IRS Restructuring and Reform Act of
1998
Senate
Report page3
 
1.
Expansion of authority to award costs and certain
fees (sec. 3101 of the bill and sec. 7430 of the
Code)
Present
Law:
Any person who substantially prevails in any action
by or against the United States in connection with
the determination, collection, or refund of any tax,
interest, or penalty may be awarded reasonable
administrative costs incurred before the
IRS
and reasonable litigation costs incurred in
connection with any court proceeding. Reasonable
administrative costs are defined as (1) any
administrative fees or similar charges imposed by
the
IRS
and (2) expenses, costs and fees related to
attorneys, expert witnesses, and studies or analyses
necessary for preparation of the case, to the extent
that such costs are incurred before earlier of the
date of the notice of decision by
IRS
Appeals or the notice of deficiency (sec.
7430(c)(2)). Net worth limitations apply.
Reasonable litigation costs include reasonable fees
paid or incurred for the services of attorneys,
except that the attorney's fees will not be
reimbursed at a rate in excess of $110 per hour
(indexed for inflation) unless the court determines
that a special factor, such as the limited
availability of qualified attorneys for the
proceeding, justifies a higher rate.
Rule 68 of the Federal Rules of Civil Procedure (FRCP)
provides a procedure under which a party may recover
costs if the party's offer for judgment was rejected
and the subsequent court judgment was less favorable
to the opposing party than the offer. The offering
party's costs are limited to the costs (excluding
attorney's fees) incurred after the offer was made.
The FRCP generally apply to tax litigation in the
district courts and the United States Court of
Federal Claims.
Code section 7431 permits the award of civil damages
for unauthorized inspection or disclosure of return
information. The Federal appellate courts are split
over whether a party who substantially prevails over
the United States in an action under Code section
7431 is eligible for an award of fees and reasonable
costs.28
Reasons
for Change
The Committee believes that taxpayers should be
allowed to recover the reasonable administrative
costs they incur where the
IRS
takes a position against the taxpayer that is not
substantially justified, beginning at the time that
the
IRS
establishes its initial position by issuing a letter
of proposed deficiency which allows the taxpayer an
opportunity for administrative review by the
IRS
Office of Appeals.
The Committee believes that the pro bono publicum
representation of taxpayers should be encouraged and
the value of the legal services rendered in these
situations should be recognized. Where the
IRS
takes positions that are not substantially
justified, it should not be relieved of its
obligation to bear reasonable administrative and
litigation costs because representation was provided
the taxpayer on a pro bono basis.
The Committee is concerned that the
IRS
may continue to litigate issues that have previously
been decided in favor of taxpayers in other
circuits. The Committee believes that this places an
undue burden on taxpayers that are required to
litigate such issues. Accordingly, the Committee
believes it is important that the court take into
account whether the
IRS
has lost in the courts of appeals of other circuits
on similar issues in determining whether the
IRS
has taken a position that is not substantially
justified and thus liable for reasonable
administrative and litigation costs.
The Committee believes that settlement of tax cases
should be encouraged whenever possible. Accordingly,
the Committee believes that the application of a
rule similar to FRCP 68 is appropriate to provide an
incentive for the
IRS
to settle taxpayers' cases for appropriate amounts,
by requiring reimbursement of taxpayer's costs when
the
IRS
fails to do so.
The Committee believes that when the
IRS
violates taxpayer's right to privacy by engaging in
unauthorized inspection or disclosure activities, it
is appropriate to reimburse taxpayers for the costs
of their damages.
Explanation
of Provision
The provision :
(1) moves the point in time after which reasonable
administrative costs can be awarded to the date on
which the first letter of proposed deficiency which
allows the taxpayer an opportunity for
administrative review in the
IRS
Office of Appeals is sent;
(2) permits awards of reasonable attorney's fees by
deleting the hourly rate caps (and the exceptions to
those caps);
(3) permits the award of reasonable attorney's fees
to specified persons who represent for no more than
a nominal fee a taxpayer who is a prevailing party;
(4) provides that in determining whether the
position of the United States was substantially
justified, the court shall take into account whether
the United States has lost in other courts of appeal
on substantially similar issues;
(5) provides that if a taxpayer makes an offer after
the taxpayer has a right to administrative review in
the
IRS
Office of Appeals, the
IRS
rejects the offer, and later the
IRS
obtains a judgment29
against the taxpayer in an amount that is equal to
or less than the taxpayer's offer for the amount of
the tax liability (excluding interest), reasonable
costs and attorney's fees from the date of the offer
would be awarded; and
(6) permits the award of attorney's fees in actions
for civil damages for unauthorized inspection or
disclosure of taxpayer returns and return
information. The above rules for making awards apply
subject to the same net worth limitations as under
present law.
