No Innocent Spouse Relief for Widow Who Failed to Report Insurance Proceeds on Form 8857

(Parker Tax Publishing July 2018)

The Tax Court held that a widow was not entitled to innocent spouse relief from tax liabilities that arose over several years in which she and her husband filed joint returns but did not pay taxes owed. The court cited the fact that, after her husband's death, the widow invested the proceeds of life insurance policies purchased by her husband without her knowledge in several savings accounts opened in her parents' names and did not report the proceeds to the IRS when she requested relief. Hale v. Comm'r, T.C. Memo. 2018-93.

Background

Kimberly and Stephen Hale were married in 2003. That year, Mr. Hale bought real estate in Memphis, Tennessee needing extensive renovations. The renovations created three apartments, one of which the Hales occupied while they rented out the other two. Sometime before 2004, the Hales also acquired a timeshare in Cancun, Mexico which they used for annual one week vacations.

Mrs. Hale maintained the household and cared for the couple's three children. After her third child, Mrs. Hale received medication for postpartum depression. Mr. Hale was an attorney who was a name partner of a general practice firm. The firm experienced difficulties as a result of adverse market conditions beginning in 2007. Mr. Hale's friend and accountant, J. Anthony Marston, described him as a very controlling person who was reluctant to turn over the accounting to the professionals. Mrs. Hale was not involved in household finances; Mr. Hale kept the checkbook at his office, had all bills sent to his office, and paid the bills from there.

The Hales filed tax returns for 2004 through 2009 but did not pay the taxes owed. Mr. Hale prepared the returns and Mrs. Hale signed them. In 2010, the IRS filed a notice of tax lien, which was sent to Mr. Hale at his law firm.

In 2011, a bank filed suit to collect unpaid interest on a mortgage on the Hales' property. On the day of a scheduled hearing, Mr. Hale did not appear. It was later discovered that he had taken his own life. After Mr. Hale's death, Marston found in Mr. Hale's office evidence of many personal and business debts, including household bills, unopened IRS correspondence, default notices and creditor lawsuits. Marston notified Mrs. Hale of the unpaid taxes.

Mrs. Hale's father, Steven Reid, served as the executor of Mr. Hale's estate. Mr. Hale's gross estate was valued at approximately $17 million, including over $15.7 million in insurance on Mr. Hale's life and the Memphis property valued at around $1.2 million. The estate was not a beneficiary of any of the insurance policies. The estate's Tennessee inheritance tax return showed a deduction for bequests to Mrs. Hale of $8.1 million, which included life insurance proceeds of almost $8 million that Mr. Hale had purchased and funded with his own income. It also reported expenses and debts totaling almost $10 million.

Mrs. Hale did not know about the life insurance policies. Although there was sufficient insurance at Mr. Hale's death to provide Mrs. Hale, their children, and his law firm with over $15 million in benefits, other policies had lapsed because the premiums were not paid. After Mr. Hale's death, the Memphis property went into foreclosure and the estate received no proceeds from it.

A few weeks after Mr. Hale's death, IRS agent Kimberly Huston contacted Marston's office because she believed that one of the mortgages on the Memphis property was paid off with insurance proceeds. Around one week after Huston's inquiry, Mrs. Hale signed three checks totaling approximately $4.7 million, which were deposited in cash deposit (CD) accounts at three different banks. Each deposit exceeded $200,000, and all of the accounts were opened in the names of Mrs. Hale's parents. Mrs. Hale relied on her father and professional advisors to help with her finances. Reid had been advised regarding the implications, including in terms of Federal Deposit Insurance Co. (FDIC) protection, of dispersing assets in different accounts at different banks.

In May 2012, Mrs. Hale submitted two Forms 8857, Request for Innocent Spouse Relief. An attached statement explained that Mrs. Hale owned only some personal property and a retirement account. She reported monthly income of $6,400 and expenses of $7,900.

In July 2012, a payment of $1.5 million, on behalf of Mr. Hale's estate, was made to the IRS for the taxes owed. An additional $350,000 was paid to the IRS on behalf of Mrs. Hale for taxes, penalties and interest. These payments satisfied the Hales' tax liabilities in full. Mrs. Hale then petitioned the Tax Court for a refund, asserting innocent spouse relief under Code Sec. 6015(f).

