Opinion

Kathryn Cheshire v. Commissioner

115 T.C. No. 15

Court: United States Tax Court
Filed: Aug 30, 2000
Cited by: 0 cases
Authority: More cited than 6.0%

Supreme Court looks to other statutes in defining “intelligence sources” and “confidential source[s]”.

How later courts described this case

Supreme Court looks to other statutes in defining “intelligence sources” and “confidential source[s]”.

Written by the judges who cited it.

The opinion

115 T.C. No. 15

UNITED STATES TAX COURT

KATHRYN CHESHIRE, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3483-99. Filed August 30, 2000.

P and H filed a joint 1992 Federal income tax return

on which a portion of retirement distribution proceeds H

received and interest received from a joint bank account

were omitted from gross income. Although P acknowledges

that when she signed the joint return she had actual

knowledge of the omitted retirement distribution

proceeds, she posits that, relying on H’s false

statements, she had reason to believe that the omitted

retirement distribution proceeds were not taxable and

that she should be entitled to relief under sec. 6015(b),

(c), and/or (f), I.R.C., with respect thereto. Further,

P seeks innocent spouse relief with respect to the sec.

6662(a), I.R.C., accuracy-related penalty.

1. Held: P is not entitled to innocent spouse

relief with respect to the omitted items of income.

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2. Held, further, knowledge of the “item giving

rise to a deficiency” for purposes of sec. 6015(c)(3)(C),

I.R.C., does not mean knowledge of the tax consequences

of the item or that the entry on the return is incorrect.

3. Held, further, after taking into account all

the facts and circumstances presented in this case, R’s

denial of equitable relief to P under sec. 6015(f),

I.R.C., as it relates to the sec. 6662(a), I.R.C.,

penalty applicable to the omitted retirement distribution

proceeds, constitutes an abuse of his discretion.

John Edward Leeper, for petitioner.

Sheila R. Pattison and Gerald L. Brantley, for respondent.

JACOBS, Judge: Respondent determined a $66,069 deficiency in

Kathryn and David Cheshire’s 1992 Federal income tax, a $16,518

section 6651(a)(1) addition to tax, and a $13,214 section 6662(a)

accuracy-related penalty. Only Kathryn Cheshire has contested this

determination; she does so claiming innocent spouse relief under

section 6015(b), (c), and/or (f).

After concessions by respondent, see infra, the issue to be

resolved is whether Mrs. Cheshire is entitled to innocent spouse

relief with respect to: (1) The taxation of an omitted portion of

the distributions Mr. Cheshire received upon his retirement from

Southwestern Bell Telephone Co., and omitted interest income from

a joint bank account, and (2) the section 6662(a) accuracy-related

penalty.

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All section references are to the Internal Revenue Code as in

effect for the year under consideration. All Rule references are

to the Tax Court Rules of Practice and Procedure. All dollar

amounts are rounded.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

Background

Petitioner resided in Cedar Creek, Texas, at the time she

filed her petition.

Petitioner and Mr. Cheshire were married on June 20, 1970;

they permanently separated on July 13, 1993, and were divorced on

December 5, 1994. For 1992, petitioner and Mr. Cheshire

(collectively, the Cheshires) filed a joint Federal income tax

return.

Petitioner received a bachelor of science degree in secondary

education. Upon graduating from college in 1970, she worked

approximately 3 years as an elementary school teacher, then stayed

home for approximately 10 years (1974-84) in order to raise her 2

children. She returned to teaching in 1984.

In September 1985, the Cheshires purchased property located at

24A Simpson Avenue, Cedar Creek, Texas, for use as the family

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residence. The Cheshires borrowed $99,000 to purchase the

property.

David Cheshire’s Retirement and Compensation Package

Mr. Cheshire took early retirement from Southwestern Bell

Telephone Co. (Southwestern Bell), effective January 1, 1992. As

a result, Mr. Cheshire received the following distributions (the

retirement distributions) in 1992:

Amount

Nations Bank of Texas, Trustee, for

“SBNCNPP EMP LUMP SUM” $199,771

Southwestern Bell LESOP for salaried employees 5,919

Southwestern Bell savings plan for salaried

employees 23,263

Southwestern Bell ESOP 971

Total 229,924

Of the $229,924, $42,183 was rolled over into a qualified account.

On January 31, 1992, Mr. Cheshire deposited $184,377 of the

retirement distributions into an account (account No. 9633-09) in

the name of “David D. Cheshire and Kathy Cheshire” at the Austin

Telco Federal Credit Union (the Austin Telco account).1 In 1992,

the funds in this account earned $1,168 in interest.

Petitioner was aware of Mr. Cheshire’s receipt of the

retirement distributions and the amount thereof, as well as the

interest earned on the Austin Telco account.

An additional $29,786 was deposited into this account

between Jan. 29 and Feb. 4, 1992. The record does not reveal the

source of these funds.

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The Cheshires’ Use of the Retirement Distributions

The Cheshires made several large disbursements out of the

Austin Telco account in 1992. Specifically, $99,425 was withdrawn

to pay off the mortgage on the family residence, and $20,189 was

withdrawn to purchase a 1992 Ford Explorer.

