BILL ANALYSIS                                                                                                                                                                                                    Ó






                                                                     SB 526


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          Date of Hearing:  July 13, 2015





                     ASSEMBLY COMMITTEE ON REVENUE AND TAXATION


                                 Philip Ting, Chair





          SB  
          526 (Fuller) - As Amended May 18, 2015





          Majority vote.  Fiscal committee. 


          SENATE VOTE:  39-0


          SUBJECT:  Personal income taxes: joint returns: relief from  
          liability.


          SUMMARY:  Modifies the "innocent spouse" equitable relief  
          provisions by expanding the Franchise Tax Board's (FTB)  
          authority to relieve an individual of tax liability on his/her  
          own income.  Specifically, this bill:  


          1)Direct the FTB to consider the terms of a judgment of  











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            dissolution of marriage in determining whether to grant  
            equitable relief to a spouse on income earned by, or subject  
            to the exclusive management and control of, that spouse.  


          2)Specifies that the fact that a spouse's unpaid tax liability  
            or deficiency has been revised under the judgment of marriage  
            dissolution may be a factor weighing in favor of tax relief,  
            even if one of the following applies:


             a)   The spouse was not a victim of abuse at the time the  
               return was filed;


             b)   The funds that would have been used to pay the tax  
               liability or deficiency were not misappropriated by the  
               other spouse. 


          3)Applies to any unpaid tax or deficiency for any taxable year  
            where a joint return has been filed, without regard to Revenue  
            and Taxation Code (R&TC) Section 19006(b).  


          4)Is operative for requests for relief received by the FTB on or  
            after January 1, 2016. 


          EXISTING LAW:   


          1)Provides that, whenever a joint return is filed by a husband  
            and wife, the liability for the tax on the aggregate income is  
            joint and several.  

          2)Allows an individual who has made a joint return to seek  
            "innocent spouse" tax relief if the following conditions are  
            met:  











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             a)   On that return there is an understatement of tax  
               attributable to erroneous items of one individual filing  
               the joint return;

             b)   The other individual filing the joint return establishes  
               that he/she did not know of, and had no reason to know of,  
               that understatement;

             c)   Taking into account all facts and circumstances, it is  
               inequitable to hold the other individual liable for the  
               deficiency in tax attributable to that understatement; and,  


             d)   The other individual elects relief within two years of  
               the date FTB begins collection activities.  

          3)Limits an individual's liability for any deficiency assessed  
            with respect to a joint return to the portion of the  
            deficiency properly allocable to the individual if:

             a)   At the time of election, the individual is no longer  
               married to, or is legally separated from, the person with  
               whom that individual filed the joint return; or, 

             b)   The individual was not a member of the same household as  
               the person with whom the joint return was filed at any time  
               during the 12-month period ending on the date the election  
               is filed. 

          4)Authorizes the FTB to relieve an individual of liability on  
            equitable grounds, if relief is not available under the  
            provisions set forth above.   

          5)Provides that any individual who has been granted "innocent  
            spouse" relief under Internal Revenue Code (IRC) Section 6015,  
            relating to joint and several liability with respect to a  
            federal joint income tax return, shall be eligible for state  
            relief if all of the following conditions are satisfied:











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             a)   The individual requests relief;

             b)   The facts and circumstances that apply to the  
               understatement and liabilities for which relief is  
               requested are the same facts and circumstances that applied  
               to the understatement and liabilities for which the  
               individual was granted relief under IRC Section 6015; and, 

             c)   The individual seeking relief provides the Franchise Tax  
               Board (FTB) with a copy of the federal determination  
               granting relief. 

          6)Specifies that these relief provisions shall  not  apply if the  
            other individual who filed the joint return submits specified  
            information to FTB indicating that relief should not be  
            granted.  

          7)Provides that, if the individual seeking relief demonstrates  
            to FTB that a federal request for relief has been filed with  
            the Internal Revenue Service (IRS) and demonstrates that the  
            federal request for relief involves the same facts and  
            circumstances as the request pending before FTB, then FTB may  
            not deny relief with respect to that request until action on  
            the federal request is final.  

