The opinion
T.C. Memo. 1997-478
UNITED STATES TAX COURT
SHERRY P. AUDE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 45011-85, 18375-86. Filed October 21, 1997.
Gordon B. Cutler, for petitioner.
Glorianne Gooding-Jones, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WRIGHT, Judge: Respondent determined the following
deficiencies in and additions to petitioner’s Federal income
taxes:
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Additions to Tax
Year Deficiency Sec. 6653(a)(1) Sec. 6653(a)(2) Sec. 6659 Sec. 6661
1980 $28,885 $1,444.25 --- --- ---
1
1981 37,414 1,870.70 $11,224.20
2
1982 57,560 2,878.00 $5,756.00
1
50% of the interest due on $37,414
2
50% of the interest due on $57,560
After concessions,1 the issue for decision is whether
petitioner qualifies for innocent spouse relief under section2
6013(e), for taxable years 1980, 1981, and 1982. We hold that
she qualifies for innocent spouse relief.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and attached exhibits are incorporated
herein. Petitioner resided in Northridge, California, when the
petition was filed.
Background
During the years at issue, petitioner was married to Peter
F. Aude (Mr. Aude). Petitioner and Mr. Aude were divorced in
1
In April of 1988, petitioner and respondent entered into
two Stipulations of Agreed Issues providing that if petitioner
did not prevail in her innocent spouse claim, she would be
entitled to take advantage of the settlement offer extended to
petitioner’s former husband (Mr. Aude).
Petitioner has conceded that she is not allowed the claimed
interest expense deductions of $1,725 in 1981 and $2,875 in 1982.
Therefore, petitioner is liable for the portion of the 1981 and
1982 income tax understatements relating thereto.
2
All section references are to the Internal Revenue Code
in effect for the years in issue, unless otherwise indicated.
All Rule references are to the Tax Court Rules of Practice and
Procedure.
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September of 1983. The Audes filed joint Federal income tax
returns for each taxable year at issue.
Petitioner was born on August 10, 1951. In 1969, she
graduated from high school with approximately a 2.0 grade point
average. After graduating from high school, petitioner worked
primarily as a receptionist in the Los Angeles area.
In August of 1969, petitioner married for the first time.
She had a son, Michael, in January of 1972. Petitioner divorced
in 1973; however, in August of 1974, petitioner and her first
husband had a second child, who was later given up for adoption.
In 1975, petitioner worked as a receptionist for the
Landsberg Company (Landsberg). There, she met Mr. Aude, who
worked as a salesperson for Landsberg. At the time, Mr. Aude was
divorced with two children from a prior marriage. In February
1976, petitioner and Mr. Aude, who was then 33 years old, were
married. Petitioner and Mr. Aude had two sons: Peter, born in
December 1978, and Erik, born in April 1980.
During her marriage to Mr. Aude, petitioner worked as a
housewife and mother.3 She had the role of taking care of five
children: Michael, Peter, Erik, and Mr. Aude’s two sons from his
prior marriage (who lived part of the time with petitioner and
Mr. Aude).
3
In 1980 and 1981, petitioner had a part-time job selling
books for World Book--Childcraft International, Inc. However,
petitioner only earned $37.68 in 1980 and $144.17 in 1981 from
this part-time job.
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During the years at issue, petitioner did not buy any
jewelry or expensive clothes. She drove a 1980 station wagon.
During this period, the Audes took one vacation to Hawaii in
December of 1982. Until their divorce, petitioner and Mr. Aude
lived in the same house, which they purchased in 1976. They had
built an addition to that house in 1978-79.
Throughout their marriage, petitioner and Mr. Aude
maintained a joint bank account. Initially, Mr. Aude handled all
the finances. In 1978, Mr. Aude gave petitioner a monthly
allowance of $3,000 to pay the household bills. This monthly
allowance was used to pay Mr. Aude's alimony and child support to
his ex-wife, household bills, food, and medical expenditures.
While the allowances at times decreased during the years at
issue, they never increased. Using her monthly allowance,
petitioner wrote checks out of the joint bank account, and
recorded the checks in her register; however, the Audes
maintained separate check registers. Petitioner never saw the
checks Mr. Aude wrote or his check register. Petitioner never
examined the bank statements because it was Mr. Aude's job to
review the bank statements.
Petitioner was uninvolved in the business affairs of Mr.
Aude. Occasionally, petitioner would accompany Mr. Aude to
business meetings, but after introductions she would stay in the
lobby or in the car during the actual meeting. She was unaware
of Mr. Aude's salary and his investment income. If petitioner
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questioned Mr. Aude about the financial affairs, Mr. Aude would
respond that it was his money, and therefore it was not her
concern.
