T.C. Memo. 1995-523
UNITED STATES TAX COURT
ESTATE OF MARK R. WOODWARD, DECEASED, LILLIAN H. WOODWARD,
EXECUTRIX, AND LILLIAN H. WOODWARD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10137-88. Filed November 6, 1995.
Victor F. Keen, for petitioners.
John Aletta, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
DAWSON, Judge: This case was assigned to Special Trial
Judge Robert N. Armen, Jr., pursuant to the provisions of section
7443A(b)(4) of the Internal Revenue Code of 1986, as amended, and
Rules 180, 181, and 183.1 The Court agrees with and adopts the
Opinion of the Special Trial Judge, which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
ARMEN, Special Trial Judge: Respondent determined
deficiencies in petitioners' Federal income taxes and additions
to tax for the taxable years as follows:
Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6653(a) 6653(a)(1) 6653(a)(2) 6659(a)
1980 $10,180 $509 --- --- $3,054
1
1981 9,620 --- $481 2,886
2
1982 700 --- 35 ---
3
1983 755 --- 38 ---
1
50 percent of the interest due on $9,620.
2
50 percent of the interest due on $700.
3
50 percent of the interest due on $755.
Respondent also determined that petitioners are liable for
the increased rate of interest under section 6621(c) for the
taxable years 1980 and 1981.
After concessions by the parties,2 the only issue remaining
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
2
Petitioner Estate of Mark R. Woodward, Deceased, concedes
all of the determinations set forth in the notice of deficiency
except for the additions to tax under sec. 6659(a) for the
taxable years 1980 and 1981. For the taxable years 1980 and
1981, petitioner Lillian H. Woodward (petitioner) concedes that
if petitioner is not an innocent spouse, then she is liable for
the deficiencies in tax and additions to tax under secs. 6653(a),
6653(a)(1), and 6653(a)(2), and the increased rate of interest
under sec. 6621(c) as determined by respondent. For the taxable
years 1982 and 1983, petitioner concedes that she is liable for
the deficiencies in tax and additions to tax as determined by
respondent. For the taxable years 1980 and 1981, respondent
concedes that petitioners are not liable for the addition to tax
under sec. 6659(a).
for decision is whether petitioner Lillian H. Woodward
(petitioner) qualifies for relief as an innocent spouse under
section 6013(e) for the taxable years 1980 and 1981.
FINDINGS OF FACT
Some of the facts have been stipulated, and they are so
found. Petitioners resided in Shaker Heights, Ohio, at the time
their petition was filed with the Court.
1. General Background
Petitioners were married at all relevant times. From 1980
to 1983, petitioners timely filed joint individual Federal income
tax returns.
Petitioner received a bachelor's degree in history from the
University of California at Los Angeles. Thereafter, petitioner
worked for a suburban newspaper for approximately 2 years.
Petitioner then entered the U.S. Coast Guard. At some point
petitioner married Mark R. Woodward and remained married to him
until his death in 1991. Petitioner and Mr. Woodward had three
children. Although petitioner did not work outside the home
while she raised her children, she resumed working in 1970 as a
customer service representative for the Higbee Company, a
department store in Cleveland, Ohio. Petitioner worked for the
Higbee Co. until 1985. Her duties as a customer service
representative included tracing deliveries and answering
customers' questions that could not be handled on the floor by a
salesperson. Petitioner earned $14,118.36 in 1983 working as a
customer service representative.
Mr. Woodward attended the University of Illinois for 3
years, but did not obtain a college degree. During the taxable
years at issue, Mr. Woodward worked as a district sales manager
for the Master Builders division of the Martin-Marietta Corp.
Mr. Woodward retired in 1982.
Petitioner and Mr. Woodward maintained a joint checking
account for the taxable years 1980 through 1983. Prior to Mr.
Woodward's retirement, petitioner and Mr. Woodward shared the
clerical tasks concerning household expenses. For example, both
Mr. Woodward and petitioner paid the mortgage and utility bills.
However, Mr. Woodward was responsible for the family's financial
planning, including tax preparation. After his retirement, Mr.
