[Federal Register Volume 68, Number 132 (Thursday, July 10, 2003)]
[Rules and Regulations]
[Pages 41067-41073]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-17386]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9074]
RIN 1545-AY83


Treatment of Community Income for Certain Individuals Not Filing 
Joint Returns

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
treatment of community income under Internal Revenue Code section 66 
for certain married individuals in community property states who do not 
file joint Federal income tax returns. The final regulations also 
reflect changes in the law made by the Internal Revenue Service 
Restructuring and Reform Act of 1998.

EFFECTIVE DATE: These final regulations are effective July 10, 2003.

FOR FURTHER INFORMATION CONTACT: Robin M. Tuczak, 202-622-4940 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in the final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) 
under control number 1545-1770. Responses to this collection of 
information are required in order for certain individuals to receive 
relief from the operation of community property law.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    Estimated total annual reporting burden for 2001 for Form 8857, 
``Request for Innocent Spouse Relief '': 21,123 hours.
    Estimated average annual burden hours per response: 59 minutes.
    Estimated number of responses for 2001 for Form 8857: 21,336.
    Requests for relief under section 66(c) constitute less than 1% of 
the total requests filed using Form 8857.
    Comments on the collection of information should be sent to the 
Office of Management and Budget, Attn: Desk Officer for the Department 
of the Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP, Washington, DC 
20224.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
return information are confidential, as required by section 6103 of the 
Internal Revenue Code (Code).

Background

    This document contains amendments to 26 CFR part 1 under section 66 
of the Code, relating to the treatment of community income for certain 
individuals not filing joint returns. For rules regarding relief from 
joint and several liability when a joint return is filed, see section 
6015 and the regulations thereunder.
    A notice of proposed rulemaking (REG-115054-01) was published in 
the Federal Register (67 FR 2841) on January 22, 2002. No public 
hearing was requested or held. Written comments responding to the 
notice of proposed rulemaking were received. After consideration of all 
the comments, the proposed regulations are adopted as amended by this 
Treasury Decision. The comments and revisions are discussed below.

Explanation and Summary of Comments

1. General

    One commentator suggested that the proposed regulations under 
section 66 (particularly Sec.  1.66-2) were not helpful, given the 
community property laws of the commentator's state. This commentator 
also suggested that the proposed regulations appear to assume that the 
community property laws of all community property states are the same. 
The intent of these regulations is not to provide guidance based on the 
community property laws of any particular state. Instead, the 
regulations provide guidance on the effect of section 66 on taxpayers' 
community income as determined under state law. After a determination 
that an item of income is community income under state law, these 
regulations provide guidance on the treatment of this income under 
section 66 for certain individuals not filing joint returns.
    One commentator noted that there are fundamental differences 
between married taxpayers who filed joint returns and request relief 
from joint and several liability under section 6015 and married 
taxpayers who filed separate returns and request relief from the 
Federal income tax liability resulting from the operation of community 
property law under section 66(c).
    The final regulations do not address differences between or make 
generalizations concerning married taxpayers who file joint returns and 
those who do not. The final regulations focus on providing guidance on 
the treatment of community income for certain taxpayers under section 
66.
    The preamble to the proposed regulations under section 66 
references

[[Page 41068]]

the spousal notification requirements set forth in regulations under 
section 6015 and discusses similar notification requirements under 
section 66. If the IRS grants relief under section 66, the liability of 
the requesting spouse will shift to the nonrequesting spouse. Thus, 
notification and participation requirements similar to those applicable 
in section 6015 cases are also appropriate for section 66 cases. In 
addition, information provided by a nonrequesting spouse may help to 
determine the appropriate amount of relief for the requesting spouse, 
if any.
    Similarities between the guidance set forth in the regulations 
under section 6015 and the regulations under section 66 are due to the 
similarities in the elements required, or factors considered, in 
determining relief under these statutes. The analysis set forth in 
proposed Sec.  1.66-4(a)(2) and (3) regarding knowledge or reason to 
know and benefit is similar to that contained in Sec.  1.6015-2(c) and 
(d). The final regulations modify this analysis and adopt commentators' 
suggestions to the extent that the suggestions are consistent with the 
statute, legislative history, and case law under section 66(c). These 
changes are more fully discussed in the comments and explanation under 
Sec.  1.66-4 below.