Magnum Oil and Gas
In late 1979 or early 1980, Mr. Aude met with Mr. Saranni, a
sales representative, to discuss a potential investment in Magnum
Oil and Gas (Magnum), a limited partnership. Magnum was
organized to acquire and develop oil and gas properties. While
the record is unclear regarding this meeting, infra, we determine
at a minimum that this meeting was attended by Mr. Aude, Mr.
Saranni, petitioner, and Mr. Gruys, the Audes' certified public
accountant and attorney. After the meeting, Mr. Gruys discussed
the investment with Mr. Aude and petitioner. In this discussion,
Mr. Gruys did not tell the Audes that it was a sham investment,
nor did he advise the Audes of the audit risk. He recommended
that the Audes not purchase an interest in Magnum because it was
"an inappropriate investment."4
In July 1980, Mr. Aude purchased 2.3 units in Magnum for
$86,250.5 Only Mr. Aude executed the investment papers and he
alone made the required capital contribution payments. At a
later date, petitioner discovered that Mr. Aude invested in
4
To Mr. Gruys, an inappropriate investment meant that they
might lose their capital investment.
5
Mr. Aude paid the purchase price through installments:
$23,000 in July 1980; $23,000 in March 1981; $23,000 in March
1982; and $17,250 in March 1983.
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Magnum, but Mr. Aude did not disclose the tax shelter nature of
the investment to petitioner. She never saw the investment
papers concerning Magnum, and she was unaware of Mr. Aude's
capital contribution in Magnum.
1980, 1981, 1982 Joint Income Tax Returns
For the years at issue, Mr. Gruys prepared the Audes'
Federal income tax returns. He only occasionally talked with
petitioner, generally around the tax preparation time. Instead,
he generally saw Mr. Aude. Petitioner's main involvement in
completing the returns was to compile a list of household
expenditures for Mr. Gruys. She would accompany her husband to
deliver the list to Mr. Gruys. After preparation, Mr. Aude would
present the returns, folded to the signature page, for
petitioner's signature. At these times, both Mr. Aude and Mr.
Gruys had already signed the return. Prior to signing the
returns, petitioner did not review them.
In regard to the Magnum investment, Mr. Gruys never reviewed
any papers regarding the investment. In preparation of the tax
returns for the years at issue, Mr. Gruys relied on the Schedules
K-1 prepared by Magnum. In advising the Audes, Mr. Gruys did
speak with Mr. Aude in passing regarding the validity of the
deductions for the investment, but he did not talk with
petitioner about the deduction.
The joint returns for 1980, 1981, and 1982, as originally
filed, reflect income, Magnum deductions, adjusted gross income,
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itemized deductions, and taxable income as follows:
Year Income Magnum Adjusted Itemized Taxable
from Wages, Deduction Gross Income Deductions Income
Interest
1980 $137,219 $ 99,015 $38,204 $44,311 (6,107)
1981 145,168 105,103 40,065 44,962 (11,897)
1982 124,958 114,731 10,227 39,553 (36,326)
Respondent disallowed in part the Magnum loss deductions,6
medical and dental expenses, and interest expense deductions.
The understatement for the years at issue was primarily created
by the disallowance of the Magnum loss deduction.
The Audes' Marriage and Divorce
Petitioner and Mr. Aude had a rocky marriage, filled with
arguments, separations, reconciliations, and professional
therapy. Prior to and during the years at issue, Mr. Aude
physically abused petitioner. The abuse resulted in petitioner's
sustaining cracked ribs, bruised lungs, and concussions, which at
times required medical treatment and hospitalization. As a
result of the abuse, petitioner called the police several times,
and also obtained a restraining order against Mr. Aude. A
pattern of violence developed in their marriage, especially when
petitioner questioned Mr. Aude's decisions or behavior. As a
result of this pattern of abuse, petitioner avoided questioning
Mr. Aude on any issue.
6
Respondent disallowed the following Magnum deductions:
$90,626 in 1980; $105,103 in 1981; and $114,731 in 1982.
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In December 1979, petitioner, prompted by Mr. Aude's
physical abuse, filed for a divorce. The action was later
dismissed in early 1983. During this period, petitioner and Mr.
Aude were sometimes separated, and they attended counseling for a
period of time.
In March 1983, petitioner filed a second divorce action.
As with the first divorce action, this action was based on Mr.
Aude's physical abuse. The divorce was granted in September of
1983. Pursuant to the divorce proceedings, petitioner received
the following distribution of community assets: personal effects,
the family home, household furniture, a 1980 station wagon, and
an interest in Mr. Aude's profit sharing fund. Tax refunds were
not apportioned to petitioner. In the divorce settlement, Mr.
Aude received the Magnum investment.
