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.
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<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
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<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