T.C. Memo. 1995-576
UNITED STATES TAX COURT
PHILIP H. AND ANNA FRIEDMAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent1
Docket No. 7359-90. Filed December 4, 1995.
Jay J. Freireich, Harvey R. Poe, and Gerald S. Rotunda, for
petitioners.
Susan G. Lewis, Albert G. Kobylarz, and Guy G. Lavignera,
for respondent.
SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: This case has been the subject of three
prior opinions of this Court,2 the last of which held that Anna
1
This opinion supplements a previously released opinion:
Friedman v. Commissioner, T.C. Memo. 1993-549.
2
Friedman v. Commissioner, 97 T.C. 606 (1991), concerning
(continued...)
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Friedman (petitioner) was not an innocent spouse within the
meaning of section 6013(e).3 The decision entered following the
third opinion was affirmed in part and reversed in part, and the
case was remanded to this Court for further proceedings.
Friedman v. Commissioner, T.C. Memo. 1993-549, affd. in part and
revd. in part 53 F.3d 523 (2d Cir. 1995).
To qualify for innocent spouse relief, a taxpayer must meet
all four of the requirements of section 6013(e). We found that
petitioner had shown that she filed a joint return and that a
certain tax shelter investment constituted a "grossly erroneous
item" within the meaning of section 6013(e). However, we found
that petitioner did not qualify for relief because she failed to
meet the third requirement; i.e., the requirement that she did
not know and did not have reason to know that the deduction would
give rise to a substantial understatement. Having reached that
conclusion, we did not consider whether petitioner met the fourth
2
(...continued)
whether "grossly erroneous items" could have been contained on a
refund claim, Form 1045, rather than on the Form 1040, within the
meaning of sec. 6013(e)(1)(B); Friedman v. Commissioner, T.C.
Memo. 1992-89, concerning whether the testimony of an expert
witness could be offered to show whether one of petitioners was a
truthful witness; and Friedman v. Commissioner, T.C. Memo. 1993-
549, which concerned whether Anna Friedman was an innocent spouse
within the meaning of sec. 6013(e).
3
All section references are to the Internal Revenue Code
in effect for the taxable period under consideration, and all
Rule references are to this Court's Rules of Practice and
Procedure, unless otherwise indicated.
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test; i.e., whether, under the circumstances, it would be
inequitable to hold her jointly liable for the deficiencies.
The U.S. Court of Appeals for the Second Circuit reversed
our holding that petitioner failed the third, or knowledge, test
as to the tax shelter item only, and remanded the matter to this
Court to find additional facts, if necessary, and to decide
whether petitioner has shown that, under the circumstances, it
would be inequitable to hold her jointly liable for the
deficiencies.
FINDINGS OF FACT4
Petitioner met Philip Friedman in 1976 when she was hired as
his secretary. They were married in 1979, the year that Philip
obtained a divorce from his prior wife. In the course of that
divorce, Philip gave almost everything he owned to his first
wife. Petitioner was a young widow with two small children and
depleted savings at the time of her first husband's death.
Petitioner had only a few assets when she married Philip,
including a cooperative residence and an automobile.
When petitioners were first married, they lived in a rented
apartment in New York, New York, with petitioner's two daughters,
4
By this reference, the facts found in Friedman v.
Commissioner, T.C. Memo. 1993-549, are incorporated to the extent
that they are in accord with the opinion of the U.S. Court of
Appeals for the Second Circuit, which affirmed in part and
reversed in part our decision. We repeat some of these findings
here, as relevant to the issue now before us. The parties have
agreed that we may proceed to find facts and decide this matter
on remand based on the existing record and the briefs that have
been filed in this Court by the parties.
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who were 13 and 17 years old. At that time, petitioner and
Philip were splitting their time between the New York apartment
and an apartment in North Miami Beach, Florida. The New York
apartment was in a building with a doorman and a beautiful lobby.
The Florida apartment was a two-bedroom unit.
