BILL ANALYSIS                                                                                                                                                                                                    




            SENATE REVENUE & TAXATION COMMITTEE

            Senator Lois Wolk, Chair

                                                   SB 1065 - Walters

                                          Introduced: February 17, 2010

                                                                       

            Hearing: April 14, 2010                         Fiscal: Yes




            SUMMARY:  Makes Permanent Currently Expired Innocent Spouse  
                      Relief Conformity to Federal Law

              
                   EXISTING STATE AND FEDERAL LAW provide that spouses  
            who file a joint tax return are individually responsible  
            for the return's accuracy and the tax liability, regardless  
            of the amount of income each spouse generates, often called  
            "joint and several" liability.  Because spouses can  
            occasionally misrepresent tax information without the  
            knowledge of the other spouse, federal law (The Internal  
            Revenue Restructuring Act of 1998) allows an innocent  
            spouse to qualify for relief under one of the following  
            provisions:

            1.Understatement/Apportionment.  To qualify for relief the  
              taxpayer must show that the understatement of tax is a  
              result of an erroneous item.  In addition, the taxpayer  
              must show that at the time the return was signed he or  
              she did not know and had no reason to know of the  
              understatement of tax.  Another option allows the  
              requesting spouse to show partial liability.  To qualify  
              for relief from the liability that is attributed to the  
              portion of the understatement of income, the taxpayer  
              must show the same lack of knowledge, as described above,  
              when they signed the return.
            2.Separate liability election.  A requesting spouse may  
              elect to be taxed as though he or she filed a married  
              filing separate tax return.  Any liability for  








                                                       SB 1065 - Walters

                                                                  Page 4
            

              understatement of tax, interest, and penalties will be  
              limited to the amount attributable to the income the  
              individual spouse actually earned.  This relief is  
              available to taxpayers that are no longer married, are  
              legally separated, or have lived apart from their spouse  
              for 12 months prior to requesting relief.  At the time  
              the joint return was signed, the requesting spouse must  
              have lacked actual knowledge of the item resulting in the  
              tax deficiency.  

            3.Equitable relief.  The Internal Revenue Service (IRS)  
              determines from a review of all the facts and  
              circumstances that the requesting taxpayer would not  
              qualify for relief under either 1 or 2 above and it would  
              not be equitable to hold the requesting spouse liable for  
              any unpaid tax or any deficiency.  

              California conformed to portions of the 1998 federal Act  
            by enacting the Taxpayer Bill of Rights Act of 1999, which  
            revised and expanded innocent spouse relief at the state  
            level (SB 94, Chesbro, 1999).  As a result, the California  
            innocent spouse provision was based upon, and similar to,  
            the federal provision.  



                 EXISTING LAW , prior to 2003 and currently in place  
            because the provisions of SB 285 have expired (as discussed  
            below), requires FTB to provide notice and appeal rights to  
            the taxpayer on the joint return that did not request the  
            innocent spouse relief.  California law allows two avenues  
            for relief that is not available under federal law.

            1.Relief from Self-Assessed or Deficiency Tax Amounts by  
              Court Order.  A taxpayer may seek a divorce court order  
              relieving the taxpayer of joint and several liabilities  
              for state income tax on a joint return as well as state  
              income tax resulting from an audit.  The order cannot  
              relieve tax on any income that was earned by or derived  
              from assets under the exclusive control and management of  
              the taxpayer seeking relief.  The gross income reported  
              on the return must not exceed $150,000 and the tax  








                                                       SB 1065 - Walters

                                                                  Page 4
            

              liability must not exceed $7,500.  The court order must  
              state the tax years involved and can revise only unpaid  
              tax amounts.  In those instances where either the gross  
              income or the tax liability exceeds the thresholds for  
              relief, and the taxpayer wants judicial relief, the  
              taxpayer must obtain and file with the court an FTB Tax  
              Revision Clearance Certificate.  
            2.Relief from Self-Assessed Tax Amounts.  A taxpayer may  
              seek relief from the department on any  unpaid  
              self-assessed  tax liability on a joint return, including  
              penalties and interest.  The tax liability must not be  
              attributable to income that was under the exclusive  
              control and management of the taxpayer seeking relief.   
              State law requires the taxpayer to demonstrate that he or  
              she did not know and had no reason to know of the  
               nonpayment of tax  at the time the return was filed.

                 EXISTING LAW clarified that a taxpayer requesting  
            innocent spouse relief that previously received relief at  
            the federal level would be allowed similar relief at the  
            state level (SB 285, Speier, 2003).  FTB would grant  
            innocent spouse relief whenever the IRS did, if:

                         The individual requests relief from FTB under  
                    the federal IRS section;
                         The facts and circumstances that apply to the  
                    understatement and the liabilities for which the  
                    relief is requested are the same;
                       The non-requesting spouse has the opportunity  
                   to provide information to FTB that is contrary to  
                   information submitted by the requesting spouse.  
                 SB 285 allowed the non-requesting spouse to provide  
            information that relief should not be granted to the extent  
            that:

                       Information that provides the facts and  
                   circumstances for state relief are different than  
                   those for federal relief;
                       Information that finds there has not been  
                   relief granted under the federal provisions or that  
                   relief has been substantially altered.









