FROM THE OFFICE OF PUBLIC AFFAIRS

Chairman Johnson and Members of the Subcommittee:

I am pleased to appear before you today in response to your request to discuss the Department of the Treasury's recently-released Report to the Congress on Joint Liability and Innocent Spouse Issues (Report). As we indicated in the Report and in the President's budget proposals, we share with many in Congress the concern that the existing statutory framework on these issues sometimes works imperfectly for taxpayers, particularly those who are divorced or separated from a former spouse. I welcome the opportunity to discuss these provisions and various possible solutions with you today.

As Secretary Rubin has stated, "it is imperative that we protect taxpayers whose spouses violate the tax laws without their knowledge." Treasury and the Internal Revenue Service (IRS) are taking steps to achieve this goal, and we are also committed to working with Congress to find a solution.

Let me first remind the Subcommittee of the genesis of our Report and explain the procedure we followed. In the years following the enactment of the first Omnibus Taxpayer Bill of Rights in 1988 and leading up to the enactment of the Taxpayer Bill of Rights 2 (TBOR 2) in 1996, Congress heard complaints from many taxpayers and their representatives about the tax rules applicable to married taxpayers who file joint returns, particularly those who later divorce or separate. Concern has focused especially on the Internal Revenue Code's standard of "joint and several liability" for joint filers and the so-called "innocent spouse" provisions that provide relief from joint and several liability in certain situations. Rather than abruptly changing these rules, however, Congress in TBOR 2 prudently directed Treasury and the IRS, as well as the General Accounting Office, to conduct studies of these issues, and in particular to analyze four specific items:

• (1) The effects of changing the liability for tax on a joint return from being joint and several to being "proportionate" to the tax attributable to each spouse;
• (2) The effects of providing that, if a divorce decree allocates liability for tax on a joint return, the IRS may collect such liability only in accordance with the decree;
• (3) Whether the innocent spouse provisions of the Internal Revenue Code provide meaningful relief in all cases where such relief is appropriate; and
• (4) The effect of providing that community income, which (in accordance with the rules contained in I.R.C.  879(a)) may currently be treated as the income of one spouse, is exempt from a levy for failure to pay any tax by the other spouse for a taxable year ending before their marriage.

The legislative history accompanying TBOR 2 further directed us to examine the effects of legislatively reversing a 1930 Supreme Court case, Poe v. Seaborn, for income tax purposes in community property states, and finally to consider "the tax policy implications, the equity implications, and operational changes which would face the IRS" if any of these rules were changed by statute.

As part of the Administration's own initiatives to enhance taxpayer's rights, Treasury and the IRS had begun studying these issues even before TBOR 2 was finally enacted. In 1996, we requested public input on the topics identified by Congress, and we received a great number of thoughtful comments and reform proposals. These generated extensive discussions, both internally among members of our working group and publicly with interested tax practitioner groups, such as the American Bar Association (ABA) and the American Institute of Certified Public Accountants (AICPA).

As you know, Madam Chairman, the Report of our study was delivered to Congress nearly a full year late. I sincerely apologize for that tardiness, but I want to assure you and the other members of the Subcommittee that the delay was caused substantially by our desire to analyze all of these issues thoroughly and in as complete and even-handed a manner as we could. We hope you will agree with us that eventually we did evaluate all of the proposals fully, fairly, and in considerable depth, and that ultimately what we provided in our Report meets the Congress's request for an inquiry into these problems.