Effective
Date
The provision applies to eligible costs and services
incurred more than 180 days after the date of
enactment.
2.
Civil damages for collection actions (sec. 3102 of
the bill and secs. 7426 and 7433 of the Code)
Present
Law
A taxpayer may sue the
United States
for up to $1 million of civil damages caused by an
officer or employee of the
IRS
who recklessly or intentionally disregards
provisions of the Internal Revenue Code or Treasury
regulations in connection with the collection of
Federal tax with respect to the taxpayer.
Reasons
for Change
The Committee believes that taxpayers should also be
able to recover economic damages they incur as a
result of the negligent disregard of the Code or
regulations by an officer or employee of the
IRS
in connection with a collection matter. The
Committee also believes that taxpayers should be
able to recover civil damages they incur as a result
of a willful violation of the Bankruptcy Code by an
officer or employee of the
IRS
. As third parties may also be subject to
IRS
collection actions, the Committee believes that it
is appropriate to afford them the opportunity to
recover damages for unauthorized collection actions.
Explanation
of Provision
The provision permits (1) up to $100,000 in civil
damages caused by an officer or employee of the
IRS
who negligently disregards provisions of the
Internal Revenue Code or Treasury regulations in
connection with the collection of Federal tax with
respect to the taxpayer, and (2) up to $1 million in
civil damages caused by an officer or employee of
the
IRS
who willfully violates provisions of the Bankruptcy
Code relating to automatic stays or discharges. The
provision also provides that persons other than the
taxpayer may sue for civil damages for unauthorized
collection actions. No person is entitled to seek
civil damages in a court of law without first
exhausting administrative remedies.
Effective
Date
The provision is effective with respect to actions
of officers or employees of the
IRS
occurring after the date of enactment.
3.
Increase in size of cases permitted on small case
calendar (sec. 3103 of the bill and sec. 7463 of the
Code)
Present
Law
Taxpayers may choose to contest many tax disputes in
the Tax Court. Special small case procedures apply
to disputes involving $10,000 or less, if the
taxpayer chooses to utilize these procedures (and
the Tax Court concurs) (sec. 7463). The
IRS
cannot require the taxpayer to use the small case
procedures. The Tax Court generally concurs with the
taxpayer's request to use the small case procedures,
unless it decides that the case involves an issue
that should be heard under the normal procedures.
After the case has commenced, the Tax Court may
order that the small case procedures should be
discontinued only if (1) there is reason to believe
that the amount in controversy will exceed $10,000
or (2) justice would require the change in
procedure.
Small tax cases are conducted as informally as
possible. Neither briefs nor oral arguments are
required and strict rules of evidence are not
applied. Most taxpayers represent themselves in
small tax cases, although they may be represented by
anyone admitted to practice before the Tax Court.
Decisions in a case conducted under small case
procedures are neither precedent for future cases
nor reviewable upon appeal by either the government
or the taxpayer.
Reasons
for Change
The Committee believes that use of the small case
procedures should be expanded.
Explanation
of Provision
The provision increases the cap for small case
treatment from $10,000 to $50,000. The Committee
recognizes that an increase of this size may
encompass a small number of cases of significant
precedential value. Accordingly, the Committee
anticipates that the Tax Court will carefully
consider
IRS
objections to small case treatment, such as
objections based upon the potential precedential
value of the case.
Effective
Date
The provision applies to proceedings commenced after
the date of enactment.
4.
Expansion of Tax Court jurisdiction to responsible
person penalties (sec. 3104 of the bill and sec.
6672 of the Code)
Present
Law
In general, employers are required to withhold
income taxes (sec. 3402) and social security taxes
(sec. 3102) from their employee's wages. These
withheld taxes constitute a trust in favor of the
United States
from the time that the employer deducts them from
the employee's wages, and the employer is liable to
the government for the payment of such taxes (sec.