          8)Allows a taxpayer to appeal FTB's decision on an "equitable  
            relief" request for innocent spouse relief.  

          FISCAL EFFECT:  Unknown, but may be substantial. 


          COMMENTS:  


           1)The Author's Statement  .  The author has provided the following  
            statement in support of this bill:













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          "According to members of the Board of Equalization (BOE), the  
            BOE has adjudicated a number of appeals from the Franchise Tax  
            board (FTB) that have involved taxpayers who believed they had  
            successfully divided assets and debts, including tax  
            liabilities, in a divorce agreement. Current law does not  
            allow the FTB, and by extension the BOE in its quasi-judicial  
            function, to rely on a marital settlement agreement to relieve  
            a spouse of a joint income tax liability unless the agreement  
            meets a number of technical conditions contained in Revenue  
            and Taxation Code Section 19006(b).

          "SB 526 grants the FTB the authority to consider a divorce  
            agreement as a factor weighing in favor of granting relief  
            when a taxpayer requests that the agency assign outstanding  
            tax liabilities to the spouse who agreed to pay them, rather  
            than holding both parties jointly liable.

          "The current law forces the spouse requesting relief to return  
            to court in order to have the marital settlement agreement  
            enforced.  After negotiating a fair division of assets and  
            debts, taxpayers are surprised when they learn that their  
            agreement will not be honored by the state government.  By  
            providing the FTB the ability to abide by the agreement that  
            was negotiated between spouses, this would limit additional  
            needless litigation in both the courts of California as well  
            as appeals to the Board of Equalization."
           2)Arguments in Support  .  The proponents state that this bill  
            would authorize "California tax agencies to abide by divorce  
            judgments assigning liability to one spouse or the other,  
            without the imposition of onerous requirements."  The  
            proponents believe that providing relief to the non-assigned  
            spouse would strengthen the enforcement of divorce judgments  
            and would permit an equitable result if the assigned spouse  
            failed to pay.  The proponents of this bill argue that  
            authorizing the FTB "to consider divorce agreements when  
            granting equitable relief, even when the agreements do not  
            meet the requirements of Section 19006(b), will reduce the  
            amount of additional litigation - as well as appeals brought  











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            before the BOE."  Finally, the proponents urge consideration  
            of expanding the class of judgments to include "Legal  
            Separations and Judgments for dissolution of Registered  
            Domestic Partnership."  

          3)Background: "Innocent Spouse" Relief  :  Under both federal and  
            state law, spouses who file a joint tax return are  
            individually responsible for the return's accuracy and for the  
            full tax liability for that tax year.  This concept, referred  
            to as "joint and several liability," can inequitably impact  
            one spouse in particular circumstances.  Consequently, both  
            the federal government and the state have enacted "innocent  
            spouse" legislation.  These provisions allow taxpayers, under  
            specified circumstances, to be relieved of some or all of the  
            responsibility for a joint tax debt.
           
             a)   Federal "Innocent Spouse" Law  :  The IRS Restructuring  
               and Reform Act of 1998 (1998 Act) made innocent spouse  
               relief easier to obtain.  Specifically, the 1998 Act allows  
               an innocent spouse to qualify for relief under any of the  
               following three provisions:
              
               i)     Understatement/Apportionment  :  A spouse may request  
                 relief for a taxable year to the extent the liability is  
                 attributable to an assessment of tax exceeding the amount  
                 reported on the return (i.e., an 'understatement of  
                 tax').  Generally, the requesting party must show that  
                 the understatement resulted from an erroneous item, such  
                 as an omission of income or an overstatement of  
                 deductible expenses.  In addition, the taxpayer must show  
                 that, at the time the return was signed, he/she did not  
                 know and had no reason to know of the erroneous item that  
                 caused the understatement.  If the taxpayer can show lack  
                 of knowledge with respect to a portion of the  
                 understatement, the taxpayer may be relieved of liability  
                 for the tax attributable to that portion of the  
                 understatement.  
                
