Schwimmer v. Commissioner

T.C. Memo. 1996-353

UNITED STATES TAX COURT

ANGELA SCHWIMMER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 24583-93. Filed August 1, 1996.

Robert D. Howard, for petitioner.

Catherine R. Chastanet and Peggy Gartenbaum, for

respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: Respondent determined deficiencies in and

additions to petitioner and her husband Martin J. Schwimmer’s

(Martin’s) joint 1981, 1982, 1983, and 1984 Federal income taxes

as follows:
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Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6653(b) 6653(b)(1) 6653(b)(2) 6661

1981 $ 202,543 $101,272 --- --- ---
1982 1,648,220 --- $ 824,110 * $409,875
1983 3,038,233 --- 1,519,117 * 746,901
1984 768,593 --- 384,297 * 192,148

* 50 percent of interest due on portion of underpayment
attributable to fraud.

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

Petitioner, in general, does not contest the correctness of

respondent's determinations regarding the amounts of the income

tax deficiencies, nor the additions to tax for fraud and for

substantial underpayment of income tax. Petitioner, however,

contends that she qualifies as an innocent spouse with regard to

the income tax deficiencies and to all additions to tax.

Alternatively, petitioner contends that the fraud on which the

additions to tax under section 6653 are based is attributable

solely to Martin.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

Martin and petitioner filed separate petitions regarding the
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above income tax deficiencies and additions to tax. At the time

petitioner filed her petition, she resided in Kings Point,

New York. On September 28, 1994, an Order and Decision was

entered with respect to Martin's petition, wherein the Court

found that Martin was liable for all income tax deficiencies and

all additions to tax determined by respondent.

Martin's and Petitioner's Education and Business Activity

Martin has a bachelor’s degree in public accounting, a

master's degree in public administration, and a Ph.D. in

accounting. Martin has been a college professor of economics, a

financial consultant, an investment adviser to a pension plan,

owner of at least seven real estate and leasing business

ventures, owner of a Roy Rogers restaurant franchise, and,

generally, a wealthy businessman.

Throughout most of the 1970's and 1980's, Martin controlled

numerous stock brokerage accounts in his individual name, in

petitioner's individual name, and in his and petitioner’s joint

names. Martin annually engaged in numerous stock transactions

involving hundreds of thousands of dollars.

Petitioner has a college degree and a master's degree in

speech pathology and audiology. Except for a brief teaching

career and an occasional job as a substitute teacher, petitioner

has not worked outside the home, and petitioner’s primary

occupation has been as a mother and homemaker.
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Petitioner had only minimal involvement in Martin's business

and investment ventures. Martin did not discuss his business

ventures or the family's financial affairs with petitioner.

Martin never referred to petitioner as his business partner or

employee, and Martin discouraged his business associates and

contacts from discussing business when petitioner was present.

On records of a number of Martin's business ventures,

petitioner was nominally designated as a corporate officer and

was vested with authority to sign checks and business documents.

Petitioner, however, in these instances, was designated as an

officer and held signatory authority only as a convenience to

Martin. Petitioner performed no meaningful duties for or on

behalf of any of Martin’s businesses and investments.

With regard to Martin’s stock trading activity, Martin

engaged in this activity independently, without petitioner’s

involvement or participation. Martin made all decisions

regarding the stock transactions.

For the Roy Rogers restaurant franchise that Martin owned,

petitioner did write some checks to pay bills but only those that

Martin and/or his manager had identified and directed petitioner

to pay.

During 1981 through 1984, Martin acted as an investment

adviser for First United Fund, Ltd. (First United), an investment

firm that provided employee benefit plan services and investment

advice to labor unions.
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In 1983, one of Martin's controlled partnerships made a

$615,000 payment representing a contribution into a split-funded

defined benefit retirement plan trust. Pursuant to the plan,

life insurance policies on Martin's and petitioner's lives were

to be purchased, and funds were to be deposited into a separate

investment account, to be invested at the discretion of Martin,

the plan's trustee and administrator. Martin and petitioner, as

participants in the plan, were each a beneficiary on each other's

life insurance policies and were entitled to retirement benefits

upon reaching retirement age. Before Martin and petitioner

reached retirement age or received any benefits, all assets of

the plan's trust were forfeited to the U.S. Government, as

described below.