2. Section 1.66-1

    One commentator stated that Sec.  1.66-1 of the proposed 
regulations failed to expressly require each of the spouses to report 
those items of separate income that are attributable to each spouse 
under applicable state community property laws. Generally, community 
income is reportable half by each spouse pursuant to Poe v. Seaborn, 
282 U.S. 101 (1930), and section 61. Whether income is separate or 
community is determined under state law and the income is included in 
gross income under section 61. The final regulations do not include 
guidance on how to report income that is not community income under 
state law, as this would be outside the scope of section 66.
    The final regulations clarify in Sec.  1.66-1(a) that the general 
rule of community property applies to married individuals domiciled in 
community property states. A taxpayer should report income in 
accordance with the laws of the state in which he or she is domiciled. 
United States v. Mitchell, 403 U.S. 190, 197 (1971); Commissioner v. 
Wilkerson, 368 F.2d 552, 553 (9th Cir. 1966). For example, a taxpayer 
who is domiciled in State A, a community property state, should report 
income in accordance with the community property laws of State A, 
although she may be living in State B temporarily, due to a work 
detail, military assignment, etc.
    One commentator noted that under Sec.  1.66-1(b), the limitation of 
the scope of the regulations to married taxpayers was too restrictive. 
The commentator noted that income earned during a marriage, but 
received after the dissolution of the marital community, was community 
income under the laws of the commentator's state. The commentator 
suggested that section 66 should apply to this income, as it is 
community income under state law. The final regulations frame the issue 
in terms of application of section 66 to community income, rather than 
in terms of marital status.
    The final regulations state that section 66 applies only to 
community income, as defined by state law. The final regulations, 
however, make a distinction between community income and income from 
property that was formerly community property but, in accordance with 
state law, is converted to a form of property that is not community 
property, such as separate property or property held by joint tenancy 
or tenancy in common.
    Under the laws of certain community property states, property that 
was community property during the marriage ceases to be community 
property after the dissolution of the marital community. Conversely, 
some state laws treat property that was not community property as 
community property for the limited purpose of dividing assets upon 
divorce. See Estate of Mitchell v. Mitchell, 76 Cal. App. 4th 1378 
(Cal. Ct. App. 1999). Income from such property is not community income 
subject to the provisions of section 66. The determination as to 
whether income from such property is community income may be confusing 
due to the fact that sometimes courts will refer to the property, using 
``universally recognized shorthand,'' as community property. See 
Bouterie v. Commissioner, 36 F.3d 1361 (5th Cir. 1994) (in which the 
court found that the wife did not have community income from community 
property and the IRS improperly relied on a state court's imprecise use 
of the term ``community property'' in referring to property that was 
formerly community property), rev'g T.C. Memo. 1993-510.
    Thus, in determining whether section 66 applies to income, it is 
first necessary to determine whether the income is community income 
under state law. The marital status of the parties likely will be 
relevant to this initial determination.

3. Section 1.66-2

    One commentator noted that it may be difficult to determine whether 
a transfer of income is a transfer of earned income under Sec.  1.66-
2(a)(5). A transfer of earned income precludes the reporting of income 
in accordance with Sec.  1.66-2, even if a taxpayer meets the other 
requirements of Sec.  1.66-2. The commentator suggested that there 
should be a presumption under Sec.  1.66-2 that any transfer of income 
or property is a transfer of earned income. The final regulations adopt 
this recommendation with respect to transfers of income. It is a 
logical presumption that income is more likely to be earned than 
unearned, and that a taxpayer who has unearned income is likely to have 
earned income as well.
    Another commentator suggested that the final regulations clarify 
the requirement of Sec.  1.66-2 that spouses live apart. The final 
regulations adopt this recommendation by cross-referencing the 
definition of members of the same household in Sec.  1.6015-3(b).
    The final regulations clarify that, when reporting income in 
accordance with section 66(a), an individual must report all income in 
accordance with section 66(a). Section 66(a) does not apply on an item-
by-item basis.

4. Section 1.66-3

    One commentator recommended that the final regulations emphasize 
that the IRS may disallow the Federal income tax benefits of any 
community property law under section 66(b) on an item-by-item basis. 
Because the proposed regulations already reference ``item of community 
income'' in every sentence of Sec.  1.66-3, however, the final 
regulations do not adopt this recommendation.
    One commentator suggested that the IRS should assert section 66(b) 
sparingly, only if ``the * * * spouse had no knowledge whatever of the 
income * * * and did not benefit from the income in a division of 
marital assets.'' Section 66(b) allows the IRS to deny the Federal 
income tax benefits of community property law only when a taxpayer 
acted as if solely entitled to the income and failed to notify the 
taxpayer's spouse of the income. The final regulations do not impose 
additional requirements on the IRS.
    Commentators also recommended that the final regulations provide 
examples of what constitutes treating income as solely one's own and 
how specific a taxpayer must be when notifying his or her spouse of the 
nature and amount of the income. The final regulations adopt this 
recommendation.