In 1982, petitioners bought a condominium (condo) in
Bayside, Queens, New York, because they thought it would be a
better environment in which to raise children. The condo was a
three-bedroom, two-bathroom, nicely furnished unit. One of the
bedrooms was converted into an office for Philip. The condo was
purchased jointly, without a mortgage, for $171,000. The condo
was worth $295,000 and had unpaid liens of $290,000 against it at
the time of trial. During 1984 and 1985, the condo had a similar
value and outstanding liens of $175,000. Petitioners hired an
interior decorator to decorate the condo in 1982 and again in
1985, spending a total of over $50,000.
Petitioners also owned a home on Fire Island, New York.
Philip purchased the land in 1978 and built a three-bedroom house
in 1979, all without a mortgage on the property. That home cost
in the range of $74,000 to $79,000 and had a value of
approximately $200,000 at the time of trial. Philip transferred
the Fire Island property to petitioner, as sole owner, in 1980.
An equity loan and $150,000 mortgage were taken on the Fire
Island house by petitioner in January 1991, and Philip was
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jointly liable for the mortgage and responsible for making the
payments on that obligation.
Petitioners went on an annual, week-long vacation to Puerto
Rico and, occasionally, petitioner's daughters would go with
them. Petitioner and Philip went on numerous gambling trips
together. On some of those trips, petitioners' room, food,
beverage, entertainment, and sometimes transportation (i.e.,
airfare) were paid for by the casino. Although petitioner did
not gamble much, she did obtain the benefit of the amenities
provided by the resort or casino. Philip gave petitioner a
diamond wedding band, but petitioner did not receive much
additional jewelry during their marriage. During April 1986,
Philip purchased an automobile for petitioner at a cost of almost
$14,000. Petitioner had a VISA credit card and other credit
cards for major New York City area department stores, including
Saks Fifth Avenue, Bloomingdale's, Fortunoff, A&S, and Macy's.
During the years in issue, petitioner obtained a black mink coat.
She also enjoyed the theater and attended many shows.
Petitioner's daughters' tuition and some expenses for
private school education, tutoring, and college were paid for by
Philip. Philip paid for food, clothing, and other expenses for
petitioner's daughters, including the acquisition of an
automobile for one of the daughters. During 1983, petitioner
transferred stocks and bonds with a $20,000 value from her and
Philip's joint account with Merrill Lynch to the account of one
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of her daughters. Petitioner paid her daughters' and mother's
income tax out of her joint bank account with Philip. Philip
paid a total of approximately $15,000 for petitioner's daughter's
wedding expenses.
Petitioners had a joint bank account from which to pay
household expenses. Philip would deposit either cash or checks
into the account for petitioner to use to pay various expenses.
Petitioners also paid a variety of their expenses in cash.
Philip would give petitioner the cash to pay for groceries, dry
cleaning, domestic help, etc. The cash Philip gave petitioner
was in addition to the money he deposited in their joint account.
Philip also had several individual bank accounts.
Petitioners' recreation was combined with gambling. They
went to Las Vegas, Nevada, on their honeymoon and took other
vacations where gambling was a focal point, such as their annual
trip to Puerto Rico. Philip would go on day trips to Atlantic
City, New Jersey, or take weekend trips to Las Vegas, Nevada.
Petitioner would occasionally accompany Philip on the weekend
trips, or they would both go with their good friends Adrienne and
Elwood Lerman (Lerman). Lerman was also petitioners' accountant
and financial adviser. Some of these gambling trips would be
"comped"; i.e., the casino would pay for travel, meals, and hotel
room.
While on these trips, Philip would spend most of his time
gambling in the casinos. He usually played at the craps table
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and preferred the tables with a large minimum bet. While Philip
gambled, petitioner would either play at a different table or go
shopping. Petitioner was aware of the amount of time Philip
spent gambling, and they would often argue about it.
Philip gambled with large amounts of money. He often signed
markers to the casinos to get more cash with which to gamble.
Philip tried to pay off the markers before they could be noticed
by petitioner. When petitioner was with him, Philip tried to
hide the size of his bets and his winnings or losings from her.
Petitioners would often go together or with the Lermans for
an evening at the racetrack. Petitioner would make small bets
during the evening, while Philip made larger, more substantial
bets. He tried to keep the tickets hidden, or show petitioner
tickets with smaller bets, so that she would not know how much
money he was risking. Petitioners even invested in racehorses.
They had an interest in several racehorses during the years in
issue.