Martin's Embezzlement Activity

During 1981, 1982, 1983, and 1984, Martin and a co-

conspirator, taking advantage of their relationship with First

United, illegally transferred in excess of $16 million from the

bank accounts of two labor unions’ employee benefit plan trusts

to private bank accounts for the personal use of Martin and his

co-conspirator.

In June of 1987, Martin was indicted for racketeering,

embezzlement, unlawful acceptance of pension kickbacks,

conspiracy to defraud the U.S. Government, and income tax

evasion.
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On February 14, 1989, Martin and his co-conspirator were

convicted of racketeering, unlawful acceptance of pension plan

kickbacks, embezzlement of employee benefit plan funds,

conspiracy to defraud the U.S. Government, and income tax evasion

for 1981, 1982, 1983, and 1984 in connection with the scheme to

embezzle from the pension funds.

In 1989, Martin entered into a forfeiture agreement under

which Martin forfeited to the U.S. Government various assets that

were regarded as acquired by Martin with embezzled funds.1 The

amount of funds realized by the U.S. Government upon liquidation

of these assets is not found in the record. Also in 1989, Martin

transferred title in the Kings Point residence from his and

petitioner's names to just petitioner's name.

In 1990, various assets of Martin that had not been acquired

by Martin with embezzled funds were sold, and a total of $812,148

was realized from such sale and credited towards satisfying

Martin’s obligation under the forfeiture agreement.

In 1992, as a result of his conviction, Martin was sentenced

to imprisonment for 10 years, fined $1.6 million, and ordered to

1
Under the forfeiture agreement and pursuant to 18 U.S.C.
1963 (1994), the following assets were regarded as acquired by
Martin with embezzled funds and were forfeited by Martin to the
U.S. Government: Marketable securities; precious gems; interests
in retirement plan and trust of the above-referenced defined
benefit plan; 1978 Rolls Royce; 1986 Mercedes Benz; 1984
Corvette; 1974 Buick; 1986 Honda motorcycle; loans receivable
from various entities; shares of stock in various corporations;
and various limited partnership interests.
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pay a forfeiture penalty of $4.5 million to the U.S. Government,

as well as other penalties.

Also in 1992, Martin began serving his 10-year term in a

minimum security prison in Allenwood, Pennsylvania (Allenwood).

In 1994, Martin escaped from Allenwood and was arrested with

cocaine in his possession. At the time of trial in this case,

Martin was in prison in Florida and under indictment for illegal

possession of cocaine.

At no time was petitioner involved in any way in Martin's

embezzlement activity. Petitioner had no knowledge of Martin's

embezzlement activity until Martin was criminally prosecuted

therefor. Petitioner did not have signatory authority on the

bank accounts into which the embezzled funds were transferred,

and petitioner derived no benefit from the embezzled funds. A

large portion of Martin's share of the embezzled funds appears to

have been invested in speculative securities. Martin did not

maintain the bookkeeping and paperwork associated with these

speculative investments in his and petitioner's home. The

investments and securities owned by Martin as of February 14,

1989, were forfeited to the U.S. Government on that date pursuant

to the forfeiture agreement signed the same day.

Martin and Petitioner's Marriage and Lifestyle

Martin and petitioner married when petitioner was 18 years

of age. At the time of trial, Martin and petitioner had been
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married for 26 years. Petitioner has never been legally

separated or divorced from Martin. From their marriage, Martin

and petitioner have two daughters.

Upon their marriage in 1968, Martin and petitioner took a 6-

week honeymoon to Europe.

In 1976, Martin purchased for the family a lavish residence

in Kings Point, New York. Between 1976 and 1984, Martin paid for

extensive interior decorating and landscaping of this residence

and property.