[[Page 41069]]

5. Section 1.66-4

    The proposed regulations describe relief granted under the first 
sentence of section 66(c) as ``specific relief.'' The final regulations 
adopt the term traditional relief to describe relief granted under this 
provision. The final regulations retain the term ``equitable relief'' 
to describe the relief granted under the second sentence of section 
66(c).
    The proposed regulations require that a spouse requesting relief 
under Sec.  1.66-4 file a separate return for the taxable year relating 
to the request. One commentator noted that section 66(c)(1) requires 
only that an individual not file a joint return. The legislative 
history of section 66(c) confirms that Congress did not intend to 
require an individual to file a return to be eligible for relief under 
this provision. The House Report uses the phrase ``at the time the 
return was filed (if a return is filed).'' H.R. Rep. No. 98-432, pt. 2, 
at 1503 (1984). In earlier cases regarding relief under section 66(c), 
the Tax Court implies that a requesting spouse must file a separate 
return. See, e.g., Roberts v. Commissioner, T.C. Memo. 1987-391, aff'd 
860 F.2d 1235 (5th Cir. 1988). More recent cases, however, specifically 
state that not filing any return meets the requirement of not filing a 
joint return. See, e.g., Ollestad v. Commissioner, T.C. Memo. 1996-139; 
Costa v. Commissioner, T.C. Memo. 1990-572. The final regulations adopt 
the recommendation to limit the requirement to not filing a joint 
return.
    One commentator suggested that the discussion of knowledge and 
reason to know of an item of community income in Sec.  1.66-4 ignores 
the low probability that a requesting spouse would have access to 
accurate information or knowledge regarding what the nonrequesting 
spouse reported or did not report for Federal income tax purposes. 
Under section 66(c), a requesting spouse is required to prove, among 
other things, that ``he or she did not know of, and had no reason to 
know of, such item of community income'' to obtain traditional relief. 
The final regulations include a discussion of knowledge and reason to 
know, as this is an element required by section 66(c)(3). The facts and 
circumstances considered in making the determination of knowledge or 
reason to know are consistent with the knowledge and reason to know 
analysis set forth in case law determining relief under section 66(c).
    Additionally, the final regulations include new language regarding 
the knowledge standard under section 66(c). To more closely track the 
language of section 66(c), the phrase item of community income replaces 
the term understatement when referring to the item about which the 
requesting spouse has knowledge or reason to know. Finally, the final 
regulations clarify that knowledge of the source of community income or 
the income-producing activity, without knowledge of the specific amount 
of income, is sufficient knowledge to preclude relief under section 
66(c). This is consistent with the knowledge and reason to know 
analysis set forth in case law under section 66(c). See, e.g., McGee v. 
Commissioner, 979 F.2d 66, 70 (5th Cir. 1992), aff'g T.C. Memo. 1991-
510.
    Two commentators questioned whether the standard of significant 
benefit in excess of normal support, which is used in determining 
whether it is equitable to grant relief under section 6015, is the 
applicable standard under section 66. One commentator noted that under 
community property laws, each spouse generally is entitled to half of 
the income of the other spouse. Under section 66, a requesting spouse 
essentially is seeking relief for half the income of both spouses, 
which may have been used to provide normal support to both spouses. 
Contrast this situation to that under section 6015, which permits a 
requesting spouse to seek relief from joint and several liability for 
the tax on all of the income of the nonrequesting spouse. This 
commentator suggested that the tax liability should be shifted to the 
nonrequesting spouse only if the nonrequesting spouse has treated the 
income in a manner inconsistent with the community property regime, for 
example, has not allowed use of the income for normal support or has 
transferred no part of the income to the requesting spouse.
    A majority of cases decided under section 66(c) make the 
determination of whether it is equitable to grant relief based on the 
``benefit'' received by the requesting spouse, as opposed to the 
``significant benefit'' standard applied by courts in determining 
relief under former section 6013(e) and section 6015(b). See Beck v. 
Commissioner, T.C. Memo. 2001-198, acq. 2002-49 I.R.B.; Hardy v. 
Commissioner, T.C. Memo. 1997-97. The court in Beck and Hardy cited the 
legislative history of section 66(c) when discussing benefit under 
section 66. The legislative history provides that, in determining 
whether it is equitable to grant relief under section 66(c), the 
standard is ``whether the [requesting] spouse benefitted from the 
untaxed income.'' H. Rep. No. 98-432, pt. 2, at 1503 (1984). The final 
regulations adopt this standard.
    One commentator suggested that the time limitations set forth in 
Sec.  1.66-4 for requesting relief under section 66(c) are not 
supported by the language of section 66(c). Although the statute itself 
does not set forth time limitations on the filing of a request for 
relief, the time limitations in the proposed regulations are supported 
by the legislative history of the traditional relief provision of 
section 66(c). Specifically, the House Report explaining traditional 
relief under section 66(c) states that, in making the determination as 
to relief, the IRS should consider (among other things) ``whether the 
defense was promptly raised so as to prevent the period of limitations 
from running on the other spouse.'' H.R. Rep. No. 98-432, pt. 2, at 
1501 (1984). Thus, the final regulations retain the time limitations 
set forth in the proposed regulations. In contrast, Sec.  1.66-
4(j)(2)(ii) sets forth timing requirements for requesting equitable 
relief that are broader than the requirements applicable to traditional 
relief because the legislative history of the equitable relief 
provision does not contain similar timing requirements. Therefore, a 
requesting spouse who does not meet the time limitations to request 
traditional relief may be eligible to request equitable relief.
    Another commentator noted that perhaps the timeliness of the 
requesting spouse's request should be only one factor in determining 
whether to grant traditional relief under section 66(c), as opposed to 
a threshold requirement. This comment was not adopted because a 
requesting spouse who does not meet the timing requirements for 
traditional relief still may receive equitable relief under section 
66(c).
    One commentator urged that no request for relief under section 66 
should be considered premature. There must be some indication that the 
IRS may determine a deficiency prior to the filing of a request for 
relief from a deficiency under section 66(c). Thus, the final 
regulations retain the timing limitations set forth in the proposed 
regulations regarding premature requests.
    The final regulations incorporate an item-by-item approach to 
relief from the Federal income tax liability resulting from the 
operation of community property law under section 66(c). If a 
requesting spouse receives relief under section 66(c), the proposed 
regulations provide for treatment of any community income of the 
spouses in accordance with the rules provided by section 879(a), which 
is consistent with the statutory rule under section 66(a). The