Let me turn now to the results of our study. As you can see, the organization of our Report varies slightly from the enumeration of questions in the TBOR 2 statute and legislative history. There are several reasons for this. First, our research convinced us that it is important to consider the narrow topics Congress asked us to analyze within a much broader context. Joint return filing, joint and several liability, the interplay of the Federal income tax law with State common law or community property law, and the innocent spouse relief provisions have evolved over many decades. Reviewing this history convinced us that the current rules on these issues are the end result of a series of considered tax policy decisions by Congress. They are also integrally related to a number of more fundamental tax considerations, such as the existence of different filing statuses for individual income taxpayers and the many factors that go into determining the amount of tax, including marginal rates, phase-outs, other deduction and credit limitations, and so forth. Finally, the IRS has in many respects structured its administration of the income tax system around the current joint filing and liability rules, and significant changes to those rules would have major effects on return processing, account servicing, examination and collection, and dispute resolution. It is important to recall that the IRS receives over 51 million returns from married taxpayers each year, and that according to the General Accounting Office the universe of potential innocent spouse cases may be as few as 35,000 annually. (General Accounting Office, Information on the Joint and Several liability Standard, No. GAO/GGD-97-34 (March, 1997) at 4.) In short, reform proposals cannot and should not be considered in isolation.

Our study also persuaded us that the current system has many basic features that are worth preserving. These include, in particular, the joint filing option for married couples, the principle of joint and several liability for the tax due in most joint filing situations, and the allowance for equitable relief, currently in the form of the innocent spouse provisions, as the exception rather than the rule. Let me discuss each of these for a moment.

First, there are sound policy reasons for permitting married couples to file joint income tax returns and thereby treating them as a single economic unit for tax purposes. This permits spouses to offset each other's income and losses with great ease and simplicity, provides that couples in similar economic situations pay the same amount of tax, and permits married taxpayers in common law property jurisdictions the same income-splitting effect that is available to taxpayers by operation of law in community property jurisdictions. There are also practical reasons for joint filing, in particular to simplify filing obligations for the roughly 49 million married couples who do file jointly, and to reduce by up to half the resources that the IRS must devote to handling the annual income tax returns of married individuals.

Second, the basic principle that taxpayers who file joint income tax returns are jointly and severally liable for the correct amount of tax due for the period covered by the return is appropriate in the vast majority of cases. By signing and filing a joint return, each spouse voluntarily undertakes the responsibility for the correct total joint liability, just as other taxpayers undertake responsibility for their correct tax liability upon the filing of a return. Taxpayers who wish to avoid the rule of joint and several liability, and in effect to obtain proportional liability, already may elect to file separate returns using married filing separate status, although we recognize that there are frequently drawbacks to doing so. Undeniably, however, taxpayers should be made more fully aware of their filing status options and the legal consequences of each filing status.

We acknowledge that joint and several liability can lead to inequitable results in some factual situations, for instance where one spouse withholds information or intentionally deceives the other. The innocent spouse provisions are intended to rectify such situations, and they do so in many cases but, we realize, may also work imperfectly in some other cases. Eventually we concluded, however, that some of the reform proposals, such as shifting to a mandatory separate return system or a proportionate liability system at the "front-end" (return filing) stage of the tax process, would have significant drawbacks affecting millions of taxpayers, in an effort to address these relatively infrequent situations. Such a dramatic change would impose large compliance and paperwork burdens on taxpayers and the IRS, yet they would provide very little compensating benefits to the overall operation of the tax system. In certain egregious situations, moreover, they would still require some kind of equitable relief provisions, like the current innocent spouse rules.

More limited "back-end" proposals, which would apply only in the event of a controversy over the amount or collection of a tax liability, do have some distinct advantages when compared to current law, but they also suffer from potentially serious defects of their own. We discuss two of these proposals -- the ABA's proportionate liability recommendation and the AICPA's allocated liability concept -- at some length in our Report, because they were the two proposals that were presented to us in the most complete and thorough form. On the positive side, back-end reform proposals would as a general rule not be nearly as disruptive to the processing of income tax returns as front-end approaches, and they would potentially limit the ultimate tax exposure of a spouse for whom the current standard of joint and several liability for the full joint tax amount may be perceived as unfair. Each proposal also bears distinct disadvantages, however. There are many technical or "mechanical" problems with each proposal, which could create significant difficulties in tax administration and collection for taxpayers and the IRS. In addition, many of the problems that individuals experience with the current innocent spouse provisions relate to the individuals' inability to prove that they qualify for the relief, and these proposals, in which taxpayers would bear the burden of demonstrating the proper treatment of a challenged item, would not resolve such difficulties. Moreover, some kinds of equitable relief (like the current innocent spouse rules) still would be needed in certain situations in which the liability-limiting rules would leave results that may still be considered unfair. Thus, while these approaches possibly would reduce the number of cases in which innocent spouse relief is needed, they would not eliminate it entirely.

