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No innocent spouse relief for wife where husband not deceptive and wife didn’t ask questions

Arobo, TC Memo 2016-66TC Memo 2016-66

The Tax Court has held that where a couple filed jointly, the husband had always been the primary financial provider, and their lifestyle hadn’t changed from earlier years when the couple reported significant business income on their returns, the wife did not qualify for innocent spouse relief with respect to their returns that showed either losses from, or didn’t even report activity from, the husband’s business. The principal reason for this holding was that she failed to establish that she didn’t have reason to know there was an understatement on those returns.

Background. In general, married taxpayers who file a joint Federal income tax return are jointly and severally liable for the tax reported or reportable on the tax return. (Code Sec. 6013(d)(3))

However, Code Sec. 6015(a)(1) provides that a spouse who has made a joint return may elect to seek relief from joint and several liability under Code Sec. 6015(b).

Code Sec. 6015(b)(1) provides that a taxpayer will be relieved of liability for an understatement of tax if: (A) a joint return was made for the tax year in question; (B) there is an understatement of tax attributable to erroneous items of the nonrequesting spouse; (C) the requesting spouse “establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement”; (D) taking into account all the facts and circumstances, it would be inequitable to hold the requesting spouse liable for the deficiency attributable to the understatement; and (E) the requesting spouse elects to invoke Code Sec. 6015(b) within two years after the date IRS has begun collection actions with respect to the requesting spouse.

Code Sec. 6015(f) provides for equitable innocent spouse relief under procedures prescribed by IRS if: (1) taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency and (2) relief is not available to the requesting spouse under Code Sec. 6015(b) or Code Sec. 6015(c). The requesting spouse has the burden of proving that he/she is entitled to relief. (Alt, (2002) 119 TC 306119 TC 306)

Rev Proc 2013-34, 2013-43 IRB 399, sets forth a 3-step procedure to be followed in evaluating requests for this equitable relief: (1) section 4.01 lists seven threshold conditions which must be met; (2) section 4.02 lists circumstances in which IRS will make streamlined relief determinations; and (3) section 4.03 sets forth nonexclusive factors that IRS will consider in determining whether equitable relief should be granted because it would be inequitable to hold a requesting spouse jointly and severally liable. The section 4.03 factors include: (a) marital status (i.e., do the spouses remain together?); (b) economic hardship; (c) knowledge or reason to know of the requesting spouse; (d) legal obligation arising from a divorce decree or other binding agreement; (e) significant benefit gained by the requesting spouse; (f) compliance with income tax laws; and (g) mental or physical health at the time of filing the request for relief. No single factor is determinative.

Facts. The taxpayers, Mr. and Mrs. Arobo, filed joint returns for all of the years at issue—2004 through 2007. Mr. Arobo was the family’s primary financial provider. Mrs. Arobo had a college degree and earned roughly $20,000 per year during those years.

Mr. Arobo was the sole owner of a mortgage origination company during the years involved. It ceased doing business in 2008. Mrs. Arobo was not involved in the operation of the company.

Mrs. Arobo paid the household bills. Mr. Arobo regularly gave Mrs. Arobo checks drawn on his individual account or on one of the company’s accounts to pay household expenses.

The taxpayers’ Federal income tax return for each year involved—2004-2007—was filed late. The taxpayers’ income tax return for 2004 was filed on Jan. 19, 2010. IRS commenced an audit of that return in October 2010. The taxpayers filed their 2005 and 2006 income tax returns in 2011, while the 2004 return was under audit, through the IRS examining agent. Mr. Arobo was responsible for the preparation and filing of the taxpayers’ income tax returns. Mrs. Arobo did not review the returns; rather, she “entrusted her husband and just signed them.” She testified that she learned that Mr. Arobo had failed to file their 2004, 2005, 2006, and 2007 tax returns only when they were contacted by IRS.

The 2004 and 2005 income tax returns each reported on the first page, on line 12, a business loss; they also reported negative adjusted gross income. The 2006 and 2007 income tax returns reported adjusted gross income of $52,163 and $32,049, respectively; no business income or loss was reported on, and no Schedule C, Profit or Loss From Business, was attached to, either the 2006 return or the 2007 tax return.

The Arobos came to a settlement with IRS with respect to their unpaid tax liabilities. Mr. Arobo testified that he had recently found employment, which he anticipated would provide him with funds to pay the taxpayers’ outstanding income tax liabilities.

No innocent spouse relief. The Court held that Mrs. Arobo didn’t meet the requirements of either Code Sec. 6015(b)(1) or Code Sec. 6015(f) innocent spouse relief.