7501(a)). Section 6672 subjects all persons
considered responsible for the withholding and
payment of taxes to a penalty equal to the amount of
taxes due where the employer fails to turn over such
funds to the government (the "responsible
person" penalty, also known as the "100
percent" penalty). Generally, the determination
of whether a person is a "responsible
person" is a question of the person's status,
duty, and authority in the context of the business
which has failed to collect and pay over taxes
required to be withheld. A responsible person
penalty may also be imposed on a payroll lender
(sec. 3505).
The Tax Court has no jurisdiction over the
determination of the correctness of the assessment
of the responsible person penalty. Accordingly, as
the Tax Court is the only pre-payment forum for the
determination of tax liability, the imposition of
the responsible person penalty can only be
challenged in a refund suit in the appropriate
district court or the U.S. Court of Federal Claims
after payment of such penalty. The responsible
person penalty is a divisible tax. Thus, unlike a
refund suit for income taxes, a responsible person
need not pay the full amount of the assessment to
invoke the jurisdiction of the district court or the
U.S. Court of Federal Claims. Instead, the alleged
responsible person may commence a refund suit after
payment of the portion of the penalty attributable
to one employee for one quarter.
Reasons
for Change
The Committee is concerned that persons who have a
responsible person penalty assessed against them
must pay a portion of the penalty before challenging
the imposition of the penalty, before there is a
judicial determination that they have any liability.
Explanation
of Provision
The provision provides Tax Court jurisdiction over
the "responsible person" penalty.
Accordingly, the responsible person does not have to
make a payment before challenging the imposition of
the penalty.
Effective
Date
The provision applies to penalties imposed after the
date of enactment.
5.
Actions for refund with respect to certain estates
which have elected the installment method of payment
(sec. 3105 of the bill and sec. 7422 of the Code)
Present
Law
In general, the U.S. Court of Federal Claims and the
U.S.
district courts have jurisdiction over suits for the
refund of taxes, as long as full payment of the
assessed tax liability has been made. Flora v.
United States , 357 U.S. 63 (1958), aff'd on
reh'g, 362 U.S. 145 (1960). Under Code section 6166,
if certain conditions are met, the executor of a
decedent's estate may elect to pay the estate tax
attributable to certain closely-held businesses over
a 14-year period. Courts have held that U.S.
district courts and the U.S. Court of Federal Claims
do not have jurisdiction over claims for refunds by
taxpayers deferring estate tax payments pursuant to
section 6166 unless the entire estate tax liability
has been paid (i.e., timely payment of the
installments due prior to the bringing of an action
is not sufficient to invoke jurisdiction). See,
e.g., Rocovich v. United States, 933 F.2d 991
(Fed. Cir. 1991), Abruzzo v.
United States
, 24 Ct. Cl. 668 (1991). Under section 7479, the
U.S. Tax Court has limited authority to provide
declaratory judgments regarding initial or
continuing eligibility for deferral under section
6166.
Reasons
for Change
The Committee believes that the refund jurisdiction
of the U.S. Court of Federal Claims and the
U.S.
district courts should apply without regard to
whether the taxpayer has elected, and the Secretary
accepted, the payment of that tax in installments.
Explanation
of Provision
The provision grants the U.S. Court of Federal
Claims and the
U.S.
district courts jurisdiction to determine the
correct amount of estate tax liability (or refund)
in actions brought by taxpayers deferring estate tax
payments under section 6166, as long certain
conditions are met. In order to qualify for the
provision, (1) the estate must have made an election
pursuant to section 6166, (2) the estate must have
fully paid each installment of principal and/or
interest due (and all non-6166-related estate taxes
due) before the date the suit is filed, (3) no
portion of the payments due may have been
accelerated, (4) there must be no suits for
declaratory judgment pursuant to section 7479
pending, and (5) there must be no outstanding
deficiency notices against the estate. In general,
to the extent that a taxpayer has previously
litigated its estate tax liability, the taxpayer
would not be able to take advantage of this
procedure under principles of res judicata.
Taxpayers are not relieved of the liability to make
any installment payments that become due during the
pendency of the suit (i.e., failure to make such
payments would subject the taxpayer to the existing
provisions of section 6166(g)(3)).