Some other reform proposals that we considered would depart fairly dramatically from appropriate and well-established tax policy and have serious defects that become readily apparent upon close review. These include, for instance, the proposals to reverse Poe v. Seaborn or to limit the amount of community property that is subject to collection for federal tax debts. Both proposals would create significant anomalies between community property and common law jurisdictions, depart from traditional deference to State law regarding what constitutes property or rights to property, and unilaterally impair collection of Federal taxes vis-a-vis other creditors who would continue to follow and be bound by State property law.

We concluded in our study that the best option for reform in this area is to devise strategies that will preserve the many advantages of the current system and yet will modify the system to afford innocent spouse relief in more cases where such relief is appropriate. Our plan will affect taxpayer contacts with the IRS at all stages of the process, from initial filings through a new ultimate remedy in the Tax Court.

Treasury and the IRS have already undertaken several administrative actions to improve the operation of the innocent spouse provisions, and we are considering other changes in the regulations, forms, and publications concerning joint and several liability and innocent spouse issues. These include:

• Expediting the issuance of a new form to assist taxpayers in preparing claims for relief under the innocent spouse provisions. These forms will be processed in one central location to ensure the technical expertise of the IRS examiner and consistent treatment for all taxpayers.
• Reviewing current training materials to ensure that they stress the responsibility of employees to identify situations where the innocent spouse provisions might apply even if the taxpayer does not know about the process. When appropriate, the IRS will provide these taxpayer with the new form and assist them in preparing it.
• Making telephone assistors, specially trained in the innocent spouse provisions, available to answer questions from taxpayers received through IRS's toll free telephone system.
• Developing special training courses on the innocent spouse provisions to be given to IRS collection and examination personnel in both basic training as well as annual continuing professional education and training.
• Alerting couples who file joint income tax returns of the legal consequences of joint filing in the instructions in their tax packages and revising other publications to make innocent spouses more aware of the relief provisions available to them.
• Reaching out at both the national and local levels to community organizations that serve abused or battered spouses to identify those who might qualify for relief under the innocent spouse provisions.

We have also recommended to Congress certain statutory changes to both the innocent spouse rules themselves and the procedures in which they may be invoked. In particular, we recommend legislation that would:

• totally eliminate dollar thresholds that bar innocent spouse relief in some meritorious cases;
• liberalize the treatment of erroneous items of deduction and credit to treat them the same way as income items in applying the innocent spouse rules;
• extend the relief provisions applicable to taxpayers in community property states to make them comparable to those applicable in non-community property states;
• significantly expand taxpayers' procedural opportunities to claim substantive relief under the innocent spouse provisions, by making access to Tax Court routinely available; and
• prohibit collection of a joint liability from one spouse when the other spouse is contesting the amount of liability in the Tax Court.

The new procedures we are recommending will prevent many of the cases of abuse by collection officers that have so disturbed you and us. We do not, however, recommend elimination of the joint and several liability standard or the current "knowledge" standard in the innocent spouse rules, because we believe that they are critical to maintaining the legal significance of an income tax return and, ultimately, to the successful operation of our voluntary self-assessment system. Eliminating them would greatly complicate the administration of this system without benefiting the vast majority of taxpayers who are never involved in a potential innocent spouse situation.

Our Report discusses our conclusions in some depth, and as you know the President's FY 1999 budget proposal incorporated our legislative recommendations. Several of our proposed changes have been incorporated in the IRS restructuring bill (H.R. 2676) passed by the House of Representatives last fall. We hope to add our other new proposals to H.R. 2676 as that legislation is considered in the Senate this year. Treasury and the IRS look forward to working with the tax-writing committees of Congress to enact these important reforms.

This concludes my prepared remarks. I would be happy to answer your questions at this time.