Mr. Aude was ordered to pay alimony to petitioner for 6
years. The amount of alimony ranged from $3,000 per month in
1983 to $2,000 per month in 1986. Following the divorce,
petitioner was granted custody of Peter and Erik. Due to an
accident in 1989, Erik sustained severe injuries, which require
substantial medical care and attention. This has prevented
petitioner from working. Currently, petitioner has full custody
of Erik, while Mr. Aude has full custody of Peter. Mr. Aude was
also ordered to pay child support, which ranged from $1,000 per
month in 1983 to $1,500 per month in 1986 to $2,650 per month in
1989 to $1,600 per month currently. At times, Mr. Aude was in
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arrears in the alimony and child support payments.
Events Subsequent to the Audes' Divorce
After the marriage ended, petitioner learned information
regarding the financial affairs for the years at issue. She
discovered that Mr. Aude had written checks to supermarkets,
which were hundreds of dollars over the actual purchase price.
She also learned the financial worth of the household during the
years at issue.
In 1988, petitioner sold the family home, which she received
in the divorce, and used the proceeds to purchase a home in
Palmdale, California (Palmdale home). The Palmdale house was
later refinanced to pay Erik's medical bills. Currently, the
Palmdale home is held as a rental property, but the rental income
derived from the property does not cover the mortgage on the
property. After withdrawing funds for attorney fees for the
divorce and for medical expenses for Erik, petitioner rolled over
the balance of the profit-sharing fund into an individual
retirement account.
After her divorce from Mr. Aude, petitioner worked part-time
for a university. She attended college on a part-time basis from
1983 through 1985, but she had to quit when Mr. Aude became
delinquent in his alimony payments. In 1990, petitioner enrolled
in a junior college to study computers. Petitioner remarried in
1990. At the time of trial, petitioner and her current husband
were unemployed.
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Currently, Mr. Aude is financially stable. Through a
bankruptcy proceeding, he has been discharged of his obligation
on his tax liability.
OPINION
As a general rule, a husband and wife who file joint tax
returns are jointly and severally liable for Federal income tax
due on their combined incomes. Sec. 6013(d)(3); Guth v.
Commissioner, 897 F.2d 441, 442 (9th Cir. 1990), affg. T.C. Memo.
1987-522; Price v. Commissioner, 887 F.2d 959, 961 n.3 (9th Cir.
1989), revg. an Oral Opinion of this Court. However, section
6013(e)(3) mitigates this general rule to some extent. Guth v.
Commissioner, supra at 442-443; Price v. Commissioner, supra at
961.
For petitioner to qualify as an innocent spouse, she must
establish: (1) That a joint return was filed for each year in
issue; (2) that there were substantial understatements of tax
attributable to grossly erroneous items of the other spouse on
the return; (3) that, in signing the returns, she did not know or
have reason to know of the substantial understatements; and (4)
that taking into account all the facts and circumstances, it
would be inequitable to hold her liable for the deficiencies and
additions to tax. Sec. 6013(e)(1)(A) through (D)7; Guth v.
7
The current “innocent spouse” provisions were enacted as
part of the Deficit Reduction Act of 1984 (the Act), Pub. L. 98-
369, 98 Stat. 494, 801. Sec. 424(c) of the Act rendered the
amendments to sec. 6013(e) applicable to all taxable years to
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Commissioner, supra at 443; Price v. Commissioner, supra at 961-
962. Petitioner has the burden of proving each element of
section 6013(e) by a preponderance of the evidence. Rule 142(a);
Price v. Commissioner, supra at 962; Bokum v. Commissioner, 94
T.C. 126, 138 (1990), affd. 992 F.2d 1132 (11th Cir. 1993).
Since the elements are conjunctive, the failure to prove any one
of the elements will preclude petitioner from relief. Stevens v.
Commissioner, 872 F.2d 1499, 1504 (11th Cir. 1989), affg. T.C.
Memo. 1988-63.
Respondent and petitioner stipulated that joint returns were
filed for the years in issue and that the returns contain
substantial understatements of tax attributable to grossly
erroneous items of Mr. Aude. Therefore, the controversy, arising
from the erroneous deduction of the Magnum loss, focuses on the
third and fourth requirements: (1) Whether the petitioner, in
signing the return, knew or had reason to know of the substantial
understatement and (2) whether it would be inequitable to hold
petitioner liable for the deficiency.
Section 6013(e)(1)(C) Knowledge or Reason To Know
Section 6013(e)(1)(C) requires that the petitioner establish
"that in signing the return he or she did not know, and had no
reason to know, that there was such substantial understatement".
which the Internal Revenue Code of 1954 applies. Therefore, sec.
6013(e), as so amended, governs the tax years at issue in the
instant proceeding.