The provision further provides that once a final
judgment has been entered by a district court or the
U.S. Court of Federal Claims, the
IRS
is not permitted to collect any amount disallowed by
the court, and any amounts paid by the taxpayer in
excess of the amount the court finds to be currently
due and payable are refunded to the taxpayer, with
interest. Lastly, the provision provides that the
two-year statute of limitations for filing a refund
action is suspended during the pendency of any
action brought by a taxpayer pursuant to section
7479 for a declaratory judgment as to an estate's
eligibility for section 6166.
Effective
Date
The provision is effective with respect to claims
for refunds filed after the date of enactment.
6.
Tax Court jurisdiction to review an adverse
IRS
determination of a bond issue's tax-exempt status
(sec. 3106 of the bill and sec. 7478 of the Code)
Present
Law
Interest on debt incurred by States or local
governments generally is excluded from gross income
if the proceeds of the borrowing are used to carry
out governmental functions of those entities and the
debt is repaid with governmental funds (sec. 103).
Interest on debt incurred by those governments where
the proceeds are used to finance activities of other
persons and the repayment of which is derived from
the funds of such other person (e.g., private
activity bonds), is taxable unless a specific
exception is included in the Code.
In general, an initial determination of whether
interest on State or local government bonds is
tax-exempt is made by issuers when the bonds are
issued. This initial determination is made by
reference to how the bond proceeds are "to be
used" (sec. 141). Intentional acts after the
date of issuance to use bond-financed property
(indirectly, a use of bond proceeds) in a manner not
qualifying for tax exemption may render interest on
the bonds taxable, retroactive to the date of
issuance. Like other tax positions taken by
taxpayers, this initial determination, and issuer
decisions relating to the effect of subsequent
actions are subject to review and challenge by the
IRS
under regular examination procedures.
A State or local government that seeks to issue
bonds, the interest on which is intended to be
excludable from gross income under section 103, can
request a ruling from the
IRS
regarding the eligibility of such bonds for
tax-exemption. The prospective issuer can challenge
the
IRS
's determination (or failure to make a timely
determination) in a declaratory judgment proceed the
in the Tax Court under Code section 7478. Because
bondholders, not issuers, are the parties whose tax
liability is affected, issuers are not allowed to
litigate the tax-exempt status of the bonds directly
after the bonds are issued.
Reasons
for Change
The Committee believes that issuers of governmental
bonds, as parties with a strong incentive to ensure
the continued tax-exemption of outstanding bonds,
should have the opportunity to challenge
IRS
revocations of the tax-exempt status of the bonds,
to protect the holders of those bonds and the market
better.
Explanation
of Provision
The provision extends the declaratory judgment
procedures currently applicable to prospective bond
issuers to issuers of outstanding bonds. The issuer
must provide adequate notice30
to outstanding bondholders, and the bondholders are
authorized to intervene in court proceedings brought
under this provision. The statute of limitations on
assessment and collection of the tax liability of
the bondholders is suspended during the pendency of
the proceeding.
Effective
Date
The provision applies to determinations of
tax-exempt status made after the date of enactment.
A special rule provides that, in the case of a
determination under a technical advice memorandum
the public release of which occurs within one year
of the date of enactment, a pleading may be filed
not later than 90 days after the date of enactment.
7.
Civil action for release of erroneous lien (sec.
3107 of the bill and sec. 6325 of the Code)
Present
Law
Prior to 1995, the provisions governing jurisdiction
over refund suits had generally been interpreted to
apply only if an action was brought by the taxpayer
against whom tax was assessed. Remedies for third
parties from whom tax was collected (rather than
assessed) were found in other provisions of the
Internal Revenue Code. The Supreme Court held in Williams
v. United States, 115 S.Ct. 1611 (1995),
however, that a third party who paid another
person's tax under protest to remove a lien on the
third party's property could bring a refund suit,
because she had no other adequate administrative or
judicial remedy. In Williams, the
IRS
had filed a nominee lien against property that was
owned by the taxpayer's former spouse and that was
under a contract for sale. In order to complete the
sale, the former spouse paid the amount of the lien
under protest, and then sued in district court to
recover the amount paid. The Supreme Court held that
parties who are forced to pay another's tax under
duress could bring a refund suit, because no other
judicial remedy was adequate.
