The Tax Court in Brief – November 28th – December 2nd, 2022

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation: The Week of November 28th, 2022, through December 2nd, 2022

• Lipka v. Comm’r, T.C. Memo. 2022-116 | December 1, 2022 | Gustafson, J. |Docket No. 11455-20L
• Hallmark Research Collective v. Comm’r, 159 T.C. No. 6 | November 29, 2022 | Gustafson | Dkt. No. 21284-21
• Showalter, v. Commissioner, T.C. Memo. 2022-114 | November 30, 2022 |Lauber, J.| Dkt. No. 13116-18
• Heather P. Dunn and Edison Dunn v. Comm’r |T.C. Memo 2022-112 | November 29, 2022 | Wells, J. | Dkt. No. , No. 9996-17

Reynolds v. Comm’r, T.C. Memo. 2022-115 | November 30, 2022 |Wells, J. |Docket No. 14433-16

Short Summary: This case involves the IRS’s denial of a taxpayer’s request for innocent spouse relief following findings of deficiencies and assessment of penalties and interest for tax years 2004 through 2007. Most of the deficiencies resulted from the husband’s embezzlement of funds his employer, a church where he served as the director of finance. However, deficiencies also arose from the couple’s failure to report income earned by the wife including unemployment compensation, legal fees, and interest. The couple also failed to account for the wife’s self-employment taxes and erroneously claimed deductions for her legal practice and certain child tax credits. The husband was incarcerated for the embezzlement in 2013. In 2014, the wife received a discharge of her debts in Chapter 7 bankruptcy and timely filed Form 8857, Request Innocent Spouse Relief. The coupled did not divorce or legally separate during the incarceration. During the bankruptcy, the family lost their home to foreclosure. The wife moved in with her parents until she was able to purchase a new home in 2016. Upon release from prison in 2018, the husband moved back in with the wife and their 5 children.

Key Issue: The Tax court evaluated whether the IRS appropriately denied the petitioner wife’s request for innocent spouse relief on June 1, 2017.

Primary Holding: The petitioner wife was not entitled to full or partial relief under 6015(b), proportional relief under 6015(c), or equitable relief under 6015(f) and remained jointly and severally liable. The Tax Court evaluated the five conditions for relief under section 6015(b)(1). First, the Court found that innocent spouse relief could not apply to portions of the understatement that were attributable to her. For portions of the understatement that were attributable to the petitioner husband, the court found that the petitioner wife did not qualify for relief because (1) she had reason to know of the understatement at the time the return was signed and (2) holding her liable would not be inequitable.

The wife apparently did not have direct knowledge of the husband’s embezzlement, but the Tax Court found that the petitioner spouse had a duty of inquiry into the couple’s returns. The husband did the taxes and primarily handled their finances, but the court found that the wife should have known about the understatements for the following reasons:

1. She used jointly held accounts to cover household expenses in which the embezzled payments were deposited in addition to the husband’s biweekly payments from the church.
2. She reviewed the returns before signing them.
3. She was responsible for many household purchases and should have known the family’s income far exceeded what they reported.
4. Her legal training should have alerted her to a likely understatement.
5. She derived a significant benefited from the understatements. The couple sent their kids to private school and the husband purchased the wife gifts such as a vintage coat, a diamond anniversary ring, and a designer handbag.

The court held that the wife could not elect under section 6015(c) to limit liability consistent with section 6015(d) and could not elect proportionate relief. Those options apply, respectively, when the requesting spouse is (i) divorced or legally separate from the other spouse or (ii) not a member of the same household during 12-month period ending on the date section 6015 relief is requested. Despite the petitioners’ argument to the contrary, the Tax Court found the petitioners were never legally separated under Maryland law during the husband’s incarceration and that they remained part of the same household.

Finally, the court applied the analysis stipulated by Revenue Procedure 2013-34 and found that the petitioner wife was not entitled to equitable relief under section 6015(f). The respondent conceded that the petitioner wife met the seven threshold conditions for equitable relief, but the court agreed she failed to qualify for a “streamlined determination” because the couple was still married. Therefore, the finding as to equitable relief was appropriately based on the facts and circumstances for the same reasons that she did not qualify under section 6015(b).