Analysis

Spouses filing joint tax returns are generally jointly and severally liable for any taxes owed. However, Code Sec. 6015(f) allows a spouse to be relived from liability if it would be inequitable to hold the spouse liable.

Rev. Proc. 2013-34 lists seven factors to consider if certain threshold conditions do not apply. The factors are: (1) whether the couple is still married, (2) whether economic hardship would arise if relief is not granted, (3) whether the requesting spouse had reason to know that the taxes would not be paid, (4) whether either spouse had a legal obligation to pay the taxes, (5) whether the requesting spouse significantly benefitted from the unpaid taxes, (6) whether the requesting spouse made a good faith effort to comply with the income tax laws in subsequent years, and (7) whether the requesting spouse was in poor health at the time the returns were filed.

Mrs. Hale argued that she had no reason to know about the unpaid taxes because she was not involved in the couple's financial decisions. She pointed out that she complied with the tax laws in subsequent years because she filed returns and had no balance owing, and that her failure to list the insurance proceeds on her Forms 8857 was due to a miscommunication among her advisors. She claimed that the transfers of her insurance proceeds into nominee CD accounts was not concealment from the IRS but rather a way to obtain greater FDIC coverage and avoid harassment from creditors. She also asserted that she suffered postpartum depression required medication and severe mental struggles after Mr. Hale's death.

The IRS argued that Mrs. Hale would experience no economic hardship because she received almost $8 million in insurance proceeds and that, contrary to her Forms 8857, her monthly income exceeded her expenses by over $6,000. The IRS argued that Mrs. Hale structured her assets in nominee accounts to avoid collection by the IRS and that Mr. Hale's accumulation of significant assets during the years at issue, including the Cancun timeshare, should have given her reason to suspect that the taxes were not being paid. According to the IRS, Mrs. Hale significantly benefitted from the unpaid taxes because Mr. Hale's life insurance policies were funded by income that could have been used to pay the taxes. The IRS also argued that Mrs. Hale did not comply with the tax laws in subsequent years because she failed to fully disclose her assets on her Forms 8857.

The Tax Court held that it would not be inequitable to deny relief to Mrs. Hale. The court explained that a simple toting up of the seven factors would support granting relief, because Mrs. Hale's lack of knowledge and mental health weighed in her favor and strictly applied, no factor weighed against relief. However, the court noted that the factors are nonexclusive, the degree of importance of each factor varies depending on the facts and circumstances, and that the court was not bound by the IRS's published guidelines.

The Tax Court found that there would be no inequity in requiring Mrs. Hale to bear the burden of the unpaid taxes because, by her own admission, the payments did not cause her economic hardship. The court explained that Rev. Proc. 2013-34 amended earlier guidance by providing that the lack of economic hardship is a neutral factor rather than one weighing against relief. Nevertheless, the court found that under the circumstances, Mrs. Hale's ability to pay the taxes out of the insurance proceeds weighed against her.

The court also reasoned that the tax payments were funded with proceeds from insurance policies for which Mr. Hale paid premiums out of his income. In the court's view, Mr. Hale might have had to allow the policies to lapse if he had paid the couple's taxes. The court further reasoned that the IRS would likely be unable to collect the tax from any source other than the insurance proceeds if the refunds were allowed.

The Tax Court viewed with suspicion the transfers of insurance proceeds and failure by Mrs. Hale to mention them on her Forms 8857. The court noted the timing of the transfers, which occurred one week after the IRS's inquiry about Mrs. Hale's receipt of insurance money. The court also found that the Form 8857 omission could not be attributed entirely to Mrs. Hale's advisors. Rather, the court reasoned that even in her situation, the omission should have been obvious. In the court's view, the Forms 8857 misleadingly suggested that Mrs. Hale lacked the resources to pay the taxes from which she sought relief.

The Tax Court also found that Mrs. Hale's mental condition weighed only slightly in her favor. The court found that she was not involved in the couple's financial decisions, so the failure to pay taxes could not be attributed to her postpartum depression. The court also found no evidence of the severity or duration of Mrs. Hale's condition after her husband's death other than the fact that she attending counseling with her children, and viewed the counseling as being for the children at least as much as it was as for Mrs. Hale.

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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