[[Page 41070]]

final regulations provide that if a requesting spouse receives relief 
for an item, the rules provided by section 879(a) will govern the 
treatment of the item. The item-by-item approach adopted in the final 
regulations is consistent with the statutory language in section 66(c) 
that states ``such item of community income shall be included in the 
gross income of the other spouse (and not in the gross income of the 
individual).'' (Emphasis added.)
    Traditionally, section 66(c) provided relief from liability 
resulting only from items of income, unlike former section 6013(e) and 
section 6015. The final regulations expand equitable relief under Sec.  
1.66-4(b) to include relief for underpayments of tax or any deficiency, 
including those arising from disallowed deductions or credits. This is 
consistent with the equitable relief provision in section 66(c).

Special Analyses

    It has been determined that these final regulations are not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to the regulations, and because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply.

Drafting Information

    The principal author of the regulations is Robin M. Tuczak of the 
Office of Associate Chief Counsel (Procedure and Administration), 
Administrative Provisions and Judicial Practice Division.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry in numerical order to the table to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Section 1.66-4 also issued under 26 U.S.C. 66(c). * * *


0
Par. 2. Sections 1.66-1 through 1.66-5 are added to read as follows:


Sec.  1.66-1  Treatment of community income.

    (a) In general. Married individuals domiciled in a community 
property state who do not elect to file a joint individual Federal 
income tax return under section 6013 generally must report half of the 
total community income earned by the spouses during the taxable year 
except at times when one of the following exceptions applies:
    (1) The spouses live apart and meet the qualifications of Sec.  
1.66-2.
    (2) The Secretary denies a spouse the Federal income tax benefits 
resulting from community property law under Sec.  1.66-3, because that 
spouse acted as if solely entitled to the income and failed to notify 
his or her spouse of the nature and amount of the income prior to the 
due date for the filing of his or her spouse's return.
    (3) A requesting spouse qualifies for traditional relief from the 
Federal income tax liability resulting from the operation of community 
property law under Sec.  1.66-4(a).
    (4) A requesting spouse qualifies for equitable relief from the 
Federal income tax liability resulting from the operation of community 
property law under Sec.  1.66-4(b).
    (b) Applicability. (1) The rules of this section apply only to 
community income, as defined by state law. The rules of this section do 
not apply to income that is not community income. Thus, the rules of 
this section do not apply to income from property that was formerly 
community property, but in accordance with state law, has ceased to be 
community property, becoming, e.g., separate property or property held 
by joint tenancy or tenancy in common.
    (2) When taxpayers report income under paragraph (a) of this 
section, all community income for the calendar year is treated in 
accordance with the rules provided by section 879(a). Unlike the other 
provisions under section 66, section 66(a) does not permit inclusion on 
an item-by-item basis.
    (c) Transferee liability. The provisions of section 66 do not 
negate liability that arises under the operation of other laws. 
Therefore, a spouse who is not subject to Federal income tax on 
community income may nevertheless remain liable for the unpaid tax 
(including additions to tax, penalties, and interest) to the extent 
provided by Federal or state transferee liability or property laws 
(other than community property laws). For the rules regarding the 
liability of transferees, see sections 6901 through 6904 and the 
regulations thereunder.


Sec.  1.66-2  Treatment of community income where spouses live apart.