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The Court of Appeals for the Ninth Circuit's test for knowledge
in erroneous deduction cases is applicable to this case. Golsen
v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th
Cir. 1971). Under this test, mere knowledge of the transaction
will not cause denial of relief; rather, the test is whether
petitioner had knowledge that the deduction would give rise to a
substantial understatement. Price v. Commissioner, supra at 963.
Respondent contends that the evidence clearly shows that
petitioner had actual knowledge of the underlying facts of the
investment. Respondent primarily relies on petitioner's
participation in the late 1979 or early 1980 meeting where the
Magnum investment was discussed.
While the meeting regarding the Magnum investment occurred,
the record provides conflicting evidence concerning who attended
this meeting. Mr. Gruys clearly stated that he and petitioner
attended the meeting along with Mr. Aude and Mr. Saranni.
However, petitioner's recollection is that Mr. Gruys did not
attend the meeting; that she met with Mr. Saranni briefly; and
that she sat in the lobby of the hotel while the meeting between
Mr. Saranni and Mr. Aude occurred in another room. In light of
petitioner's burden, we cannot find that petitioner did not
attend the meeting.
While petitioner had knowledge of the underlying transaction
by attending the meeting, knowledge of the transaction alone will
not cause denial of relief to petitioner, unless petitioner knew
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that the deductions attributable to Mr. Aude's investment in the
transaction would give rise to a substantial understatement. Id.
In regard to the meeting, Mr. Gruys could not recall the
specifics of the tax discussion, such as whether tax writeoff
ratios were discussed or not. At this time, while explaining the
investment, Mr. Saranni did not say that the investment was a
sham, and Mr. Saranni did not say that the claimed losses would
be disallowed if the returns were audited. Furthermore, Mr.
Gruys did not tell the Audes that it was a sham investment, nor
did he advise the Audes of the audit risk. He merely recommended
that the Audes not purchase an interest in Magnum because it was
"an inappropriate investment."
An examination of the record reveals that Mr. Aude alone
executed the investment papers, and he made the required capital
contribution payments. Petitioner never saw the investment
papers, and was unaware of the amount of money that Mr. Aude
invested in Magnum. Further, Mr. Aude did not tell her that the
investment would save taxes or that it was a tax shelter.
Further, petitioner's lack of knowledge regarding the
transaction is corroborated by Mr. Gruys' responses. Mr. Gruys
only occasionally talked with petitioner; instead, he generally
saw only Mr. Aude. Never reviewing any papers regarding the
investment, Mr. Gruys relied on the Schedules K-1 prepared by
Magnum in his preparation of the Audes' returns. In advising the
Audes, Mr. Gruys did not speak to petitioner regarding the
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validity of the deductions for the investment, but Mr. Gruys did
talk to Mr. Aude, in passing, about this.
Considering the evidence and finding petitioner to be a
credible witness, we find that petitioner was uninformed about
the nature of the Magnum investment.8 We find that petitioner
did not have actual knowledge that the deductions attributable to
the Magnum investment would result in the substantial
understatements of tax on petitioner's income tax returns for the
years at issue.
Section 6013(e)(1)(C) also requires that the petitioner
establish that she did not have reason to know that there was
such substantial understatement. Whether an alleged innocent
spouse had reason to know of a substantial understatement is a
question of fact that must be determined based upon the entire
record. Guth v. Commissioner, 897 F.2d at 442; Terzian v.
8
Respondent contends that it is obvious that petitioner
"had previously asked questions concerning the Magnum investment,
that she knew a substantial number of facts pertaining to the
investment, and that she possessed both the ability and the
opportunity to have asked more questions of those knowledgeable
about the shelter, namely the Magnum salesman as well as her own
CPA, Mr. Gruys." In making this assertion, respondent relies on
petitioner's following response: "It was after being educated by
Mr. Cutler [petitioner's attorney], that we should have been
advised that this was not a good investment, that I was angry
that I had been such a fool, and not asked more questions."
While respondent asserts that petitioner obviously knew of the
investment, we do not find that this statement shows that
petitioner had the ability or opportunity to ask about the
investment. The response indicates that petitioner did not know
the nature of the investment until years after the tax years at
issue; thus, the statement by petitioner does not obviously lead
to respondent's conclusion.
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Commissioner, 72 T.C. 1164, 1170-1172 (1979). A taxpayer has
reason to know of a substantial understatement of tax if a
reasonably prudent taxpayer under the circumstances of the spouse
at the time of signing the return could be expected to know that
the tax liability stated was erroneous or that further
investigation was warranted. Stevens v. Commissioner, supra at
1505. We must place the reasonably prudent person in the
particular circumstances of the taxpayer. Pietromonaco v.
Commissioner, 3 F.3d 1342, 1345 (9th Cir. 1993), revg. T.C. Memo.