Reasons
for Change
The Committee believes that third parties should
have a mechanism to release an erroneous tax lien.
Accordingly, the Committee believes it is
appropriate to provide relief similar to that
provided to third parties who are subject to
wrongful levy of property.
Explanation
of Provision
The provision creates an administrative procedure
similar to the wrongful levy remedy for third
parties in section 7426. Under this procedure, a
record owner of property against which a Federal tax
lien had been filed could obtain a certificate of
discharge of property from the lien as a matter of
right. The third party would be required to apply to
the Secretary of the Treasury for such a certificate
and either to deposit cash or to furnish a bond
sufficient to protect the lien interest of the
United States
. Although the Secretary would determine the amount
of the bond necessary to protect the Government's
lien interest, the Secretary would have no
discretion to refuse to issue a certificate of
discharge if this procedure was followed, thus
curing the defect in this remedy that the Supreme
Court found in Williams. A certificate of
discharge of property from a lien issued pursuant to
the procedure would enable the record owner to sell
the property free and clear of the Federal tax lien
in all circumstances. The provision also authorizes
the refund of all or part of the amount deposited,
plus interest at the same rate that would be made on
an overpayment of tax by the taxpayer, or the
release of all or part of the bond, if the tax
liability is satisfied or the Secretary determines
that the United States does not have a lien interest
or has a lesser lien interest than the amount
initially determined.
The provision also establishes a judicial cause of
action for third parties challenging a lien that is
similar to the wrongful levy remedy in section 7426.
The period within which such an action must be
commenced would be 120 days after the date the
certificate of discharge is issued to ensure an
early resolution of the parties' interests. Upon
conclusion of the litigation, the
IRS
would be authorized to apply the deposit or bond to
the assessed liability and to refund to the third
party any amount in excess of the liability, plus
interest, or to release the bond. Actions to quiet
title under 28 U.S.C. §2410 would still be
available to persons who did not seek the expedited
review permitted under the new statutory procedure.
Effective
Date
The provision is effective on the date of enactment.
C.
Relief for Innocent Spouses and for Taxpayers Unable
to Manage Their Financial Affairs Due to
Disabilities
1.
Spousal election to limit joint and several
liability on joint return (sec. 3201 of the bill and
new sec. 6015 of the Code)
Present
Law
Relief from liability for tax, interest and
penalties is available for "innocent
spouses" in certain circumstances. To qualify
for such relief, the innocent spouse must establish:
(1) that a joint return was made; (2) that an
understatement of tax, which exceeds the greater of
$500 or a specified percentage of the innocent
spouse's adjusted gross income for the preadjustment
(most recent) year, is attributable to a grossly
erroneous item of the other spouse; (3) that in
signing the return, the innocent spouse did not
know, and had no reason to know, that there was an
understatement of tax; and (4) that taking into
account all the facts and circumstances, it is
inequitable to hold the innocent spouse liable for
the deficiency in tax. The specified percentage of
adjusted gross income is 10 percent if adjusted
gross income is $20,000 or less. Otherwise, the
specified percentage is 25 percent.
The proper forum for contesting the Secretary's
denial of innocent spouse relief is determined by
whether an underpayment is asserted or the taxpayer
is seeking a refund of overpaid taxes. Accordingly,
the Tax Court may not have jurisdiction to review
all denials of innocent spouse relief.
Reasons
for Change
The Committee is concerned that the innocent spouse
provisions of present law are inadequate. The
Committee believes that a system based on separate
liabilities will provide better protection for
innocent spouses than the current system. The
Committee generally believes that an electing
spouse's liability should be satisfied by the
payment of the tax attributable to that spouse's
income and that an election to limit a spouse's
liability to that amount is appropriate.
The Committee intends that this election be
available to limit the liability of spouses for tax
attributable to items of which they had no
knowledge. The Committee is concerned that taxpayers
not be allowed to abuse these rules by knowingly
signing false returns, or by transferring assets for
the purpose of avoiding the payment of tax by the
use of this election. The Committee believes that
rules restricting the ability of taxpayers to limit
their liability in such situations are appropriate.