    (a) Community income of spouses domiciled in a community property 
state will be treated in accordance with the rules provided by section 
879(a) if all of the following requirements are satisfied--
    (1) The spouses are married to each other at any time during the 
calendar year;
    (2) The spouses live apart at all times during the calendar year;
    (3) The spouses do not file a joint return with each other for a 
taxable year beginning or ending in the calendar year;
    (4) One or both spouses have earned income that is community income 
for the calendar year; and
    (5) No portion of such earned income is transferred (directly or 
indirectly) between such spouses before the close of the calendar year.
    (b) Living apart. For purposes of this section, living apart 
requires that spouses maintain separate residences. Spouses who 
maintain separate residences due to temporary absences are not 
considered to be living apart. Spouses who are not members of the same 
household under Sec.  1.6015-3(b) are considered to be living apart for 
purposes of this section.
    (c) Transferred income. For purposes of this section, transferred 
income does not include a de minimis amount of earned income that is 
transferred between the spouses. In addition, any amount of earned 
income transferred for the benefit of the spouses' child will not be 
treated as an indirect transfer to one spouse. Additionally, income 
transferred between spouses is presumed to be a transfer of earned 
income. This presumption is rebuttable.
    (d) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Living apart. H and W are married, domiciled in State 
A, a community property state, and have lived apart the entire year 
of 2002. W, who is in the Army, was stationed in Korea for the 
entire calendar year. During their separation, W intended to return 
home to H, and H intended to live with W upon W's return. H and W do 
not file a joint return for taxable year 2002. H and W may not 
report their income under this section because a temporary absence 
due to military service is not living apart as contemplated under 
this section.
    Example 2. Transfer of earned income--de minimis exception. H 
and W are married, domiciled in State B, a community property state, 
and have lived apart the entire year of 2002. H and W are estranged 
and intend to live apart indefinitely. H and W do not file

[[Page 41071]]

a joint return for taxable year 2002. H occasionally visits W and 
their two children, who live with W. When H visits, he often buys 
gifts for the children, takes the children out to dinner, and 
occasionally buys groceries or gives W money to buy the children new 
clothes for school. Both W and H have earned income in the year 2002 
that is community income under the laws of State B. H and W may 
report their income on separate returns under this section.
    Example 3. Transfer of earned income--source of transfer. H and 
W are married, domiciled in State C, a community property state, and 
have lived apart the entire year of 2002. H and W are estranged and 
intend to live apart indefinitely. H and W do not file a joint 
return for taxable year 2002. W provides H $1,000 a month from March 
2002 through August 2002 while H is working part-time and seeking 
full-time employment. W is not legally obligated to make the $1,000 
payments. W earns $75,000 in 2002 in wage income. W also receives 
$10,000 in capital gains income in December 2002. H wants to report 
his income in accordance with this section, alleging that the $6,000 
that he received from W was not from W's earned income, but from the 
capital gains income W received in 2002. The facts and circumstances 
surrounding the periodic payments to H from W do not indicate that W 
made the payments out of her capital gains. H and W may not report 
their income in accordance with this section, as the $6,000 W 
transferred to H is presumed to be from W's earned income, and H has 
not presented any facts to rebut the presumption.


Sec.  1.66-3  Denial of the Federal income tax benefits resulting from 
the operation of community property law where spouse not notified.

    (a) In general. The Secretary may deny the Federal income tax 
benefits of community property law to any spouse with respect to any 
item of community income if that spouse acted as if solely entitled to 
the income and failed to notify his or her spouse of the nature and 
amount of the income before the due date (including extensions) for the 
filing of the return of his or her spouse for the taxable year in which 
the item of income was derived. Whether a spouse has acted as if solely 
entitled to the item of income is a facts and circumstances 
determination. This determination focuses on whether the spouse used, 
or made available, the item of income for the benefit of the marital 
community.
    (b) Effect. The item of community income will be included, in its 
entirety, in the gross income of the spouse to whom the Secretary 
denied the Federal income tax benefits resulting from community 
property law. The tax liability arising from the inclusion of the item 
of community income must be assessed in accordance with section 6212 
against this spouse.
    (c) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Acting as if solely entitled to income. (i) H and W 
are married and are domiciled in State A, a community property 
state. W's Form W-2 for taxable year 2000 showed wage income of 
$35,000. W also received a Form 1099-INT, ``Interest Income,'' 
showing $1,000 W received in taxable year 2000. W's wage income was 
directly deposited into H and W's joint account, from which H and W 
paid bills and household expenses. W did not inform H of her 
interest income or the Form 1099-INT, but W gave H a copy of the W-2 
when she received it in January 2001. W did not use her interest 
income for bills or household expenses. Instead W gave her interest 
income to her brother, who was unemployed. Neither the separate 
return filed by H nor the separate return filed by W included the 
interest income. In 2002, the IRS audits both H and W. The Internal 
Revenue Service (IRS) may raise section 66(b) as to W's interest 
income, denying W the Federal income tax benefit resulting from 
community property law as to this item of income.
    (ii) H and W are married and are domiciled in State B, a 
community property state. For taxable year 2000, H receives $45,000 
in wage income that H places in a separate account. H and W maintain 
separate residences. H's wage income is community income under the 
laws of State B. That same year, W loses her job, and H pays W's 
mortgage and household expenses for several months while W seeks 
employment. Neither H nor W files a return for 2000, the taxable 
year for which the IRS subsequently audits them. The IRS may not 
raise section 66(b) and deny H the Federal income tax benefits 
resulting from the operation of community property law as to H's 
wage income of $45,000, as H has not treated this income as if H 
were solely entitled to it.
    Example 2. Notification of nature and amount of the income. H 
and W are married and domiciled in State C, a community property 
state. H and W do not file a joint return for taxable year 2001. H's 
and W's earned income for 2001 is community income under the laws of 
State C. H receives $50,000 in wage income in 2001. In January 2002, 
H receives a Form W-2 that erroneously states that H earned $45,000 
in taxable year 2001. H provides W a copy of H's Form W-2 in 
February 2002. W files for an extension prior to April 15, 2002. H 
receives a corrected Form W-2 reflecting wages of $50,000 in May 
2002. H provides a copy of the corrected Form W-2 to W in May 2002. 
W files a separate return in June 2002, but reports one half of 
$45,000 ($22,500) of wage income that H earned. H files a separate 
return reporting half of $50,000 ($25,000) in wage income. The IRS 
audits both H and W. Even if H had acted as if solely entitled to 
the wage income, the IRS may not raise section 66(b) as to this 
income because H notified W of the nature and amount of the income 
prior to the due date of W's return (including extensions).