Woodward managed the family's financial affairs, including paying
household expenses, without the help of petitioner. Mr. Woodward
recorded family financial matters on his computer. Petitioner
did not know how to operate the computer.
On December 8, 1983, Mr. Woodward invested in a tax shelter
promoted by Saxon Energy Corp. (Saxon).3 Thomas Graham of Graham
& Associates introduced Mr. Woodward to the Saxon Energy
investment. Petitioner knew Mr. Woodward was considering making
an investment with Graham & Associates, but did not know anything
specifically about the Saxon tax shelter. When petitioner's
signature was needed on the investment documents, Mr. Woodward
3
See Schillinger v. Commissioner, T.C. Memo. 1990-640,
affd. per order 1 F.3d 954 (9th Cir. 1993) (discussing the Saxon
Energy program in some detail).
signed her name.4 Petitioner was not aware that her husband was
signing the Saxon documents on her behalf. Mr. Woodward's
actions were consistent, however, with petitioners' arrangement
for Mr. Woodward to manage the financial planning. Although Mr.
Woodward did not discuss the Saxon investment with petitioner, he
did not conceal his business activities or the family's financial
affairs from her.
On their joint income tax return for the taxable year 1983,
petitioners reported the putative income tax consequences of
their Saxon investment including claimed Schedule C deductions
totaling $14,168, and a claimed investment tax credit in the
amount of $20,500. Concurrently with the filing of their return,
petitioners filed Form 1045, Application For Tentative Refund,
which generated refunds by carrying back unused investment tax
credits of $10,180, $9,620, and $700 to the taxable years 1980,
1981, and 1982, respectively. Mr. Woodward prepared the joint
returns for 1980 and 1981. Graham & Associates prepared the
joint returns for 1982 and 1983.
Petitioner signed each of the income tax returns that she
and Mr. Woodward filed with the Internal Revenue Service (IRS).
Petitioner also signed the Form 1045, Application For Tentative
Refund, filed with the IRS. Petitioner trusted Mr. Woodward to
handle their financial matters, including tax return preparation.
4
Mr. Woodward signed petitioner's name on most of the Saxon
documents including the lease application, the business adviser's
questionnaire, the lease agreement, and the election to pass
investment tax credit from lessor to lessee.
Thus, when Mr. Woodward requested that petitioner sign the income
tax returns and application for refund, she did so without
examining them and without hesitation.
Mr. Woodward died in 1991. Petitioner was the sole
beneficiary of his estate.
During their marriage, petitioner and Mr. Woodward did not
live extravagantly, nor did their standard of living vary
dramatically over the course of their marriage. In 1983
petitioners sold their home and rented an apartment. Petitioners
did not purchase any "big ticket" items in 1983, 1984 or 1985.
At some point in 1983 or 1984, petitioners leased a Chevrolet
Nova automobile.
2. The Income Tax Returns
On their joint income tax returns for 1980 through 1983,
petitioner and Mr. Woodward reported total income and income tax
as follows:
Year Total income Income tax
1
1980 $48,585.21 $10,180
2
1981 47,598.00 9,620
3
1982 47,388.00 5,233
1983 1,568.00 ---
1
Without regard to the claimed investment credit carryback from
1983 in the amount of $10,180.
2
Without regard to the claimed investment credit carryback from
1983 in the amount of $9,620.
3
Without regard to the claimed investment credit carryback from
1983 in the amount of $700.
a. 1983 Return
Petitioner and Mr. Woodward attached a Schedule C to their
income tax return for 1983. The Schedule C revealed that the
proprietorship's main business activity was "investments" and
reported negative gross income in the amount of $7,455 in respect
of "Frozen Confection of Ohio 1983-1". The Schedule C claimed
total deductions in the amount $14,576. Of the $14,576 claimed
deductions, at least $14,168 were claimed in respect of the Saxon
investment. In this regard, petitioners claimed a $13,500
deduction as an equipment lease expense and $668 for management
expenses. A net loss in the amount of $22,031 was then claimed
on the Schedule C and was used to dramatically reduce income
reported from other sources. Petitioners ultimately reported
negative taxable income in the amount of $5,702 and claimed a
refund of all of the income tax withheld from their compensation.
