Yakubik, TC Summary Opinion 2008-74
Mike Habib, EA The Tax Court recently held that the IRS abused its discretion in not granting equitable innocent spouse relief to a husband whose wife embezzled funds from her employer and forged checks taken from her stepfather.
Facts. The taxpayer was married throughout 2003 and divorced in 2005. During 2003, his wife was employed by an attorney as a paralegal. At some point during that year, she began to embezzle funds from her employer, write bad checks on a joint account held by the taxpayer and his wife, and forge checks belonging to her stepfather.
The wife was arrested for allegedly committing felonies and pled guilty to some of them, including forgery and embezzlement. On 12/1/03, she was sentenced to prison and ordered to pay restitution of $17,000 to her former employer and $3,000 to her stepfather. She remained incarcerated from 10/20/03 to 11/9/05.
On 3/8/04, the taxpayer and his wife filed a joint tax return for 2003. Although the wife was incarcerated at that time, she had executed a Form 2848, Power of Attorney and Declaration of Representative, that gave the taxpayer authority to act on her behalf for the 2003 tax year. He used this authority to file the joint return.
The joint return failed to include the amount the wife had embezzled and obtained by means of forgery. It also omitted wages the wife earned from her employment as a paralegal. Based on the income reported on the return, the couple qualified for an earned income credit; they would not have received the credit had they reported their full income. Consequently, the IRS issued a refund for $5,017.
The taxpayer received a Form W-2 from his wife’s employer after the return was filed, but he did not file an amended return to include that income. The IRS examined the return and issued a deficiency notice in 2005. The taxpayer then requested relief from joint and several liability.
The IRS sent separate letters to each of the spouses indicating a preliminary determination to grant the taxpayer relief from liability under Section 6015(c) and to deny relief under Section 6015(f). The wife, as an intervenor, sent a letter to the IRS disagreeing with the determination. The IRS then issued a final notice of determination denying the taxpayer’s request for innocent spouse relief under Sections 6015(b), (c), and (f). The taxpayer sought Tax Court review of this determination.
Section 6013(d)(3) provides that joint return filers are jointly and severally liable for the taxes due. Despite this, however, Section 6015 offers limited relief from joint and several liability. Section 6015(e)(4) gives the spouse who has not elected to request relief the right to intervene in the proceeding of a spouse who has sought relief.
Section 6015(b). To qualify for relief under Section 6015(b)(1), the requesting spouse must establish the following:
(1) A joint return was filed. (2) The understatement of tax was attributable to erroneous items of the nonrequesting spouse. (3) When the return was signed, the spouse seeking relief did not know, or have reason to know, of the understatement. (4) Taking into account all the facts and circumstances, it is inequitable to hold the spouse seeking relief liable for the deficiency in tax attributable to the understatement.
(5) The requesting spouse seeks relief within two years of the first collection activity.
The taxpayer did not qualify for this relief. He and his wife shared a joint bank account, but their testimony varied as to who had access to the account. He said she controlled it and that he would give his paycheck to her for her to deposit. She said that he did make deposits and withdrawals. Further, the taxpayer admitted receiving a Form W-2 for the wife’s income after he filed the joint return and that he knew she had embezzled funds (even if he did not know the exact amount embezzled). Thus, he had reason to know of the understatement.
Section 6015(c). Relief may be available under Section 6015(c) if the following requirements are met:
(1) At the time relief is requested, the taxpayer is no longer married to, or is legally separated from, the person with whom the joint return was filed.
(2) For the 12-month period preceding the request, the taxpayer did not live with the other person.
Any relief that is granted may not exceed the portion of the deficiency properly allocable to the other person. Relief is not available under Section 6015(c) with respect to an unpaid liability that was reported on a return. Furthermore, relief is not allowed with respect to an item if the IRS proves the taxpayer seeking it had actual knowledge at the time the return was signed of that item giving rise to the deficiency. As stated above, the taxpayer did not qualify for relief under Section 6015(b) because he had reason to know of the items giving rise to the understatement. The court also believed that he had actual knowledge of the items giving rise to the deficiency (even if he did not know their exact amounts), so it denied relief under Section 6015(c) as well.
Section 6015(f). A third avenue for relief from joint and several liability is provided by Section 6015(f). It is available if these conditions are satisfied:
(1) Relief is not available to the taxpayer under Section 6015(b) or (c). (2) Taking into account all the facts and circumstances, it is inequitable to hold the taxpayer liable for any unpaid tax or deficiency.
In Rev. Proc. 2003-61, 2003-2 CB 296, the IRS has prescribed guidelines for determining whether this equitable relief should be granted under Section 6015(f). To prevail under this provision, the taxpayer must show that the IRS’s denial of equitable relief was an abuse of discretion. The seven threshold conditions listed in Rev. Proc. 2003-61 and the court’s application of them are as follows:
(1) The spouses must be separated or divorced. The taxpayer had divorced, so this factor favors his request. (2) The spouse seeking relief will suffer economic hardship without relief. The court disagreed with the IRS’s evaluation and found that the taxpayer would suffer economic hardship if relief were not granted. Thus, this factor favors the taxpayer.
(3) The spouse seeking relief did not know or have reason to know of the item giving rise to the deficiency. As stated above, the taxpayer had the requisite knowledge or reason to know. This supports the position of the IRS.
(4) The spouse not seeking relief had a legal obligation to pay the outstanding liability. This factor is neutral because the divorce agreement does not mention responsibility for payment of any outstanding taxes.
(5) The spouse seeking relief received a significant benefit from the item giving rise to the deficiency. The taxpayer used the refund to make restitution payments on the wife’s behalf, pay past-due bills for rent and utilities, and purchase Christmas presents for her children. As such, this factor favors the taxpayer.
(6) The spouse seeking relief made a good faith effort to comply with income tax laws in later years. This factor is neutral because the taxpayer was in compliance.
(7) The spouse seeking relief was abused by the other spouse. No abuse was alleged, so this factor also is neutral. (8) The spouse seeking relief was in poor mental or physical health when signing the return or requesting relief. Here too the factor is neutral because no evidence indicated that the taxpayer suffered any ailment that affected his ability to pay the tax obligation.
The court therefore concluded that three factors favored relief, one weighed against relief, and four were neutral. Even though actual knowledge is given a strong weight in evaluating these factors, it can be overcome if other factors favoring relief are particularly compelling. In this case, the taxpayer’s lack of significant benefit, his marital status, and the prospect of economic hardship are sufficiently compelling to outweigh his knowledge of the wife’s earnings and embezzlement income. Thus, denying him relief from joint and several liability would be inequitable, and the IRS abused its discretion in doing so.
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