In the family residence, petitioner occasionally hosted

social activities for Martin’s clients and business associates,

and petitioner answered the telephone to take business messages

for Martin. In no other way did petitioner participate in

Martin's business affairs. Martin purposefully and

autocratically kept petitioner out of his office and uninformed

of his business and financial affairs and of the family finances.

Throughout the 1970's, Martin and petitioner vacationed

approximately four to five times a year in locations such as Club

Med, Martinique, and Aruba. During 1981 through 1984, the years

in issue, Martin and petitioner and their family traveled less

frequently than in prior years.

In 1978, Martin purchased for himself a Rolls Royce. In

1980, he purchased a Mercedes Benz for petitioner. By 1980,

Martin estimated his net worth to be in excess of $1 million.
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In 1980, one of petitioner's daughters developed a serious

ear condition that resulted in the daughter's losing her hearing,

undergoing several ear surgeries, and becoming severely learning

disabled.

In 1982, petitioner's other daughter was diagnosed as having

scoliosis which required treatment with full body braces and

constant therapy. Petitioner’s primary activity during the years

in issue was the care of her two daughters.

Prior to 1981, petitioner frequently received a number of

expensive items of jewelry from Martin and from other members of

her family. During the years in issue, petitioner received no

new items of jewelry.

In 1984, Martin purchased for himself a 1984 Corvette, and

in 1986, Martin purchased for himself a 1986 Honda motorcycle.

Martin did not permit petitioner to drive either of these two

vehicles, and Martin purchased no cars for petitioner during the

years in issue.

Martin and petitioner did not own any boats and did not

belong to any country clubs. Their children generally attended

public schools.

During 1976 through 1989, including the years in issue,

Martin and petitioner’s marital and family lifestyle remained

affluent, but during the years in issue their lifestyle was not

as affluent as in prior years.
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On occasion, petitioner inquired of Martin as to the amount

of his income and as to the family’s annual living expenses.

Martin responded with vague and general answers and refused to

provide any specific information to petitioner.

Martin and Petitioner's Joint Income Tax Returns
and Respondent's Audits

For years prior to 1981, and for 1981, 1982, 1983, and 1984,

Martin and petitioner filed joint Federal income tax returns. It

is not clear from the record who prepared the joint Federal

income tax returns filed by Martin and petitioner for years prior

to 1981. For 1981 and 1982, Martin prepared the returns. For

1983 and 1984, an accounting firm prepared the returns with the

assistance of Martin.

After the tax returns for each year were prepared, Martin

presented the returns to petitioner for her signature without

giving petitioner any realistic opportunity to review the

returns, presenting petitioner with the returns only after they

had been prepared and insisting that she sign the returns

immediately. This was Martin's general practice with regard to

all documents signed by petitioner.

The schedule below reflects Martin and petitioner's joint

Federal income tax liabilities for 1970 through 1980 as reported

on their returns:

Year Tax Liability
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1970 $2,484
1971 1,601
1973 646
1974 260
1975 -0-
1976 514
1977 135
1978 2,248
1979 -0-
1980 -0-

On Martin and petitioner's joint Federal income tax returns

for 1981, 1982, 1983, and 1984, none of the funds embezzled by

Martin were reported.

Martin claimed on his and petitioner's 1983 joint Federal

income tax return a deduction of $600,000 reflecting the above-

referenced contribution into a Keogh plan.