Petitioner and Mr. Woodward also attached Form 3468,
Computation of Investment Credit, to their income tax return for
1983. In Part II of Form 3468, petitioner and Mr. Woodward
claimed an unadjusted basis in their investment property in the
amount of $205,000.5 Based upon this value, petitioners claimed
an investment credit in the amount of $20,500. Of this amount,
petitioners used $0 in 1983, and carried back $10,180, $9,620,
and $700 to 1980, 1981, and 1982, respectively.
3. The Application for Tentative Refunds
In or about early March 1984, petitioner and Mr. Woodward
filed Form 1045, Application For Tentative Refund. The Form 1045
5
The business name of the investment was not disclosed.
However, the Form 3468 relates to Saxon.
claimed refunds in the amount of $10,180, $9,620, and $700 for
the taxable years 1980, 1981, and 1982, respectively.
4. The Notice of Deficiency
In the notice of deficiency, respondent disallowed the Saxon
deductions claimed by petitioners on their Schedule C for
equipment leasing and management expenses in the amount of
$14,168.
In the notice of deficiency, respondent also disallowed the
investment tax credit claimed by petitioners on Form 3468 in the
amount of $20,500.
ULTIMATE FINDING OF FACT
In signing the joint income tax return for 1983 and the
application for refund, petitioner had reason to know that there
were substantial understatements of tax attributable to grossly
erroneous items.
OPINION
1. Background
The parties have resolved all of the issues in this case
except whether petitioner qualifies for relief as an innocent
spouse under section 6013(e) for the 2 taxable years in issue.
Section 6013(a) permits a husband and wife to file a joint
income tax return. This is a valuable privilege because the
filing of a joint return generally serves to decrease the
spouses' overall tax liability. Sec. 1.
The privilege of filing a joint income tax return does not
come without a price, however. Thus, as a general rule, spouses
who file joint income tax returns are jointly and severally
liable for the full amount of tax due on the combined incomes.
Sec. 6013(d)(3).
Joint and several liability applies even under circumstances
where "one spouse may be far less informed about the contents of
the return than the other". Sonnenborn v. Commissioner, 57 T.C.
373, 381 (1971). However, the general rule is somewhat mitigated
by the innocent spouse provisions of section 6013(e).
Section 6013(e) relieves a spouse of liability, to the
extent provided by the statute, for tax (including interest,
penalties, and other amounts) if each of the following four
requirements is satisfied: (1) A joint Federal income tax return
was filed by the spouses; (2) there is a substantial
understatement of tax attributable to grossly erroneous items of
the other spouse; (3) in signing the return, the putative
innocent spouse neither knew, nor had reason to know, of such
substantial understatement; and (4) taking into account all the
facts and circumstances, it would be inequitable to hold the
putative innocent spouse liable for the deficiency attributable
to the understatement. Sec. 6013(e)(1). If the substantial
understatement is attributable to any claim of a deduction,
credit, or basis by the other spouse in an amount for which there
is no basis in fact or law, then an additional requirement must
be satisfied; namely, the substantial understatement must exceed
a specified percentage of the putative innocent spouse's adjusted
gross income for the "preadjustment year". Sec. 6013(e)(4).
The putative innocent spouse has the burden of proving that
each of the foregoing requirements is satisfied. Rule 142(a);
Bokum v. Commissioner, 94 T.C. 126, 138 (1990), affd. 992 F.2d
1132 (11th Cir. 1993). Failure to satisfy any of the
requirements will preclude a holding that the putative innocent
spouse is entitled to relief under section 6013(e). Stevens v.
Commissioner, 872 F.2d 1499, 1504 (11th Cir. 1989), affg. T.C.
Memo. 1988-63.
The parties agree that petitioner and Mr. Woodward filed
joint income tax returns for the taxable years 1980 through 1983.
The parties also agree that the credits claimed by petitioner and
Mr. Woodward for the taxable years 1980 and 1981 are grossly
erroneous items giving rise to understatements of tax for those
years. Although it is far from apparent, we shall proceed on the
basis that the grossly erroneous items were items of Mr.