For the years in question, Philip reconstructed the amounts
expended on gambling as follows:
Cash Marker Personal Checks
Year Philip Checks to Casino Total
1
1981 --- --- ---
1982 $72,800 -0- -0- $72,800
1983 137,400 $36,000 $8,300 181,700
1984 76,800 119,500 31,500 227,800
1985 63,500 112,500 500 176,500
Total 658,800
1
Petitioner did not provide any evidence of gambling
expenditures for 1981.
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The reconstruction is, to some extent, overstated because some of
the source documents were shown not to reflect gambling
expenditures. In addition, it has not been established that the
amounts reflected were expended solely for gambling. The
expenditures do not reflect the source of the funds expended.
Some of the funds may represent winnings, and some may represent
Philip's and petitioner's cash-flow from other income, tax
savings, or other sources.
Petitioner was aware that Philip was an avid gambler both
when she married him and during their marriage. During the years
in issue, petitioner was not aware of the full extent of Philip's
gambling expenditures. Philip wrote checks and depleted both his
and the couple's checking accounts to the point where checks on
the account used by petitioner for household matters were
returned because of insufficient funds. By 1990, petitioner and
Philip argued, and their relationship deteriorated due to
Philip's gambling and the overdrawn accounts.
Petitioner's and Philip's joint income tax returns for the
taxable years 1981 through 1985 reported income in the amounts of
$297,982, $595,375, $216,932, $660,892, and $1,264,674. The
income tax deficiencies determined by respondent for the taxable
years 1981 through 1985 are as follows:
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Year Income Tax Deficiency
1981 $41,221.00
1982 129,944.00
1983 119,644.76
1984 183,985.50
1985 501,303.00
Total 976,098.26
Of the total of $976,098.26 for the 5 years, approximately 72
percent, or $702,791, is attributable to respondent's
disallowance of the tax shelter deductions and carryback losses
which represent the "grossly erroneous item".
On February 4, 1991, Philip and petitioner entered into a
separation agreement. Pursuant to the agreement, Philip assigned
a partnership interest to petitioner. At the time of trial,
income distributions from the partnership amounted to $4,371 per
month. The separation agreement provided that, upon petitioner's
vacating the condo, Philip would be entitled to live there and
would be required to pay all expenses, taxes, utilities, etc.
connected therewith. By allowing Philip to reside in the condo,
petitioner did not waive her ownership rights in the property.
In the event of Philip's death, petitioner would receive full
ownership of the condo. Petitioner was given the other
residential real property and certain specific personalty which
was then located in the condo. Petitioner also received a 1986
automobile under the separation agreement.
The separation agreement contained Federal income tax
provisions as follows:
Any refund payable with respect to any joint tax
return, now or hereafter filed, shall be paid to the
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Husband, and the Wife shall endorse refund checks such
[sic] payment. If there is any deficiency or tax
liability assessed on any jointly filed tax return,
such deficiency or tax liability, with any interest or
penalties thereon, shall be paid solely by the Husband,
and the said Husband does hereby forever save, hold
harmless, indemnify and defend the Wife of, from and
against any and all claim or claims that may be made
against them or her for the payment, collection or
satisfaction of any such tax, interest or penalty due
or alleged to be or become due as a result of the
filing and/or failure to file any such joint tax
return. * * * The cost, if any[,] incurred or to be
incurred by either of the parties in connection with
the examination and/or audit of any such joint return
shall be borne solely and exclusively by the Husband.
On April 9, 1992, petitioner, with Philip's consent, filed
for a divorce. Petitioner asserts that she and Philip were
divorced during 1992. As of the time of trial (April 6, 7, and
8, 1992), the separation agreement was still in effect; however,
petitioner and Philip continued to live together at the same
location.
OPINION
The U.S. Court of Appeals for the Second Circuit outlined
its mandate to this Court as follows:
The resolution of this issue [whether it would be
inequitable to hold petitioner jointly liable for the
tax deficiencies] depends upon a fact-intensive inquiry
into the surrounding facts and circumstances. I.R.C.