Sec.  1.66-4  Request for relief from the Federal income tax liability 
resulting from the operation of community property law.

    (a) Traditional relief--(1) In general. A requesting spouse will 
receive relief from the Federal income tax liability resulting from the 
operation of community property law for an item of community income 
if--
    (i) The requesting spouse did not file a joint Federal income tax 
return for the taxable year for which he or she seeks relief;
    (ii) The requesting spouse did not include in gross income for the 
taxable year an item of community income properly includible therein, 
which, under the rules contained in section 879(a), would be treated as 
the income of the nonrequesting spouse;
    (iii) The requesting spouse establishes that he or she did not know 
of, and had no reason to know of, the item of community income; and
    (iv) Taking into account all of the facts and circumstances, it is 
inequitable to include the item of community income in the requesting 
spouse's individual gross income.
    (2) Knowledge or reason to know. (i) A requesting spouse had 
knowledge or reason to know of an item of community income if he or she 
either actually knew of the item of community income, or if a 
reasonable person in similar circumstances would have known of the item 
of community income. All of the facts and circumstances are considered 
in determining whether a requesting spouse had reason to know of an 
item of community income. The relevant facts and circumstances include, 
but are not limited to, the nature of the item of community income, the 
amount of the item of community income relative to other income items, 
the couple's financial situation, the requesting spouse's educational 
background and business experience, and whether the item of community 
income was reflected on prior years' returns (e.g., investment income 
omitted that was regularly reported on prior years' returns).
    (ii) If the requesting spouse is aware of the source of community 
income or the income-producing activity, but is unaware of the specific 
amount of the nonrequesting spouse's community income, the requesting 
spouse is considered to have knowledge or reason to know of the item of 
community income. The requesting spouse's lack of knowledge of the 
specific amount of community income does not provide a basis for relief 
under this section.
    (3) Inequitable. All of the facts and circumstances are considered 
in determining whether it is inequitable to

[[Page 41072]]

hold a requesting spouse liable for a deficiency attributable to an 
item of community income. One relevant factor for this purpose is 
whether the requesting spouse benefitted, directly or indirectly, from 
the omitted item of community income. A benefit includes normal 
support, but does not include de minimis amounts. Evidence of direct or 
indirect benefit may consist of transfers of property or rights to 
property, including transfers received several years after the filing 
of the return. Thus, for example, if a requesting spouse receives from 
the nonrequesting spouse property (including life insurance proceeds) 
that is traceable to items of community income attributable to the 
nonrequesting spouse, the requesting spouse will have benefitted from 
those items of community income. Other factors may include, if the 
situation warrants, desertion, divorce or separation. Factors relevant 
to whether it would be inequitable to hold a requesting spouse liable, 
more specifically described under the applicable administrative 
procedure issued under section 66(c) (Revenue Procedure 2000-15 (2000-1 
C.B. 447) (See Sec.  601.601(d)(2) of this chapter), or other 
applicable guidance published by the Secretary), are to be considered 
in making a determination under this paragraph.
    (b) Equitable relief. Equitable relief may be available when the 
four requirements of paragraph (a)(1) of this section are not 
satisfied, but it would be inequitable to hold the requesting spouse 
liable for the unpaid tax or deficiency. Factors relevant to whether it 
would be inequitable to hold a requesting spouse liable, more 
specifically described under the applicable administrative procedure 
issued under section 66(c) (Revenue Procedure 2000-15 (2000-1 C.B. 
447), or other applicable guidance published by the Secretary), are to 
be considered in making a determination under this paragraph.
    (c) Applicability. Traditional relief under paragraph (a) of this 
section applies only to deficiencies arising out of items of omitted 
income. Equitable relief under paragraph (b) of this section applies to 
any deficiency or any unpaid tax (or any portion of either). Equitable 
relief is available only for the portion of liabilities that were 
unpaid as of July 22, 1998, and for liabilities that arise after July 
22, 1998.
    (d) Effect of relief. When the requesting spouse qualifies for 
relief under paragraph (a) or (b) of this section, the IRS must assess 
any deficiency of the nonrequesting spouse arising from the granting of 
relief to the requesting spouse in accordance with section 6212.
    (e) Examples. The following examples illustrate the rules of this 
section:

