asserted liability
        !Taxes fully paid before lien filed

       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).

              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” clause.

          In a “CDP” appeal, check for compliance with all applicable IRM procedures. See Murphy v. Comm’r,
125 T.C. 301, 307 (2005).

         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 filing was premature or
in violation of administrative procedures, or the liability 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). Inquiries about routine lien releases and payoff amounts can
be made to the Centralized Lien Unit, 800-913-6050.

       How to Apply for Lien Subordination

        IRS Publication 784 sets forth the procedures for subordination of IRS liens to the claims of
other creditors. There is no standard form for applying for a Certificate of Subordination of Federal
Tax Lien. Your request should be prepared in the form of a typed letter and submitted with the
required documents.

       The taxpayer or his attorney should sign the perjury declaration. If you, as attorney need
personal tax information from the IRS, you will need either a Form 8821 or Form 2848 signed by the
taxpayer. A Form 8821 should suffice in most cases.

        For all Louisiana real estate, the request for lien subordination and required documents should
be sent by mail or hand delivery to:

       Internal Revenue Service
       1555 Poydras St., Suite 220
       Stop 65
       New Orleans, Louisiana 70112-3747
       Attn: Subordination

       Requests for subordination may not be faxed to the IRS.

       IRS Review of Lien Status

        When it receives a subordination request, the IRS normally reviews liens to see if they are
enforceable or paid.39 Often, liens are not enforceable because they were not properly recorded or
have prescribed without timely reinscription. The IRS checks to see if the lien has in fact been paid.
Also, the IRS checks to see if the requester is the real person against whom the lien was recorded.

             Note that this information may not be known to a heir if the lien was for taxes owed by an ancestor.

        If the lien is unenforceable, paid or involves another person (not your client), the IRS will
issue the appropriate documents or certificates to cancel the lien.

       IRS Conditional Commitment Letter

        Generally, the IRS can issue a “conditional commitment” letter within 1 week of receiving
the subordination request. This letter states that the IRS will subordinate its lien if the transaction
takes place. Next, the IRS will send you the Certificate of Subordination of Federal Tax Lien for
recording at the parish recording office.

       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, 528 U.S. 49
(1999). IRS policies discourage levies of houses and retirement plans even though they are not
exempt. Most commonly, the IRS levies on bank accounts, wages and federal payments. 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 $8,230 (for 2009)
       !Books and tools of a trade, business or profession up to $4,120 (for 2009)
       !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 2009 exempted weekly wages are:

               Exemptions              1               2              3               4

Single                                 $180            250            320             390
Married, Joint Return                  $289            360            430             500

        See IRS Publication 1494 (or IRS Notice 2008-114, IRB 2008-51) 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 judgments. 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).

        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 consider 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 (h)(2)(A).

       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 levy.”

       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. If the IRS
erroneously levied a bank account, the taxpayer may file a Form 8546 for reimbursement of bank
charges. A Form 8546 must be filed within 1 year after the bank charge.

      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 jurisdiction 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. 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
outweighed delay to IRS); United States v. Jones, 877 F. Supp. 907 (D. N.J. 1995) (nondebtor wife
kept house in return for ½ 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).40 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). 41 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

            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.

        of deficiency or did not otherwise have an opportunity to dispute tax liability.42
        !Tax assessed and lien filed while bankruptcy stay in effect
        !Time to collect tax expired before lien filed
        !Taxpayer did not have opportunity to dispute asserted liability
        !Taxes fully paid before lien filed

       An Offer in Compromise is a “collection alternative” which can be heard by the Appeals
Officer. Offers in Compromise raised in a CDP appeal may be judicially reviewed by the Tax Court
under the abuse of discretion standard.43 IRC § 6330(d)(1)(A); Murphy v. Comm’r, 125 T.C. 301
(2005) aff’d 469 F.3d 27 (1st Cir. 2006).

        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 liability.

        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

        The IRS must release a levy on wages upon a determination of currently not collectible status.
IRC § 6343(e). 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 property 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). Wrongful levy claims may be
asserted administratively or judicially if the IRS levied property to collect a tax that the taxpayer did
not owe. IRC §§ 6343(b), 7426; IRS Publication 4528.

        4.        Collection Due Process Appeals–General Tips

       The format of the IRS appeal form for collection due process appeals does not help the
taxpayer to provide the necessary information for the appeal. The IRS appeal form should be
supplemented by a more specific appeal letter that is similar to a pre-trial memorandum. Use your

           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.

            W hether abuse of discretion has occurred depends on whether the exercise of discretion is arbitrary,
 capricious or without sound basis in fact or law. Freije v. Comm’r, 125 T.C. 14, 23 (2005).

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 to be considered in the appeal and subsequent judicial proceedings.

        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 requests.

        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 suspend a CDP hearing until the conclusion of an Earned Income
Credit audit reconsideration.

        A telephone hearing may constitute an appeal hearing even when the taxpayer requested an
in person hearing. Katz v. Comm’r, 115 T.C. 329, 337-38 (2000). The taxpayer may audio record the
§ 6330 hearing. Keene v. Comm’r, 121 T.C. 8, 19 (2003).

       For an excellent discussion of judicial review of CDP appeals, see N. Zotos, Service
Collection Abuse of Discretion: What is the Appropriate Standard and Scope of the Record in
Collection Due Process Appeals, 62 Tax Lawyer 223 (Fall 2008). For a large collection of CDP court
cases and the IRS Chief Counsel’s views on CDP issues, see IRS CCN-CC-2006-019, 2006 WL
2547088 (Aug. 18, 2006) (102 pp.).

       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

       !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
       !Separate liability election
       !Divorce spouse if property or wages levied for premarital tax debts

       !State law basis for one spouse compromising her share of joint liability
       !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 agreement if:

       !The tax liability (excluding penalties and interest) is $10,000 or less
       !The taxpayer, within the previous 5 years, has filed timely tax returns for each year, timely
       paid the taxes shown on the tax returns, and has not entered into or defaulted on a prior
       installment agreement
       !If requested by the IRS, the taxpayer submits financial statements and the IRS determines
       that the taxpayer is unable to pay in full
       !The installment agreement provides for full payment within 3 years, and
       !The taxpayer agrees to continue to comply with tax laws and the agreement for the period
       during the term of the agreement

IRS Form 9465 is used to request installment agreements under $10,000.

         The IRS is required to send every taxpayer in an installment agreement an annual statement
of the initial balance owed, the payments made during the year and the remaining balance. Ordinarily,
the IRS will send a monthly coupon to the taxpayer on which the remaining balance is also indicated.
Penalties and interest accrue on the unpaid balance during the term of the installment agreement. The
failure to pay tax penalty, ordinarily 0.5% per month on the unpaid balance, is reduced to 0.25% per
month while an installment agreement is in effect. Since the aggregate penalties and interest (all of
which are not tax deductible) can easily reach 15% per year, it is best for the taxpayer to exhaust other
credit and resources to pay the entire balance as soon as possible.

         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. The IRS recently
issued revised guidelines for allowable monthly expenses and certain types of expenses.44 The
guidelines are intended to approximate a reasonable amount to be spent on certain items or categories.
If the taxpayer spends more than the guideline amounts, generally only the guideline amount will be
allowed as an expense for the calculation of the minimum monthly payment. Certain items, such as

              IR-2007-163 (10/1/07)

voluntary pension contributions, charitable contributions, and entertainment expenses cannot be
claimed regardless of the amount actually incurred. A court order is technically required to claim a
child support or alimony expense, but most agents are willing to consider allowing part or all of those
payments if the amount of payment is reasonable and proof of payment is provided. Remember to
include payments for outstanding state tax debts, federal and state taxes withheld from wages, and
any required quarterly estimated tax payments when you calculate the allowable monthly expenses.
If the taxpayer’s proposal is rejected, he can keep negotiating and ask to speak to the collection
agent’s supervisor.