The retirement distributions were also used to pay family

expenses, provide startup capital for Mr. Cheshire’s newly formed

sole proprietorship, Academic Resources Management Systems (ARMS),

and for investments.2 In addition, the retirement distributions

were used to satisfy loans taken out to acquire a family truck and

a car for one of their children as well as to open a college bank

account for their daughter. The Cheshires retained joint ownership

of this account.

On September 22, 1992, Mr. Cheshire opened a second account

(account No. 25239-87) at the Austin Telco Federal Credit Union and

transferred the remaining proceeds of the retirement distributions

from account No. 9633-09 into this account. On November 12, 1992,

Mr. Cheshire wrote a check from this second account in the amount

of $6,300 payable to “A.R.M.S.”; this amount was subsequently

deposited into ARMS’ bank account. In 1992, the funds in account

No. 25239-87 earned $26 in interest.

On Apr. 24 and May 19, 1992, Mr. Cheshire deposited

$40,000 and $5,301, respectively, into a brokerage account at

Edward D. Jones & Co.

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Petitioner’s Separation and Divorce

Mr. Cheshire was arrested several times for driving while

intoxicated (DWI). In June 1993, he was involved in an alcohol-

related automobile accident. Approximately a month later,

petitioner and Mr. Cheshire permanently separated; they divorced 17

months after their separation.

Pursuant to a divorce decree, Mr. Cheshire transferred to

petitioner his interest in the property constituting the family

residence and title to the 1992 Ford Explorer. At the time of

transfer, the family residence and the Ford Explorer were

unencumbered.

The Cheshires’ 1992 Federal Income Tax Return

Mr. Cheshire prepared and filed his and Mrs. Cheshire’s joint

income tax returns. Mr. Cheshire prepared the Cheshires’ 1992

joint Federal income tax return (the 1992 return) in March 1993,

prior to beginning a jail sentence for a DWI conviction. Before

signing the return, petitioner questioned her husband about the

potential tax ramifications of the retirement distributions. Mr.

Cheshire falsely told petitioner he had consulted with a local

certified public accountant, J.D. Mican (Mr. Mican), and had been

advised that proceeds used to pay off the mortgage on their home

would reduce the taxable amount of the retirement distributions.

Accepting her husband’s answer, petitioner did not inquire further

and signed the 1992 return on March 14, 1993. Petitioner assumed

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that the 1992 return would be timely filed. On the 1992 return,

the Cheshires reported that they had received a $199,771 retirement

distribution and that $56,150 of that amount constituted taxable

income. In addition, they reported $477 in interest income, as

well as a $12,349 loss on their Schedule C, Profit or Loss From

Business.

In August 1994, petitioner received a letter from the Internal

Revenue Service (IRS) stating that it had not received the

Cheshires’ 1992 return. In searching for a copy of the 1992

return, petitioner discovered in a desk drawer the original 1992

return as well as a check for the amount of tax shown to be owing

($23.86). Petitioner immediately contacted Mr. Mican; he advised

her to file the 1992 return and enclose payment for the tax

liability reflected on the return as soon as possible. Petitioner

filed the 1992 return along with the remittance on August 15, 1994.

In early October 1994, petitioner received notification from

the IRS that $8,502 in estimated tax payments claimed on the

Cheshires’ 1992 return had not been paid. Despite Mr. Cheshire’s

reassurance that he had made the estimated tax payments, petitioner

discovered that the payments in fact had not been made. Upon the

advice of Mr. Mican, petitioner paid the estimated tax using

borrowed funds.

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Notice of Deficiency

Respondent determined that $187,741 of the retirement

distributions ($229,924 total distributions less the $42,183

rollover) constituted taxable income, and thus the Cheshires

understated the taxable amount of the retirement distributions by

$131,591 ($187,741 - $56,150). Respondent further determined that

the Cheshires understated (1) their interest income by $717, (2)

their dividend income and capital gains by $132 and $1,889,

respectively, and (3) their self-employment tax by $353. In

addition, respondent disallowed $14,843 in Schedule C expenses. As

a result of these determinations, as well as the late filing of the

1992 return, respondent determined that a section 6651(a)(1)

addition to tax and a section 6662(a) accuracy-related penalty

should be imposed.

Respondent’s Concessions

Prior to trial, respondent conceded that petitioner qualified

for innocent spouse relief with respect to the following:

Item Amount

Schedule C expenses $14,843

Self-employment taxes 353

Capital gains 1,889

Dividend income 132

Interest income 26

Southwestern Bell LESOP distribution 5,919

Southwestern Bell savings plan distribution 23,263

Southwestern Bell ESOP distribution 971

Section 6651(a)(1) addition to tax 16,518

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OPINION

As a general proposition, if a joint return is filed by a

husband and wife, liability with respect to any tax shown on the

return or found to be owing is joint and several. See sec.

6013(d)(3). In 1971, Congress enacted section 6013(e), the

predecessor to section 6015, in order to correct perceived grave

injustices often resulting from the imposition of joint and several

liability. See S. Rept. 91-1537, at 2 (1970), 1971-1 C.B. 606,

607; see also Act of Jan. 12, 1971, Pub. L. 91-679, sec. 1, 84

Stat. 2063 (enacted sec. 6013(e)), as amended by the Deficit

Reduction Act of 1984, Pub. L. 98-369, sec. 424, 98 Stat. 494, 801-

803.