               ii)    Separate Liability Election  :  A requesting spouse  











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                 may elect to be taxed as though he/she filed a "married  
                 filing separate" tax return.  This relief is available to  
                 taxpayers who are no longer married, are legally  
                 separated, or who have lived apart from their spouse  
                 during the 12-month period preceding the request for  
                 relief.  
                
               iii)   Equitable Relief  :  An individual who does not  
                 qualify for the relief specified above may still obtain  
                 relief if, after taking into account all the facts and  
                 circumstances, it is determined to be inequitable to hold  
                 the individual liable for any unpaid tax or any  
                 deficiency.  However, even under equitable relief, the  
                 income tax liability from which the requesting spouse  
                 seeks relief generally must be attributable to an item of  
                 the non-requesting spouse or an underpayment resulting  
                 from the non-requesting spouse's income.  The IRS,  
                 nonetheless, will consider granting equitable relief even  
                 though the deficiency or underpayment may be attributable  
                 in part or in full to an item of the requesting spouse  
                 (a) in the case of abuse prior to the time the return was  
                 filed or (b) where funds that would have been used to pay  
                 the tax or deficiency were misappropriated by the  
                 non-requesting spouse. 

               The IRS has issued guidance for taxpayers seeking equitable  
                 relief from joint income tax liability.  In general, a  
                 nonexclusive list of factors is applied in determining  
                 whether relief should be granted because it would be  
                 inequitable to hold a requesting spouse liable.  One of  
                 the factors is the existence of a legal obligation  
                 arising from a divorce decree or other legally binding  
                 agreement. It will weigh in favor of relief if the  
                 non-requesting spouse has the sole obligation to pay the  
                 outstanding income tax liability pursuant to a divorce  
                 decree or agreement.  However, this factor will be only  
                 neutral if the requesting spouse knew or had reason to  
                 know, when entering into the divorce decree or agreement  
                 that the non-requesting spouse would not pay the income  











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                 tax liability.<1>

              b)   State "Innocent Spouse Law"  :  In 1999, California  
               conformed to portions of the 1998 Act by enacting the  
               Taxpayers' Bill of Rights Act of 1999.  In addition,  
               California provides two avenues for innocent spouse relief  
               not available under federal law:

               i)     The liability may be revised by a court in a  
                 proceeding for dissolution of marriage, under specified  
                 circumstances; and, 

               ii)    A taxpayer may seek relief from FTB on any unpaid  
                 self-assessed tax liability on a joint return, including  
                 penalties and interest.

               Thus, unlike the federal "innocent spouse' provisions that  
               consider a legal obligation under dissolution of marriage  
               as one of many factors, the state law provides that the  
               liability may be revised by a court in a proceeding for  
               dissolution of the marriage, and thus creates an  
               independent exception to the general rule of joint and  
               several liability.  The FTB will grant relief to the  
               requesting spouse provided the court order does not relieve  
               the requesting spouse of tax liability on income earned by,  
               or subject to the exclusive management and control of, that  
               spouse.  In the case the gross income reported on the tax  
               return exceeds $150,000 or the amount of tax liability  
               relief exceeds $7,500, the requesting spouse must also  
               obtain from the FTB and file with the divorce court a tax  
               revision clearance certificate.  A taxpayer has the right  
               to appeal FTB's decision on a request for equitable  
               innocent spouse relief.


          ---------------------------
          ---------------------------
          <1>


           Internal Revenue Bulletin: 2003-32, Rev. Proc. 2003-61.










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           4)What is the Problem  ?  In a recent BOE case,<2> the taxpayer  
            appealed FTB's denial of equitable relief for past unpaid  
            taxes.  The taxpayer requested the "innocent spouse" relief  
            and submitted a copy of the marital settlement agreement that  
            had assigned all of the couple's California tax debts  
            (including the ones arising from the taxpayer's own income) to  
            the taxpayer's former spouse.  The FTB determined that the  
            taxpayer failed to qualify for the equitable relief under R&TC  
            Section 18533(f).  Furthermore, the FTB stated that the court  
            order submitted by the taxpayer did not comply with the  
            applicable statutory requirements to provide an independent  
            ground for relief under R&TC Section 19006(b).  The taxpayer  
            argued that the divorce settlement between her and her husband  
            allocated the obligation to pay delinquent taxes to him, so  
            she should be absolved of any tax debt.   The FTB, however,  
            relied on R&TC Section 19006(b), which specifically prohibits  
            a court, in a proceeding for dissolution of the marriage, from  
            relieving a spouse of tax liability on income earned by the  
            spouse, or income subject to the exclusive management and  
            control of the spouse.  While R&TC Section 19006(c) expressly  
            authorizes the FTB to revise the unpaid tax liability, it  
            similarly prohibits the FTB from relieving a spouse from tax  
            liability on income earned or exclusively controlled by the  
            spouse, among other conditions.<3>   