§6013(e)(1)(D). Relevant factors include significant
benefits received as a result of the understatements by
the spouse claiming relief, any participation in
wrongdoing on the part of the "innocent" spouse, and
the effect of a subsequent divorce or separation. See
S. Rep. No. 1537, 91st Cong., 2d Sess. (1970)
(considering bill to amend the Internal Revenue Code of
1954), reprinted in 1970 U.S.C.C.A.N. 6089, 6092.
Normal support, measured by the circumstances of the
parties, is not considered a significant benefit for
purposes of this determination. Flynn, 93 T.C. at 367
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* * *. The magnitude of Friedman's gambling losses,
which allegedly exceed the total tax deficiencies owed,
would be a factor weighing heavily in favor of a
finding that taxpayer did not personally benefit from
the tax shelter. See Pietromonaco, 3 F.3d at 1348.
[Friedman v. Commissioner, 53 F.3d at 531.]
The statute requires that petitioner show that "taking into
account all the facts and circumstances, it is inequitable to
hold * * * [her] liable". Sec. 6013(e)(1)(D). Petitioner bears
the burden of proof as to whether it would be inequitable to hold
her liable for the tax shelter portion of the deficiency. Rule
142(a); Russo v. Commissioner, 98 T.C. 28, 31-32 (1992). In
deciding whether it was inequitable to hold a spouse liable,
courts have considered whether the purported innocent spouse
benefited5 beyond normal support, either directly or indirectly,
from the understatement of tax liability. Hayman v.
Commissioner, 992 F.2d 1256, 1262 (2d Cir. 1993), affg. T.C.
Memo. 1992-228; Belk v. Commissioner, 93 T.C. 434, 440 (1989);
Purcell v. Commissioner, 86 T.C. 228, 242 (1986), affd. 826 F.2d
470 (6th Cir. 1987); H. Rept. 98-432 (Part 2), at 1501-1502
(1984); sec. 1.6013-5(b), Income Tax Regs. Deduction items, to
the extent that they reduce taxpayers' tax burden, have the
potential to benefit the purported innocent spouse. Bokum v.
Commissioner, 94 T.C. 126, 157 (1990), affd. 992 F.2d 1132 (11th
Cir. 1993). Normal support is determined in the context of the
5
The statute once required a significant benefit, but the
wording of the statute for the years under consideration does not
specify a significant benefit. See Purificato v. Commissioner, 9
F.3d 290 (3d Cir. 1993), affg. T.C. Memo. 1992-580.
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circumstances of taxpayers. Sanders v. United States, 509 F.2d
162, 168 (5th Cir. 1975); Flynn v. Commissioner, 93 T.C. 355, 367
(1989).
Evidence of direct or indirect benefits may consist of
property transfers, including transfers received several years
after the year in which the erroneous deductions were claimed.
See sec. 1.6013-5(b), Income Tax Regs. This would include the
division of property in a subsequent divorce proceeding.
Pettinato v. Commissioner, T.C. Memo. 1995-85. Finally, in
deciding whether it is equitable to hold a spouse liable for
deficiencies or "innocent" under section 6013(e), we are to
consider the probable future hardships that would be imposed on
the spouse seeking relief, if such relief was denied. Sanders v.
United States, supra at 171 n.16; Dakil v. United States, 496
F.2d 431, 433 (10th Cir. 1974).
Petitioner admits that her lifestyle may have been
considered lavish, but it was the standard she had enjoyed during
her marriage with Philip. Respondent contends that petitioner
and Philip entered into the marriage on a relatively equal
financial footing and that any benefits to petitioner were earned
and consumed during the marriage and the years in issue.
Petitioner also contends that Philip gambled away the tax shelter
benefits. The tax benefits in question stem from a 1983
transaction for which losses were claimed for 1983, 1984, and
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1985. In addition, net operating loss deductions were carried
back to 1981 and 1982.
Although petitioner and Philip entered into their marriage
on a similar footing as to assets, Philip had a substantial
earning capacity and, from the beginning, was able to provide a
high standard of living for himself, petitioner, and petitioner's
daughters. Throughout the period under consideration,
petitioners lived in high-quality residences. However, the
important factor here is that their standard of living did not
increase, either during or after the years that the grossly
erroneous deductions drastically reduced their tax liability.