As amended,3 section 6013(e) provided that a spouse could be

relieved of tax liability if the spouse proved: (1) A joint income

tax return was filed; (2) the return contained a substantial

understatement of tax attributable to grossly erroneous items of

the other spouse; (3) in signing the return, the spouse seeking

relief did not know, and had no reason to know, of the substantial

understatement; and (4) under the circumstances it would be

inequitable to hold the spouse seeking relief liable for the

Initially, sec. 6013(e) provided relief only in cases

involving an omission of income. In 1984, the scope of sec.

6013(e) was expanded to provide relief in erroneous deduction

cases. See Deficit Reduction Act of 1984, Pub. L. 98-369, sec.

424, 98 Stat. 494, 801-803; H. Conf. Rept. 98-861, at 1119

(1984), 1984-3 C.B. (Vol. 2) 1, 373.

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substantial understatement. The relief granted under section

6013(e) is commonly referred to as innocent spouse relief.

The Enactment of Section 6015

For many taxpayers, relief under section 6013(e) was difficult

to obtain. In order to make innocent spouse relief more

accessible, Congress repealed section 6013(e) and enacted a new

innocent spouse provision (section 6015) in 1998 as part of the

Internal Revenue Service Restructuring and Reform Act of 1998 (RRA

1998), Pub. L. 105-206, sec. 3201(a), 112 Stat. 734. See H. Conf.

Rept. 105-599, at 249 (1998). The newly enacted statute provided

three avenues of relief from joint and several liability: (1)

Section 6015(b)(1) (which is similar to former section 6013(e))

allows a spouse to escape completely joint and several liability;

(2) section 6015(b)(2) and (c) allow a spouse to elect limited

liability through relief from a portion of the understatement or

deficiency; and (3) section 6015(f) confers upon the Secretary

discretion to grant equitable relief in situations where relief is

unavailable under section 6015(b) or (c). Section 6015 generally

applies to any liability for tax arising after July 22, 1998, and

any liability for tax arising on or before July 22, 1998, that

remains unpaid as of such date. See H. Conf. Rept. 105-599, at 251

(1998).

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Applicable Statutory Provisions

Section 6015(b) provides:

SEC. 6015(b). Procedures for Relief From Liability

Applicable to All Joint Filers.--

(1) In general.--Under procedures prescribed

by the Secretary, if–-

(A) a joint return has been

made for a taxable year;

(B) on such return there is an

understatement of tax attributable to

erroneous items of 1 individual filing

the joint return;

joint return 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 is

inequitable to hold the other individual

liable for the deficiency in tax for such

taxable year attributable to such

understatement; and

(E) the other individual elects (in

such form as the Secretary may prescribe)

the benefits of this subsection not later

than the date which is 2 years after the

date the Secretary has begun collection

activities with respect to the individual

making the election,

then the other individual shall be relieved of

liability for tax (including interest,

penalties, and other amounts) for such taxable

year to the extent such liability is

attributable to such understatement.

(2) Apportionment of relief.–-If an

individual who, but for paragraph (1)(C),

would be relieved of liability under paragraph

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(1), establishes that in signing the return

such individual did not know, and had no

reason to know, the extent of such

understatement, then such individual shall be

relieved of liability for tax (including

interest, penalties, and other amounts) for

such taxable year to the extent that such

liability is attributable to the portion of

such understatement of which such individual

did not know and had no reason to know.

Section 6015(c) provides in relevant part:

SEC. 6015(c). Procedures to Limit

Liability For Taxpayers No Longer Married or

Taxpayers Legally Separated or Not Living

Together.--

(1) In general.--Except as

provided in this subsection, if an

individual who has made a joint

return for any taxable year elects

the application of this subsection,

the individual’s liability for any

deficiency which is assessed with

respect to the return shall not

exceed the portion of such

deficiency properly allocable to the

individual under subsection (d).

* * * * * * *

(3)(C) Election not valid with

respect to certain deficiencies.–-If

the Secretary demonstrates that an

individual making an election under

this subsection had actual

knowledge, at the time such

individual signed the return, of any

item giving rise to a deficiency (or

portion thereof) which is not

allocable to such individual under

subsection (d), such election shall

not apply to such deficiency (or

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portion). This subparagraph shall

not apply where the individual with

actual knowledge establishes that

such individual signed the return

under duress.

Section 6015(d) specifies how an allocation under section

6015(c) is to be made, providing in relevant part:

SEC. 6015(d). Allocation of Deficiency.--For

purposes of [section 6015(c)]--

(1) In general.--The portion of any

deficiency on a joint return allocated to an

individual shall be the amount which bears the

same ratio to such deficiency as the net

amount of items taken into account in

computing the deficiency and allocable to the

individual * * * bears to the net amount of

all items taken into account in computing the

deficiency.

* * * * * * *

(3) Allocation Of Items Giving Rise To

The Deficiency.--For purpose of * * * [section

6015(c)]--

(A) In general.--Except as

provided in paragraphs (4) and (5),

any item giving rise to a deficiency

on a joint return shall be allocated

to individuals filing the return in

the same manner as it would have

been allocated if the individuals

had filed separate returns for the

taxable year.