          Currently, there is no legal avenue for the BOE to provide  
            relief to taxpayers under Section 19006(b).  Consequently, the  
            BOE sustained the FTB's action regarding the taxpayer's  
            liability attributable to her income because the court order  
            presented by the taxpayer did not comply with the requirements  
            of Section 19006(b).  Furthermore, no relief was allowed for  
          ---------------------------
          <2> In the Matter of the Appeal of:  TONJA M.  JARRELL, Case No.  
          571357, BOE, 2014 Cal. Tax LEIXS 178, May 22, 2014.
          <3> Section 19006(c) prescribes an additional requirement before  
          the tax liability may be revised by the FTB, namely, that the  
          spouse whose liability is to be revised must establish a lack of  
          knowledge of the nonpayment at the time the return was filed.










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            the tax liability attributable to income earned by the  
            taxpayer because she failed to satisfy the necessary  
            conditions for equitable relief from that liability under R&TC  
            Section 18533(f).   However, the BOE granted the "innocent  
            spouse" relief to the taxpayer as to the portion of the  
            couple's tax liabilities that was attributable to the  
            taxpayer's former spouse.  

           5)What Would This Bill Do  ?  This bill creates an exception to  
            R&TC Section 19006(b) that currently prohibits a court as well  
            as the FTB from relieving a spouse of the tax liability on  
            income earned or controlled by that spouse.   Specifically,  
            this bill provides that, for purposes of determining whether  
            an individual qualifies for the "innocent spouse" equitable  
            relief under R&TC Section 18533(f), the fact that the  
            individual's liability for unpaid taxes or deficiency has been  
            revised under a court's judgment of dissolution of marriage  
            may be a factor "weighing in favor" of that individual.  In  
            other words, the FTB may (or may not) consider a divorce  
            agreement when grating equitable relief even if the agreement  
            does not comply with the requirements of Section 19006(b).   
            Thus, the individual may be relieved by the FTB of the tax  
            liability attributable to his/her own income if the judgment  
            reassigns this liability to the non-requesting spouse.  


          6)"  Weighting in Favor of Relief:" Non-Conformity  ?  Divorce  
            settlements result from often difficult negotiations between  
            two former spouses to allocate their former joint assets and  
            liabilities, which often involve tax debts.  This bill  
            provides that the FTB may consider a court judgment revising  
            the individual's liability for any unpaid tax or deficiency as  
            a factor weighing in favor of relief from tax liability on  
            income earned by the individual.  



          Under federal law, in determining whether equitable relief  
            should be granted to a requesting spouse, the IRS will  











