Vince Nardone: Tax and Controversy

Innocent Spouse Relief - Fraudulent Income of Spouse

Guest Author: M. Pilar Honer, Esq., Columbus, Ohio

 

In Yakubic, TC Summary Opinion 2008-74, the Tax Court held that it was an abuse of discretion when the Service failed to grant a taxpayer relief for failing to report his ex-wife’s income that she fraudulently obtained.  In 2003, the taxpayer’s wife worked as a paralegal, and embezzled funds from her employer.  She also wrote out bad checks on the couple’s joint bank account and forged checks belonging to the taxpayer’s stepfather.  Later that year, she was caught, sentenced to prison, and ordered to pay restitution to her employer and the taxpayer’s stepfather.  In 2004, while his wife was in prison, the taxpayer filed a joint tax return for 2003.  Although he knew that his wife worked in 2003, and he knew she obtained money through dishonest means, he did not report the additional income.  After filing the original return, he received a W-2 form from his wife’s employer and failed to amend the return to reflect the income.  Due to his understatements, the couple qualified for an earned income credit and the Service issued a refund for $5,017.

 

In May 2005, the Service detected the taxpayer’s understatements and sent him a notice of deficiency indicating an increase in the couple’s tax liability along with a penalty for not reporting all of their income.  A few months later, the taxpayer divorced his wife.  Then in December of that same year, the taxpayer filed a Form 8857 Request for Innocent Spouse Relief.  The Service denied his request, and the taxpayer filed a petition with the Tax Court.

           

            Generally, under the Code, taxpayers filing joint Federal Income tax returns are jointly and severally liable for taxes due. Section 6013(d)(3).  A taxpayer, however, may obtain relief from joint and several liability if he qualifies under any of the exceptions listed in Sections 6015 (b) (c) or (f) of the Code.  The taxpayer seeking relief bears the burden of proof. Rule 142 (a).

 

            In this case, the taxpayer failed to qualify for relief under either Section 6015(b) or (c).  Both of these exceptions require that the taxpayer not know or have reason to know of the understatements of income at the time of filing.  Here the taxpayer knew he was understating their income when filing their return.  He knew his wife worked in 2003, and he knew his wife was convicted for embezzling money, but he did not report either of those monies as income.  The taxpayer, nevertheless, obtained relief under the last exception listed in Section 6015(f).

 

            Under Section 6015(f), a taxpayer must first satisfy seven conditions before a court will even consider giving the taxpayer relief.  The seven conditions are that the requesting spouse (1) filed a joint return; (2) does not qualify for relief under section 6015(b) or (c); (3) applied for relief no later than 2 years since the first collection activity; (4) did not transfer assets as part of a fraudulent scheme; (5) did not get assets transferred to him by the non-requesting spouse; (6) did not file the returns with a fraudulent intent; and (7) is seeking relief attributable to an item of the non-requesting spouse.  In the present case, the taxpayer satisfied all seven conditions.

           

            After determining that the taxpayer satisfies all seven conditions, the court must then weigh eight non-exclusive factors to determine whether it would be inequitable to hold the taxpayer liable for all or part of the deficiency.  These factors are: (1) the taxpayer is separated or divorced from the non-requesting spouse; (2) the taxpayer will suffer economic hardship without relief; (3) the taxpayer did not know or have reason to know of the deficiency; (3) the non-requesting spouse had a legal obligation to pay the liability; (4) the taxpayer did not receive significant benefit from the item giving rise to the deficiency; (5) the taxpayer has made a good faith effort to comply with tax laws in subsequent years; (6) the taxpayer was abused by the non-requesting spouse; and (8) the taxpayer was in poor physical or mental condition when signing the return or requesting relief.  In the present case, factor (3) weighed against the taxpayer because he knew he was understating their income at the time of filing.  In general, factor (3) weighs heavily against granting relief.  That factor, however, may be outweighed by the other factors weighing in favor for relief.  In the present case, the Tax Court found that factors (1), (2), and (4) weighed in favor for relief and were sufficiently compelling to outweigh factor (3).  The taxpayer was divorced, he would have suffered economic hardship in paying the tax liability, and he did not obtain any significant benefit from the refund check.  He instead used the check to pay their outstanding debts, restitution on bad checks his wife wrote out, and his wife’s children’s Christmas presents.  The rest of the factors were neutral.  Therefore, the Court found that it would be inequitable to deny the taxpayer relief.