                                                       SB 1065 - Walters

                                                                  Page 4
            

                 The bill prohibited the FTB from issuing its  
            determination (denying or granting a request for relief) if  
            a request for federal relief is pending, and also precluded  
            relief if a court revises tax liability as part of a  
            dissolution of marriage.  SB 285 applied to innocent spouse  
            relief requests received on or after its effective date,  
            January 1, 2004, but expired due to its sunset provision on  
            January 1, 2009.

                 THIS BILL reenacts the above provisions from SB 285.   
            Provisions relative to requests for innocent spouse relief  
            apply retroactively to January 1, 2009.


            FISCAL EFFECT: 

                 According to FTB, SB 1065 results in revenue losses of  
            $90,000 in 2009-10, and $200,000 annually thereafter.


            COMMENTS:

            A.   Purpose of the Bill

                 Most married taxpayers file a joint tax return.  In  
            the event a couple divorces, each individual is what the  
            law calls "jointly and severally liable" for the entire tax  
            liability. In situations where one individual, without the  
            knowledge of the other individual, has manipulated the  
            joint tax liability by concealing income or inflating  
            deductions, both individuals remain "jointly and severally  
            liable."   

                 The law permits a taxpayer relief of the joint and  
            several liability if they demonstrate they did not know or  
            had no reason to know about the improperly reported income  
            or deductions.  This person is deemed an "innocent spouse."  
             In these situations, collections efforts cease for the  
            "innocent spouse" and continue against the remaining  
            responsible taxpayer.  

                 During the period from January 1, 2004, through  








                                                       SB 1065 - Walters

                                                                  Page 4
            

            December 31, 2008, under changes made by SB 285 (Speier,  
            Stats. 2003, Ch. 370), the Franchise Tax Board could grant  
            innocent spouse relief where the IRS already made an  
            innocent spouse finding.  These changes relieved the burden  
            on a taxpayer to show for a second time that they were  
            entitled to relief and reduced the use of the state's  
            financial and personnel resources, in short, a WIN-WIN  
            situation.

                 In addition to reauthorizing the Franchise Tax Board  
            to rely on a federal innocent spouse determination, SB 1065  
            would enhance equitable treatment by conforming to recent  
            federal changes that broaden the appeal rights applicable  
            to innocent spouse relief determinations and would reduce  
            taxpayer confusion by eliminating obsolete language.

                 Taxpayers who request innocent spouse relief are often  
            going through a turbulent and emotional period.  The  
            changes SB 1065 would make are both appropriate to the  
            circumstances and compassionate.



            B.   Not That Innocent

                 As part of SB 285, FTB submitted its review to the  
            Legislature displaying statistics for applicants of the  
            program on April 3, 2008.  FTB staff have found the program  
            to be an effective improvement over past laws by  
            eliminating barriers for innocent spouses to claim and  
            receive relief.  Additionally, given the difficult personal  
            issues involved with innocent spouse cases, having a  
            superior procedure assists both taxpayers and tax  
            administrators.  The table below shows the quantitative  
            elements of innocent spouse relief:  

                            Innocent Spouse Relief Claims



             









                                                       SB 1065 - Walters

                                                                  Page 4
            

             ----------------------------------------------------------- 
            |           |Claims     |           |Claims     |           |
            |           |Received   |           |Granted    |           |
            |           |           |           |           |           |
            |-----------+-----------+-----------+-----------+-----------|
            |Year       |Count      |Value      |Count      |Value      |
            |           |           |           |           |           |
            |-----------+-----------+-----------+-----------+-----------|
            |2004       |730        |$7,817,501 |123        |$3,624,320 |
            |           |           |           |           |           |
            |-----------+-----------+-----------+-----------+-----------|
            |2005       |721        |$21,168,260|125        |$4,866,962 |
            |           |           |           |           |           |
            |           |           |           |           |           |
            |-----------+-----------+-----------+-----------+-----------|
            |2006       |470        |$10,895,524|185        |$4,369,407 |
            |           |           |           |           |           |
            |           |           |           |           |           |
            |-----------+-----------+-----------+-----------+-----------|
            |2007       |483        |$3,020,471 |116        |$1,851,216 |
            |           |           |           |           |           |
            |-----------+-----------+-----------+-----------+-----------|
            |Total      |2004       |$42,901,756|549        |$14,711,905|
            |           |           |           |           |           |
            |           |           |           |           |           |
            |-----------+-----------+-----------+-----------+-----------|
            |           |           |           |           |           |
            |           |           |           |           |           |
             ----------------------------------------------------------- 



            Support and Opposition

                 Support:Franchise Tax Board (Sponsor)



                 Oppose:None Received











                                                       SB 1065 - Walters

                                                                  Page 4
            

            ---------------------------------

            Consultant: Colin Grinnell