1991-472. "[T]he more a spouse knows about a transaction,
ceteris paribus, the more likely it is that she will know or have
reason to know that the deduction arising from that transaction
may not be valid." Price v. Commissioner, 887 F.2d at 963, n.9.
When deciding whether an alleged innocent spouse had reason
to know of a substantial understatement in both omission and
deduction cases, the following factors are considered: (a) The
spouse's level of education; (b) the spouse's involvement in the
family's business and financial affairs; (c) 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 (d) the culpable spouse's evasiveness and deceit
concerning the couple's finances. Price v. Commissioner, supra
at 965; see also Stevens v. Commissioner, 872 F.2d 1499, 1505
(11th Cir. 1989). In making our determination, we must consider
the interplay or balance of the factors, instead of merely
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counting the factors in a spouse's favor. Guth v. Commissioner,
supra at 444.
We first consider petitioner's level of education. At the
time petitioner signed the returns, her highest level of
education was a high school diploma, which she earned with a 2.0
grade point average. She did not have any education or work
experience in tax, financial or accounting matters. Respondent
contends that petitioner "possesses considerable common sense and
life experience", but we find nothing in the record regarding her
education and experiences that would or should have alerted her
to the pitfalls of this situation.
We next consider petitioner's involvement in her family's
financial and business affairs. Mr. Aude dominated the financial
side of the marriage with petitioner playing a minor role in the
family's finances. While petitioner was introduced to Mr. Aude's
business contacts, she did not attend the meetings (except for
the initial Magnum meeting). She was not informed of the
specifics of Mr. Aude's investments. If petitioner questioned
Mr. Aude about the financial affairs, Mr. Aude would respond that
it was his money, and therefore it was not her concern.
Petitioner's only job with regard to the family's finances
was to pay the household bills from the monthly allowance. She
wrote checks out of a joint account and recorded the checks in
her own check register. However, petitioner never saw the checks
Mr. Aude wrote or his check register. Additionally, petitioner
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never examined the bank statements because it was Mr. Aude's job
to review the bank statements.
Petitioner played a minimal role in the tax preparation of
her and Mr. Aude's returns. While petitioner prepared a summary
of the household expenditures for Mr. Gruys, she was generally
not present when Mr. Aude furnished his information to Mr. Gruys.
Mr. Gruys primarily talked with Mr. Aude, and only occasionally
talked with petitioner, usually when petitioner submitted her
list of expenditures.
The third factor we consider is the presence of lavish or
unusual expenditures by the family. Examining the record, there
were no major differences in the Audes' standard of living
before, during, or after the period in which these deductions
were claimed. First, petitioner received a monthly allowance,
which was used to care for five children and the other household
expenses. While the allowances at times decreased during the
years at issue, they never increased. Petitioner did not buy any
jewelry or expensive clothes during this period, and she drove a
1980 station wagon. During the 3 years at issue, the Audes only
took one vacation in December of 1982. Further, during the years
at issue, petitioner and Mr. Aude lived in the same house, which
they purchased in 1978. They had built an addition to that house
in 1978-79. Taken together, these expenditures do not amount to
unusual, lavish, or extravagant expenditures.
The fourth factor is whether Mr. Aude was evasive or
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deceitful about the couple's finances. Under case law, this
factor is to be viewed in a broader context by looking at the
totality of the circumstances. As such, this factor can include
a taxpayer's refusal to be forthright about the couple's income
or a taxpayer's refusal to discuss investments. Sanders v.
United States, 509 F.2d 162, 167 (5th Cir. 1975).
Besides the monthly allowance, Mr. Aude dominated all
aspects of the financial situation. There is no evidence that
Mr. Aude was deceitful regarding the finances. However, if
petitioner asked Mr. Aude any question regarding their finances,
Mr. Aude would say it was his money and thus not her concern. It
was only after the marriage ended that petitioner learned more
details regarding the financial affairs for the years at issue,
including the financial worth of the household. By keeping
petitioner uninformed about "his money," Mr. Aude was not open
about the couple's finances. His refusal to discuss the family
finances and investment impeded petitioner's "reason to know"
about the understatement.
Considering all of the circumstances concerning these
returns, we conclude that a reasonably prudent person under
petitioner's circumstances--living a modest life, uninvolved in
the financial affairs of the family, and without any financial
background -- at the time of signing could not be expected to
know that Mr. Aude's deductions would give rise to an
understatement of tax.
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Respondent asserts that a cursory review of the return would
have alerted petitioner to the erroneous loss deduction.
Respondent alleges that a casual glance by petitioner would have
revealed that the deductions substantially reduced gross income
to arrive at adjusted gross income. In addition, respondent
relies on the fact that petitioner knew the amount of her monthly
household expenditures, so that petitioner should have been aware
that "they were living tax free" in light of the differential
between those expenditures and the negative taxable income
reported on their returns for the years at issue. In light of
these factors, respondent contends that petitioner had a reason
to investigate.