(B) Exception where other

spouse benefits.--Under rules

prescribed by the Secretary, an item

otherwise allocable to an individual

under subparagraph (A) shall be

allocated to the other individual

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filing the joint return to the

extent the item gave rise to a tax

benefit on the joint return to the

other individual.

Secretary may provide for an

allocation of any item in a manner

not prescribed by subparagraph (A)

if the Secretary establishes that

such allocation is appropriate due

to fraud of one or both individuals.

The electing spouse has the burden of proof with respect to

establishing the portion of any deficiency allocable to such

individual. See sec. 6015(c)(2). As with section 6015(b), an

election for section 6015(c) relief must be made within 2 years

from the date the Secretary begins collection activities with

respect to the individual making the election. See sec.

6015(c)(3)(B).

Section 6015(f) provides:

SEC. 6015(f). Equitable Relief.–-Under procedures

prescribed by the Secretary, 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 (or any portion of either); and

(2) relief is not available to such

individual under subsection (b) or (c),

the Secretary may relieve such individual of such

liability.

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Availability of Relief to Petitioner

For the reasons that follow, we conclude that petitioner is

not entitled to innocent spouse relief except to the extent

provided below.

A. Relief Under Section 6015(b)

Neither party disputes that in this case the requirements of

subparagraphs (A), (B), and (E) of section 6015(b)(1) have been

satisfied.4 Their dispute involves whether the requirements of

subparagraphs (C) and (D) of section 6015(b)(1) have been met.

Section 6015(b)(1)(C) contains a no “knowledge of the

understatement” requirement. Petitioner maintains that the

standard of inquiry to be used in determining whether the putative

innocent spouse knew, or had reason to know of, an understatement

of tax is whether, at the time the return was signed, a reasonably

prudent taxpayer in the spouse’s position could be expected to know

that the stated tax liability was erroneous or that further

investigation was warranted. Based on this standard, petitioner

posits that even though she knew of the retirement distributions

and the interest income, she did not know that there was an

understatement of tax on the 1992 return.

Respondent has not objected to the manner in which

petitioner has raised a claim for innocent spouse relief under

sec. 6015. We thus treat the raising of innocent spouse relief

in the petition as a timely filed election. See Butler v.

Commissioner, 114 T.C. 276, 281-282 (2000); Charlton v.

Commissioner, 114 T.C. 333, 339 (2000).

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We do not agree with petitioner’s standard of inquiry. The no

knowledge of the understatement requirement of section

6015(b)(1)(C) is similar to that found in former section

6013(e)(1)(C). Where relief was requested under section 6013(e)

with respect to the omission of income (the situation involved

herein), both this Court and the Court of Appeals for the Fifth

Circuit, the court to which an appeal in this case would lie, have

concluded that where a spouse seeking relief has actual knowledge

of the underlying transaction that produced the omitted income,

innocent spouse relief is denied. See Reser v. Commissioner, 112

F.3d 1258, 1265 (5th Cir. 1997), affg. in part and revg. in part

T.C. Memo. 1995-572; Bokum v. Commissioner, 94 T.C. 126, 148

(1990), affd. 992 F.2d 1132 (11th Cir. 1993). We believe this

standard applies for section 6015(b)(1) relief as well.

Here, petitioner possessed actual knowledge of the underlying

transactions (the distribution of retirement proceeds and the

interest earned on the Austin Telco account) that gave rise to the

Cheshires’ understatement of tax. Petitioner had been informed by

Mr. Cheshire that he was contemplating retirement and was eligible

to receive a substantial sum of money from his retirement plan. By

the end of January 1992, petitioner was aware of both the

retirement distribution proceeds and the existence of the Austin

Telco account. In fact, Mr. Cheshire showed petitioner the deposit

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slip and discussed with her the purposes for which the retirement

distribution proceeds would be used.

Petitioner also had actual knowledge that interest was earned

on the Austin Telco account. At all times, petitioner was aware of

the balance in this account and frequently wrote checks drawn on

its funds. Moreover, bank statements and a Form 1099, Interest

Income, setting forth the amount of interest earned on the account

were sent to petitioner’s home. Thus, petitioner does not satisfy

the no knowledge of the understatement requirement of section

6015(b)(1)(C). Moreover, because petitioner knew, or had reason to

know, of the entire amount of the retirement distributions and the

interest earned on the Austin Telco account, she is not entitled to

proportionate relief under section 6015(b)(2).

B. Relief Under Section 6015(c)

In general, section 6015(c) allows proportionate tax relief

(if a timely election is made) through allocation of the deficiency

between individuals who filed a joint return and are no longer

married, are legally separated, or do not reside together for a 12-

month period. Such allocation, however, is not permitted if the

Secretary demonstrates that the individual electing relief had

actual knowledge, at the time the return was signed, of any item

giving rise to a deficiency (or portion thereof) which is not

allocable to such individual. See sec. 6015(c)(3)(C). For

purposes of section 6015(c), unlike for purposes of section 6015(b)

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and (f), equitable considerations in holding the putative innocent

spouse liable for unpaid tax or any deficiency are of no import.