    Example 1. Item-by-item approach. H and W are married, living 
together, and domiciled in State A (a community property state). H 
and W file separate returns for taxable year 2002 on April 15, 2003. 
H earns $56,000 in wages, and W earns $46,000 in wages, in 2002. H 
reports half of his wage income as shown on his Form W-2, in the 
amount of $28,000, and half of W's wage income as shown on her Form 
W-2, in the amount of $23,000. W reports half of her wage income as 
shown on her W-2, in the amount of $23,000, and half of H's wage 
income as shown on his Form W-2, in the amount of $28,000. Neither H 
nor W reports W's income from her sole proprietorship of $34,000 or 
W's investment income of $5,000 for taxable year 2002. The Internal 
Revenue Service (IRS) proposes deficiencies with respect to H's and 
W's taxable year 2002 returns due to the omission of W's income from 
her sole proprietorship and investments. H timely requests relief 
under section 66(c). Because the IRS determines that H satisfies the 
four requirements of the traditional relief provision of section 
66(c) with respect to W's omitted investment income, the IRS grants 
H's request for relief as to the omitted investment income. The IRS 
determines that H does not satisfy the four requirements of the 
traditional relief provision of section 66(c) as to W's sole 
proprietorship income. The IRS further determines that, under the 
equitable relief provision of section 66(c), it is not inequitable 
to hold H liable for the sole proprietorship income. Relief is 
applicable on an item-by-item basis. Thus, H is liable for the tax 
on half of his wage income in the amount of $28,000, half of W's 
wage income in the amount of $23,000, half of W's sole 
proprietorship income in the amount of $17,000, but none of W's 
investment income, for which H obtained relief under section 66(c). 
W is liable for the tax on half of H's wage income in the amount of 
$28,000, half of W's wage income in the amount of $23,000, half of 
W's sole proprietorship income in the amount of $17,000, and all of 
W's investment income in the amount of $5,000, because H obtained 
relief under section 66(c).
    Example 2. Benefit. H and W are married, living together, and 
domiciled in State B (a community property state). Neither H nor W 
files a return for taxable year 2000. H earns $60,000 in 2000, which 
he deposits in a joint account. H and W pay the mortgage payment, 
household bills, and other family expenses out of the joint account. 
W earns $20,000 in 2000. W uses a portion of the $20,000 to make 
monthly loan payments on the family cars, but loses the remainder at 
the local racetrack. In 2002, the IRS audits H and W. H requests 
relief under section 66(c), stating that he did not know or have 
reason to know of W's additional income, as H travels extensively 
while W handles the family finances. Regardless of whether H had 
knowledge or reason to know of the source of W's income, H is not 
eligible for traditional relief under section 66(c) because H 
benefitted from W's income. H's benefit, the portion of W's income 
used to make monthly payments on the car loans, was more than a de 
minimis amount. While this benefit was not in excess of normal 
support, it is enough to preclude relief under the traditional 
relief provision of section 66(c). H may still qualify for equitable 
relief under section 66(c), depending on all of the facts and 
circumstances.

    (f) Fraudulent scheme. If the Secretary establishes that a spouse 
transferred assets to his or her spouse as part of a fraudulent scheme, 
relief is not available under this section. For purposes of this 
section, a fraudulent scheme includes a scheme to defraud the Secretary 
or another third party, such as a creditor, ex-spouse, or business 
partner.
    (g) Definitions--(1) Requesting spouse. A requesting spouse is an 
individual who does not file a joint Federal income tax return with the 
nonrequesting spouse for the taxable year in question, and who requests 
relief from the Federal income tax liability resulting from the 
operation of community property law under this section for the portion 
of the liability arising from his or her share of community income for 
such taxable year.
    (2) Nonrequesting spouse. A nonrequesting spouse is the individual 
to whom the requesting spouse was married and whose income or deduction 
gave rise to the tax liability from which the requesting spouse seeks 
relief in whole or in part.
    (h) Effect of prior closing agreement or offer in compromise. A 
requesting spouse is not entitled to relief from the Federal income tax 
liability resulting from the operation of community property law under 
section 66 for any taxable year for which the requesting spouse has 
entered into a closing agreement (other than an agreement pursuant to 
section 6224(c) relating to partnership items) with the Secretary that 
disposes of the same liability that is the subject of the request for 
relief. In addition, a requesting spouse is not entitled to relief from 
the Federal income tax liability resulting from the operation of 
community property law under section 66 for any taxable year for which 
the requesting spouse has entered into an offer in compromise with the 
Secretary. For rules relating to the effect of closing agreements and 
offers in compromise, see sections 7121 and 7122, and the regulations 
thereunder.
    (i) [Reserved]
    (j) Time and manner for requesting relief--(1) Requesting relief. 
To request relief from the Federal income tax liability resulting from 
the operation of