Even if a spouse has no "reason to know" of the substantial
understatement, the spouse may know facts that put her "on
notice" of the understatement. Price v. Commissioner, 887 F.2d
at 965; Stevens v. Commissioner, 872 F.2d at 1505. With a duty
to inquire, the spouse seeking relief cannot turn a blind eye to
facts within his or her reach that would have put a reasonably
prudent taxpayer on notice to inquire further. McCoy v.
Commissioner, 57 T.C. 732, 734 (1972). Petitioner would not
qualify for section 6013(e) relief merely because she relied on
others, such as her husband or a tax preparer, to complete the
return properly. Hayman v. Commissioner, 992 F.2d 1256, 1262 (2d
Cir. 1993), affg. T.C. Memo. 1992-228; Park v. Commissioner, T.C.
Memo. 1993-252, affd. 25 F.3d 1289 (5th Cir. 1994).
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In order for a spouse's duty of inquiry to arise, she must
first harbor doubts about the accuracy of the return. Stevens v.
Commissioner, supra at 1507. A spouse may be put on notice of
the understatement if a reasonably prudent person "in her
position would be led to question the legitimacy of the
deduction." Price v. Commissioner, supra at 965. One relevant
factor looks at the extent to which family expenditures, about
which the spouse had knowledge, exceed reported income. Hammond
v. Commissioner, T.C. Memo. 1990-22, affd. 938 F.2d 185 (8th Cir.
1991). Other factors include a spouse's specific and detailed
knowledge of the transaction giving rise to the deduction and the
spouse's involvement in the family's financial affairs. Shea v.
Commissioner, 780 F.2d 561, 567 (6th Cir. 1986), affg. in part,
revg. in part, and remanding in part T.C. Memo. 1984-310.
Physical or mental abuse may be a factor in considering innocent
spouse relief. Kistner v. Commissioner, 18 F.3d 1521, 1526 (11th
Cir. 1994), revg. and remanding T.C. Memo. 1991-463; Makalintal
v. Commissioner, T.C. Memo. 1996-9.
"Tax returns setting forth large deduction, such as tax
shelter losses offsetting income from other sources and
substantially reducing or eliminating the couple's tax liability,
generally put a taxpayer on notice that there may be an
understatement of tax liability." Hayman v. Commissioner, supra
at 1262. The Audes claimed the following loss deductions arising
from Magnum: $99,015 in 1980; $105,103 in 1981, and $114,731 in
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1982. If petitioner had made a examination of the returns, she
would have noticed the deductions, but we need to determine
whether a reasonably prudent taxpayer in petitioner's position
would have inquired further.
In the instant case, besides writing checks for the
household expense, she was uninvolved in the family's finances.
She was unaware of Mr. Aude's salary during the years at issue.
When petitioner signed the returns, she was aware of the
existence of the Magnum transaction, but she never saw the
investment papers or knew the amount of Mr. Aude's capital
contributions in Magnum. Further, she was unaware of its tax
shelter nature. There were also no unexplained lavish or unusual
expenditures around this time which should have aroused
petitioner's curiosity. In sum, there were no facts present
which would have caused petitioner to harbor doubts about the
accuracy of the returns.
In signing the returns, petitioner neither reviewed the
returns nor questioned Mr. Gruys or Mr. Aude regarding the
returns. While petitioner's duty cannot be relieved based solely
on petitioner's reliance on her preparer, it is a factor to be
considered in light of the other circumstances. See Hayman v.
Commissioner, supra at 1262. In the preparation of the tax
returns, petitioner would submit her information regarding the
household expenses to Mr. Gruys, but she was not present when Mr.
Aude furnished his information to Mr. Gruys. Further, Mr. Gruys
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rarely talked with petitioner. Instead he primarily discussed
matters with Mr. Aude. Relying on Mr. Gruys as the professional
preparer, petitioner signed the returns without questioning the
return, in light of the fact that Mr. Gruys had already signed
the return. Under the circumstances, petitioner was entitled to
rely upon the legitimacy that Mr. Gruys lent to the joint
returns.
Complete deference to the husband's judgment concerning the
couple's business affairs alone is not enough to grant innocent
spouse relief. Stevens v. Commissioner, supra at 1505-1506.
"Nevertheless, where physical or mental abuse is shown, even when
the abuse does not rise to the level of coercion, a basis may
exist for allowing innocent spouse relief." Kistner v.
Commissioner, supra at 1526 (treating the taxpayer's professed
fear of physical violence as one of the factors to determine if
she could be expected to know of the deduction or whether further
inquiry was necessary).