       Individuals who owe $25,000 or less in combined tax, penalties and interest can use the
Online Payment Agreement application provided by the IRS. This is easier than preparing and
submitting hard copy financial statements and speaking to an agent on the phone.

        It is recommended that only the taxpayer’s representative speak to the IRS under a filed Power
of Attorney (Form 2848) to avoid unnecessary disclosure of the taxpayer’s assets or other collection
related information that the IRS could use in its collection efforts. An IRS agent may also be less
aggressive and more willing to compromise when dealing with a representative.

       Once approved, the IRS and the taxpayer are bound by the agreement unless any of the
following happens:

       !The taxpayer fails to file tax returns or pay taxes arising after agreement
       !The taxpayer misses a payment45 ( if there is a good excuse, Taxpayer Advocate or Problems
       Resolution may be able to help prevent a termination)
       !The taxpayer’s financial condition improves or worsens
       !The taxpayer provided inaccurate information during negotiations

        A taxpayer may refuse to extend the statute of limitations on collections 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, a request
that collection be suspended due to financial hardship, 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 agreements which do not provide for full payment over
the life of the agreement. The 2004 amendment 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

             Usually, a defaulted installment agreement can be reinstated once.

reduce the outstanding liability.

        As of May 2008, the filing fee for an installment agreement is $105 ($43 for low-income
taxpayers, or $52 if paid by direct debit). The fee to restructure or reinstate an installment agreement
is $45.

        In some cases, it may be possible to defer payment in a manner sufficient for the taxpayer
without entering an installment agreement. The Internal Revenue Manual § (May 2007)
provides that an IRS agent generally has the authority to suspend collection activity for up to 120 days
for an individual taxpayer (30 days for most businesses) to allow the taxpayer to gather the funds to
pay the tax liability. If the period is about to expire and the taxpayer is unable to make full payment,
the taxpayer should contact the IRS to request an installment agreement before the end of the
collection suspension period. In cases of financial hardship, there is a statute allowing for a
suspension of collection activity for a reasonable period of up to 6 months, with an additional 6
months if the taxpayer is abroad.46

       Denial of an installment agreement may be reviewed by the Tax Court or a district court under
the “abuse of discretion” standard. Fifty Below Sales & Marketing, Inc. v. U.S., 497 F.3d 828 (8th Cir.

       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(d)(3).

      Effective July 16, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA)
changed the Offer in Compromise rules as follows:

        !Taxpayers submitting lump sum offers must make a 20% non-refundable, up-front payment
to the IRS. IRC § 7122(c)(1)(A). A lump sum offer means any offer of payments made in 5 or fewer

       !Taxpayers making periodic payment offers must pay the first installment with the application
and pay additional installments while the IRS evaluates the offer. IRC § 7122(c)(1)(B).
A periodic payment offer means any offer of payments made in 6 or more installments;

             IRC §6161(a)(1); Reg. § 1.6161-1(a), (b).

        !An Offer in Compromise application is deemed accepted if the IRS fails to act on it within
2 years.

         Failure to pay the 20% lump sum or the first installment on a periodic payment offer will
result in the IRS returning the offer as non-processable. The 20% payment and installment payments
are payments on tax and are not refundable. The taxpayer must specify in writing when submitting
their offers how to apply the payments to tax, penalties and interest due. Otherwise, the IRS will apply
the payments in the government’s best interest.

         Taxpayers who qualify as low-income (currently 250% of poverty) qualify for waiver of the
20% lump sum or first installment payment. These taxpayers should submit a Form 656-A for waiver
of the filing fee and required payments. Taxpayers who submit a Form 656-L based on doubt as to
liability also qualify for waiver of the 20% payment on a lump sum offer.

       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 taxpayers whose incomes are below 250% 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 off the debt
in cash or over a period of time, not to exceed the time remaining 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 documentation 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 compromise. 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 realizable assets” equals the Quick Sale Value of an
asset (generally 80% of fair market value)47 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-

            IRM Quick Sale Value cannot be less than 75% of fair market value. R. Schriebman, IRS Tax
 Collection Procedures, ¶ 14,041.

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 appropriate adjustments may be used for cars.
Retirement funds may be discounted by income taxes due on the withdrawal. Bank accounts (and
similar liquid assets) may not be discounted.

        Retirement, profit-sharing and pension plans may present problems for some taxpayers. These
assets may be subject to levy. IRM Thus, their value may be considered in the financial
analysis of the taxpayer’s reasonable collection potential.

       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 limitations 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 considered 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. See also, IRM for community property states and IRM for other states. 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 contributes.

       3.      Determine which expenses are “shared” and which are the taxpayer’s sole

       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 provision, taxpayers may now qualify for Offers-in-Compromise if they
have economic hardships48 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 inability to manage
finances or file tax returns. Taxpayers in these special hardship situations may be able to settle for
less than the maximum collection potential.49

         Possible disadvantages to an Offer-in-Compromise include an extension 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. Also, an OIC will preclude a
subsequent innocent spouse claim for a tax year covered by the OIC. IRM

       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 (e). 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. 2003-71.50

         An Offer in Compromise may be raised in a collection due process (CDP) appeal and first
heard by an OIC Appeals Officer.51 But, Appeals may not consider a CDP offer based on doubt as to
liability when the taxpayer received a statutory notice of deficiency and had an opportunity to litigate
liability. Practitioners report that OIC decisions by Appeals Officers are more accurate than those by
OIC examiners. OIC decisions by the Appeals Officers in timely CDP appeals may be judicially
reviewed by the Tax Court for abuse of discretion.

               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 §

     Examples of cases where the Tax Court found abuse of discretion in the denial of an Offer in
Compromise are:

       !rejection was not based on a financial analysis of the taxpayer’s income, assets, expenses
       and ability to pay and due consideration was not given to collection alternatives. Skrizowski
       v. Comm’r, T.C. Memo 2004-229

       !return of ETA offer in compromise, as distinguished from rejection, was abuse of discretion.
       Chavez v. United States, 2004 WL 1124914 (W.D. Tx. 2004)

       !national expense standards were used instead of the taxpayer’s actual expenses. Fowler v.
       Comm’r, T.C. Memo 2004-163

       !rejection of Offer in Compromise for a taxpayer whose reasonable collection potential was
       zero because of his history of tax non-compliance. Oman v. Comm’r, T.C. Memo 2006-231
       ( court could not decide abuse of discretion on the record since the IRS’s “best interest of the
       government” reasoning was unclear)

       !failure to consider a collection alternative proposed by the taxpayer during the hearing.
       Blosser v. Comm’r, T.C. Memo 2007-323

       !appeals officer did not allow the taxpayer to amend his offer to a lower acceptable amount
       under the reasonable collection potential guidelines Samuel v. Comm’r, T.C. Memo 2007-312.

        Reasonable application of the OIC guidelines is not second guessed by the Tax Court. Speltz
v. Comm’r, 124 T.C. 165 (2005) aff’d 454 F.3d 782 (8th Cir. 2005). The Tax Court determines
whether the rejection of the taxpayer’s actual offer was arbitrary and capricious. Woodral v. Comm’r,
112 T.C. 19, 23 (1999). There is no duty to negotiate with the taxpayer or to offer a higher amount
before rejecting an Offer in Compromise. Fargo v. Comm’r, 447 F.3d 706, 713 (9th Cir. 2006); but
see IRM §; Samuel, supra. Delays in submitting information requested on Offer in
Compromise justified issuance of adverse § 6330 determination and resumption of collection. Roman
v. Comm’r, T.C. Memo 2004-20.

         Failure to pay current taxes allows the IRS to reject collection alternatives such as Offers in
Compromise and installment agreements. See e.g., Giamelli v. Comm’r, 129 T.C. 107, 111-12 (2007);
Christopher Cross, Inc. v. Cross, 461 F.3d 610, 613 (5th Cir. 2006); Orum v. Comm’r, 412 F.3d 819
(7th Cir. 2005). The Tax Court will use federal common law to interpret Offers in Compromise and
whether a breach has occurred. Trout v. Comm’r, 131 T.C. No. 16 (2008).