In the instant case, neither party disputes that the principal

item giving rise to the deficiency is Mr. Cheshire’s receipt of the

retirement distribution proceeds,5 and that such item is allocable

to him under section 6015(d). Nor is there any dispute that

petitioner is entitled to make an election under section 6015(c) as

she and Mr. Cheshire were no longer married when petitioner filed

her petition in this Court. The dispute between the parties

involves whether petitioner had actual knowledge, at the time the

joint return was signed, of “any item giving rise to the deficiency

(or portion thereof)”.

Petitioner posits that because she did not know that the

taxable amount of the retirement distribution was misstated on the

1992 joint return, she is entitled to section 6015(c) relief.

Respondent, on the other hand, maintains that ignorance of the tax

law is of no import–-if petitioner knew of the event or transaction

giving rise to the deficiency (which she admits she did), then

petitioner cannot obtain relief under section 6015(c).

In our opinion, the knowledge requirement of section

6015(c)(3)(C) does not require the electing spouse to possess

knowledge of the tax consequences arising from the item giving rise

Petitioner does not claim sec. 6015(c) relief with

respect to the omitted interest income.

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to the deficiency or that the item reported on the return is

incorrect. Rather, the statute mandates only a showing that the

electing spouse actually knew of the item on the return that gave

rise to the deficiency (or portion thereof). See Wiksell v.

Commissioner, 215 F.3d 1335 (9th Cir. 2000) (“the actual knowledge

inquiry in section 6015(c)(3)(C) focuses on whether the taxpayer

had knowledge ‘of any item giving rise to a deficiency’, not on the

tax deficiency itself”; Court of Appeals held that spouse

demonstrated actual knowledge of certain tax items by questioning

her spouse about them), affg. without published opinion T.C. Memo.

1999-32. Here, when petitioner signed the joint return, she was

aware of the amount, the source, and the date of receipt of the

retirement distribution and interest. She was, however, under a

misapprehension as to the taxable amount of the retirement

distribution.

We believe the knowledge standard for purposes of section

6015(c)(3)(C) is an actual and clear awareness (as opposed to

reason to know) of the existence of an item which gives rise to the

deficiency (or portion thereof). In the case of omitted income

(such as the situation involved herein), the electing spouse must

have an actual and clear awareness of the omitted income.6

Section 6015(c)(3)(C) does not require actual knowledge on the part

We leave to another day the manner in which the actual

knowledge standard will be applied in erroneous deduction cases.

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of the electing spouse as to whether the entry on the return is or

is not correct.

We recognize that the Senate and conference reports contain

the statement that “if the IRS proves that the electing spouse had

actual knowledge that an item on a return is incorrect, the

election will not apply to the extent any deficiency is

attributable to such item.” H. Conf. Rept. 105-599, at 253

(1998); see S. Rept. 105-174, at 70 (1998). Arguably, this

statement conflicts with our knowledge standard for purposes of

section 6015(c)(3)(C). On the other hand, it can be read merely as

an example where relief is not warranted.

Section 6015(c)(3)(C) does not explicitly state or reasonably

imply that relief is denied only where the electing spouse has

actual knowledge that the item giving rise to the deficiency (or

any portion thereof) is incorrectly reported on the return. As the

Supreme Court has stated “courts must presume that a legislature

says in a statute what it means and means in a statute what it says

there”. Connecticut Natl. Bank v. Germain, 503 U.S. 249, 253-254

(1992). Were we to interpret section 6015(c)(3)(C) narrowly (by

denying relief only where the electing spouse actually knows that

the item giving rise to the deficiency is incorrectly reported on

the return), we would be redrafting the statute, something we may

not do.

We now turn to the meaning of the word “item” for purposes of

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section 6015(c)(3)(C). Although the word “item” is not defined in

section 6015(c)(3)(C), we believe that in omitted income situations

“item” refers to the item of income that should have been reported

on the return . An example contained in the report issued by the

Joint Committee on Taxation, accompanying RRA 1998, supports this

interpretation:

The rule that the election will not apply to the

extent any deficiency is attributable to an item the

electing spouse had actual knowledge of is expected to be

applied by treating the item as fully allocable to both

spouses. For example, a divorced couple filed a joint

return during their marriage with wage income of $150,000

allocable to the wife and $30,000 of self-employment

income allocable to the husband. On examination, an

additional $20,000 of the husband’s self-employment

income is discovered, resulting in a deficiency of

$9,000. The IRS proves that the wife had actual

knowledge of $5,000 of this additional self-employment

income, but had no knowledge of the remaining $15,000.

In this case, the husband would be liable for the full

amount of the deficiency, since the item giving rise to

the deficiency is fully allocable to him. In addition,

the wife would be liable for the amount that would have

been calculated as the deficiency based on the $5,000 of

unreported income of which she had actual knowledge.

Even if the wife elects to limit the liability for the

deficiency under this provision, the IRS would be allowed

to collect that amount from either spouse, while the

remainder of the deficiency could be collected only from

the husband. [Emphasis supplied.]

Staff of Joint Comm. on Taxation, General Explanation of Tax

Legislation Enacted in 1998, at 70 (J. Comm. Print 1998).

