Innocent Spouse Claim Nixed by Significant Benefit to Taxpayer from Underpayments

(Parker Tax Publishing February 2024)

The Tax Court held that a taxpayer was not entitled to equitable relief from joint and several liability under Code Sec. 6015(f) because she significantly benefited from the underpayments of income tax underlying the case. The court found that the unpaid tax liabilities were at least partly attributable to early retirement distributions that were used to make mortgage payments on properties the taxpayer continued to own and that the taxpayer continued spending for a lavish lifestyle despite knowing about the unpaid liabilities. Thomas v. Comm'r, 162 T.C. No. 2 (2024).

Background

Sydney Thomas is a business owner, part-time college instructor, and former bank employee. She holds a bachelor of science degree in political science and government and economics from Oregon State University. In 1994, Sydney married her next-door neighbor, Tracy Thomas. Tracy held a finance degree and worked at Halliburton. He eventually transitioned into a career in the construction industry.

The Thomases' marriage was initially a happy one, and the couple went on to have two daughters. Eventually, they purchased a 4-bedroom home in Moraga, California (Moraga Property), an affluent suburb of San Francisco. Around this time, Tracy was making good money, so Sydney stopped working to take care of their children. Also around this time, the Thomases purchased a second home near various ski resorts in the Lake Tahoe area (Truckee Property). Tracy also purchased a five-carat diamond ring for Sydney that she still owned at the time of trial.

The Thomases eventually experienced marital and financial problems. Sometime between 2007 and 2009, Tracy stopped receiving regular bonuses from his employer as a result of the global financial crisis. He eventually left his job for others in the construction industry. The Thomases had trouble making credit card and mortgage payments and defaulted on approximately $125,000 in credit card debt. In 2011 the Moraga Property went into foreclosure. But, before the Moraga Property could be auctioned off, Sydney got the home out of foreclosure. Then, to help pay their mortgages in 2012, 2013, and 2014, the Thomases took early retirement distributions from an individual retirement account (IRA). Sydney knew about the early retirement distributions when they occurred.

For the 2012, 2013, and 2014 tax years, the Thomases jointly filed federal income tax returns, which were signed by Sydney. Each return reported income tax due in excess of the amount the Thomases paid. The Thomases did not pay these amounts at the time they filed their returns, and most of the amounts remained outstanding at the time of trial. Sydney knew about the underpayments at the time the Thomases filed their returns. Around this time, Sydney sold property she had inherited from her mother and used a portion of the proceeds to buy a 2013 Land Rover for her personal use.

In 2016, Tracy texted Sydney that "[t]he taxes and mortgages have been dealt with [and] now it is in IRS and Chase's court." However, this was not the end of the Thomases' tax issues. The Thomases continued to argue over their finances. In July 2016, for example, the Thomases argued about a $1,000 plane ticket Sydney purchased for their daughter to go to Hawaii. In 2016, they also argued over various personal expenses incurred by Sydney and their daughters (who at the time of trial were 21 and 22 years old), including a trip to Paris Sydney was taking with one daughter, among other expenditures. And they argued about expenses for Sydney's sailing apparel business, Ocean SF, in which Tracy had invested.

In 2016, Tracy passed away. His estate consisted primarily of his interest in the Moraga Property and the Truckee Property, as well as a 2004 Lexus, a Porsche Boxster, and a golf membership at a country club. Sydney also was left to deal with the finances and unpaid income taxes. In the years following Tracy's death, Sydney traveled to New York with one of her daughters to celebrate that daughter's birthday. She also traveled to Rome, Paris, and Florence, to Napa for wine tastings, and to Tahoe for skiing with her daughters. She took out loans to put her daughters through college, gave one daughter $3,500 for an advanced math class, and paid for her daughters' cell phones and car insurance.

During these same years, Sydney maintained a blog. She blogged about Tracy, her two daughters, her lifestyle, and Ocean SF. She blogged about her various trips with her daughters and about purchasing her daughter "a gorgeous bottle green Dior bag for her 18th birthday." In the same blog post, she stated that she "own[s] five bags," including a "white Italian Furla," two from Kate Spade, and a "black woven Bottega Veneta." The following day, she blogged about paying a business coach "$220 per hour" for private sessions. In another post from about a year after Tracy died, Sydney wrote that she would "listen politely as friends said, you have to sell your Tahoe house, and be realistic. For the record, I will never sell my Tahoe house. Ever."

In 2019, Sydney filed with the IRS a Form 8857, Request for Innocent Spouse Relief, seeking relief from her unpaid tax liabilities for 2012, 2013, and 2014. The IRS denied Sydney's request for innocent spouse relief, and Sydney petitioned the Tax Court for review.