        A bankruptcy court has held that IRS policy against consideration of Offers-in-Compromise
from bankrupt debtors is discriminatory and prohibited under 11 U.S.C. § 525 (a). Mills v. United
States, 240 B.R. 689 (Bankr., S.D. W. Va. 1999). Nevertheless, other courts disagree and Rev. Proc.
2003-71 still states that the IRS will not process an Offer-in-Compromise for a taxpayer who is in

bankruptcy. See e.g., In re 1900 M Restaurant Associates, Inc., 352 B.R. 1 (Bankr. D.D.C. 2006).

        In an Offer-in-Compromise is accepted, a taxpayer must file tax returns and pay her taxes for
the next 5 years. Non-compliance could result in a default and enforcement of the compromised taxes
by the IRS. Be sure to advise your client of her duty to file and pay taxes per the Offer-in-
Compromise agreement.

       8.       “Currently Not Collectible” Hardship

        A taxpayer may be placed in “Currently Not Collectible” status if collection would cause
undue hardship by leaving her unable to meet necessary 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, housekeeping 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 standard or the amount
actually paid, whichever is less. IRM § On-line access to the national and local standards
can be found at IRM § 5.15.1-2.

       “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. A bankruptcy court
may also have jurisdiction to determine a tax liability where the taxpayer has not fully paid the tax.
The rules for determining whether a tax is dischargeable are very complex.52 Income taxes are only
dischargeable if:

           See National Consumer Law Center Bankruptcy Manual; Borison, Effectively Representing your Client
Before the New IRS (ABA 2004), Ch. 21.

       !No fraud or willful evasion53
       !Tax return was due at least 3 years before bankruptcy filed
       !Tax return was actually filed at least 2 years before bankruptcy filed
       !Taxes assessed at least 240 days before bankruptcy filed

       These time periods are increased if the taxpayer filed a prior bankruptcy. 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.

        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 lawsuits 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 depending 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.54 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 proceeding. 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 prohibited under 11 U.S.C. § 525 (a). Mills v. United
States, 240 B.R. 689 (Bankr., S.D. W. Va. 1999); contra, In re 1900 M Restaurant Associates, Inc.,
352 B.R. 1 (Bankr. D.D.C. 2006).

       10.          Taxpayer Assistance Orders

       In 1998, Congress expanded the authority of the Taxpayer Advocate (IRS ombudsman) to

              See e.g., Matter of Bruner, 55 F.3d 195 (5 th Cir. 1995).

              Generally, a lien will be valid until the 10 year statute of limitations has run. IRC §§ 6322, 6502 (a).

issue Taxpayer Assistance Orders (TAO) to stop collection 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 action55
        !Delay of 30 days or more in resolving a taxpayer’s account problems
        !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.

       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 liability 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 thresholds 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). A taxpayer can’t use § 6015 (b) for an underpayment. Hopkins v. Comm’r, 121 T.C. 73, 88
(2003). 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 she:

        !Did not know or have reason to know about the unreported income or erroneous items, and

        !Did not receive benefits from the unreported income or erroneous items.

           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.”

         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. For a comprehensive
discussion of innocent spouse relief, see R. Nadler, The Innocent Spouse Manual (2009).56

         If the requesting spouse knew or had reason to know of the understatement, innocent spouse
relief is not available. Reg. § 1.6015-2(a)(3). The reason to know standard considers all the facts and
circumstances (including the nature of the item, the requesting spouse’s education and business
background, and the extent of that spouse’s participation) and inquires whether a reasonable person
in similar circumstances would have known of the understatement. Reg. § 1.6015-2(c).

         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. A taxpayer can’t use § 6015 (c) for an underpayment
Hopkins v. Comm’r, 121 T.C. 73, 88 (2003). The determination of separate liability is made without
regard to community property rights. Thus, the electing 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 of an erroneous item, as distinguished from
“reason to know”, to deny apportioned liability under §6015(c).57 Reg. § 1.6015-3(c)(2)(I); 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) apportioned 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 activities 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

               Go to to order a copy.

           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).

not prove that she actually knew that the charitable contribution deductions were false.

        However, the IRS may show that the requesting spouse had actual knowledge of an item
giving rise to the deficiency to deny relief under § 6015(c)(3)(C). The knowledge standard requires
actual and clear awareness of the existence of the item. Cheshire v. Comm’r, 115 T.C. 183, 194
(2000), aff’d 282 F.3d 326 (5th Cir. 2002). The IRS need not show that the spouse possesses
knowledge of the tax consequences of the item. Id., see also Jonson v. Comm’r, 118 T.C. 106 (2002),
aff’d 353 F.3d 1181 (10th Cir. 2003); Mitchell v. Comm’r, 292 F.3d 800, 805 (D.C. Cir. 2002) aff’g
T.C. Memo 2000-332; Hopkins v. Comm’r, 121 T.C. 73, 86 (2003).

         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 [6015(b)] or the separate liability
election [6015(c)] 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 relief from an underpayment of income tax. § 6015(b) and (c) only permit
relief from understatements or proposed deficiencies. Rev. Proc. 2003-61, §4.04 may even allow
refunds to the requesting spouse in some circumstances.

         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 liability. IRC § 66 (c) provides equitable relief in community property states where a joint
return was not filed. IRC § 6015(f) applies if a joint return was filed (even in community property

       Current IRS guidelines for § 6015 (f) and § 66 (c) equitable relief are in Rev. Proc. 2003-61,
IRB 2003-32 (eff. Nov. 1, 2003).58 In order to be eligible for equitable relief under § 6015(f), the
requesting spouse must satisfy 7 threshold conditions. Rev. Proc. 2003-61, § 4.01. Conditions 1 and
2 below don’t apply for a § 66(c) equitable relief request. The threshold conditions are:

        1.       Filing a joint return
        2.       Relief denied under § 6015(b) and (c)
        3.       Application withing 2 years of first collection activity59
        4.       No transfer of asset as part of fraudulent scheme
        5.       No transfer of disqualified assets
        6.       Requesting spouse did not file or fail to file with fraudulent intent
        7.       Item resulting in deficiency or underpayment is attributable to non-
                 requesting spouse, unless:

          Rev. Proc. 2003-61 supersedes Rev. Proc. 2000-15 for requests for relief filed after Nov. 1, 2003. Alioto
 v. Comm’r, T.C. Memo 2008-185, n. 15 at 23.

           But see, Lantz v. Comm’r, 132 T.C. No. 8 (2009), which declares condition 3 invalid as to § 6015(f)
 claims. The Tax Court has not decided whether time limits for § 66(c) equitable relief claims are invalid.

               " Attribution is due to operation of community property laws
               " Item is only nominally owned by requesting spouse
               " Non-requesting spouse misappropriated funds and the
                 requesting spouse had no knowledge or reason to know of
                 the misappropriation, or
               " Abuse not amounting to duress led the requesting spouse not
                 to challenge treatment of items. (For helpful discussion of the
                 “abuse exception”, see Brown v. Comm’r, TCS 2008-121).

        If a case involves an underpayment on a joint return, the IRS will ordinarily grant § 6015(f)
equitable relief if the taxpayer meets the 3 “safe harbor” conditions in § 4.02 of Rev. Proc. 2003-61.
See Gonce v. Comm’r, T.C. Memo 2007-328. Equitable relief under § 4.02 is available to all joint
return taxpayers with underpayments, including taxpayers in community property states.

       The § 4.02 “safe harbor” conditions are:

       1.      Marital status--The requesting spouse is no longer married or has not been a member
               of the nonrequesting spouse’s household during the 12 month period ending on the
               date of the request for relief..