 

Innocent Spouse Relief - Fraudulent Income of Spouse

Guest Author: M. Pilar Honer, Esq., Columbus, Ohio

 

In Yakubic, TC Summary Opinion 2008-74, the Tax Court held that it was an abuse of discretion when the Service failed to grant a taxpayer relief for failing to report his ex-wife’s income that she fraudulently obtained.  In 2003, the taxpayer’s wife worked as a paralegal, and embezzled funds from her employer.  She also wrote out bad checks on the couple’s joint bank account and forged checks belonging to the taxpayer’s stepfather.  Later that year, she was caught, sentenced to prison, and ordered to pay restitution to her employer and the taxpayer’s stepfather.  In 2004, while his wife was in prison, the taxpayer filed a joint tax return for 2003.  Although he knew that his wife worked in 2003, and he knew she obtained money through dishonest means, he did not report the additional income.  After filing the original return, he received a W-2 form from his wife’s employer and failed to amend the return to reflect the income.  Due to his understatements, the couple qualified for an earned income credit and the Service issued a refund for $5,017.

 

In May 2005, the Service detected the taxpayer’s understatements and sent him a notice of deficiency indicating an increase in the couple’s tax liability along with a penalty for not reporting all of their income.  A few months later, the taxpayer divorced his wife.  Then in December of that same year, the taxpayer filed a Form 8857 Request for Innocent Spouse Relief.  The Service denied his request, and the taxpayer filed a petition with the Tax Court.

           

            Generally, under the Code, taxpayers filing joint Federal Income tax returns are jointly and severally liable for taxes due. Section 6013(d)(3).  A taxpayer, however, may obtain relief from joint and several liability if he qualifies under any of the exceptions listed in Sections 6015 (b) (c) or (f) of the Code.  The taxpayer seeking relief bears the burden of proof. Rule 142 (a).

 

            In this case, the taxpayer failed to qualify for relief under either Section 6015(b) or (c).  Both of these exceptions require that the taxpayer not know or have reason to know of the understatements of income at the time of filing.  Here the taxpayer knew he was understating their income when filing their return.  He knew his wife worked in 2003, and he knew his wife was convicted for embezzling money, but he did not report either of those monies as income.  The taxpayer, nevertheless, obtained relief under the last exception listed in Section 6015(f).

 

            Under Section 6015(f), a taxpayer must first satisfy seven conditions before a court will even consider giving the taxpayer relief.  The seven conditions are that the requesting spouse (1) filed a joint return; (2) does not qualify for relief under section 6015(b) or (c); (3) applied for relief no later than 2 years since the first collection activity; (4) did not transfer assets as part of a fraudulent scheme; (5) did not get assets transferred to him by the non-requesting spouse; (6) did not file the returns with a fraudulent intent; and (7) is seeking relief attributable to an item of the non-requesting spouse.  In the present case, the taxpayer satisfied all seven conditions.

           

            After determining that the taxpayer satisfies all seven conditions, the court must then weigh eight non-exclusive factors to determine whether it would be inequitable to hold the taxpayer liable for all or part of the deficiency.  These factors are: (1) the taxpayer is separated or divorced from the non-requesting spouse; (2) the taxpayer will suffer economic hardship without relief; (3) the taxpayer did not know or have reason to know of the deficiency; (3) the non-requesting spouse had a legal obligation to pay the liability; (4) the taxpayer did not receive significant benefit from the item giving rise to the deficiency; (5) the taxpayer has made a good faith effort to comply with tax laws in subsequent years; (6) the taxpayer was abused by the non-requesting spouse; and (8) the taxpayer was in poor physical or mental condition when signing the return or requesting relief.  In the present case, factor (3) weighed against the taxpayer because he knew he was understating their income at the time of filing.  In general, factor (3) weighs heavily against granting relief.  That factor, however, may be outweighed by the other factors weighing in favor for relief.  In the present case, the Tax Court found that factors (1), (2), and (4) weighed in favor for relief and were sufficiently compelling to outweigh factor (3).  The taxpayer was divorced, he would have suffered economic hardship in paying the tax liability, and he did not obtain any significant benefit from the refund check.  He instead used the check to pay their outstanding debts, restitution on bad checks his wife wrote out, and his wife’s children’s Christmas presents.  The rest of the factors were neutral.  Therefore, the Court found that it would be inequitable to deny the taxpayer relief.