T.C. Memo. 1996-327
UNITED STATES TAX COURT
PHILIP H. FRIEDMAN AND ANNA FRIEDMAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent*
Docket No. 7359-90. Filed July 17, 1996.
Jay J. Freireich, for petitioners.
Susan G. Lewis, for respondent.
SUPPLEMENTAL MEMORANDUM OPINION
GERBER, Judge: This case has been the subject of four prior
opinions of this Court,1 the last of which held that Anna
*
This opinion supplements a previously released opinion:
Friedman v. Commissioner, T.C. Memo. 1995-576.
1
Friedman v. Commissioner, 97 T.C. 606 (1991), concerning
whether "grossly erroneous items", within the meaning of sec.
6013(e)(1)(B), could have been contained on a refund claim, Form
(continued...)
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Friedman (petitioner) was an innocent spouse within the meaning
of section 6013(e).2 The parties' current controversy involves
their conflicting Rule 155 tax computations.
Initially, we found that petitioner was not entitled to
innocent spouse relief with respect to two items. Concerning the
capital loss carryover, we found it was not a grossly erroneous
item and that it did not meet the section 6013(e) requirements.
The U.S. Court of Appeals for the Second Circuit affirmed that
holding. Regarding losses from a computer leasing transaction,
we found the deductions of those losses to be grossly erroneous
items. However, we also found that petitioner failed to meet the
requirement that she did not know, or have reason to know, that
the deductions would give rise to substantial understatements
when she signed the returns. Sec. 6013(e)(1)(C). The Court of
Appeals reversed our finding on whether petitioner knew or had
1
(...continued)
1045, rather than on the Form 1040; 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; Friedman v. Commissioner, T.C. Memo. 1993-549,
affd. in part, revd. and remanded in part 53 F.3d 523 (2d Cir.
1995), which concerned whether Anna Friedman was an innocent
spouse within the meaning of sec. 6013(e); and Friedman v.
Commissioner, T.C. Memo. 1995-576, where we held that Anna
Friedman was an innocent spouse with respect to a grossly
erroneous item in accord with the judgment and remand of the
Court of Appeals and made findings concerning whether it was
equitable to hold her liable.
2
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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reason to know and remanded the matter for our consideration of
whether it would be equitable to hold her liable with respect to
the grossly erroneous leasing transaction deductions. Friedman
v. Commissioner, 53 F.3d 523 (2d Cir. 1995), affg. in part and
revg. and remanding in part T.C. Memo. 1993-549.
This case involves 5 taxable years, and the losses claimed
for the leasing transaction occur in all years, whereas the
capital loss item occurs in only one year, 1983. The parties'
computations agree with respect to the 1981, 1982, 1984, and 1985
tax years; i.e., petitioner would be relieved of income tax
liability and all additions to tax because the leasing loss was
the sole adjustment. With respect to 1983, petitioner reaches
the same result as in the other 4 years (no liability), and
respondent computes a $53,307.36 income tax liability and
additions to tax in the amounts of $47,640.233 and $13,326.84
under sections 6653(a) and 6661, respectively. This opinion
addresses the parties' differing approaches to the Rule 155
computation.
3
For 1983, the sec. 6653(a)(1) addition to tax set forth in
the notice of deficiency was $5,982.24, without considering sec.
6653(a)(2), which provided for 50 percent of the interest due on
the underpayment. At the time of assessment (Mar. 28, 1994),
following the entry of decision based on T.C. Memo. 1993-549, the
addition to tax had increased to $106,925.26, including the 50-
percent interest addition. After proposed abatement for the
portion not attributable to the capital loss, the sec. 6653(a)(1)
and (2) addition amounts to $47,640.23.