       2.      No knowledge of underpayment--On the date the requesting spouse signed the
               return, the requesting spouse had no knowledge or reason to know that the
               nonrequesting spouse would not pay the income tax liability. The test for knowledge
               in an underpayment case is whether the requesting spouse knew or had reason to know
               that the nonrequesting spouse would not pay the income tax liability. See e.g., Hopkins
               v. Commissioner, 121 T.C. 73, 88 (2003); Washington v. Commissioner, 120 T.C.
               137, 151 (2005). For a good discussion of the knowledge factor, see Alioto v. Comm’r,
               T.C. Memo 2008-185.

       3.      Economic hardship–the requesting spouse will suffer economic hardship if relief is
               not granted. Generally, economic hardship exists if collection of the tax liability will
               cause the taxpayer to be unable to pay reasonable basic living expenses. This is
               determined by the following nonexclusive factors: (1) taxpayer’s age, employment
               status and history, ability to earn, number of dependents; (2) an amount reasonably
               necessary for food, clothing, housing, medical expenses, transportation, current tax
               payments, and expenses necessary to the taxpayer’s production of income; (3) cost of
               living in taxpayer’s geographic area; (4) the amount of property available to satisfy
               taxpayer’s expenses; (5) any extraordinary expenses; and any other factor bearing on
               economic hardship. See e.g., IRC § 301.6343-1 (b)(4); Alioto v. Comm’r, T.C. Memo
               2008-185, n. 15 at 23. supra at 32. This factor envisions consideration of the
               taxpayer’s retirement needs. Alioto, supra.

       A taxpayer may qualify for relief under § 4.03 of Rev. Proc. 2003-61 if he filed a joint tax

return, but does not qualify for “safe harbor” relief under § 4.02. Also, if partial relief is granted under
§ 4.02, a taxpayer may be eligible for total relief under § 4.03. Cf. Bruen v. Comm’r, T.C. Memo

         Equitable relief is available under § 4.03 for the following taxpayers:

         1.        A “community property state” taxpayer who did not file a joint return, who requested
                   relief under IRC § 66(c) and met the applicable threshold conditions of § 4.01, i.e.,
                   conditions 3 to 7.

         2.        A spouse who filed a joint return, who met the § 4.01 threshold conditions, but did not
                   qualify for “safe harbor” relief under § 4.02.

       Under § 4.03, no single factor is determinative. All factors must be considered and weighed
appropriately. Rosenthal v. Commissioner, T.C. Memo 2004-89. The factors in § 4.03 of Rev. Proc.
2003-61 are nonexclusive.

         Under § 4.03, the following factors may be considered:

         !Current marital status60
         !Current financial hardship or inability to pay basic living expenses61
         !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.
         !Spouses’ legal obligation to pay the tax liability pursuant to a divorce or agreement to pay
         the liability
         !Significant benefit received by the requesting spouse62
         !Whether the requesting spouse has made a good faith effort to comply with tax laws63

         Rev. Proc. 2003-61, § 4.03(2)(b) also sets forth additional factors that will weigh in favor of

             Divorce favors the taxpayer. Bruen v. Comm’r, T.C. Memo 2009-249. For married taxpayers, this factor
 is neutral. Butner v. Comm’r, T.C.Memo 2007-136.

            Alioto v. Comm’r; T.C. Memo 2008-185; Butner v. Comm’r, T.C. Memo 2007-136. The definition of
 economic hardship in § 4.02(1)(c) of Rev. Proc. 2003-61 is used for this factor. It is important to document the
 taxpayer’s wages, assets and expenses. See e.g., Marquez v. Comm’r, T.C.S. 2009-67. National and local IRS
 expense standards may be used where the taxpayer fails to document his expenses.

            The absence of significant benefit is a factor in favor of relief. Porter v. Commissioner, 132 T.C. No. 11,
 p. 15 (2009). The issue is whether the “innocent spouse” received a significant benefit from the unpaid tax liability
 beyond normal support. Normal support is measured by the circumstances of the particular parties. Porter, supra at
 15; see also Alioto v. Comm’r; T.C. Memo 2008-185; Billings v. Comm’r, T.C. Memo 2007-234.

               Tax compliance favors the taxpayer. Chou v. Comm’r, T.C. Memo 2007-102.

relief if present, but not weigh against relief if not present. Beatty v. Comm’r, T.C. Memo 2007-167.
These factors are:

        !Abuse experienced during marriage
        !Poor mental or physical health of requesting spouse

        Tax Court case law has been favorable to taxpayers seeking reversal 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.64

        In Wiest v. Comm’r., T.C. Memo 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 attributable 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 taxpayer did
not benefit from the underpayment attributable to his spouse.

       Ferrarese v. Comm’r., T.C. Memo 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 superseded) that the significant benefit factor
could only be considered as a factor against relief.

        Beatty, supra, is also a useful case as it provides a clear analysis of each factor and concludes
that despite the requesting spouse’s failure to timely pay taxes and constructive knowledge of tax due,
other factors weighed strongly in favor of 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(b), (c) or (f) 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); see also Christensen v. Comm’r, 523 F.3d 957 (2008). Thus, a

            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.

taxpayer may only obtain Tax Court review of a § 66(c) claim by raising the issue in a collection due
process appeal (or as a defense to a deficiency). Felt v. Comm’r, T.C. Memo 2009-245, n. 15 at 45.
Also, the Tax Court does not have jurisdiction to review denials of stand alone nondeficiency requests
for § 6015(f) equitable relief from tax liabilities incurred and paid before December 20, 2006. Billings
v. Comm’r, 127 T.C. 7, 17 (2006); see also, Kollar v. Comm’r, 131 T.C. No. 12 (2008)(jurisdiction
exists if accrued interest not paid before Dec. 20, 2006); Butner v. Comm’r, T.C. Memo 2007-136.
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(c) relief at any time after the IRS
asserts a deficiency. The legislative 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. The Form 8857 should be mailed to the IRS even if the taxpayer is communicating
directly with an IRS employee or appeals officer.

       One may also present an innocent spouse claim in an Offer-in-Compromise. See IRM; IRS Form 656-L, the doubt as to liability form. However, it is more efficient to first submit
an innocent spouse claim and pursue an Offer-in-Compromise if the innocent spouse claim is denied.

       Upon written request, a taxpayer may obtain information from the IRS on whether the IRS has
attempted to collect from the non-requesting spouse, the amount collected, current collection status,
and the reasons for suspension of collection. IRM

        An innocent spouse relief election must be made not later than 2 years after the IRS began
“collection activity” with respect to the electing spouse.65 “Collection activity” includes:

         !Notice of administrative levy or seizure66
         !Offset of an overpayment of the electing spouse67
         !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).

               Actual receipt of the notice of levy is not required. Mannella v. Comm’r, 132 T.C. No. 10 (2009).

               McGee v. Comm’r, 123 T.C. 314 (2004).

         It does not include:

         !Notice of deficiency (but you should assert innocent spouse relief as an affirmative defense
         within Tax Court Petition)
         !Demand for payment of tax

        The collection activity must be specifically directed to the electing spouse in order to trigger
the running of the 2 year limit. 68 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. 314 (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.

      Innocent spouse determinations may be appealed to an IRS Appeals Officer. See Rev. Proc.
2003-19, 2003-1 C.B. 371; IRM 25.15.12 (Appeal Procedures).