The meaning we give to an “item” that gives rise to a

deficiency, for purposes of the knowledge requirement found in

section 6015(c)(3)(C), is consistent with that of other sections of

the Code where the word “item” is used. See, e.g., CIA v. Sims,

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471 U.S. 159, 169 (1985) (Supreme Court looks to other statutes in

defining “intelligence sources” and “confidential source[s]”.) For

instance, the Code defines “item” in other contexts, as follows:

Section 6231(a)(3) defines “partnership item” as “any item required

to be taken into account for the partnership’s taxable year under

any provision of subtitle A”; section 6231(a)(5) defines “affected

item” as “any item to the extent such item is affected by a

partnership item”; and section 6245 defines a “subchapter S item”

as “any item of an S corporation to the extent regulations

prescribed by the Secretary provide that, for purposes of * * *

[subtitle F of the Code (Procedure and Administration)], such item

is more appropriately determined at the corporate level than at the

shareholder level.” In these circumstances, “item” is defined

without reference to its tax consequences. Moreover, it is clear

under section 61 that an “item” is gross income from a particular

source, including pensions (the type of omitted income involved in

this case).

Generally, ignorance of the tax law is not a defense to a

deficiency. As we have previously stated:

We reject [the taxpayer’s] assertion that she did not

have “reason to know” * * * because of her insufficient

legal acumen. As a practical matter, this argument is

tantamount to a claim that ignorance of the law is an

element of the innocent spouse defense, and, as such, is

incorrect. * * * A taxpayer is presumed to have knowledge

of the tax consequences of a transaction, but is not

presumed to have knowledge of the transaction itself.

- 23 -

Bokum v. Commissioner, 94 T.C. at 150 (quoting Stevens v.

Commissioner, 872 F.2d 1499, 1508 n.8 (11th Cir. 1989), affg. T.C.

Memo. 1988-63 (citations omitted)); Estate of Hall v. Commissioner,

T.C. Memo. 1996-93, affd. 103 F.3d 112 (3d Cir. 1996). Were we to

accept the knowledge standard petitioner advocates (i.e., the

putative innocent spouse is entitled to relief if she/he

misunderstood or lacked knowledge of the Internal Revenue Code (the

Code)), then potentially any spouse who is not a certified public

accountant or tax attorney would be allowed to escape paying income

tax. We do not believe Congress intended such a result.

To conclude, petitioner had actual knowledge of the disputed

item of income (the retirement distribution proceeds), as well as

the amount thereof, that gave rise to the deficiency at the time

she signed the joint 1992 return. The fact that petitioner did not

know that the amount of the retirement distribution was misstated

on the return is of no import. Consequently, the benefits of

section 6015(c) are unavailable to her.

C. Relief Under Section 6015(f)

Section 6015(f) confers discretion on the Secretary (and the

Secretary has delegated that discretion to respondent) to grant

innocent spouse relief to an individual (where relief is not

available under section 6015(b) or (c)) if taking into account all

the facts and circumstances, it is inequitable to hold the

individual liable for any unpaid tax or deficiency (or any portion

- 24 -

of either). In the instant case, petitioner sought but was denied

relief under section 6015(f). Petitioner maintains that

respondent’s refusal to grant relief to her was arbitrary,

capricious, and without sound basis in fact.

Respondent acknowledges that we have jurisdiction to review

his denial of innocent spouse relief under section 6015(f). See

Butler v. Commissioner, 114 T.C. 276 (2000); Fernandez v.

Commissioner, 114 T.C. 324 (2000); Charlton v. Commissioner, 114

T.C. 333 (2000). We review respondent’s denial of equitable relief

to petitioner under an abuse of discretion standard. See Butler v.

Commissioner, supra at 292; Mailman v. Commissioner, 91 T.C. 1079,

1083 (1988); Estate of Gardner v. Commissioner, 82 T.C. 989, 1000

(1984). This is a question of fact. See Hospital Corp. of Am. v.

Commissioner, 81 T.C. 520, 594 (1983); Foster v. Commissioner, 80

T.C. 34, 160, 178 (1983), affd. in part and revd. in part on

another ground 756 F.2d 1430 (9th Cir. 1985).

Petitioner’s claim for innocent spouse relief was initiated in

her petition to this Court. Prior to trial, respondent conceded

that petitioner was entitled to relief with respect to certain

items omitted from the 1992 joint return and was not liable for the

section 6651(a)(1) addition to tax. Presumably before doing so,

respondent followed standard procedures by reviewing his

administrative files and considered petitioner’s contentions.

Respondent opposes petitioner’s claim for equitable relief

- 25 -

with respect to the retirement distribution proceeds, the interest

income, and the section 6662(a) accuracy-related penalty on the

grounds that it would not be inequitable to hold petitioner liable

for the tax on these items and that she failed to demonstrate

reasonable cause in omitting these items. After taking into

account the facts and circumstances presented in this case, we do

not believe respondent abused his discretion in denying equitable

relief to petitioner with respect to the retirement distribution

proceeds and interest income or with respect to the section 6662

penalty as it relates to the omitted interest income. However, we

believe respondent’s denial of equitable relief to petitioner under

section 6015(f) to be an abuse of his discretion as it relates to

the section 6662(a) penalty applicable to the omitted retirement

distribution proceeds. The reasons for our overruling respondent’s

denial of relief regarding the section 6662(a) penalty applicable

to the retirement distribution proceeds are as follows:

Section 6662(a) does not apply to “any portion of an

underpayment if it is shown that there was a reasonable cause for

such portion and that the taxpayer acted in good faith with respect

to such portion.” Sec. 6664(c)(1). After carefully observing

petitioner while testifying, we are satisfied that at the time she

signed the 1992 tax return, petitioner believed that the portion of

retirement distribution proceeds used to pay off the mortgage on

- 26 -

the family residence would be nontaxable. Further, we believe

petitioner acted in good faith in reaching this erroneous

conclusion.

