IRS Must Repay Innocent Spouse Widow for Tax Lien, Court Says

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Everyone makes mistakes, and that includes the IRS. When the IRS collected an overpayment of unpaid taxes from a widow who qualified as an innocent spouse, the United States Tax Court told the government to give the money back.

IRS Assesses Tax Lien Against Widow

Sarah O’Nan and her husband were a married couple, living in Ohio. In 2012, they bought a home using the state’s “survivorship tenancy” law granting them a joint tenancy with right of survivorship. The property was financed using two mortgages.

The O’Nans completed their tax returns for 2012 and 2013, but never paid their reported tax liabilities. As a result, they were issued tax liabilities for $24,683 for tax year 2012 and $90,108 for tax year 2013. Just days after the latter assessment, Mr. O’Nan passed away on November 25, 2014, at age 43. Mrs. O’Nan filed a survivorship affidavit with the Ohio recorders’ office on March 11, 2015, confirming that she was now the sole title owner of the family home. Nonetheless, on April 28, 2015, the IRS filed a notice of federal tax lien against both spouses.

Following her husband’s death, Mrs. O’Nan faced substantial financial difficulties. She stopped making payments on the home’s mortgages, which led to a foreclosure action. On May 6, 2015, Mrs. O’Nan submitted a Request for Innocent Spouse Relief for the 2012 and 2013 tax years.

IRS Denied Refund After Granting Innocent Spouse Relief

In June 2015, while that foreclosure was still pending, Mrs. O’Nan sold the family home for $895,000. At closing, the title company distributed the funds:

  • $423,020 to the primary mortgage lender, in full satisfaction of the loan
  • $257,955 to the secondary mortgage lender, in full satisfaction of the loan
  • $123,200 to the IRS in full satisfaction of the tax lien for the unpaid 2012 and 2013 tax debt
  • $14,290 in closing costs
  • $76,535 to Mrs. O’Nan

This resulted in the IRS filing a Certificate of Release of Federal Tax Lien, and the mortgage lender dismissing the foreclosure action against her.

On February 13, 2017, the IRS granted Mrs. O’Nan partial relief for 2012 and full relief for 2013. It determined that Mrs. O’Nan’s liability for 2012 was $3,340, rather than $24,683. However, the IRS denied Mrs. O’Nan’s claim for a refund of the $123,200 tax lien payment.

What Innocent Spouse Relief Means for Joint Tax Debts

Married taxpayers are allowed to file joint tax returns, but when they do, each spouse is jointly and severally liable for the tax debt. That means the IRS can collect those unpaid tax debts from either spouse’s assets. A spouse may request relief from that joint liability in certain circumstances. When they do, the IRS can grant:

  • Full or partial relief for the tax debt attributable only to one spouse
  • Proportionate relief where spouses divorce or become legally separated after filing a joint return
  • Equitable relief by recalculating the debt as if the spouses had filed their taxes “married-filing-separately”

Here, the IRS granted Mrs. O’Nan partial relief under the last option. Mrs. O’Nan didn’t challenge that decision, Instead, she sued to collect the tax lien distribution back from the government.

Court Says IRS Must Repay Innocent Spouse Widow for Tax Lien

The United States Tax Court considered whether Mrs. O’Nan was entitled to a refund as an innocent spouse. Such a refund is only allowed when the overpayment was made from her own separate funds. The Court said:

“If a tax payment is made from jointly owned property, the innocent spouse may qualify for a refund if she can trace some or all of the payment to her separate portion of the property.”

It said the IRS obtained liens against the family home immediately after making its 2012 tax year assessment. The amount of that lien increased when it issued a new assessment for the 2013 tax year. When Mr. O’Nan died in 2014, Mrs. O’Nan automatically inherited his one-half interest in the home, but that did not affect the IRS’s liens, which applied to Mr. O’Nan’s estate, even after his death.

The Court said that, had Mrs. O’Nan filed separately in 2012, her tax liability would have been $3,340 (based on her partial liability), but her 2013 tax liability would have been $0 (since the IRS granted her full relief for that year). It said that the IRS still retained a tax lien on the family home for the full amount, but that it did not encumber her original one-half interest in the property beyond the $3,340 she owed for 2012.

However, one half of the property – and by extension the value of the sale – was attributable to Mr. O’Nan’s ownership interest. This meant that at the time of the sale, Mrs. O’Nan owned $447,500, and $447,500 belonged to Mr. O’Nan’s former interest through his estate. That amount could be used to satisfy the liabilities against it, including the tax lien.

Because Mr. O’Nan was the only party who signed the first mortgage’s promissory note, that mortgage would have been paid first from his share of the property sale before the tax lien was paid. It was not clear from the evidence provided, whether Mrs. O’Nan signed the second mortgage’s promissory note, though it was clear that Mr. O’Nan was the family’s primary earner. Because of this, the Tax Court treated the second mortgage the same as the first, applying the payment to Mr. O’Nan’s share of the property.

The Court used those determinations to calculate the portion of the tax lien distribution that was an overpayment using Mrs. O’Nan’s separate funds. Because the outstanding mortgage balances and one half the closing costs exceeded Mr. O’Nan’s one-half interest in the property, the $123,200 tax lien payment, less the $3,340 for which Mrs. O’Nan remained liable, was an overpayment the IRS must repay Mrs. O’Nan as an innocent spouse.

If there is a “moral” in this story, it is that the IRS makes mistakes. It can take time – this case took more than seven years due to the pandemic – but by hiring a knowledgeable and experienced tax attorney to represent you in Tax Court, you can hold the IRS accountable for its mistakes, and recover overpayments and improper assessments.

Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 35 years experience. If you have questions IRS tax assessments and tax liens, contact Joe Viola to schedule a free consultation.

Categories: Tax / IRS Penalties