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IRS review may change innocent-spouse relief rules after bipartisan criticism

Written by
Sandra Block | USA Today
<b>Melinda Smith, left, of Murfreesboro, was left with a $30,000 tax bill after her divorce in 2007. The IRS turned down her request for innocent spouse status, but the decision was overturned in court.</b>

Melinda Smith of Murfreesboro divorced her husband in 2007. Not long after, she received a bill for $30,000 in unpaid taxes related to her ex-husband’s business.

Smith thought she would have no trouble qualifying for innocent-spouse relief — freedom from responsibility even if the couple filed jointly — but she was wrong. The IRS denied her application and advised her to sue her ex-husband in civil court for the money.

Fearful that she would lose her home, Smith sought help from the Legal Aid Society of Middle Tennessee. Her attorney, Robert Nadler, appealed the IRS ruling, and in the spring of 2009 Smith was granted innocent-spouse relief.

“I remember doing a little dance around the house,” she said.

Many miss out

But thousands of others in Smith’s position don’t win. Many are blamed for missing a two-year deadline to file for relief after receiving an IRS collection notice.

That practice ignited a firestorm of criticism from lawmakers, the IRS taxpayer advocate and legal aid attorneys. They argue that the deadline is particularly unfair to victims of domestic abuse, who are often kept in the dark about their spouse’s finances for years.

The IRS says it’s reviewing the innocent spouse rules and plans to announce changes within the next few weeks. “We are seeing from our review so far that clearly our procedures need to be improved in this area,” said IRS spokesman Terry Lemons.

The move for change has generated rare bipartisan support in Congress. In April, Minnesota Rep. Michele Bachmann, a Republican presidential candidate and former federal tax attorney, introduced legislation in the House that would remove the time limit for innocent-spouse relief. Separately, House Democrats Pete Stark, of California, and Jim McDermott, of Washington, sent a letter to the IRS urging it to revoke the two-year rule. The letter was signed by 48 of their colleagues.

Some taxpayers miss the filing deadline because their spouses hide the mail from them, which prevents them from seeing IRS notices, tax attorneys say. Others may not realize that a refund offset — which occurs when the IRS withholds a taxpayer’s refund to cover unpaid taxes — will start the clock.

Some miss out because they’re divorced or their spouses are incarcerated, and the innocent spouse doesn’t find out about the problem until after the deadline.

Case in point

Cathy Marie Lantz’s husband, Richard Chentnik, a dentist, was arrested on charges of Medicare fraud in 2000. The IRS assessed the couple for $900,000 in additional taxes, interest and penalties. Chentnik told his wife he would file an innocent-spouse claim on her behalf, but died in a halfway house before submitting the application. By the time Lantz filed a claim, the two-year deadline had passed, and her application was denied.

The Tax Court overturned the IRS ruling, but the IRS appealed. While it agreed that the IRS’ decision was harsh, an appeals court upheld the IRS decision.

Obtaining innocent-spouse relief is difficult, even for taxpayers who file on time. The IRS receives more than 50,000 innocent-spouse applications a year and grants fewer than half of them. Last year, about 1,500 of the denials were related to the two-year deadline.

To obtain innocent-spouse relief, taxpayers must prove to the IRS that they didn’t know, or have reason to know, that their spouse underpaid income taxes.

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