The Committee believes that taxpayers need to be
informed of their right to make this election and
that the
IRS
is the best source of that information. The
Committee also believes that the
IRS
should take appropriate steps to insure that both
spouses are made aware of their tax situation, and
not rely on a single notice sent to a single address
to inform both spouses.
Explanation
of Provision
In
general
The bill modifies the innocent spouse provisions to
permit a spouse to elect to limit his or her
liability for unpaid taxes on a joint return to the
spouse's separate liability amount. In the case of a
deficiency arising from a joint return, a spouse
would be liable only to the extent items giving rise
to the deficiency are allocable to the spouse.
Special rules apply to prevent the inappropriate use
of the election.
Items are generally allocated between spouses in the
same manner as they would have been allocated had
the spouses filed separate returns. The Secretary
may prescribe other methods of allocation by
regulation. The allocation of items is to be
accomplished without regard to community property
laws.
The election applies to all unpaid taxes under
subtitle A of the Internal Revenue Code, including
the income tax and the self-employment tax. The
election may be made at any time not later than 2
years after collection activities begin with respect
to the electing spouse. The Committee intends that 2
year period not begin until collection activities
have been undertaken against the electing spouse
that have the effect of giving the spouse notice of
the
IRS
' intention to collect the joint liability from such
spouse. For example, garnishment of wages, a notice
of intent to levy against the property of the
electing spouse would constitute collection activity
against the electing spouse. The mailing of a notice
of deficiency and demand for payment to the last
known address of the electing spouse, addressed to
both spouses, would not.
The Tax Court has jurisdiction of disputes arising
from the separate liability election. For example, a
spouse who makes the separate liability election may
petition the Tax Court to determine the limits on
liability applicable under this provision. The Tax
Court is authorized to establish rules that would
allow the Secretary of the Treasury and the electing
spouse to require, with adequate notice, the other
spouse to become a party to any proceeding before
the Tax Court. The Secretary of the Treasury is
required to develop a separate form with
instructions for taxpayers to use in electing to
limit liability.
Allocations
of items
Under the bill, allocation of items of income and
deduction follows the present-law rules determining
which spouse is responsible for reporting an item
when the spouses use the married, filing separate
filing status. The Secretary of the Treasury is
granted authority to prescribe regulations providing
simplified methods of allocating items.
In general, apportionment of items of income are
expected to follow the source of the income. Wage
income is allocated to the spouse performing the job
and receiving the Form W-2. Business and investment
income (including any capital gains) is allocated in
the same proportion as the ownership of the business
or investment that produces the income. Where
ownership of the business or investment is held by
both spouses as joint tenants, it is expected that
any income is allocated equally to each spouse, in
the absence of clear and convincing evidence
supporting a different allocation.
The allocation of business deductions is expected to
follow the ownership of the business. Personal
deduction items are expected to be allocated equally
between spouses, unless the evidence shows that a
different allocation is appropriate. For example, a
charitable contribution normally wold be allocated
equally to both spouses. However, if the wife
provides evidence that the deduction relates to the
contribution of an asset that was the sole property
of the husband, any deficiency assessed because it
is later determined that the value of the property
was overstated would be allocated to the husband.
Items of loss or deduction are allocated to a spouse
only to the extent that income attributable to the
spouse was offset by the deduction or loss. Any
remainder is allocated to the other spouse.
Income tax withholding is allocated to the spouse
from whose paycheck the tax was withheld. Estimated
tax payments are generally expected to be allocated
to the spouse who made the payments. If the payments
were made jointly, the payments are expected to be
allocated equally to each spouse, in the absence of
evidence supporting a different allocation.
The allocation of items is to be made without regard
to the community property laws of any jurisdiction.
If the electing spouse establishes that he or she
did not know, and had no reason to know, of an item
and, considering all the facts and circumstances, it
is inequitable to hold the electing spouse
responsible for any unpaid tax or deficiency
attributable to such item, the item may be equitably
reallocated to the other spouse. In cases where the
IRS
proves fraud, the
IRS
may distribute, apportion, or allocate any item
between spouses.
Tax
deficiencies
If a spouse makes the separate liability election,
the liability for deficiencies determined after a
joint return is filed is allocated to the spouse
whose item gives rise to the deficiency. For
example, if a deficiency is assessed after an
IRS
audit that relates to the husband's income that he
failed to report on the return, the entire
deficiency is allocated to the husband. If the wife
elects separate liability, she owes none of the
deficiency. The deficiency is the sole
responsibility of the husband who failed to report
the income.