Stipulating that joint returns were filed for the years at
issue, petitioner raises the argument that Mr. Aude's physical
abuse of petitioner is a factor to be considered when determining
petitioner's duty to inquire. See Wiksell v. Commissioner, 90
F.3d 1459, 1462 (9th Cir. 1996), revg. on other grounds T.C.
Memo. 1994-99.
In Wiksell, the Court of Appeals for the Ninth Circuit
rejected the taxpayer's argument that tragedy and duress clouded
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her perception. In reaching this decision, the court noted that
the taxpayer had asked her husband "why there was no income on
the returns reflecting the money that * * * [they] had been
living off". Id. at 1462. She stated that he gave her a bizarre
explanation that did not make sense to her. Id. at 1462-1463.
Prior to signing the return, the taxpayer had learned of a
restraining order preventing her husband from soliciting
investments, and she read an article that purportedly explained
the sham her husband was involved in. Id. at 1461. At the very
least, the court stated that the taxpayer "knew something was
awry, but refused to go further." Id. at 1463. In light of
extremely small sums of income reported, the evidence of
excessive spending, and the large sums of money on hand, the
court held the evidence of an understatement was overwhelming and
the taxpayer could not hide from it. Id. In light of this
overwhelming evidence, any abuse did not provide an adequate
explanation for her behavior. Id. at 1463 n.2 (citing Kistner v.
Commissioner, 18 F.3d at 15269.
Petitioner's situation is distinguishable from the
9
In Wiksell v. Commissioner, 90 F.3d 1459, 1463 n.2 (9th
Cir. 1996), revg. T.C. Memo. 1994-99, the Court of Appeals for
the Ninth Circuit noted the Eleventh Circuit's holding in Kistner
v. Commissioner, 18 F.3d 1521 (11th Cir. 1994), revg. and
remanding T.C. Memo. 1994-463, that spousal abuse could reach a
point so as to provide an adequate explanation for deference to
offending spouse. However, under the facts, the Court of Appeals
for the Ninth Circuit held that the taxpayer could not hide from
the overwhelming evidence and that any abuse did not provide an
explanation. Id.
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taxpayer's situation in Wiksell. We find that petitioner did not
have reason to know about the understatement. Petitioner did not
have substantial cash on hand, did not report small sums, and did
not have unusual expenditures for the years at issue. In our
case, the evidence does not show that petitioner knew or had
reason to know that something was awry on the joint returns. As
a result, we find that the physical abuse by Mr. Aude is one of
the factors for us to consider in explaining her deference to Mr.
Aude. See Makalintal v. Commissioner, T.C. Memo. 1996-9.
In Estate of Brown v. Commissioner, T.C. Memo. 1988-297,
spousal abuse was considered as a factor. In that case,
taxpayer's husband repeatedly physically abused his wife. Id.
When he needed taxpayer's signature on a document, he would
merely present the document and did not give her an opportunity
to read it. Id. Taxpayer "always complied with his demands, for
fear that she would be beaten if she refused." Id. In that
case, the following was emphasized: That taxpayer's husband was
primarily responsible for the operations of the business; that he
told his wife almost nothing about the company's affairs; and
furthermore that she was forced to sign documents in fear that
she would be beaten if she did not comply with her husband's
demands. Id. Brown concluded that the taxpayer did not know or
have reason to know of the income omitted from the joint returns.
Id.
While petitioner was not coerced or physically threatened
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into signing the returns, she was intimidated by Mr. Aude because
she feared being physically abused if she refused. Petitioner
testified that she didn't have "any right" to question Mr. Aude,
and if she did, she feared she "would be physically attacked."
From this, she learned that she had to skirt issues with Mr.
Aude, or face his wrath. Petitioner testified that if she "had
not felt intimidated by [Mr. Aude], [she] might have had the
option of going through" the returns. We find this to be a
factor explaining why petitioner did not review or inquire about
the returns.
Considering all of the circumstances, we conclude that
petitioner did not know facts that put her "on notice" of the
understatement. We find that a reasonably prudent person under
petitioner's circumstances, at the time of signing the returns,
could not be expected to know that Mr. Aude's deductions would
give rise to a substantial understatement of tax or that further
investigation was warranted. Petitioner has satisfied the
section 6013(e)(1)(C) requirement.
Section 6013(e)(1)(D) Equitable Considerations
The final question is whether, taking into account the facts
and circumstances, it would be inequitable to hold petitioner
liable for deficiencies attributable to the substantial
understatements. Sec. 6013(e)(1)(D); see sec. 1.6013-5(b),
Income Tax Regs. Relevant factors include significant benefits
received as a result of the understatement of the spouse claiming
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relief, any participation in the wrongdoing on the part of the
innocent spouse, and the effect of a subsequent divorce or
separation. See S. Rept. 91-1537 (1970), 1971-1 C.B. 606, 607-
608.
