Third Circuit Sends Innocent Spouse Relief Case Back to Tax Court: Mannella v. IRS

February 16, 2011

A few months ago I wrote about a case I argued in the United States Court of Appeals for the Third Circuit. The case concerned whether an IRS regulation requiring taxpayers requesting equitable innocent spouse relief to request the relief within two years was valid. The effect of the regulation is that any request made after two years would be rejected, regardless of how inequitable it would be to deny the request, which I argued was contrary to Congress’ intent when the law was passed in 1998.

On January 17, 2011, the Third Circuit released its Opinion which leaves the issue ultimately still undecided. In the appeal, I argued that the IRS’s regulation was invalid because Congress intended the section to not have a statute of limitations, but if the regulation was valid, it was subject to "equitable tolling," which means that the statute of limitations would not bar a taxpayer from requesting relief if the taxpayer was prevented from discovering the liability or requesting relief within two years. The court held that the regulation was valid, with Judge Ambro dissenting, and the court sent the case back to the Tax Court to determine if equitable tolling applied to the regulation, and if so, whether the taxpayer was entitled to tolling in the case. I believe the court saw equitable tolling as the preferable result for two reasons. First, it has a similar effect to finding the regulation invalid. It allows taxpayers that file for relief beyond two years to still receive innocent spouse relief if they can show a good reason for doing so. Second, it allowed the Third Circuit to reach this result without disagreeing with the Seventh Circuit, which found the regulation to be valid about six months before our appeal.

What this means is that the equitable tolling issue will be argued in the Tax Court, with the government taking the position that it does not apply. Regardless of what the Tax Court finds, the issue will be appealed to the Third Circuit again. I am inclined to think the Third Circuit will find that equitable tolling does apply to the regulation because the court stated that “the tolling of filing deadlines is appropriate where principles of equity would make the rigid application of a limitation period unfair.” The Third Circuit provided the Tax Court with its equitable tolling standard, and the standard is rather favorable for this particular situation. It would certainly be unfair to hold taxpayers to a statute of limitations who are prevented from finding out about their liability because of their spouses, like the taxpayer in this case, who was prevented from discovering her tax liability because her husband forged her signature on a certified mail receipt.

This issue is somewhat complex and, perhaps, only seems interesting to lawyers involved in tax law; however, the manner in which this issue is ultimately decided will affect many ordinary Americans who find themselves incurring tax liabilities and may qualify for innocent spouse relief. If the Tax Court finds that equitable tolling does not apply, then no request for relief more than two years after the IRS begins to collect on the tax liability will be considered. For example, if husband and wife file a joint return that fails to accurately reflect their joint income, there will be a resulting tax liability from an understatement of tax, and both husband and wife will be liable. If wife knows about the understatement, but does not say anything because she is in an abusive marriage, and is unable to free herself from the relationship for three years after the IRS begins to collect the debt, her claim for innocent spouse relief will be denied without ever being considered. If equitable tolling applies the claim will be considered because she will have a compelling reason for requesting the relief when she did. It seems perfectly fair for the IRS to consider these claims on the merits and determine if it is fair to hold these taxpayers responsible for tax liabilities attributable to their spouses.