T.C. Memo. 1996-55
UNITED STATES TAX COURT
LINDSEY C. NELSON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 733-95. Filed February 14, 1996.
Lindsey C. Nelson, pro se.
Amy Dyar Seals, for respondent.
MEMORANDUM OPINION
POWELL, Special Trial Judge: Respondent determined
deficiencies in petitioner's Federal income taxes and accuracy-
related penalties pursuant to section 6662(a)1 in the following
amounts:
1
Section references are to the Internal
Revenue Code in effect for the years in issue, and
Rule references are to the Tax Court Rules of Practice
and Procedure.
- 2 -
Year Deficiency Penalty
1991 $4,599 $920
1992 5,879 1,176
1993 5,641 1,128
At the time the petition was filed, petitioner resided in
Greensboro, North Carolina. The deficiencies result from the
inclusion in income of funds embezzled by petitioner's wife,
Linda, in the respective amounts of $17,450 in 1991, $25,997 in
1992, and $28,379 in 1993, and the disallowance of losses in the
respective amounts of $3,345 in 1991, $3,213 in 1992, and $2,055
in 1993 claimed on the returns from a bookkeeping business
operated by Linda.
The sole issue is whether petitioner is entitled to relief
as a so-called innocent spouse pursuant to section 6013(e)(1).
The facts may be summarized as follows. Petitioner and
Linda married in 1988. They had a child in 1992. Petitioner had
worked as a "general superintendent" for several construction
companies. Petitioner dropped out of college in 1979 but went
back in the fall of 1991 as a full time student majoring in civil
engineering with a stipend that included tuition and books.
Linda worked full-time as a bookkeeper/accountant for Datanet
Services, Inc. (Datanet), and essentially supported the family.
Linda was approximately 28 years old during 1991. Petitioner was
apparently a few years older.
From the beginning, petitioner and Linda had financial
difficulties. In 1988, they sought protection under chapter 13
of the Bankruptcy Code. The bankruptcy plan required them to pay
- 3 -
$465 per month. During 1991, 1992, and 1993, Linda received
wages in the amounts of $37,882, $30,085, and $27,191,
respectively. Petitioner's employment was "sporadic". He had
income in the amounts of $4,013 for 1992 and $2,203 for 1993.
During 1991, when petitioner reentered college, Linda began
embezzling funds from Datanet. She embezzled $17,450, $25,997,
and $28,379 during 1991, 1992, and 1993, respectively. These
funds were spent on food, clothing, rent, furniture, and other
living expenses, including expenses for petitioner's education.
Petitioner and Linda took vacations to the beach each year and
also a trip to Colorado. Linda was arrested in September 1993,
and convicted on March 25, 1994.
Petitioner and Linda filed joint Federal income tax returns
for each of the years in issue reporting wages discussed above.
Petitioner and Linda did not report the amounts embezzled from
Datanet. Petitioner and Linda deducted losses from the alleged
accounting service operated by Linda. These losses were
fictitious. Respondent determined that the embezzled funds
constituted gross income and disallowed the losses. Respondent
also determined that accuracy-related penalties for negligence
were due. Petitioner does not contest any of the adjustments,
but rather contends that he is entitled to relief of liability
under the so-called innocent spouse provisions contained in
section 6013(e).
Section 6013(a) permits a husband and wife to file a joint
income tax return. When a joint return is filed, both spouses
- 4 -
become jointly and severally liable for the entire tax. Sec.
6013(d)(3). A spouse may be relieved of liability, however, if
the following requirements of section 6013(e) are satisfied: (1)
The taxpayer and his or her spouse file a joint return for the
taxable year; (2) there is a substantial understatement of tax
attributable to grossly erroneous items of the latter spouse; (3)
the taxpayer establishes that in signing the return he or she
neither knew, nor had reason to know, of the substantial
understatement; (4) taking account of all the facts and
circumstances, it is inequitable to hold the taxpayer liable for
the deficiency in tax resulting from the substantial
understatement; and (5) the understatement exceeds 10 percent of
the taxpayer's adjusted gross income for the preadjustment year
(if such adjusted gross income is $20,000 or less). An
understatement is substantial if it exceeds $500. Sec.