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            consider the existence of a legal obligation arising from a  
            divorce decree or other legally binding agreement.  As  
            discussed, this factor will weigh in favor of relief if the  
            non-requesting spouse has the sole obligation to pay the  
            outstanding income tax liability pursuant to a divorce decree  
            or agreement.  However, this factor will be only neutral if  
            the requesting spouse knew or had reason to know, when  
            entering into the divorce decree or agreement, that the  
            non-requesting spouse would not pay the income tax liability.   
            In contrast, SB 526 does not differentiate between the spouses  
            who knew and those who did not know.  Furthermore, IRS's  
            recent guidance indicates that it will grant relief on the  
            requesting spouse's own income in cases of abuse or  
            misappropriation of funds.  In contrast, this bill will apply  
            in cases where no abuse or misappropriation of funds occurred.  
             As such, this bill's approach substantially deviates from the  
            federal statutes and regulations, taking California out of  
            conformity with the federal tax laws. 
           7)"Revising" a Judicial Order  .   Under existing law, a court  
            order, in a proceeding for marriage dissolution, must  
            separately state the income tax liabilities for the taxable  
            years for which revision is granted.  Taxpayers with income  
            above a specified amount also must obtain a tax revision  
            clearance certificate from FTB to give to a court issuing the  
            divorce settlement, detailing the amounts of tax, interest,  
            and penalties due to ensure this information is incorporated  
            into the settlement.  Under this bill, FTB or BOE are  
            authorized to grant the requesting spouse equitable relief  
            merely by showing that the settlement agreement revised any  
            unpaid tax, thereby shifting the obligation from the  
            requesting spouse to the other one, regardless of the taxable  
            year.  Spouses could then seek to reassign tax debts on their  
            own income for specific taxable years to their former spouses,  
            when the divorce settlement only speaks in more general terms  
            about tax debts from income generated by one spouse or the  
            other, or both, without being specific to the taxable year.   
            Additionally, this bill does not compel notification to the  
            other spouse, or grant him or her opportunity to comment,  
            which innocent spouse relief provisions currently require.   











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            The Committee may wish to consider whether a tax agency should  
            have such a broad authority to revise the terms of a  
            previously settled divorce agreement.


           8)Following the Law (or Not)  .  As noted, existing law allows  
            taxpayers to have the liability revised by a court proceeding  
            for dissolution of marriage. However, existing law is very  
            clear in that it prohibits a court from relieving a spouse of  
            tax liability on income earned or control by him/her.  To the  
            extent that the court follows all of the statutory  
            requirements of R&TC Section 19006(b), the order itself will  
            provide an independent ground for innocent spouse relief.   
            Presumably, in reassigning the spouses' tax liability, a court  
            strives to comply with the existing statute.  But if a court  
            does not follow this law, then its order will be unenforceable  
                                                                                for purposes of the "innocent spouse" relief provisions. 



          The supporters of this bill argue that the requirements of  
            Section 19006(b) are onerous.  However, instead of deleting  
            these requirements to allow courts expressly to revise the  
            spouses' tax liabilities the way they see fit, this bill  
            appears to condone an occasional deviation by some courts from  
            the prescribed statutory requirements in issuing divorce  
            judgments.  In particular, this bill authorizes the FBT to  
            take into account the existence of a court order, regardless  
            of whether or not it complies with Section 19006(b).  The  
            Committee may wish to consider whether the approach suggested  
            by this bill is the most efficient way of achieving the  
            intended goal of providing equitable relief to innocent  
            spouses. 
           9)Slippery Slope  ?  Innocent spouse relief exists for tax  
            agencies to provide relief from joint tax liabilities for  
            taxpayers who signed joint returns with their spouses, but  
            were kept in the dark about the other spouse's income,  
            business interests, or financial activities.  IRS and FTB  
            grant innocent spouse relief to these taxpayers because they  











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            have no legitimate reason to know that they have a tax  
            obligation arising from items about which they had no  
            knowledge.  Only in a few, limited circumstances has the IRS  
            granted relief for unpaid liability on income earned by the  
            requesting spouse, because that spouse should know that tax  
            applies whenever he or she earns income.  This bill sets a new  
            precedent to allow the FTB, and BOE as part of an appeal of  
            FTB's determination, to grant relief on the requesting  
            spouse's own income in any case where the requesting spouse  
            has a divorce agreement obligating the non-requesting spouse  
            to pay any outstanding taxes.  IRS's recent guidance indicates  
            that it will grant relief on the requesting spouse's own  
            income in cases of abuse or misappropriation of funds, and FTB  
            will follow that guidance regardless of any legislative  
            change, so this bill will only apply in cases where no abuse  
            or misappropriation of funds occurred, setting a new precedent  
            in the area of "innocent spouse" tax relief.  


          REGISTERED SUPPORT / OPPOSITION:




          Support


          George Runner, State Board of Equalization, Member


          The Executive Committee of the Family Law Section, the State Bar  
          of California




          Opposition













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          None on file




          Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916)  
          319-2098