Key Points of Law:

• After spouses elect to file a joint federal income tax return under section 6013(a), each spouse is jointly and severally liable for the entire tax due for that taxable year.
• To qualify for relief under section 6015(b) for a taxable year, the requesting spouse must satisfy the following conditions: (A) a joint return was made; (B) there is an understatement of tax attributable to the nonrequesting spouse; (C) the requesting spouse did not know and had no reason to know of the understatement; (D) based on all facts and circumstances, it would be inequitable to hold liable the requesting spouse; and (E) timely relief is requested.
• All five conditions must be met for a taxpayer to qualify for innocent spouse relief under section 6015(b). Rogers v. Commissioner, T.C. Memo. 2018-53, at *100–01; Haltom v. Commissioner, T.C. Memo. 2005-209.
• Treasury regulations provide that a requesting spouse and a nonrequesting spouse “are considered members of the same household during either spouse’s temporary absences from the household if it is reasonable to assume that the absent spouse will return to the household, and the household or a substantially equivalent household is maintained in anticipation of such return.” Treas. Reg. § 1.6015-3(b)(3)(i)
• Under section 6015(f) the Secretary may grant equitable relief to a requesting spouse on the basis of the facts and circumstances. Revenue Procedure 2013-34 provides a three-step analysis for evaluating a request for equitable relief. The first step consists of seven threshold conditions that must be met. Rev. Proc. 2013-34, § 4.01, 2013- 43 I.R.B. at 399. The first step requires meeting seven threshold conditions for the portions of deficiencies attributable to the nonrequesting spouse. The second step of the analysis provides three conditions that must be met to qualify for a streamlined determination of relief; the first being that the spouses are no longer married. Id. § 4.02, 2013-43 I.R.B. at 400. A third step is a finding that holding the requesting spouse liable would be inequitable; it is available if the threshold conditions are satisfied but a streamlined determination is not available. Id. § 4.03.
• The taxpayer bears the burden of proving that he or she is entitled to section 6015 relief. Rule 142(a); Alt v. Commissioner, 119 T.C. 306, 311 (2002), aff’d, 101 F. App’x 34 (6th Cir. 2004).
• When considering a request for relief, the Tax Court applies a de novo standard of review and the scope of review is limited to the administrative record; however, at the time the petition was filed, the scope of review was de novo as Congress had not yet enacted Section 6015(e)(7). See Porter v. Commissioner, 132 T.C. 203, 210 (2009); Sutherland v. Commissioner, 155 T.C 95, 105–06 (2020).
• The Tax Court may consider the guidance set forth in Revenue Procedure 2013-34, but its determination ultimately rests on an evaluation of all the facts and circumstances. See Pullins v. Commissioner, 136 T.C. 438–39; Johnson v. Commissioner, T.C. Memo. 2014-240, at *10.
• The Tax Court does not have jurisdiction to adjudicate whether a tax, fine, penalty, or addition to tax was discharged under the Bankruptcy Code. Neilson v. Commissioner, 94 T.C. 1, 9 (1990); Ashmore v. Commissioner, T.C. Memo. 2016-36, at *8.

Insights:

• Married taxpayers should proactively seek to determine whether their spouse is erroneously reporting earnings or deductions in determining income.
• If facts exist that should give a spouse concern regarding whether a spouse may be reporting income inaccurately, the other spouse should seriously consider filing a separate return.
• After discovering serious tax reporting failures by a spouse, a taxpayer should seriously consider whether a divorce is necessary to qualify for innocent spouse relief. As part of this consideration, the spouse should consult with competent tax and divorce counsel.
• The IRS took three years to issue a decision on the petitioner wife’s request for relief. If prospective relief is possible but doubtful, taxpayers should do all they can to prepare to make payment on any deficiencies, additions, and penalties while awaiting a decision.

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