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By way of background, petitioners claimed but, in
substantial part, did not use a $327,600 net short-term capital
loss on their 1980 joint income tax return. Accordingly,
petitioners claimed a $322,340 short-term capital loss carryover
from the 1980 tax year on their 1983 tax return. Respondent, in
the statutory notice of deficiency for 1983, allowed $55,803 of
this loss carryover. The balance of the loss was allowed for the
1980 taxable year pursuant to an audit examination of the 1980
tax year. In Friedman v. Commissioner, T.C. Memo. 1993-549, we
held:
With respect to the capital loss carryover, at the
time petitioners filed their 1983 return, the 1980
return had not been audited. Therefore, when the 1983
return was filed with the capital loss carryover,
petitioners did not know that the carryover duplicated
losses [subsequently] allowed in 1980. The later
disallowance was purely mechanical and a natural result
of an adjustment to a prior year's return. The
deduction was not frivolous or fraudulent. Therefore,
the deduction had a basis in fact or law and the
deduction is not grossly erroneous.
Under Rule 155, parties are required to submit "computations
pursuant to the Court's determination of the issues, showing the
correct amount of the deficiency * * * to be entered as the
decision." Parties are not permitted to raise new issues or
matters in connection with the Rule 155 computations. Bankers
Pocahontas Coal Co. v. Burnet, 287 U.S. 308 (1932). The starting
point for the computation is the statutory notice of deficiency
from which the parties compute the redetermined deficiency based
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upon matters agreed by the parties or ruled upon by the Court.
Home Group, Inc. v. Commissioner, 91 T.C. 265, 269 (1988), affd.
875 F.2d 377 (2d Cir. 1989); Whitham v. Commissioner, a
Memorandum Opinion of this Court dated Jan. 30, 1953.
The starting point for each party's computation of the 1983
tax liability here is the $178,782 taxable income per the notice
of deficiency. Petitioner then proceeds to deduct the $900,525
loss attributable to the grossly erroneous item, which results in
"negative" taxable income of $729,5904 after considering the
income per the notice of deficiency. Petitioner contends that
the negative taxable income obviates the possibility of the
capital loss item causing any taxable income.
Respondent computes her 1983 proposed tax deficiency for
petitioner in accord with the following pertinent instructions in
subsection 45(11)(20) (Guidelines for Applying "Innocent Spouse"
Provisions), 4 Examination, Internal Revenue Manual (CCH):
(7) * * * If it is proposed to hold both spouses
liable, but not to the same extent, in respect of the
total deficiency, two computations * * * will be
required. First, a computation of the total
deficiency, including any applicable penalties should
be made, without taking into consideration the innocent
spouse provisions. Next, a separate computation of the
liability, including penalties, of the non-culpable
spouse. This computation will start with the total
corrected taxable income without regard to the innocent
spouse provisions and will eliminate therefrom the
adjustments for which relief is provided under such
4
In addition to the $900,525 claimed loss, two self-
operating mathematical items are also considered--a $8,147
reduction for "medical" and a $300 increase for "contributions".
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public law. This latter computation arrives at the
amount of the liability which is considered joint. The
difference between such joint liability and the total
deficiency will constitute the separate liability of
the culpable spouse. * * *
It is noted that respondent's manual provisions have no
binding effect on petitioner or the Court. See, e.g., Zimmerman
v. Commissioner, 71 T.C. 367, 371 (1978), and cases cited
therein, affd. without published opinion 614 F.2d 1294 (2d Cir.
1979) (involving the lack of effect of a taxpayer's reliance upon
a tax guide issued by the Commissioner). Petitioner, however,
agrees with respondent that the above-quoted manual provisions
"[set] forth how the computation should be made."
Petitioner agrees with respondent that the first step is to
begin with the notice of deficiency computation of the income tax
deficiency and additions to tax. Petitioner also agrees that the
next step is to compute the separate liability of the so-called
nonculpable or innocent spouse, which, according to the manual
provisions, is the portion of the liability that is considered
joint. And, finally, the difference between the joint liability
and the total liability constitutes the individual liability of
the so-called culpable spouse.
The core of petitioner's disagreement with respondent is the
computation of the liability of the innocent spouse, which is
also the portion of the liability that is joint.5 Petitioner
5
Petitioner does not allege that respondent's mathematical
(continued...)