        The Tax Court recently held that a claim for § 6015(f) equitable relief is not barred by the 2
year limit applicable to § 6015(b) and (c) claims. Lantz v. Comm’r, 132 T.C. No. 8 (2009). The IRS
disagrees with the Lantz decision. CC-2009-012 (April 17, 2009). Lantz held that Reg. §1.6015-
5(b)(1) creating a 2 year limit was invalid. You should analyze your Circuit’s law to build an
argument that Lantz result would also apply under your Circuit’s law. See Caldwell v. Comm’r,
TCS 2009-95.69

        Tax Court review is available for denial of innocent spouse, separate liability or equitable
relief. IRC § 6015 (e). These claims may also be raised as affirmative defenses in a petition to
contest a statutory notice of deficiency or a petition to contest a notice of determination in a collection
due process appeal. The Tax Court has held that it also has jurisdiction to review unfavorable § 6015
(f) equitable relief determinations, including “stand alone” determinations.70

        The Tax Court no longer uses the abuse of discretion standard to review IRS denials of § 6015
(f) equitable relief. Porter v. Comm’r, 132 T.C. No. 11 (2009). Review of § 6015(f) claims is now
de novo. Id. In its de novo review of § 6015(f) determinations, the Tax Court analyzes the claim under
the Rev. Proc. 2003-61 procedures. Id. at 12. The parties may present evidence at the Tax Court trial
and are not bound by the administrative record. See Porter v. Comm’r, 130 T.C. No. 10 (2008);

            You will encounter IRS agents who argue that collection against the other spouse starts the 2 year time
 limit running.

          As of December 2009, the Tax Court has applied the Lantz result to cases arising in the 3d Circuit
 (Mannella), 5 th Circuit (Caldwell) and the 7 th Circuit (Lantz). Check for future Lantz rulings.

            However, review of 66(c) equitable relief determinations may be precluded for spouses in community
 property states filing separate returns. See Bernal v. Comm’r., 120 T.C. 102 (2003), IRC § 66 (c). Tax Court review
 may be obtained if the innocent spouse claim is raised in a collection due process appeal. Felt v. Comm’r, T.C.
 Memo 2009-245.

Comm’r v. Neal, 557 F.3d 1262 (11th Cir. 2009) aff’g T.C. Memo 2008-08.71 The Tax Court has not
ruled on whether de novo review also applies to equitable § 66(c) spouse relief. Felt v. Comm’r, T.C.
Memo 2009-245, n. 15. The procedures for the nonrequesting spouse to oppose relief are explained
in Rev. Proc. 2003-19.

        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 participate meaningfully in the Tax Court case. IRC § 6015
(e)(3)(B). A prior Offer-in-Compromise for a tax year will preclude innocent spouse relief as to that
tax year. IRM A prior bankruptcy case filed by the spouses in which the IRS filed a proof
of claim, may not bar a subsequent innocent spouse claim if the bankruptcy court did not make a
determination of joint liability. Rev. Rul. 2006-16, 2006-1 C.B. 694.

           Effect of Innocent Spouse Claim on Tax Collection

        An innocent spouse claim suspends pending collection until 90 days after a notice of
determination. If a Tax Court petition is timely filed, collection is further suspended until the Tax
Court decision is final. IRC § 6015(e)(1)(B)(i); IRM (7-17-09). Levies, but not liens, may
be released by an innocent spouse claim. The statute of limitations is suspended while the IRS is
prohibited from taking certain collection actions because of the innocent spouse claim. IRM

         If an innocent spouse claim is granted, the IRS may still collect the tax from the non-
requesting spouse’s interest in community property. See Ordlock v. Comm’r, 533 F.3d 1136 (9th Cir.
2008); Hegg v. IRS, 28 P.3d 1004 (Idaho 2001). Also, innocent spouse relief does not extinguish
liability that an innocent spouse may have as a transferee of the non-requesting spouse.

           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. If the
taxpayer proves duress, there is no need to reach the issue of innocent spouse relief. Stergios v.
Comm’r, T.C. Memo 2009-15.

        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.

           A joint election may be found if there was tacit consent. See IRM A joint return

                In Porter, the Tax Court held that it would continue to follow its ruling in Ewing v. Comm’r, 122 T.C. 32

with only 1 signature may be an invalid assessment as to the non-signing spouse. In this situation, the
IRS may be barred from assessing a proper amount against the non-signing spouse. IRM

         Innocent Spouse Relief Reconsideration

       In March 2008, the IRS decided to that it would offer reconsideration for denied innocent
spouse determinations. IRM § This allows the taxpayer to ask for reconsideration of
innocent spouse claims in a manner similar to the audit reconsideration process.

         12.      Injured Spouse Relief

         A taxpayer’s tax refund may not be paid to her if her spouse was delinquent 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.72 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 entitled to the income.73 IRC § 66 (b); Reg. § 1. 66-3. Only the IRS may invoke § 66(b).
Hardy v. Comm’r, 181 F.3d 1002 (9th Cir. 1999).

           IRC § 66 (a) relief is automatic if the requirements are met. For purposes of § 66 (a), any amount of
 income transferred 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.

        (3) Traditional innocent spouse relief74 from community property laws under IRC § 66 (c)
for an item of community income if:

                  (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 under the “flush language” of IRC § 66(c) for spouses who don’t meet
the requirements for traditional innocent spouse relief under IRC § 66 (c). See Rev. Proc. 2003-61,
IRB 2003-32.75

        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.

      Some community property income may be excludable from a spouse’s income by other laws.
Examples include:

       !pension distribution in a community property state is taxable to non-employee spouse even
though the employee spouse received distribution and turned funds over to non-employee spouse for
her property interest in pension as required by a state court judgment. Powell v. Comm’r, 101 T.C.
489 (1993); see also Mitchell v. Comm’r, 131 T.C. No. 15 (2008)(QDRO distribution taxable to non-
employee spouse in community property state).76

            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.

              Note that the “absence of significant benefit” test is different for equitable relief under IRC § 66(c), than
 for traditional relief under IRC § 66(c)(4). See Felt v. Comm’r, T.C. Memo 2009-245. It is easier to meet the § 66(c)
 absence of substantial benefit test.

            A different outcome may result when the employee spouse pays the non-employee spouse with his
 separate wages rather than the pension distribution.. Comm’r v. Dunkin, 500 F.2d 1065 (9 th cir. 2007).

       ! the spouse who does not receive an IRA distribution is not taxed on her community property
share of the IRA distribution. 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 distribution. 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.      Marital Disputes over Tax Refunds

        Ownership of tax refunds is governed by state law. See e.g., Rev. Rul. 2004-71, 72, 73, 74,
IRB 2004-30. In community property states, division of a tax refund may require an analysis of the
community and separate nature of the underlying income earned. By comparison, ownership of the
stimulus refund payments may be owned 50-50 and not depend on the parties’ respective incomes.
See e.g., In re Thompson, 396 B.R. 5 (Bankr. N.D. Ind. 2008).

        A practical way to resolve a dispute over a refund when the other spouse won’t cooperate, may
be the deposit of the check with 1 signature to the taxpayer’s account.

        15.      Penalty Abatement

        Penalties can be abated for reasonable cause.

        16.      Statute of Limitations for Collections

       The IRS has 10 years77 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, 866-860-4259.

        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 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.

        17.      Designation of Tax Payments

            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

        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. 501.78 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.

        18.        Criminal Penalties

       False statements to the IRS in the collection process are subject to criminal prosecution. IRC
§ 7206 (1); 18 U.S.C. § 1001.


       How do you advise a person who has failed to file tax return(s)? Under Treasury Circular 230,
§ 10.21, you must advise the client of the fact of her non-compliance and the consequences under the
IRC and regulations of such non-compliance.

        The bad news is that nonfiling is a crime if the taxpayer owes taxes. The statute of limitations
for criminal prosecution is 6 years.79 The good news is that 30% of nonfilers 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 limitations. 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

            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.

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 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 back to the 1992 tax year. 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 applicable 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 $1,900. In 2009, the maximum EIC is $5,657.

        The EIC can result in a tax refund even if the worker paid no tax whatsoever. 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 separately”, and the relationship, age and residency
tests for a qualifying child.

        3.          Income Limits

        In 2009, the applicable AGI limits for the EIC are:

        !$43,279 ($48,279 for married filing jointly) if taxpayer has more than 2 children
        !$40,295 ($45,295 for married filed jointly) if taxpayer has 2 children
        !$35,463 ($40,463 for married filed jointly) if taxpayer has 1 child
        !$13,440 ($18,440 for married filing jointly) if taxpayer has no children

        Historically, the AGI limits have increased each year.80 Note that in 2009, the law will change
to add a higher AGI limit for taxpayers with 3 qualifying children.

