by Chris Moss CPA
Welcome to TaxView with Chris Moss CPA Tax Attorney
Have any of you wives out there perhaps sometimes not quite understood the tax strategy your husband has used to prepare your income tax return? Any husbands out there traveling so much for work that your wife pays all the bills and files all tax returns? If any of these situations apply to you, then you can see why innocent Spouse Relief allowed by IRS Code Section 6015(a)(1) is probably one of most litigated of all tax strategies particularly when couples split up and divorce. In fact, chances are the IRS may just be waiting, patiently I might add, to begin a Whipsaw Innocent Spouse Audit soon after your Divorce decree is finalized. So for all you couples out there, happily married or soon to be divorced, stay tuned to TaxView with Chris Moss CPA Tax Attorney as we journey through real life Innocent Spouse Court cases to discover the best tax strategy for you to win an IRS Innocent Spouse Audit and keep your assets safe and protected from long reach of the IRS Innocent Spouse Audit agents.
Innocent Spouse Relief is litigated in US Tax Court more than just about any other tax strategy. There were 5 cases in 2015 alone including Willie and Sandra Scott decided last month in September 2015. In Scott vs IRS US Tax Court 2015-180, the facts are simple except that in this case both husband and wife stayed married. Husband was in charge of the finances and was responsible for filing the 2008 and 2009 tax returns. His wife played no role at all in filing the tax return except she gave her husband information on her two businesses for him to include in the tax return he prepared. The IRS audited and in addition to other minor adjustments against the husband’s businesses disallowed over $200,000 of expenses for wife’s businesses.
Wife did not dispute the tax she owed when she appealed to US Tax Court, but instead, claimed the resulting tax liability should not be joint and several to her because she did not have any involvement with preparation of the tax return. Judge Goeke states that Section 6015(b) provides that a taxpayer will be relieved of liability for an understatement of tax if: (1) a joint return was filed for the taxable year in question; (2) there is an understatement of tax attributable to erroneous items of the nonrequesting spouse; (3) the taxpayer requesting relief “did not know, and had no reason to know, that there was such understatement” when he or she signed the return; (4) taking into account all of the facts and circumstances, it would be inequitable to hold the taxpayer liable for the deficiency attributable to such understatement; and (5) the taxpayer elects to have section 6015(b) apply within two years of the initial collection action.
The Court further determined that of all these factors, the key and most important factor was whether the wife “had a reason to know” of the understatement. The Court of Appeals for the Eleventh Circuit, has held that a spouse has reason to know of a substantial understatement if a reasonably prudent taxpayer in her position could be expected to know that the return contained the substantial understatement. See Kistner v. Commissioner, 18 F.3d 1521 (11th Cir. 1994), rev’g T.C. Memo. 1991-463; Stevens v. Commissioner, 872 F.2d 1499 (11th Cir. 1989).
The Court then reviewed the four factor inquiry that has generally been used in deciding the question of whether a spouse asking for innocent relief has “reason to know” 1. Level of Education, 2. Involvement in family finances, 3. Routine vs lavish expenditures and 4. Deceit by the other spouse. Citing Butler v. Commissioner, 114 T.C. 276, 284 (2000). The Court noted that Wife had a college education and should have had knowledge of income tax owed relating to her own business. The Court concluded that Wife had in fact “reason to know” of the understatement. IRS Wins Wife loses Husband wins. However, the Court also concluded that Wife would have relief from husband’s business tax adjustments, since she had “no reason to know” of her husband’s business. Wife wins, IRS loses, and Husband has a partial loss.
Unlike the Scotts who stayed married, most of these innocent spouse cases end in tragic Whipsaw divorce as did Demeter v Demeter v IRS in US Tax Court 2014-238 decided November 24, 2014. The facts are simple: Husband and wife filed tax returns for 2004 2005 and 2006 prepared by tax attorney Ron Mulchi. Wife signed returns in 2007 having never met or talked with Mulchi. Taxes were not paid by husband due to his business failing and wife first became aware of this when she started receiving levy notices from IRS. Both husband and wife filed bankruptcy in 2008 and later divorced in 2009. Wife filed for Innocent Spouse Relief in 2011 and the IRS was about to grant relief, but her ex-husband filed an appeal in Demeter v Demeter v IRS in US Tax Court 2014-238 as an “Intervenor” opposing in this Whipsaw case relief to his ex-wife. With the Government conceding to the Ex-Wife, Judge Vasquez eventually ruled in favor of the Ex-wife, finding that she filed for innocent spouse relief after the divorce, during a personal economic hardship, and that her ex-husband agreed as part of the divorce settlement agreement to pay the back taxes, thereby giving the ex-wife “no reason to know” that her ex-husband, the Intervenor, would not pay the tax. Ex-wife and Government win, Intervenor Ex-husband loses.
Our final case involves a husband fighting for innocent spouse relief in Richard vs IRS vs Ellis Intervenor US Tax Court 2011-144 decided on June 27, 2011. The facts are fairly simple in that Husband and Wife filed a joint return in 2004 with the bulk of the taxable income attributed to the wife. Not reported on this tax return was an early distribution from the wife’s retirement account. The couple divorced in 2006. Shortly after the divorce, the IRS audited their joint 2004 return and increased the tax due by the failure to report the retirement income distribution. In 2007 ex-husband filed for innocent spouse relief for the early retirement distribution. Now here comes the Whipsaw: The ex-wife intervened claiming the ex-husband very well knew that they did not report the early retirement distribution on their 2004 tax return. Chief Judge Colvin ultimately finds for the Ex-husband because he credibly testified that he was unaware of his Ex-wife Intervenor’s early distribution. This is in spite of the ex-wife Intervenor testifying that ex-husband and she discussed the early retirement distribution before and after she requested the funds. Perhaps Judge Colvin heard “she said” but believed “he said” as ex-husband appears to have been more credible than ex-wife to the Court. Ex-husband wins, IRS loses, and Ex-wife loses.
So what does this all mean for anyone out there who wants to file for innocent spouse relief? First and foremost, figure out whether or not you benefited from your husband’s tax error, mistake or in some cases civil or criminal fraud. If you did not, and are separating from your spouse, make sure your divorce attorney includes Innocent Spouse Relief language in the settlement agreement. Also, if you are the ex-husband be prepared for your ex-wife to intervene to US Tax Court denying much of what you are claiming creating the tragic Whipsaw. Second, hire a tax attorney who can effectively gather sufficient evidence to prove to the Court that you had “no reason to know” of the tax liability you are claiming relief from. Perhaps if you are the ex-wife, you had “no reason to know” because you traveled a lot working out of town, or didn’t have the educational background to understand, or perhaps just didn’t get the whole truth from your now ex-husband. In other words, if your tax attorney sufficiently gathers from you the evidence needed to win, provided your testimony is credible, you will in fact win the IRS Innocent Spouse Relief Audit, Whipsaw your Ex-spouse, and at the same time keep your assets safe and protected from the long reach of IRS Innocent Spouse Relief Audit agents.
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Chris Moss CPA Tax Attorney