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directs us to a specific portion of the manual provisions, as
follows:
This computation will start with the total corrected
taxable income without regard to the innocent spouse
provisions and will eliminate therefrom the adjustments
for which relief is provided under such public law.
* * *
Petitioner contends that the elimination of the grossly erroneous
leasing transaction is tantamount to permitting the deduction to
the innocent spouse. Respondent treats the elimination language
as disregarding the grossly erroneous leasing transaction so as
not to charge petitioner, the innocent spouse, with income from
the disallowance of the claimed loss. Respondent goes on to
compute the effect of the disallowance of the short-term capital
loss carryover, which is not an item for which innocent spouse
relief was granted. In that manner, respondent arrives at a
portion of the 1983 tax liability for which Mr. Friedman (the
"culpable" spouse) and Mrs. Friedman (the "nonculpable" spouse)
are both liable. That joint liability is then subtracted from
the liability determined in the notice of deficiency, resulting
in the portion of the liability for which only Mr. Friedman (the
"culpable" spouse) is liable. We agree with respondent's
approach and interpretation.
5
(...continued)
computation is in error. Petitioner's attack is one that
concerns only theory or approach.
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To understand the dynamics of the disagreement, we must
consider some of the items reported on the 1983 Federal income
tax return and the adjustments made to that return in the notice
of deficiency. The return contained three significant items of
income: $100,000 of wages, $122,356 of capital gain, and $19,912
of rents or royalities. The capital gain reported was a netted
and reduced amount composed of a net long-term capital gain of
$656,139 reduced by the $322,340 short-term capital loss
carryover from 1980 and a $27,908 long-term capital loss, to
arrive at $305,891, 40 percent of which ($122,356) was carried
from Schedule D to page 1 of the return.
Accordingly, without considering the leasing transaction
loss ($900,5256), approximately $242,000 of income was reported
on page 1 of the 1983 return. Respondent, in the notice of
deficiency, allowed $55,803 of the short-term capital loss
carryover due to the fact that $271,800 had been used for the
1980 year. Respondent's determination resulted in $228,971.20 of
capital gain income instead of the $122,356 reported, or an
increase of $106,615.20. The $106,615.20 increase is the number
on which respondent based the Rule 155 computation of
petitioner's $53,307.36 income tax liability. Comparing the
$53,307.36 and the $119,644.76 deficiency set forth in the notice
of deficiency reveals the dichotomy between the portion of the
6
The loss was reduced by $2,227 of miscellaneous income for
a net amount of $898,298.
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income tax liability that is joint and the portion from which
petitioner has been relieved.
Section 6013(e)(1), for the tax years in issue, is expressed
in terms of relief from liability for tax "to the extent such
liability is attributable to such omission from gross income [of
tax attributable to grossly erroneous items of one spouse]."7
The benefit of section 6013(e) is provided in the form of relief
from tax, not by permitting the innocent spouse to have the
benefit of a "grossly erroneous" deduction. Petitioner's relief
from the grossly erroneous leasing transaction losses is,
accordingly, limited to not subjecting her to tax liability
attributable to the disallowance of the loss. Petitioner was not
an innocent spouse as to the short-term capital loss
disallowance. Accordingly, she would be liable, along with Mr.
Friedman, for the portion of the liability attributable to the
disallowed portion of the short-term capital loss item.
The "eliminate therefrom" language of respondent's manual
addresses relief from tax liability attributable to a grossly
erroneous item. The manual language appears to be designed to
deal with grossly erroneous items attributed to either omitted
income or claim of a deduction, the disallowance of which
generates additional income. If computation of the joint
7
Later versions of sec. 6013(e)(1) have the phrase
"substantial understatement" as a replacement for the phrase
"omission from gross income".
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liability results in zero joint liability, then petitioner (the
innocent spouse) would be the recipient of a windfall in the form
of relief from the portion of the income tax liability
attributable to the short-term capital loss disallowance--relief
that was not intended by section 6013(e).
To reflect the foregoing,
Decision will be entered in
the amounts proposed in
respondent's computation.