        4.          Earned Income

        Beginning in 2002, “earned income” includes wages, salaries, tips and other employee

              The modified AGI limits for married taxpayers filing jointly for prior years were:

                                       ›1 child                   1 child            0 child

 2008                                  $41,646                    36,995             15,880
 2007                                  $39,783                    35,241             14,590
 2006                                  $38,848                    34,001             14,120
 2005                                  $37,263                    33,030             13,750
 2004                                  $35,458                    31,338             12,490
 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

compensation, if includible in gross income81, plus net earnings from self-employment. Earned
income may also include an employer’s disability retirement plan benefits until the worker reaches
minimum retirement 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 compensation, nontaxable workfare payments,
scholarship or fellowship grants not reported on a Form W-2, 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 taxpayers 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-

       Many EIC errors involve married taxpayers who could not legally file as single or head of
household. If a taxpayer was married on December 31 of the tax year, review the taxpayer’s proof of
separate residences and the 50% support test for head of household filing status.

        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.

       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.

       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

           Prior to 2002, earned income included nontaxable earned income, e.g, voluntary salary reductions, 401 (k)
contributions, mandatory contributions to a state or local retirement plan, etc.

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 exemption, 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 dependent care credit.

        !Uniform definition of “qualifying child” is generally based on the residence, 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 test.

        !Waiver for dependency exemption by custodial parent does not apply to Earned Income
Credit, dependent care credit or head of household.

         Only taxpayers with a “qualifying child” get the large EICs. A “qualifying child” must meet
3 tests: relationship, age and residency. Beginning in the 2009 tax year, the definition of “qualifying
child” will also require (1) that the child must be younger than the person claiming the child and (2)
that the child has not filed a joint return.

        A qualifying child is a child who is the taxpayer’s:


        1.       Child, stepchild, adopted child, foster child82 or a descendant of any of them, or

         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

        2.       Sibling, step-sibling, half-sibling or a descendant of any of them


        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, regardless 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

        The Working Families Tax Relief Act of 2004 eliminates the “cared for as own
child” requirement for tax years beginning 2005. Before 2005, this was a commonly litigated issue.83

                                     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.

           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

          B.     Residency Test

        The majority of issues that arise under the “qualifying child” definition involve the residency
test. Generally, the contested issues involve documentation of the child’s residency, and not legal

         The child must have lived with the taxpayer in the United States for more than half of the
year. 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 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 ½ 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:

          !School attendance85
          !Business or military service
          !Detention in juvenile facility
          !Kidnapping (if not committed by family member)

Although not listed in IRS Publication 596, pre-conviction detention in a jail and 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”); Rowe v. Comm’r, 128 T.C. No.
3 (2007). In Rowe, the taxpayer was eligible for the Earned Income Credit even though she was absent

household, but not for others.

          Publication 596 suggests that a parent’s child may also be an “eligible foster child” of the parent’s same
sex relatives or friends who live with her. 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.

           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.

          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.

from the household for the last 7 months of the year due to her confinement in jail.

      EIC legislative history indicates that determinations of an individual’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 preparation 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, or file an electronic return without using a tax
preparation service. 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.

       Beginning with 2002, the AGI tie breaker rules were changed substantially.86 See IRC §
32(c)(1)(C). The Working Families Tax Relief Act of 2004 retains the 2002 tiebreaker rules for tax
years beginning 2005.

        Under current law, if 2 eligible persons claim the EIC, the following tie breaker rules apply:

        1.         Parent wins over non-parent87
        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 tiebreaker 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,

            Prior to 2002, only the “eligible individual” with the higher modified AGI could claim the EIC. IRC § 32
 (c)(1)(C); Jackson v. Comr., TCM 1996-54. Under the prior rules, relatives or friends with a higher modified AGI,
 but no earned income and therefore ineligible for the EIC, could defeat the parent’s EIC claim.

              A parent should win over a “step-parent.”

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.

         8.         IRS Audits of the EIC–What to Expect

        The IRS audits many Earned Income Credit (EIC) returns due to the high error rates.88 Audits
occur when more than 1 taxpayer claims a child for the EIC. Only 1 taxpayer may legally claim a
child for the EIC.89 Correspondence audits are used to examine EIC claims. The average EIC pre-
refund audit takes 225 days to resolve.90

      Typically, an EIC disallowance will be accompanied by a disallowance of the head of
household filing status, dependency exemptions and child tax credit.

        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 erroneous payments.
Qualifying child errors account for at least 31% of EIC errors. The vast majority of qualifying child
errors occur because the residency test is not met.91

         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 qualifying child of another
         person with a higher AGI

             The EIC rules are complex. This complexity leads to errors by both the IRS and taxpayers. In prior years,
 the estimated 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. W hile 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).

        !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 year

        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 taxpayer’s EIC claim. Many indigent taxpayers find the IRS demands for
documentation daunting and are unable to satisfy the IRS without a tax professional’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 opportunity 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.

       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 anticipation loans from the taxpayers rather
than have them file a correct paper tax return claiming the child who resided with them.

        B.      How to Document and Prove an EIC Claim in an Audit or Appeal

        Residency is commonly contested in an EIC audit. 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 apartments. 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 witnesses.

        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.

        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 dependents.

       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 child tax credit can also be large.

        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 2008, 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 $15,700. For higher income
taxpayers, the “married filing jointly” status generally increases the EIC by less than $500.

        For many low-income taxpayers, the head of household filing rate does not lower their taxes.
For example, a 2008 EIC taxpayer’s tax refund or tax owed will be virtually the same for single or
head of household for incomes below $15,700. Loss of 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
a few hundred dollars. By comparison, the EIC would provide a refund of about $2,200 to $3,900
for a 2008 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 household filing status or dependency exemptions if those
items have little or no effect on the taxpayer’s tax refund.92 Run a tax return for the taxpayer without
the head of household filing status to see how much money is at issue.

        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 preparers do not know this. Instead, they take the
position that a single taxpayer has to meet the head of household filing status to get the EIC. They are

         The head of household status is, however, absolutely crucial for taxpayers who are married
on December 31 of the tax year and who cannot file as “married filing jointly.” These taxpayers will
not qualify for pre-2005 EICs unless they meet the requirements for head of household filing status
as to at least 1 child.93

       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 year94
        ! they paid more than half the cost of maintaining the household

        For years before 2005, another major audit issue was whether such married taxpayers qualify

           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).

              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.

for a dependency exemption as to at least 1 child95 Fortunately, most pre-2005 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. After 2005, the dependency
exemption is not a prerequisite for a married, but separated taxpayer to receive an EIC.

        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.96 Therefore,
they may not qualify for the head of household filing status if their earned income is less than their
income from third parties.

       11.   A Taxpayer May Be Eligible for an EIC Even If He Does Not Have a Qualifying

        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 Rules

        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
§ 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

           Beginning with the 2005 tax year, the dependency exemption requirement has been eliminated by the
W orking 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 (5 th
Cir. 1981) aff’g TCM 1980-111; Lutter v. Comr., 514 F.2d 1095 (7 th Cir. 1975); Rev. Rul. 74-543, 1974-2 C.B. 39;
IRS Pub. 501.

procedures. IRC § 6213 (g)(2). The EIC 10 year ban is often asserted with a civil fraud penalty.

        14.      Death and the EIC

       A representative may file for the EIC refund if the decedent was eligible 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 creditors. See e.g., In re
Collins, 170 F.3d 512 (5th Cir. 1999).97 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.

        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.


        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.

             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.

        (However, a dependent parent may not have to live with the taxpayer).

        ! Paid more than half the cost of keeping up the home for the year.

IRC § 2(b); §7703 (b); IRS Publication 501 (2008). A helpful chart for evaluating who is a
“qualifying person” for filing as head of household is included in IRS Publication 501.