[[Page 41073]]

community property law under this section, a requesting spouse must 
file, within the time period prescribed in paragraph (j)(2) of this 
section, Form 8857, ``Request for Innocent Spouse Relief'' (or other 
specified form), or other written request, signed under penalties of 
perjury, stating why relief is appropriate. The requesting spouse must 
include the nonrequesting spouse's name and taxpayer identification 
number in the written request. The requesting spouse must also comply 
with the Secretary's reasonable requests for information that will 
assist the Secretary in identifying and locating the nonrequesting 
spouse.
    (2) Time period for filing a request for relief--(i) Traditional 
relief. The earliest time for submitting a request for relief from the 
Federal income tax liability resulting from the operation of community 
property law under paragraph (a) of this section, for an amount 
underreported on, or omitted from, the requesting spouse's separate 
return, is the date the requesting spouse receives notification of an 
audit or a letter or notice from the IRS stating that there may be an 
outstanding liability with regard to that year (as described in 
paragraph (j)(2)(iii) of this section). The latest time for requesting 
relief under paragraph (a) of this section is 6 months before the 
expiration of the period of limitations on assessment, including 
extensions, against the nonrequesting spouse for the taxable year that 
is the subject of the request for relief, unless the examination of the 
requesting spouse's return commences during that 6-month period. If the 
examination of the requesting spouse's return commences during that 6-
month period, the latest time for requesting relief under paragraph (a) 
of this section is 30 days after the commencement of the examination.
    (ii) Equitable relief. The earliest time for submitting a request 
for relief from the Federal income tax liability resulting from the 
operation of community property law under paragraph (b) of this section 
is the date the requesting spouse receives notification of an audit or 
a letter or notice from the IRS stating that there may be an 
outstanding liability with regard to that year (as described in 
paragraph (j)(2)(iii) of this section). A request for equitable relief 
from the Federal income tax liability resulting from the operation of 
community property law under paragraph (b) of this section for a 
liability that is properly reported but unpaid is properly submitted 
with the requesting spouse's individual Federal income tax return, or 
after the requesting spouse's individual Federal income tax return is 
filed.
    (iii) Premature requests for relief. The Secretary will not 
consider a premature request for relief under this section. The notices 
or letters referenced in this paragraph (j)(2) do not include notices 
issued pursuant to section 6223 relating to TEFRA partnership 
proceedings. These notices or letters include notices of computational 
adjustment to a partner or partner's spouse (Notice of Income Tax 
Examination Changes) that reflect a computation of the liability 
attributable to partnership items of the partner or the partner's 
spouse.
    (k) Nonrequesting spouse's notice and opportunity to participate in 
administrative proceedings--(1) In general. When the Secretary receives 
a request for relief from the Federal income tax liability resulting 
from the operation of community property law under this section, the 
Secretary must send a notice to the nonrequesting spouse's last known 
address that informs the nonrequesting spouse of the requesting 
spouse's request for relief. The notice must provide the nonrequesting 
spouse with an opportunity to submit any information for consideration 
in determining whether to grant the requesting spouse relief from the 
Federal income tax liability resulting from the operation of community 
property law. The Secretary will share with each spouse the information 
submitted by the other spouse, unless the Secretary determines that the 
sharing of this information will impair tax administration.
    (2) Information submitted. The Secretary will consider all of the 
information (as relevant to the particular relief provision) that the 
nonrequesting spouse submits in determining whether to grant relief 
from the Federal income tax liability resulting from the operation of 
community property law under this section.


Sec.  1.66-5  Effective date.

    Sections 1.66-1 through 1.66-4 are applicable on July 10, 2003. In 
addition, Sec.  1.66-4 applies to any request for relief filed prior to 
July 10, 2003, for which the Internal Revenue Service has not issued a 
preliminary determination as of July 10, 2003.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

0
Par. 4. The following entry is added in numerical order to the table:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                                * * * * *
1.66-4.....................................................    1545-1770
 
                                * * * * *
------------------------------------------------------------------------


David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.
    Approved: July 1, 2003.
Gregory F. Jenner,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 03-17386 Filed 7-9-03; 8:45 am]
BILLING CODE 4830-01-P