If the deficiency relates to the items of both
spouses, the separate liability for the deficiency
is allocated between the spouses in the same
proportion as the net items taken into account in
determining the deficiency. If the deficiency arises
as a result of the denial of an item of deduction or
credit, the amount of the deficiency allocated to
the spouse to whom the item of deduction or credit
is allocated is limited to the amount of income or
tax allocated to such spouse that was offset by the
deduction or credit. The remainder of the liability
is allocated to the other spouse to reflect the fact
that income or tax allocated to that spouse was
originally offset by a portion of the disallowed
deduction or credit.
For example, a married couple files a joint return
with wage income of $100,000 allocable to the wife
and $30,000 of self employment income allocable to
the husband. On examination, a $20,000 deduction
allocated to the husband is disallowed, resulting in
a deficiency of $5,600. Under the provision, the
liability is allocated in proportion to the items
giving rise to the deficiency. Since the only item
giving rise to the deficiency is allocable to the
husband, and because he reported sufficient income
to offset the item of deduction, the entire
deficiency is allocated to the husband and the wife
has no liability with regard to the deficiency,
regardless of the ability of the
IRS
to collect the deficiency from the husband.
If the joint return had shown only $15,000 (instead
of $30,000) of self employment income for the
husband, the income offset limitation rule discussed
above would apply. In this case, the disallowed
$20,000 deduction entirely offsets the $15,000 of
income of the husband, and $5,000 remains. This
remaining $5,000 of the disallowed deduction offsets
income of the wife. The liability for the deficiency
is therefore divided in proportion to the amount of
income offset for each spouse. In this example, the
husband is liable for 3/4 of the deficiency
($4,200), and the wife is liable for the remaining
1/4 ($1,400).
The rule that the election will not apply to the
extent any deficiency is attributable to an item the
electing spouse had actual knowledge of is expected
to be applied by treating the item as fully
allocable to both spouses. For example a married
couple files a joint return with wage income of
$150,000 allocable to the wife and $30,000 of self
employment income allocable to the husband. On
examination, an additional $20,000 of the husband's
self employment income is discovered, resulting in a
deficiency of $9,000. The
IRS
proves that the wife had actual knowledge that
$5,000 of this additional self employment income,
but had no knowledge of the remaining $15,000. In
this case, the husband would be liable for the full
amount of the deficiency, since the item giving rise
to the deficiency is fully allocable to him. In
addition, the wife would be liable for the amount
that would have been calculated as the deficiency
based on the $5,000 of unreported income of which
she had actual knowledge. The
IRS
would be allowed to collect that amount from either
spouse, while the remainder of the deficiency could
be collected from only the husband.
Tax
shown on a return, but not paid
The separate liability election also applies in
situations where the tax shown on a joint return is
not paid with the return. In this case, the amount
determined under the separate liability election
equals the amount that would have been reported by
the electing spouse on a separate return. However,
if any item of credit or deduction would be
disallowed solely because a separate return is
filed, the item of credit or deduction will be
computed without regard to such prohibition31
. Similarly, a base amount and an adjusted base
amount will be allowed in the determination of the
taxable portion of social security and tier 1
railroad retirement benefits without regard to the
rule in section 86(c). The calculation of the tax
that would be shown on the separate return does not
constitute the filing of a separate return. Other
actions whose character may have been dependent upon
the joint filing status of the taxpayer (for
example, the making of a deductible IRA contribution
under section 219) are unaffected by the election.
The separate liability election may not be used to
create a refund, or to direct a refund to a
particular spouse.
Special
rules
Special rules apply to prevent the inappropriate use
of the election.
First, if the
IRS
demonstrates that assets were transferred between
the spouses in a fraudulent scheme joined in by both
spouses, neither spouse is eligible to make the
election under the provision (and consequently joint
and several liability applies to both spouses).
Second, if the
IRS
proves that the electing spouse had actual knowledge
that an item on a return is incorrect, the election
will not apply to the extent any deficiency is
attributable to such item. Such actual knowledge
must be established by the evidence and shall not be
inferred based on indications that the electing
spouse had a reason to know.