Petitioner trusted and relied upon Mr. Cheshire when it came

to the preparation of their tax returns. She is an elementary

school teacher, having taken no courses in accounting or tax return

preparation. She asked Mr. Cheshire about the potential tax

ramifications of the retirement distributions, and Mr. Cheshire

assured petitioner that he had consulted with a certified public

accountant and had been advised that the payment of the outstanding

mortgage on the family residence and any amount rolled over into a

qualified account reduced the taxable amount of the retirement

distributions. Mrs. Cheshire had no reason to doubt the

truthfulness of Mr. Cheshire’s statement, and in fact believed him.

Under these circumstances, we do not believe petitioner had an

obligation to inquire further.

We conclude that petitioner would have been justified in

believing that $58,163 ($199,771 - $42,183 (rollover) - $99,425

(mortgage repayment)) of the $199,771 retirement distributions was

taxable. Indeed, $199,771 in retirement distributions was reported

on the 1992 return, albeit only $56,150 was included in the

calculation of income. (The record does not reveal the $2,013

difference between $58,163 and $56,150; we deem the $2,013

difference to be de minimis.) In our opinion, it is an abuse of

- 27 -

discretion to deny relief under section 6015(f) in an addition to

tax or penalty situation when on an individual basis the putative

innocent spouse meets the statutory standard generally applied to

all taxpayers that shows the addition to tax or penalty is

inapplicable.

Given the facts and circumstances in this case, to hold

petitioner liable for the entire section 6662(a) penalty would be

inequitable. Consequently, we hold that respondent abused his

discretion in failing to grant petitioner innocent spouse relief

from the section 6662(a) penalty as it relates to the

understatement regarding the omitted retirement distribution

proceeds. However, we conclude that respondent did not abuse his

discretion in failing to grant petitioner innocent spouse relief

from the section 6662(a) penalty as it relates to the

understatement regarding the omitted interest income. Petitioner

knew of that income, and the record is devoid of any reason for its

omission. Consistent with these conclusions, the parties should

determine the exact amount of the section 6662(a) penalty due in

their Rule 155 calculation.

- 28 -

To reflect the foregoing and respondent’s concessions,

Decision will be

entered under Rule 155.

Reviewed by the Court.

WELLS, CHABOT, COHEN, RUWE, WHALEN, HALPERN, LARO, FOLEY, and

VASQUEZ, JJ., agree with this majority opinion.

CHIECHI, J., concurs in the result only.

- 29 -

THORNTON, J., concurring: No relief is available under

section 6015(c)(3)(C) if the Commissioner shows that the spouse

seeking relief had “actual knowledge * * * of any item giving rise

to a deficiency (or portion thereof)”. Majority op. p. 17. The

majority opinion appropriately construes this statutory language to

require, in the case of omitted income, “actual and clear awareness

of the omitted income.” Thus, I believe, the majority opinion

inherently rejects respondent’s argument that actual knowledge of

an “item” means actual knowledge merely of the event or transaction

giving rise to the deficiency. This result comports with the

ameliorative purposes of section 6015(c). It is also consistent

with the statutory framework. In particular, if a spouse qualifies

under section 6015(c), the relief provided under section 6015(d) is

an allocation between spouses of the “items” giving rise to the

deficiency. In this context, “item” clearly signifies the item of

omitted income, not the underlying event or transaction.

The majority opinion harmonizes with the legislative history.

The relevant Senate and conference reports state that section

6015(c) provides no relief if the Commissioner proves that the

spouse seeking relief had “actual knowledge that an item on a

return is incorrect.” What does it mean for an “item on a return”

(as opposed to the tax treatment of such an item) to be

“incorrect”? In the context of omitted income, and in the light of

the section 61 provisions defining gross income by reference to

- 30 -

various “items,” it most likely means that gross income from a

particular source, such as a pension, is incorrectly reported

(either by virtue of understatement or omission) on the return.

The other statements of legislative purpose cited by the dissent

evince no clear consensus about any other standard of general

applicability and dictate no contrary result.

Here the question is whether Mrs. Cheshire had actual

knowledge of the gross income from the pension that gave rise to

the deficiency. Clearly she did. Whether she believed the pension

proceeds distribution was nontaxable in whole or part on the ground

that it was used to pay down a mortgage or under some other

mistaken theory is immaterial.

WHALEN, HALPERN, LARO, FOLEY, and VASQUEZ, JJ., agree with

this concurring opinion.

- 31 -

PARR, J., dissenting: I have joined with Judge Colvin in his

dissenting opinion, because I believe the language of section

6015(c)(3)(C) is ambiguous and that we should consult legislative

history for guidance in resolving that ambiguity. I write

separately only to express my concern about the Court's application

of section 6013(e) case law to the case at hand.