While the text of section 6013(e) no longer requires us to
determine whether a spouse significantly benefited from the
erroneous item, this factor is still considered to determine
whether it is inequitable to hold a spouse liable. Belk v.
Commissioner, 93 T.C. 434, 440 (1989); Purcell v. Commissioner,
86 T.C. 228, 241-242 (1986), affd. 826 F.2d 470 (6th Cir. 1987).
In making this determination, normal support, measured by the
circumstances of the parties, is not a significant benefit.
Estate of Krock v. Commissioner, 93 T.C. 672, 678 (1989); Terzian
v. Commissioner, T.C. at 1172; see sec. 1.6013-5(b), Income Tax
Regs. Unusual support and receipt of property, however, would
constitute a significant benefit. Terzian v. Commissioner, supra
at 1172; see sec. 1.6013-5(b), Income Tax Regs. During the years
at issue, petitioner received a $3,000 monthly allowance to take
care of the household expenses, which included taking care of
five children. This amount did not increase during this time,
but at times, it decreased. This normal support for household
expenditures is not considered to be a significant benefit.
Also, during the same period of time, petitioner's standard of
living did not increase in comparison to her standard of living
in prior years. She lived in the same house since 1978.
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Petitioner and Mr. Aude only went on one vacation during the 3
years at issue. Their lifestyle was not lavish. We find that
these expenditures amounted to normal support and did not rise to
the level of unusual support.
Respondent relies on the fact that even though petitioner
did not control the family wealth, she benefited by having
additional funds available to help support her and her children
and also benefited in the divorce settlement. In the divorce
decree, tax refunds were not apportioned to petitioner, and Mr.
Aude acquired the Magnum investment. Petitioner received her
share of the marital assets, which included the family home,
household furniture, personal effects, a station wagon, and an
interest in Mr. Aude's retirement account. Also, while Mr. Aude
was ordered to pay alimony to petitioner, Mr. Aude was at times
in arrears. The amount of alimony, which ranged from $3,000 per
month in 1983 to $2,000 per month in 1986, was not extraordinary
in terms of her standard of living during the Audes' marriage.
Also, the increase in child support, which ranged from $1,000 per
month in 1983 to $1,500 per month in 1986 to $2,650 per month in
1989 to $1,600 per month currently, was due in part to Erik's
medical costs. We do not find that petitioner significantly
benefited from the tax savings attributable to the losses claimed
from the Magnum investment.
In assessing the equity in holding a spouse liable under
section 6013(e), we also consider the probable future hardships
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that would be imposed on the spouse seeking the relief if such
relief were denied. Sanders v. United States, 509 F.2d at 171
n.16; Peterson v. Commissioner, T.C. Memo. 1997-18; Edmondson v.
Commissioner, T.C. Memo. 1996-393; Petitioner offered evidence of
future probable hardship if relief were denied. Since the
divorce, petitioner's standard of living has decreased. A major
factor to petitioner's hardship is the financial drain of medical
costs, which arose from Erik's accident. After selling the
family home in 1988 and reinvesting in the Palmdale home, she had
to refinance the home to pay Erik's medical bills. Currently,
while the Palmdale home is held as a rental property, the rental
income derived from the property does not cover the mortgage on
the property. The profit-sharing fund was rolled over into an
individual retirement account for the benefit of petitioner;
however, this was after withdrawing funds for attorney's fees for
the divorce and for medical expenses for Erik.
Since the divorce in 1983, petitioner has worked part-time.
She attended college on a part-time basis from 1983 through 1985,
but had to quit when Mr. Aude did not pay alimony to petitioner.
In 1990, petitioner enrolled in a junior college to study
computers. Presently, petitioner and her current husband are
unemployed.
Currently, Mr. Aude is financially stable, but through a
bankruptcy proceeding he has been discharged of his obligation on
his tax liability. If relief were not afforded to petitioner,
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she would bear the entire burden of the tax liabilities resulting
from the understatement attributable to the Magnum deductions.
Considering that petitioner did not receive significant
benefit from the understatements and the future probable hardship
that would be imposed if relief were denied, we find that it
would be inequitable to hold petitioner liable for the resulting
deficiencies. Therefore, petitioner has satisfied section
6013(e)(1)(D). In summary, we find that petitioner has
established (1) that she did not know and did not have reason to
know that there was a substantial understatement relating to the
Magnum deductions and (2) that it is inequitable to hold her
liable for the resulting deficiencies. Taking into account the
parties' stipulations, supra, we, therefore, hold that petitioner
has met all of the requirements of section 6013(e), and she is
entitled to relief as an innocent spouse for any income tax
liability attributable to the understatements for the years in
issue arising from the Magnum investment.
To reflect the foregoing,
Decisions will be entered
under Rule 155.