Ultimately, in the separation agreement, petitioner received a
partnership interest that provided her with about $4,300 per
month, the right to the Fire Island property, a moderately priced
1986 automobile, and claim to her joint share of any equity in
the condo. The $4,300 amount appears to approximate the monthly
living expenditures attributable to petitioner. At the time of
the separation agreement, the condo was substantially mortgaged,
the Fire Island property had a relatively large mortgage, and the
automobile was about 4 years old. The bulk of the assets
received in accordance with the separation agreement was
purchased for cash prior to the deduction of the "grossly
erroneous items" in question. Other than a fur coat, petitioner
did not receive lavish assets or jewelry during the marriage.
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Petitioner did, however, enjoy the benefits of traveling to
resorts in connection with gambling activities, and some of that
travel was lavish. The amount of travel was about the same,
before, during, and after the tax years for which the grossly
erroneous deductions were claimed.
Philip's reported gross income, without considering
deductions or the grossly erroneous amounts, ranged from a low of
$297,982 to a high of $1,264,674 from 1981 through 1985. The
record reflects that his reported income in other years was
similar in amount. His income fluctuated due to the nature of
his business activity--mortgage broker. That amount of income
would have provided petitioners with a high standard of living
without considering the tax savings generated by the tax shelter
in question. A substantial portion of the tax savings was likely
consumed by Philip's gambling losses. About $700,000 of tax
savings is attributable to the grossly erroneous deductions
generated by the subject tax shelter. During the same period,
Philip's gambling activity consumed as much as $650,000. In
subsequent years, Philip's gambling activity appears to have
increased, and his losses also likely increased, ultimately
ending in the conflict with petitioner that led to separation
and, allegedly, to divorce. Our record does not reflect whether
petitioner and Philip were actually divorced, but references to
the divorce appear in the appellate briefs connected with this
case. We are also unaware of the ultimate divorce settlement,
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but accept the separation agreement as the model for the ultimate
division of property.
Although petitioner continued to live with Philip after
entering into the separation agreement, petitioner testified that
she and Philip lived separately at the same location until she
was able to move. The fact that petitioner and Philip continued
to live together, as opposed to living separately and/or being
divorced, militates against an inequity finding. See sec.
1.6013-5(b), Income Tax Regs. We also note that Philip, in the
separation agreement, agreed to pay any tax deficiencies and save
petitioner harmless from any expense connected with tax audits.
The effect of such a promise has been considered by this Court on
several occasions.6 The impact on the relative equities of
holding a spouse liable if the other spouse promises to pay joint
tax deficiencies is dependent on whether the promise is reliable
or speculative. Although Philip's actions toward petitioner have
been amicable, his gambling habit, which was the root of
petitioners' marital problems, renders his promise to pay the tax
inconsequential. At the time of the separation agreement,
petitioners' bank accounts were overdrawn, and significant pieces
of property, like the condo, were fully mortgaged. Accordingly,
6
See, e.g., Stiteler v. Commissioner, T.C. Memo. 1995-279;
Foley v. Commissioner, T.C. Memo. 1995-16; Buchine v.
Commissioner, T.C. Memo. 1992-36, affd. 20 F.3d 173 (5th Cir.
1994); Henninger v. Commissioner, T.C. Memo. 1991-574; Knapp v.
Commissioner, T.C. Memo. 1988-109.
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in this case, Philip's promise to pay is not considered reliable.
See Foley v. Commissioner, T.C. Memo. 1995-16.
Based on the record, we find that petitioner has shown that
she did not benefit beyond the amount of her normal support,
either directly or indirectly, from the understatement of tax
attributable to the grossly erroneous deductions. Accordingly,
we find that, if petitioner did not know and had no reason to
know, as the U.S. Court of Appeals for the Second Circuit found,
it would be inequitable to hold petitioner liable for the portion
of the deficiencies and additions to tax attributable to these
tax shelter items. Based on our findings and in accordance with
the holding of the U.S. Court of Appeals for the Second Circuit,
we find that petitioner is an innocent spouse within the meaning
of section 6013(e) as to the deficiencies in income tax and
additions to tax attributable to the tax shelter items only.
To reflect the foregoing,
Decision will be entered
under Rule 155.