Code Sec. 6015(b)(1) relief. IRS conceded that Mrs. Arobo satisfied the requirements of Code Sec. 6015(b)(1)(A), Code Sec. 6015(b)(1)(B) and Code Sec. 6015(b)(1)(E) , but argued that she did not meet the requirements of Code Sec. 6015(b)(1)(C) (whether the requesting spouse established that she did not know, and had no reason to know, there was an understatement in income tax). And, the Court agreed.

The Court said that an individual has reason to know of an understatement if a reasonably prudent taxpayer in her position at the time she signed the return could be expected to know that the return contained the understatement. Consequently, the requesting spouse has a “duty of inquiry” with respect to the income tax return filed. The duty of inquiry is subjective, focusing on the individual seeking relief. Citing Hayman, (CA 2 1993) 71 AFTR 2d 93-176371 AFTR 2d 93-1763, the Court said that the factors to be considered in making this determination are: (1) the requesting spouse’s level of education; (2) the requesting spouse’s involvement in the family’s business and financial affairs; (3) the presence of expenditures that appear lavish or unusual when compared to the family’s past levels of income, standard of living, and spending patterns; and (4) the culpable spouse’s evasiveness and deceit concerning the couple’s finances.

The returns for 2005, 2006, and 2007 were filed only after the 2004 return was under IRS examination. As a result, a reasonably prudent person in the position of Mrs. Arobo should have been diligent, vigilant, and circumspect, and therefore she should have carefully reviewed the 2005, 2006, and 2007 tax returns for accuracy. Even a cursory review of each year’s tax return would have revealed that Mr. Arobo’s mortgage origination business had reported (on line 12 of the first page of each return) substantial losses for 2004 and 2005 and that no business income or loss was reported for 2006 and 2007.

Mrs. Arobo was responsible for paying the family’s bills. Had she reviewed the tax returns, she would have seen that the returns reported no net business income for four years and yet the family’s standard of living had not diminished. There was no indication that Mr. Arobo was deceitful or evasive with respect to the family’s finances.

Code Sec. 6015(f) relief. The Court then looked to the factors in Rev Proc 2013-34 and concluded that they pointed to Mrs. Arobo not qualifying for equitable relief.

IRS conceded that Mrs. Arobo met the threshold requirements of Rev Proc 2013-34, Sec. 4.01, and Mrs. Arobo conceded that she did not qualify for the streamlined procedures of section 4.02. So, the Court looked at the nonexclusive factors of section 4.03.

The parties agreed that factors (a) marital status, (f) tax compliance, and (g) mental/physical health were neutral and that the legal obligation factor was inapplicable. Accordingly, the Court limited its inquiry to factors (b) economic hardship; (c) knowledge or reason to know; and (e) significant benefit.

Rev Proc 2013-34, Sec. 4.03(2)(b), provides that an economic hardship “exists if satisfaction of the tax liability in whole or in part will cause the requesting spouse to be unable to pay reasonable basic living expenses.” The revenue procedure provides that factor (b) weighs in favor of relief where the requesting spouse would suffer economic hardship if relief were denied and is neutral where the requesting spouse would not suffer such hardship if relief were denied.

Mrs. Arobo stated on Form 8857 (Request for Innocent Spouse Relief) that her monthly income in 2015 was $3,420 and that her monthly expenses were $3,360; thus, her monthly expenses do not exceed her monthly income. Moreover, Mr. Arobo testified that he expected to be able to pay the taxpayers’ liability. Consequently, Mrs. Arobo did not prove she would suffer economic hardship if she was denied relief. The Court found factor (b) to be neutral.

As to knowledge or reason to know, the Court said that the analysis is essentially that same as that in Code Sec. 6015(b)(1)(C) (see above) and concluded that this factor weighed against relief.

Rev Proc 2013-34 provides that the significant benefit factor will weigh in favor of relief if the nonrequesting spouse significantly benefited from the unpaid tax or understatement and the requesting spouse had little or no benefit or the nonrequesting spouse enjoyed the benefit to the requesting spouse’s detriment.

The taxpayers testified that they used their income to maintain their lifestyle. If Mr. Arobo’s mortgage origination business had suffered the losses reported or had no income, the taxpayers’ standard of living would have been significantly decreased. Thus, Mrs. Arobo, as well as Mr. Arobo, received the benefit of paying no tax on hundreds of thousands of dollars. So, this factor also weighed against granting her relief.

References: For equitable innocent spouse relief, see FTC 2d/FIN ¶  V-8553  ; United States Tax Reporter ¶  60,154.04  ; TaxDesk ¶  570,928  ; TG ¶  1929  .