        2.          Unmarried

        Persons who are single or divorced on the last day of the year are “unmarried.”98 They can
qualify for head of household filing status even if they don’t qualify for a dependency exemption for
their child, stepchild or grandchild.

        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 exemption for her child, stepchild, or foster child (Note: other
        relatives don’t count and dependency exemption requirement is inapplicable where taxpayer
        is custodial parent who has released exemption to noncustodial parent or where the
        noncustodial parent meets the support test for children of divorced or separated parents).

Generally, the above two rules do not apply to persons who were actually unmarried at the end of the
year. For unmarried taxpayers, the dependency exemption test only applies to relatives other than
children, stepchildren, foster children or grandchildren.99

        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. Reg. § 1.2-2(c)(1). A household is considered occupied during temporary
absences due to “special circumstances.” The regulations expressly list the following as special
circumstances: 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

            If the taxpayer’s spouse died during the year, she is considered married for the whole year and may elect
married filing jointly. Taxpayers may qualify as “married” if they have a valid common law marriage recognized in
the state they live in or the state where the common law marriage began. A taxpayer is considered “unmarried” for
head of household purposes if her spouse is a nonresident alien at any time during the year and she does not choose
to treat her nonresident spouse as a resident alien.

              The dependency test will apply to married children.

that the person will return to the household after the temporary absence. A stay in a hospital is
temporary 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 temporary. Petlow v. Comm’r., 34 TCM 51, 54
(1975).Pre-conviction incarceration is a temporary absence. Rowe v. Comm’r, 128 T.C. No. 3 (2007).

       The IRS and Tax Court require the household to be the taxpayer’s principal 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 necessarily 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 of household status if each furnishes more than half of her household’s expenses).

       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 occupied 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 taxpayers under IRC § 2 and
qualified persons for “married, but deemed unmarried” taxpayers under IRC § 7703 (b). “Married
but deemed unmarried” taxpayers are only entitled to head of household status if they live in a home
with their children, step children, foster children or descendants of their children. On the other hand,
a broad range of occupants, including many relatives (but not all), may entitle an unmarried taxpayer
to head of household status under IRC § 2. Note that, from 2000 to 2004, 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-

       Expenses of maintaining a household include:

       !Property taxes and insurance
       !Mortgage interest

       !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:

       !Medical treatment
       !Life insurance
       !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 ½ 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 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 maintaining 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 furnishing less than ½ the cost of maintaining the
household. See e.g. Huynh v. Comm’r., TCM 2002-237. Public or charity assistance received because
of disasters may not count as other support for the cost of maintaining a household

       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 household 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”).


       1.      Overview

       The Working Families Tax Relief Act of 2004 amended IRC § 152 and 151 (c) for tax years

beginning in 2005. The WFTRA defines a dependent as a “qualifying child” or “qualifying relative.”
The “qualifying child” test eliminates the support test (other than for a child who provides more ½
his own support) and replaces it with a residency test. Pre-2005 law for dependency exemptions is
discussed in an Appendix to this manual.

       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 can be
found in IRS Publication 501.

        The dependency exemption may affect other tax issues. Some taxpayers may need the
dependency exemption to qualify for the head of household 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.      General requirement of qualifying child or qualifying relative

        Generally, a taxpayer can claim a person as a dependent if he is a qualifying child or
qualifying relative.

       A.      Qualifying child

       There are 5 tests for “qualifying child”:

       !Special test for qualifying child of more than one person

       (1)     Relationship

       The “child” must be:

       !A child, stepchild, foster child or a descendant of any of them, or

       !A sibling, half-sibling, step sibling, or a descendant of any of them

       (2)     Age

       The “child” must be:

       !Under the age of 19, or

        !Under the age of 24 and a “full-time” student, or

        !Permanently and totally disabled at any time during the year, regardless of age,100

        (3)        Residency

       The “child” must have lived with the taxpayer for more than half the year. There are
exceptions for temporary absences, children who were born or died during the year, kidnapped
children and children of divorced and separated parents.

        In most cases, a child of divorced or separated parents is the “qualifying child” of the custodial
parent. The “custodial parent” is the parent with whom the child lived for the greater part of the year.

        However, the child may be treated as the qualifying child of the noncustodial parent if:

        1.         The parents are divorced or legally separated, separated under a written separation
                   agreement, or lived apart at all times during last 6 months of the year, and

        2.         The child received over half of his support from the parents, and

        3.         The child is in the custody of one or both of the parents for more than half the year,

        4.         Either (a) the custodial parent signs a written declaration that he will not claim the
                   dependency exemption, and the noncustodial parent attaches the declaration to his
                   return, or (b) a pre-1985 divorce or maintenance decree or separation agreement that
                   applies to 2008, states that the noncustodial parent can claim the child as a dependent,
                   and the noncustodial parent provides at least $600 of the child’s support during the

        These rules also apply to parents who never married.

        (4)        Support test for qualifying child

        The child cannot have provided more than half of his support for the tax year. This test is
different than the test for support of qualifying relative.

        (5)        Special test for qualifying child of more than one person

        Only one taxpayer can treat the child as a “qualifying child.” Sometimes, a child meets the
qualifying child tests for more than one person. If more than one person have the same qualifying

               Halbin v. Comm’r, T.C. Memo 2009-18.

child, they can decide who will treat the child as a qualifying child. If they cannot agree, the following
tiebreaker rules are used:

        a.      Parent wins if only one person is the child’s parent
        b.      If both are parents, and they do not file joint return, the person with whom the child
                lived for the longer period in the year, wins
        c       If both are parents, no joint return, and child lived with them same amount of time,
                the parent with higher AGI, wins
        d.      None of the persons are a parent, the person with highest AGI wins

        If the child is treated as the qualifying child of the noncustodial parent under special rules for
divorced or separated parents, only the noncustodial parent may claim the dependency exemption and
child tax credit. The noncustodial parent must attach a Form 8332 to his return. Chamberlain v.
Comm’r, T.C. Memo 2007-178. However, the noncustodial parent cannot claim the Earned Income
Credit, the child as a qualifying child for head of household filing status, the credit for child and
dependent care expenses, or the exclusion for dependent care benefits.

        B.      Qualifying relative

        There are 4 tests for “qualifying relative.”

        !Not a qualifying child
        !Member of household or relationship test
        !Gross income test
        !Support test

        There is no age test for qualifying relative.

        (1)     Not a qualifying child

        A child is not a taxpayer’s qualifying relative if he is the qualifying child of the taxpayer or
any other taxpayer. However, a child of a person not required to file a tax return may meet the test
for qualifying relative.

        (2)     Member of household or relationship test

        To meet this test, a person must either live with the taxpayer for the entire year or meet one
of these relationship tests:

        !Child, stepchild, foster child or descendant of any of them
        !Sibling, step-sibling, half-sibling or descendant of any of them
        !Parent, grandparent, or other direct ancestor (but not a foster parent)

       !Child of sibling
       !Sibling of parent
       !Child-in-law, parent-in-law, sibling-in-law

       Any relationships established by marriage qualify only if the marriage has not ended by death
or divorce.

       (3)     Gross income test

       The gross income of the “qualifying relative” must be less than $3,500 (for 2008).

       (4)     Support test (for qualifying relative)

        To meet this test, a taxpayer generally must provide more than half of a person’s total support
during the tax year.

       (5)     Special support test for children of divorce or separated parents

        In most cases, a child of a divorced or separated parent will be the qualifying child of one of
the parents. However, if the child does not meet the qualifying child test for either parent, he may be
a qualifying relative of one of the parents. See rules for noncustodial parent to claim as qualifying


         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 independent contractor. For a detailed discussion of the
tests for employee status, see ABA Section on Taxation, Effectively Representing Your Client Before
the IRS, Ch. 17 (ABA 2009).

        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 information returns. § 7434 specifies damages as the minimum of $5,000 or
actual damages.