Section 6015 is a remedial statute, therefore, its provisions

should be construed and applied liberally in favor of those whom

the statute was designed to benefit. Cf. Helvering v. Bliss, 293

U.S. 144, 150-151 (1934); Allen v. Commissioner, 514 F.2d 908, 915

(5th Cir. 1975). Moreover, it is apparent that Congress intended

section 6015 to provide broader relief than that provided by

section 6013(e).

In its discussion of section 6015(f), the majority has found--

and I agree--that, considering the facts and circumstances of this

case, it is not inequitable to hold petitioner liable for the

deficiency. Since equitable consideration is also a requirement

for relief under section 6015(b)(1)(D), the majority's discussion

of section 6015(b)(1)(C) is unnecessary. The word "understatement"

used in section 6015(b)(1)(C) is different from the word "item"

construed in the discussion of section 6015(c)(3)(C). Yet the

- 32 -

majority treats both as synonymous with "transaction". I would

defer this discussion to a case that required it.1

Accordingly, I respectfully dissent.

COLVIN and MARVEL, JJ., agree with this dissenting opinion.

The facts of Charlton v. Commissioner, 114 T.C. 333 (2000),

are distinguishable, and the discussion of sec. 6015(b) therein

is thus not determinative.

- 33 -

COLVIN, J., dissenting: Section 6015(c)(3)(C) provides that

the separate liability election is not available if the

Commissioner proves that the putative innocent spouse “had actual

knowledge * * * of any item giving rise to a deficiency”. The

majority holds that in omitted income cases:

Section 6015(c)(3)(C) does not require actual knowledge

on the part of the electing spouse as to whether the

entry on the return is or is not correct. [Majority op.

pp. 19-20.]

I respectfully dissent because the majority’s construction of

section 6015(c)(3)(C) squarely conflicts with the legislative

history of section 6015(c). I also dissent because the majority

fails to discuss Charlton v. Commissioner, 114 T.C. 333 (2000), and

relies on Wiksell v. Commissioner, 215 F.3d 1335 (9th Cir. 2000)

(unpublished), affg. T.C. Memo. 1999-32, which did not present the

issue we face here.

I. The Phrase “Item Giving Rise to a Deficiency” Is Ambiguous

Section 6015(c)(3)(C) provides in pertinent part that:

[i]f the Secretary demonstrates that an individual making

an election under this subsection had actual knowledge,

at the time such individual signed the return, of any

item giving rise to a deficiency (or portion thereof)

which is not allocable to such individual under

subsection (d), such election shall not apply to such

deficiency (or portion). * * * [Emphasis added.]

Sec. 6015(c)(3)(C).

Thus, section 6015(c) relief is not available if the

Commissioner proves that the putative innocent spouse had actual

knowledge of any “item giving rise to a deficiency”. That phrase

- 34 -

is ambiguous; the “item” of which the putative innocent spouse must

have had actual knowledge could be either of two things. First, it

might refer to a transaction or activity. If so, then, as

respondent contends, see majority op. at 18, a putative innocent

spouse would not qualify for the separate liability election under

section 6015(c) if the Commissioner showed that he or she knew that

an income-producing transaction or activity had occurred.

Alternatively, knowledge of an “item giving rise to a

deficiency” might refer to knowledge that an entry on a tax return

was incorrect. Under this interpretation, the putative innocent

spouse would not be disqualified under section 6015(c) merely

because he or she knew that the income-producing transaction or

activity giving rise to the deficiency had occurred. Instead, the

Commissioner would be required to show that the electing spouse had

actual knowledge that the treatment of the item on the tax return

was incorrect.1

That “item giving rise to a deficiency” could be

reasonably construed in either of these ways is demonstrated by

the fact that the Internal Revenue Code uses the term “item” to

refer both to an underlying activity and to the tax return

treatment of an activity. As an example of the former, sec.

61(a) provides that–

SEC. 61(a). * * * Except as otherwise provided

in this subtitle, gross income means all income from

whatever source derived, including (but not limited to)

the following items:

(1) Compensation for services, including

fees, commissions, fringe benefits, and

(continued...)

- 35 -

II. Statutory Context and Legislative History Make Section

6015(c) Clear

A. Section 6015(c) Compared to Former Section 6013(e)(1)(C)

In an unreported income case, a taxpayer failed to qualify for

innocent spouse relief under former section 6013(e)(1)(C) if the

taxpayer had knowledge of the transaction which led to the

understatement. See Reser v. Commissioner, 112 F.3d 1258, 1267

(5th Cir. 1997). The instant case is also an unreported income

case, and respondent contends we should apply the same standard

here. See majority op. at 18.

Congress enacted sweeping changes to the innocent spouse

provisions in 1998. In addition to liberalizing section

6013(e)(1)(C) in new section 6015(b), Congress also provided two

additional forms of innocent spouse relief: the separate liability

election (section 6015(c)) and authority for the Secretary to grant

relief on equitable grounds (section 6015(f)). Congress also

enacted a different knowledge requirement in section 6015(c)(3)(C)

than had applied in former section 6013(e)(1)(C). First, section

(...continued)