BILL ANALYSIS Ó
SB 526
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Date of Hearing: January 11, 2016
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Philip Ting, Chair
SB
526 (Fuller) - As Amended January 4, 2016
SUSPENSE
Majority vote. Fiscal committee.
SENATE VOTE: 39-0
SUBJECT: Personal income taxes: joint returns: court orders:
relief from liability
SENATE VOTE: 39-0
SUBJECT: Personal income taxes: joint returns: relief from
liability
SUMMARY: Modifies the "innocent spouse" relief provisions by
authorizing a court of competent jurisdiction, in a proceeding
for dissolution of marriage, to relieve an individual of tax
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liability on his/her own income, subject to certain limitations.
Specifically, this bill:
1)Authorizes a court, in a proceeding for dissolution of
marriage, to relieve a spouse of joint and several liability
for the tax on income earned by, or subject to the exclusive
management and control of, the spouse, unless either of the
following applies:
a) Assets or liabilities are transferred between the
spouses filing the joint return for the principal purpose
of avoidance of the payment of tax or as part of a
fraudulent scheme; or,
b) The tax liability is uncollectible and, within three
years of the date the court order is effective, the spouse
obligated to pay that liability files for bankruptcy, as
specified, or becomes a nonresident.
2)Increases the applicable threshold for the amount of gross
income reportable on the joint tax return from $150,000 to
$200,000, and the threshold amount for tax liability relief
from $7,000 to $10,000, as provided, and requires the
inflation adjustment for these amounts, beginning on January
1, 2017.
3)Provides that the determination of the spouse to whom items of
gross income are attributable shall be made without regard to
community property laws.
4)Applies to court orders served or acknowledged on or after
January 1, 2017.
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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 a court, in a proceeding for dissolution of marriage,
to revise a spouse's tax liability reported on a joint tax
return, but prohibits the court from relieving the spouse of
tax liability on income earned or control by him/her.
3)Authorizes the FTB to relieve an individual of liability on
equitable grounds, if relief is not otherwise available.
4)Allows a taxpayer to appeal FTB's decision on an "equitable
relief" request for innocent spouse relief.
FISCAL EFFECT: Unknown
COMMENTS:
1)The Author's Statement . The author has provided the following
statement in support of this bill:
"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).
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"SB 526 makes some changes to the technical conditions in
Revenue and Taxation Code section 19006(b) that grant the FTB
the ability to honor additional divorce agreements, rather
than holding both parties jointly liable.
"If the FTB cannot honor the divorce agreement, the spouse
requesting relief has 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.
"Providing the FTB a greater ability to abide by the agreement
that was negotiated between spouses would limit additional
needless litigation in both the courts of California as well
as appeals to the BOE."
2)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.
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a) Federal "Innocent Spouse" Law : The Internal Revenue
Service (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
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
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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 and that 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.<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
-------------------------
<1>
Internal Revenue Bulletin: 2003-32, Rev. Proc. 2003-61.
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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, 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. When 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.
3)What is the Problem ? In a recent BOE case<2>, a 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
Revenue and Tax Code (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
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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.
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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
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.
4)Proposed Solution . Divorce settlements can result from
difficult negotiations between two former spouses, which often
involve an allocation of joint assets and liabilities,
including tax debts. Existing law allows taxpayers to have
their tax liability revised by a court in a dissolution of
marriage proceeding. 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.
---------------------------
<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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This bill creates an exception to R&TC Section 19006(b) that
currently prohibits courts and the FTB from relieving a spouse
of the tax liability on income earned or controlled by that
spouse. Specifically, this bill authorizes the court to
reduce the amount of the tax attributable to one of the
spouses even if the spouse is the one who earned or controlled
the income. Thus, the individual may be relieved by the court
of the tax liability attributable to his/her own income if the
judgment reassigns this liability to the non-requesting
spouse. However, the judgment will not be effective if there
is a transfer of assets or liabilities between the former
spouses for the principal purpose of tax avoidance or as part
of a fraudulent scheme. Nor will it be effective if the FTB
is unable to collect the tax, within three years from the date
of the court order, from the spouse obligated to pay who has
either filed for bankruptcy or became a nonresident.
Existing law also provides that taxpayers with gross income or
the amount of tax liability relief above a specified amount -
$150,000 and $7,500, respectively - must obtain a tax revision
clearance certificate from FTB to file with a court issuing
the divorce settlement, detailing the amounts of tax,
interest, and penalties to ensure this information is
incorporated into the settlement. This bill proposes to
increase these threshold amounts from $150,000 to $200,000 and
from $7,500 to $10,000, respectively.
5)Federal Income Tax and Divorce Decree . Under federal law,
the IRS will consider the existence of a legal obligation
arising from a divorce decree or other legally binding
agreement in determining whether equitable relief should be
granted to a requesting spouse. This bill takes a somewhat
different approach: 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
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spouse relief, even if the requesting spouse was the one who
earned or controlled the income that has given the rise to the
tax liability.
REGISTERED SUPPORT / OPPOSITION:
Support
Fiona Ma, Member, State Board of Equalization
Sen. George Runner (Retired), Member, State Board of
Equalization
Opposition
None on file
Analysis Prepared by:Oksana Jaffe / REV. & TAX. / (916)
319-2098
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