       Debt cancellation, Truth-in-Lending rescission and foreclosure may have income tax
consequences. A taxpayer who receives a Form 1099-C for debt cancellation income should review
the form for accuracy and request correction by the lender if inaccurate.

         Income from debt cancellation is generally includible in gross income. IRC § 61 (a)(2).
Typically, debt cancellation income arises when a lender forgives debt or a government waives an
overpayment.101 However, this income is excluded from income if the debt cancellation 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 insolvent taxpayer’s income. IRC § 108 (a)(3).

       The Tax Court has held that exempt assets, e.g., a homestead exemption for the family home,
must be included in determining whether a taxpayer 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 discharged 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 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.

        What are the tax consequences if the taxpayer successfully rescinds a transaction pursuant to
the Truth-in-Lending Act or another consumer protection 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 disputed. 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.

             See e.g. Waterhouse v. Comm’r, T.C. Memo 1994-467 (waiver of VA overpayment creates debt
 cancellation income).

       The Tax Court has ruled that a reduced payment in settlement of a credit card debt constituted
debt cancellation income. Payne v. Comm’r, T.C. Memo 2008-66. Because no exclusions applied in
Payne, the write-off of the credit card debt was income to the taxpayer.

        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.102 Gain for
“recourse” debt is bifurcated into gain from the sale and gain from debt cancellation. Here, the
amount realized is the fair market value of the asset.103 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.

        The Mortgage Forgiveness Debt Relief Act of 2007 allows the exclusion of debt cancellation
income from mortgage restructuring or mortgage foreclosure on a taxpayer’s home for debts forgiven
for the years, 2007-12. The Act applies only to forgiveness or cancellation of debt to buy, build or
substantially improve a principal home, or to refinance debt incurred for these purposes. A Form 982
must be filed with the taxpayer’s return to claim this exclusion from income.

       Discharge of nonbusiness debt between August 24, 2005 and January 1, 2007 may be
excluded from income for taxpayers whose primary homes were located in the Katrina disaster zone.


         Statutory attorney fees may also trigger tax liability. In Commissioner v. Banks, 543 U.S. 426
(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.104 The attorney fees may be partially 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

           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 (9 th Cir. 1987).

           The 5 th, 6 th, 9 th and 11 th Circuits had held that attorney fees were not included in the client’s gross
income. Banks did not resolve the taxability of statutory attorney fees to a plaintiff who obtains equitable relief only.

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 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 personal injury cases (contingency fees) are still taxable to the client.


         Relocation payments under the Uniform Relocation Act are not considered income for federal
tax purposes. 42 U.S.C. § 4636. Utility allowance refunds should not be taxable income since they
are a recovery or refund of public assistance that should have been granted to the tenant. Fraudulently
obtained public assistance is taxable income. Therefore, the value of the rental subsidy fraudulently
obtained could be taxable income to a subsidized housing tenant.


       SSI benefits are not subject to income tax (except possibly in cases of fraud). However, lump
sum Social Security benefits and ongoing Social Security benefits may be subject to income tax. After
1983, even Social Security disability benefits are subject to tax. See Reimels v. Comm’r, 123 T.C. 245
(2004); Maki v. Comm’r, T.C.Memo 1996-209. Generally up to 50% of Social Security benefits are
taxable to low-income taxpayers.

        Social Security benefits are included in gross income for the tax year in which the benefits are
received. IRC § 86(a)(1). The taxpayer may make an election to attribute a portion of the lump sum
benefits to prior tax years. IRC § 86(e). See IRS Publication 915 for a detailed explanation of the
election and worksheets. This election should lower the tax impact of a lump sum Social Security
benefit. The taxpayer’s attorney fees for the disability appeal may be deducted from income to the
same extent that Social Security is taxed. Rev. Rul. 87-102. This limited deduction is a Schedule A
deduction and subject to the 2% of adjusted gross income limit on certain itemized deductions. If the
taxpayer uses all or part of a Social Security lump sum to reimburse his long term disability carrier,
special tax relief may be available under IRC § 1341. If the repayment to the LTD carrier is under
$3,000, the taxpayer gets a deduction on the current year’s return. If the repayment is over $3,000,
the taxpayer chooses either the deduction or a tax credit for the excess tax paid in the prior year.


       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., T.C. Memo 1986-495. Under federal law, the parent who meets the
relationship, 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.

        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 retaliation 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

       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

        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.


       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.

        Commercial site that has tax links.

        Online resources for tax relief


        ABA Section on Taxation, Effectively Representing Your Client Before the IRS, 4th ed. (ABA

        Borison, Effectively Representing Your Client Before the New IRS, 3rd ed. (ABA 2004)

        King, Discharging Taxes in Bankruptcy, (KingsPress 2001)

        Nadler, The Innocent Spouse Manual (2009)

        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, 391-3d T.M., Employment Status: Employee or Independent Contractor

        Maule, 501-3d T.M., Gross Income, Overview of Conceptual Aspects

        Maule, 503-3d T.M., Deductions: Overview & Conceptual Aspects

        Maule, 506-2d T.M., Tax Credits: Concepts & Calculation

        Maule, 507-2d T.M., Income Tax Liability: Concepts & Calculation

        Wofford, 515-2d T.M., Divorce and Separation

       Alexander, 623-3d T.M., IRS Procedure: Examinations & Appeals

       Peyser, 627-3d T.M., Limitation Periods, Interest on Underpayments & Overpayments, &

       Peyser, 630-3d T.M., Tax Court Litigation

       Tarr, 634-2d T.M., Civil Tax Penalties

       Starczewski, 638-3d T.M., Federal Tax Collection Procedure-Defensive Measures

       List serves and newsletters

       The Low-Income Tax Practice Newsletter, edited by Robert Nadler,

       Community Tax Law Project Newsletter

       ABA’s list serve:


       1.      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 indigents.

       IRC § 152(e)(1) permits the “custodial parent” to claim her child as a dependent if the child:

       !Receives over ½ of her support from both parents, and

       !Is in the custody of one or both of the parents for more than ½ of the calendar year, and

       !The parents are divorced under a divorce decree, or

       !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 noncustodial parent actually provided more than ½ 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.”105 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

        “Custodial parent” is the “parent having custody for the greater part of the calendar year.”
IRC § 152(e)(1).106 “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 custody107, 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
difficult 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 ½ 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 custodial
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 ½ year).

       There are 3 exceptions to the § 152 (e)(1) rule that the custodial parent is deemed to provide
over ½ the child’s support:

        !The custodial parent releases the exemption to the noncustodial parent, 108

        !A multiple support agreement is in effect,

          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 mid-year.

            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.

       !A pre-1985 divorce decree is in effect that has not been modified to apply the current rules.

       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 ½ 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
exemption 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 8332.109 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.110 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 requirement. In Cramer v. Comm’r., TCS 2003-2, the court denied a dependency
exemption to a noncustodial parent who relied on a divorce decree stipulation 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 declaration
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.111 The gross income

            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 W FTRA of 2004, which
becomes effective on January 1, 2005.

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 ½ of the dependent’s total support for the year must have been furnished by the
taxpayer112 (with exceptions for divorced or separated parents and multiple support agreements)

       !The dependent must be one of the following relationships to the taxpayer:

       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-law113
       8.          Person (other than taxpayer’s spouse) who lives in house and is member of household
                   for entire year114

       !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 ½ his own support) for tax
years beginning in 2005.

         Generally, a taxpayer must furnish more than ½ 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, determine the total support
from all sources and allocate support payments among the various payers. Total support for the tax
year will include:

              This support test is eliminated for tax years beginning in 2005.

              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.”

        ! 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 apartment or house or the costs of home ownership. It can
include a reasonable 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.115 Similarly, the fair market rental value of a
home owned by a taxpayer may be higher or lower than the monthly mortgage payment.

       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, education, 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, entertainment, 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

             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

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 allocated per capita among the recipients of the assistance as support provided by

        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 household 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.


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