6013(e)(3). Petitioner bears the burden of proving all five
conditions of section 6013(e) have been satisfied. Rule 142(a);
Ratana v. Commissioner, 662 F.2d 220 (4th Cir. 1981), affg. in
part and revg. in part T.C. Memo. 1980-353.
It is undisputed that petitioner filed a joint return for
each of the years in issue and that there were substantial
understatements on those returns attributable to Linda's
activities. The dispute then focuses on whether petitioner knew
or had reason to know of the understatements and whether it is
inequitable to hold petitioner liable for the deficiencies.
- 5 -
Lack of actual knowledge is not sufficient to qualify for
innocent spouse relief. Petitioner must establish that he had no
reason to know of the understatements. Whether petitioner had
reason to know of the understatements depends on whether a
reasonable person in his circumstances could be expected to know
that income had not been reported and that erroneous deductions
had been claimed at the time the returns were signed. Flynn v.
Commissioner, 93 T.C. 355, 365 (1989). Whether a duty to inquire
into the propriety of the return arises depends on the taxpayer's
education level, involvement in family business and financial
affairs, presence of expenditures that appear lavish or unusual,
and the culpable spouse's evasiveness or deceit concerning the
couple's finances. Kistner v. Commissioner, 18 F.3d 1521, 1525
(11th Cir. 1994), revg. T.C. Memo. 1991-463. Petitioner contends
that he neither knew nor had reason to know about Linda's
defalcations from Datanet.
It is unnecessary to decide whether or not petitioner
actually knew of the unreported income and bogus deductions
because he clearly had reason to know of those items.2 During
these years petitioner and Linda received and spent over $71,000
embezzled from Datanet. At the same time they received gross
income from wages in the amount of approximately $100,000. There
were no savings, and they spent approximately $171,000 during the
2
With regard to the 1993 return, petitioner
obviously knew that that return was not correct. The
return was signed by petitioner on Mar. 9, 1994.
Linda was indicted in January 1994, and pled guilty
and was convicted on Mar. 25, 1994.
- 6 -
3 years in issue. The amounts embezzled constituted 42 percent
of that amount. It is simply ludicrous for a person who was a
mature full-time college student to say that he had no reason to
know that something was not awry with this situation. It may be
that he did not know exactly where the money came from, but
surely he was aware when the returns were filed that they spent
more than they were reporting on their returns.
The same is true concerning the deductions claimed for the
alleged accounting business. Petitioner knew that Linda worked
full-time. During 1992 and 1993 she either was pregnant or had a
baby. There is no evidence that remotely suggests that Linda's
alleged accounting business was a reality.
Finally, while it is perhaps unnecessary to discuss whether
it would be inequitable to hold petitioner liable for the
deficiencies, see sec. 6013(e)(1)(D), we note that petitioner is
in a poor position to make such a claim. In making this
observation we consider, inter alia, whether petitioner
significantly benefited from the understatement, beyond normal
support, and whether petitioner has been divorced. Belk v.
Commissioner, 93 T.C. 434, 440 (1989); sec. 1.6013-5(b), Income
Tax Regs.
Petitioner may be in the process of being divorced, and
while married to Linda he may not have enjoyed a lavish
lifestyle. But he clearly did not live the life of a full-time
student, and the lifestyle that he did enjoy was due in no small
part to Linda's defalcations. Furthermore, after Linda was
- 7 -
convicted, the only person who survived with any benefit was
petitioner. His college education had been paid for during this
period. He may not have walked away with many tangible benefits,
but he did receive that great intangible benefit. We believe,
therefore, that it is not inequitable to hold petitioner liable
for the tax liabilities.
Decision will be entered
for respondent.