Woodward. Further, the parties agree that the substantial
understatements of tax exceeded the requisite percentage of
income in 1987, the preadjustment year. Therefore, in order to
be relieved of liability as an innocent spouse, petitioner must
prove: (1) In signing the income tax return for 1983 and the
application for refund, she neither knew, nor had reason to know,
of the substantial understatements of tax on her refund claims
for 1980 and 1981; and (2) it would be inequitable to hold her
liable for the deficiencies attributable to such understatements.
Sec. 6013(e)(1)(C) and (D).
2. Knowledge or Reason to Know of the Substantial
Understatement
Petitioner must show that she did not know or have reason to
know of the substantial understatements attributable to her
husband's tax shelter investment when she signed the 1983 return
and application for refund filed in 1984.
a. Actual Knowledge
We must first decide whether petitioner had actual knowledge
of the understatements when she signed the 1983 return and the
application for refund. Respondent does not contend that
petitioner knew about the understatements at that time. The
record does not contain any evidence indicating that petitioner
had actual knowledge of the understatements. Thus, we find that
petitioner did not have actual knowledge of the understatements
when she signed the 1983 return and application for refund.
b. Reason to Know
We must next decide whether petitioner had reason to know of
the substantial understatements of income tax when she signed the
1983 return and application for refund filed in 1984. Respondent
contends that petitioner had reason to know of the
understatements caused by the Saxon investment tax credit
carrybacks. For the following reasons, we agree with respondent
that petitioner had reason to know of the substantial
understatements of tax at the critical time, and that, therefore,
petitioner does not qualify for relief as an innocent spouse.
The standard to be applied in determining whether a taxpayer
"had reason to know" is whether a reasonably prudent person under
the circumstances of the person claiming innocent spouse relief
at the time of signing the return or other relevant document
could be expected to know that the tax liability was erroneous or
that further investigation was warranted. Shea v. Commissioner,
780 F.2d 561, 566 (6th Cir. 1986), affg. in part, revg. in part
and remanding T.C. Memo. 1984-310; Sanders v. United States, 509
F.2d 162, 166-167 (5th Cir. 1975); Bokum v. Commissioner, supra
at 148; Terzian v. Commissioner, 72 T.C. 1164, 1170 (1979).
Whether a reasonable person under the circumstances of the
taxpayer at the time of signing the return or other relevant
document could be expected to know of a substantial
understatement is a question of fact. Clevenger v. Commissioner,
826 F.2d 1379 (4th Cir. 1987), affg. T.C. Memo. 1986-149.
Courts have considered a variety of factors in deciding whether a
taxpayer had reason to know of a substantial understatement.
These factors may also give a taxpayer a duty to inquire as to
the existence of an understatement which, if not satisfied, may
lead to the conclusion that the taxpayer had reason to know of
the understatement. Pettinato v. Commissioner, T.C. Memo. 1995-
85. No single factor controls. Id. Accordingly, we consider
the following factors in deciding whether petitioner had reason
to know of or a duty to inquire with respect to the
understatements of income tax at issue here.
(i) Petitioner's level of education
In the instant case, petitioner is a college graduate. An
individual with petitioner's education and experience can
reasonably be expected to question an application for refund that
purports to eliminate all Federal income tax liability for 2
previous taxable years. We conclude that petitioner's
educational level was such that, if she had examined the 1983
income tax return or application for refund, she would have
recognized that substantial understatements might exist or that
further investigation was warranted.
(ii) Petitioner's involvement in the family's financial
affairs
Another factor to consider is petitioner's involvement in
the family's financial affairs. Petitioner and Mr. Woodward
maintained a joint checking account. Prior to Mr. Woodward's
retirement, petitioner shared responsibilities in matters
relating to household expenses such as paying bills. After his
retirement, and for the year in question, 1983, Mr. Woodward was
responsible for both the family's financial planning and for all
matters concerning household expenses. Mr. Woodward did not
prevent petitioner from taking part in financial matters; rather,
petitioner chose not to participate in the financial affairs and
trusted her husband to handle them. As petitioner shifted the
responsibility for financial matters to Mr. Woodward, she cannot
claim a lack of knowledge of these affairs as a basis for
receiving innocent spouse protection where she was under a duty
to inquire into the legitimacy of the tax deductions and credits
claimed.