Innocent Spouse Relief

In certain circumstances, a spouse who has made a joint return may seek relief from joint and several liability (i.e., innocent spouse relief) under Code Sec. 6015. A requesting spouse has three alternatives: (1) full or partial relief under Code Sec. 6015(b), (2) proportionate relief under Code Sec. 6015(c), or (3) if relief is not available under subsection (b) or (c), equitable relief under Code Sec. 6015(f). In this case, subsections (b) and (c) did not apply because it involved only an underpayment of tax, not an understatement of tax or a deficiency.

Under Code Sec. 6015(f), the IRS has discretion to relieve a requesting spouse of joint liability if it would be inequitable to hold the requesting spouse liable for the unpaid tax. In Rev. Proc. 2013-34, the IRS sets out seven nonexclusive factors that will be considered in determining whether equitable relief is appropriate under Code Sec. 6015(f). Those factors are: (1) the taxpayer's marital status, (2) whether the requesting spouse will suffer economic hardship absent relief, (3) whether the requesting spouse had knowledge or reason to know that the nonrequesting spouse would not or could not pay the income tax liabilities, (4)either spouse had a legal obligation to pay the liabilities, (5) whether the requesting spouse significantly benefited from the underpayments, (6) whether the requesting spouse has complied with the income tax laws in the years following those to which the request for relief relates, and (7)mental or physical health of the requesting spouse.

Observation: Rev. Proc. 2013-34 also provides for a streamlined determination of equitable relief if certain threshold conditions are met and the requesting spouse establishes that she (1) is no longer married to the requesting spouse, (2) would suffer economic hardship if relief were not granted, and (3) did not know or have reason to know that the nonrequesting spouse would not or could not pay the underpayment of tax. In this case, the court found that streamlined relief was not available to Sydney because she did not establish that she would suffer economic hardship if she were not granted relief.

The only factors in dispute in this case were whether Sydney knew or had reason to know that Tracy would not or could not pay the income tax liabilities, and whether Sydney significantly benefited from the underpayment. The parties agreed that the other factors were neutral.

Analysis

The Tax Court found that Sydney was not entitled to relief under Code Sec. 6015(f). The court found that she significantly benefited from the underpayments of tax underlying this case, which weighed heavily against her entitlement to relief.

The court found that Sydney knew of the unpaid taxes initially when the relevant returns were filed. Despite her knowledge of the unpaid tax liabilities, Sydney argued that this factor should favor relief because she was abused by Tracy and consequently was unable to question his payment of the taxes. The court observed that Sydney's allegations of abuse, if true, could reasonably cause someone to fear questioning a spouse for fear of reprisal. However, the court found that other evidence suggested Sydney may not have been afraid to question Tracy's financial decisions. For example, there were several times when Sydney expressly disagreed with Tracy about financial decisions. And the court noted that Sydney never actually stated that she disagreed with the nonpayment of the taxes; she said only that she disagreed with the decision to take early distributions from the IRA, which underlaid at least some of the underpayments in this case. While the court had some doubt that this factor weighed in favor of Sydney, the court explained that even if this factor favored relief on account of abuse, it was outweighed by the significant benefit to Sydney from the unpaid income tax liabilities.

The court pointed to several examples of the significant benefits to Sydney while her income tax liabilities remained unpaid. To start, the court found that Sydney benefited from owning two properties, both in desirable areas. To maintain these two properties, the Thomases took early retirement distributions to pay the mortgages, and these early distributions partially underlaid the unpaid tax liabilities connected to this case. Further, in using those proceeds to pay the mortgages instead of allocating a proper share to pay the taxes, the court found that Sydney directly benefited from the unpaid liabilities. Even if she initially objected to taking the early retirement distributions, the court determined that this in no way reduced the resulting benefits to her (i.e., owning two properties).

Next, the court found that Sydney significantly benefited from her purchase of a luxury vehicle (the 2013 Land Rover) using proceeds she received from an inheritance instead of paying the unpaid tax liabilities. The court also noted that Sydney and her daughters took several vacations while the tax liabilities remained unpaid, and Sydney continued to pay significant education expenses and other expenses for her adult daughters. Finally, the court found that Sydney's blog also provided insight into her various expenses since the unpaid tax liabilities arose. For example, Sydney blogged about purchasing a green Dior bag for her daughter's 18th birthday as well as owning several designer bags herself. She has also blogged about paying a business coach $220 an hour for private sessions.

The court rejected any argument that the significant benefit factor was neutral on account of abuse, since a significant share of the lavish expenditures were made by Sydney and not Tracy. Further, responding to the contention that some of these purchases were made when Sydney thought the taxes were paid, the court found that Rev. Proc. 2013-34 draws no distinction between expenses made before a requesting spouse knows about unpaid liabilities and those made after. The court concluded that in any event, many of the lavish expenses described above were incurred at times when Sydney knew about the tax problems.

For a discussion of innocent spouse relief, see Parker Tax ¶260,560.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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