In an appeal to the Ninth Circuit an “innocent spouse” drew support from the Center For Taxpayer Rights and The Federal Tax Clinic At the Legal Services Center Of Harvard Law School in the form of an Amicus Brief. That didn’t do trick. In its opinion, the Ninth Circuit confirmed the Tax Court decision that they were liable for the deficiency from joint returns that they were deemed to have joined in filing with their ex-spouse. I think they got a raw deal, but I dug into the case because I think there are some really important lessons. And I am announcing an addition to Reilly’s Laws of Tax Planning.
As I generally do with innocent spouse and similar cases I am making up names. You can find out who everybody is by looking at the source documents, but my policy spares them having this come up when somebody googles them. Sorry if you find the singular they/them jarring, but that is the pronoun preference of all my fictitious couples. We’ll call the “innocent spouse” Robin. The ex who, possibly inadvertently, stuck Robin with the tab is Terry and Blynn is Robin’s current spouse.
Background
If you would like to play “You be the judge” you can watch the oral arguments before the Ninth Circuit.
Since the Tax Court decision was appealed there is a lot more background material available including a transcript of the Tax Court trial and redacted copies of the related returns. You can spend your own three dollars on PACER if you want to check my work. The years at issue are 2009 and 2010. Robin and Terry had separated in August 2008 although they continued to live in the same house until it was sold in October 2008. The couple worked with a mediator to come up with a marital settlement agreement (MSA) which they executed on February 2, 2011.
Terry now makes a living selling cars but during the marriage and the two years following worked in a pretty substantial family business. The business got in trouble which accounts for Terry not having withholdings or making estimated payments in 2009 and 2010. Both of those returns were filed late, without the balance due being paid. The tax was overwhelmingly attributable to Terry’s earnings.
Robin signed the 2009 return. Robin did not sign the 2010 return. Terry signed Robin’s name to the 2010 return. The tab for tax alone was almost $90,000. The address used on the return was the address of the family business and they did not forward mail to Robin. Robin first learned of the deficiency when California garnished their wages.
The Issues
There are two issues. One is whether Robin is entitled to relief under Code Section 6015(f) – Relief from joint and several liability on joint return – Equitable relief. The other is whether Robin should be considered to have joined in filing the joint return for 2010. On the second issue I and the Harvard folks think the Tax Court was wrong. Unfortunately the Ninth Circuit did not agree.
Equitable Relief
There are a number of threshold conditions to being granted equitable relief, which Robin met. Then Revenue Procedure 2013-34 provides seven non-exclusive factors to consider:
(1) the marital status of the claimant as of the date of the claim; (2) whether the claimant would suffer economic hardship if relief is not granted; (3) whether the claimant knew or had reason to know that the non-claiming spouse could not pay the tax liability; (4) whether the claimant has a legal obligation to pay the outstanding tax liability; (5) whether the claimant significantly benefited from the underpayment; (6) the claimant’s tax compliance record in subsequent years; and (7) the claimant’s physical and mental health.
Robin wins on factor 1 by no longer being married to Terry. Robin did not dispute factor 2. Tax Court gives factor 3 to the IRS holding that it was not reasonable for Robin to think that Terry would or could pay the balance due, Factor 4 is rated neutral. Factor 5 went to Robin. Factor 6 went against Robin. And Factor 7 was neutral.
Overall the equitable relief went for the IRS.
The 2010 Return
So how is it that Robin can be held to liability on a return that Robin did not sign ? The Tax Court found that Robin “tacitly consented” to the 2010 joint return. Robin had provided Terry with W-2s and other tax information. Robin failed to file a 2010 return themselves. I didn’t try to do the math but it may well have been a small refund for whatever that is worth. Since getting remarried Robin has allowed Blynn to sign both names to the income tax return.
In Robin’s Defense
Robin was nineteen at the time of the marriage to Terry and previous tax returns had been done by one of Robin’s parents. Then Terry handled things – kind of. Remember the family business. The accountant for the family business took care of the individual returns for Robin and Terry. Terry testified at the trial and indicated that they had only spoken with the accountant once or twice in all that time. Naturally the accountant never spoke with Robin.
I found part of Robin’s testimony very moving:
Because I — I feel really stupid talking about this stuff. Stuff like this is — it’s paralyzing to me. You know, I — it’s embarrassing to sit up here and have all you guys asking me all these questions, and I feel like an idiot, but it’s stuff like this is paralyzing to me. It intimidates me; I don’t understand it, and so I tend to avoid it however I can. So — I mean, I understand that filing my 2011 return so late is — you know, obviously not a responsible thing to do, but I just — I don’t know how to get things handled.
One of the things that it took me a long time to learn is that there are many otherwise quite intelligent people who appear to have their act together who cannot look at numbers and have them mean much of anything to them. Rather than be judgy about that I am inclined to reflect on other areas of life where I am pretty helpless and dependent.
The MSA
The MSA discussed a 2008 tax liability which was covered by part of the sales proceeds from the house. Under the MSA any refunds would be split equally and deficiencies from joint returns would be paid in proportion to income. The MSA indicated that the $2,825 monthly that Terry had been paying in spousal support would continue until September 30, 2011. Their divorce was was effective September 27, 2011 and incorporated the MSA.
Deficiencies are not the same as underpayments. If they were Robin might have been entitled to equitable relief. The professional who drafted the MSA indicated that they had not been aware of the possibility of taxes just not being paid. The MSA could have shifted factor 4 (legal obligation) into Robin’s column, which might have made all the difference.
What Terry Intended
Terry also testified and seemed to be pretty stand-up about the whole thing. In an “innocent spouse” case the other spouse can intervene and argue that they should not be stuck with the whole bill. That was not Terry. Terry testified that they thought that the balance due was their responsibility. They had saved up money to deal with it, but had to put the money back into the family business, which ended up going under.
Terry had no notion that IRS would go after Robin and did not even realize that the overall tax was lower from filing a joint return. Of course if Terry had been aware of that it would be something that might be discounted. Reilly’s Tenth Law of Tax Planning – Once the tax is more than you can pay, it might not matter how much more. Once you get involved with collections what they will get is your reasonable collection potential (RCP). By making it a joint return even though the tax is lower there may be an increase in total RCP because there are now two people to collect from.
Lesson For Robin
When we are married, even unhappily, our spouse will likely be meeting some of our needs. When we split up we need to figure out how to meet those needs some other way. There is some temptation to continue having some of those needs met by our ex – even “those” needs as you can see here. Generally it is not a great idea.
Starting with the 2008 return Robin should have gotten thier own tax adviser, even if it was back to the parent. Filing a joint return would not be a fait accompli in that circumstance. And clearly Robin would not be signing a joint return without knowing that payment in full was going in at the same time. Drum roll. Here is the new addition to Reilly’s Laws – Joint filing is an election. It is not one of your marital vows. And the other proactive step would be to file separately even if below the required filing threshold.
Lesson For Tax Pros
I am going to do a little bit of projecting here. I looked up the signer of the return. We will call him Joe. Joe has been a CPA even longer than I have, which is a really long time. He was of the three name partners in a firm with a pretty generic website. Joe was the accountant for the family business probably making Terry and Robin’s return a kind of tag along. It seems likely that Joe knew that the return was going in without full payment. Did it occur to Joe that Robin, even though Robin was not paying the bill, was also Joe’s client? And that Robin might have different interests than Terry ?
Some firms are proactive in making it clear that a joint return is a joint responsibility and insist on having at least some communication with both spouses. You might want to think about that if it is not how your firm runs.