Although petitioner could not operate the computer on which
the financial records were kept, she could have asked her husband
to help her gain access to the records. Nothing in the record
indicates that Mr. Woodward would have objected to making the
records more easily available to petitioner.
(iii) Unusual or lavish expenditures in comparison to
the standard of living in prior years
We accept petitioner's testimony that she and Mr. Woodward
did not live extravagantly nor did their standard of living vary
dramatically over the course of their marriage. We take note,
however, that their standard of living from 1983 forward was
financed, at least in part, by their Federal income tax refunds
from 1980 and 1981.
(iv) The culpable spouse's evasiveness concerning the
family's finances
Although the record shows that Mr. Woodward did not tell
petitioner specifically about the tax shelter investment, he did
not conceal the facts about the business transaction. The
following exchange between petitioners' attorney and petitioner
illustrates the nature of the financial relationship between
petitioner and Mr. Woodward:
Q: * * * With respect to the investments that were made, I
think you've testified that your husband was really
responsible for those matters. Did your husband ever
ask your permission with respect to making investments?
A: No.
Q: Did he ever seek your advice or your approval in making
investments?
A: No. Mostly I didn't understand any financial deals or
whatever you call it.
Q: And the reason -- you may have just answered -- the
reason that he did not ask you for your advice or
necessarily tell you what he was doing was what?
A: Well, because I wouldn't have understood it in the
first place.
Q: So you didn't have a problem with that arrangement,
that he was not hiding things from you, he was just --
A: No. I trusted him and he trusted me.
Petitioner chose to rely on Mr. Woodward regarding financial
matters.
(v) Large deductions or credits that substantially
eliminate taxable income
This factor is particularly significant in this case. Large
deductions or credits, particularly those that completely or
substantially eliminate taxable income, may give a taxpayer
reason to know that an understatement exists or a duty to inquire
as to the legitimacy of the deduction or credit. Pettinato v.
Commissioner, supra. By failing to examine the 1983 return and
the application for refund, petitioner chose to ignore facts that
would have given her reason to know of the substantial
understatements. Even the most cursory perusal of the
application for refund would have revealed claims for refunds for
all Federal income taxes paid in 1980 and 1981. A reasonably
prudent person in petitioner's position would have certainly
questioned the legitimacy of these refunds. Petitioner, by
declining to do so, failed in her duty of inquiry.
By failing her duty of inquiry, petitioner is charged with
constructive knowledge of the substantial understatements
appearing in the income tax returns. See Park v. Commissioner,
25 F.3d 1289, 1299 (5th Cir. 1994) ("by signing the return * * *
[the putative innocent spouse] undertook responsibility for it
which she cannot escape by simply ignoring its contents"), affg.
T.C. Memo. 1993-252; see also Lauer v. Commissioner, T.C. Memo.
1994-579 ("a taxpayer is not permitted to obtain the benefits of
section 6013(e) by turning a blind eye to--by preferring not to
know of--facts clearly within his or her grasp, or fully
disclosed on a return that the taxpayer signed"); McComb v.
Commissioner, T.C. Memo. 1994-577 ("A spouse may not obtain
protection as an innocent spouse in deduction cases by turning a
blind eye to facts fully disclosed on a return which, if she had
looked at the return, would reasonably have put her on notice
that further inquiry was needed").
3. Conclusion
We hold that petitioner, in signing the 1983 Federal income
tax return and application for refund, had reason to know, within
the meaning of section 6013(e)(1)(C), of the substantial
understatements of income tax for 1980 and 1981. Because we so
hold, we need not address whether it would be equitable or
inequitable to hold petitioner liable for the deficiencies in tax
attributable to those understatements.
In view of the foregoing, we sustain respondent's
determination that petitioner is liable for the deficiencies in
tax and additions to tax as set forth in the notice of
deficiency. Sec. 6013(d)(3).
In order to give effect to our disposition of the disputed
issue, as well as the parties' concessions,
Decision will be entered
for respondent, except as to
the addition to tax under
section 6659(a) for the
taxable years 1980 and 1981.