Third, the limitation on the liability of an
electing spouse is increased by the value of any
disqualified assets received from the other spouse.
Disqualified assets include any property or right to
property that was transferred to an electing spouse
if the principle purpose of the transfer is the
avoidance of tax (including the avoidance of payment
of tax). A rebuttable presumption exists that a
transfer is made for tax avoidance purposes if the
transfer was made less than one year before the
earlier of the payment due date or the date of the
notice of proposed deficiency. The rebuttable
presumption does not apply to transfers pursuant to
a decree of divorce or separate maintenance. The
presumption may be rebutted by a showing that the
principal purpose of the transfer was not the
avoidance of tax or the payment of tax.
Notification
of taxpayers
The Internal Revenue Service is required to notify
all taxpayers who have filed joint returns of their
rights to elect to limit their joint and several
liability under this provision. It is expected that
notice will appear in appropriate
IRS
publications, including
IRS
Publication 1, and in collection related notices
sent to taxpayers.
The Internal Revenue Service should, whenever
practicable, send appropriate notifications
separately to each spouses. For example, where
notifications are being sent by registered mail, it
is expected a separate notice will be sent by
registered mail to each spouse. This is intended to
increase the likelihood that separated or divorced
spouses will each receive such notices, as well as
increase the likelihood that the Internal Revenue
Service will be made aware of address changes that
apply to one, but not both spouses.
Effective
Date
The provision applies to any liability for tax
arising after the date of enactment and any
liability for tax arising on or before such date,
but remaining unpaid as of such date.
The period in which an election may be made under
the provision will not expire before the date that
is 2 years after the date of the first collection
action undertaken against the electing spouse on or
after the date of enactment that has the effect of
giving the spouse notice of the
IRS
' intention to collect the joint liability from the
spouse. However, this rule does not extend the
statute of limitations.
An individual may elect under the provision without
regard to whether such individual has previously
been denied innocent spouse relief under present
law.
2.
Suspension of statute of limitations on filing
refund claims during periods of disability (sec.
3202 of the bill and sec. 6511 of the Code)
Present
Law
In general, a taxpayer must file a refund claim
within three years of the filing of the return or
within two years of the payment of the tax,
whichever period expires later (if no return is
filed, the two-year limit applies) (sec. 6511(a)). A
refund claim that is not filed within these time
periods is rejected as untimely.
There is no explicit statutory rule providing for
equitable tolling of the statute of limitations. The
U.S. Supreme Court has held that Congress did not
intend the equitable tolling doctrine to apply to
the statutory limitations of section 6511 on the
filing of tax refund claims.
Reasons
for Change
The Committee believes that, in cases of severe
disability, equitable tolling should be considered
in the application of the statutory limitations on
the filing of tax refund claims.
Explanation
of Provision
The provision permits equitable tolling of the
statute of limitations for refund claims of an
individual taxpayer during any period of the
individual's life in which he or she is unable to
manage his or her financial affairs by reason of a
medically determinable physical or mental impairment
that can be expected to result in death or to last
for a continuous period of not less than 12 months.
Tolling does not apply during periods in which the
taxpayer's spouse or another person is authorized to
act on the taxpayer's behalf in financial matters.
Effective
Date
The provision applies to periods of disability
before, on, or after the date of enactment but does
not apply to any claim for refund or credit which
(without regard to the provision) is barred by the
statute of limitations as of
January 1, 1998
.
D.
Provisions Relating to Interest and Penalties
1.
Elimination of interest differential on overlapping
periods of interest on income tax overpayments and
underpayments (sec. 3301 of the bill and sec. 6621
of the Code)
Present
Law
A taxpayer that underpays its taxes is required to
pay interest on the underpayment at a rate equal to
the Federal short term interest rate plus three
percentage points. A special "hot
interest" rate equal to the Federal short term
interest rate plus five percentage points applies in
the case of certain large corporate underpayments.
A taxpayer that overpays its taxes receives interest
on the overpayment at a rate equal to the Federal
short term interest rate plus two percentage points.
In the case of corporate overpayments in excess of
$10,000, this is reduced to the Federal short term
interest rate plus one-half of a percentage point.
If a taxpayer has an underpayment of tax from one
| 