For years prior to 1981, Martin and petitioner were audited

three times by respondent regarding their Federal income tax

liabilities, including for 1979 a detailed, line-by-line audit

under respondent’s taxpayer compliance measurement program

(TCMP). Each of these audits was resolved with minimal

adjustments; one or more of such adjustments were in Martin and

petitioner's favor. At the conclusion of the TCMP audit for

1979, petitioner was correctly informed by Martin that respondent

had made no adjustment to their 1979 joint Federal income tax

return.
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After an audit of Martin and petitioner’s joint Federal

income tax returns for 1981 through 1984, respondent charged

Martin with receipt of unreported embezzlement income as follows:

Year Embezzlement Income

1981 $ 415,169
1982 3,269,485
1983 5,375,207
1984 1,798,305

Respondent also disallowed for 1983 the claimed $600,000

Keogh deduction.2

The schedule below reflects the taxable income as reflected

by Martin and petitioner on their joint Federal income tax

returns for 1981 through 1984 and the corrected taxable income as

determined by respondent as a result of the omitted embezzlement

income, the disallowed Keogh deduction, and other adjustments:

Taxable Corrected
Year Income Reported Taxable Income

1981 $ (3,467) $ 411,777
1982 50,227 3,330,913
1983 240,751 6,256,003
1984 (223,789) 1,574,385

Respondent further determined additions to tax for fraud for

each year based on the above omitted embezzlement income, and

respondent determined the addition to tax for fraud for 1983 also

2
Petitioner has conceded certain other adjustments, and
petitioner acknowledges that, should petitioner be found eligible
for innocent spouse treatment, a Rule 155 computation is required
with regard to the conceded adjustments.
 - 13 -

on the basis of the disallowed $600,000 claimed Keogh deduction.

Respondent attributed the alleged fraud for each year not just to

Martin, but also to petitioner.

OPINION

Generally, married taxpayers filing joint Federal income tax

returns are treated as jointly and severally liable for taxes

reported due on their combined income and for additions to tax

relating thereto. Sec. 6013(d)(3).

Because joint and several liability may produce hardship for

an "innocent spouse" whose marriage partner received substantial

unreported income, Congress enacted section 6013(e), as amended

in 1984. Section 6013(e) provides "innocent spouse" relief from

joint and several liability for a taxpayer who filed a joint

income tax return and who establishes the following: (1) That a

substantial understatement of tax resulted from a grossly

erroneous item attributable to the other spouse; (2) that, in

signing the return, the taxpayer did not know, or have reason to

know of the understatement; and (3) that, in light of all of the

facts and circumstances, it would be inequitable to hold the

innocent spouse liable for the resulting deficiency. Sec.

6013(e)(1); Hayman v. Commissioner, 992 F.2d 1256, 1260 (2d Cir.

1993), affg. T.C. Memo. 1992-228.

Respondent concedes that the embezzlement income that Martin

received constitutes a grossly erroneous item for each year and
 - 14 -

that it is attributable only to Martin for purposes of section

6013(e)(1)(B). Respondent, however, contends that petitioner had

reason to know of the embezzlement income and that it would not

be inequitable to hold petitioner liable for the income tax

deficiencies and additions to tax relating to the embezzlement

income.

With regard to the $600,000 claimed Keogh deduction,

respondent concedes that $15,000 thereof represents an allowable

deduction on Martin and petitioner's 1983 joint Federal income

tax return.

With regard to the application of the innocent spouse

provision to the $585,000 balance of the claimed Keogh deduction

that is to be disallowed, respondent concedes that the $585,000

constitutes a grossly erroneous item. Respondent, however,

contends that the $585,000 is attributable not only to Martin,

but also to petitioner, that petitioner had reason to know of the

erroneous deduction and the circumstances surrounding the

transaction giving rise to the claimed deduction, and that it

would not be inequitable to hold petitioner liable for the income

tax deficiencies and additions to tax relating to the disallowed

$585,000 claimed Keogh deduction.

Generally, an item on a return will be regarded as not

attributable to a spouse if he or she was not involved in the

activity giving rise to the item. Feldman v. Commissioner, 20
 - 15 -

F.3d 1128, 1136-1137 (11th Cir. 1994) (citing Sturm v.

Commissioner, T.C. Memo. 1993-172), affg. T.C. Memo. 1993-17.

With regard to the first element of the innocent spouse

provision (namely, whether the item in question is attributable

only to the other spouse), petitioner, whose testimony generally

we regard as credible, did not recall even knowing of the

existence of the defined benefit plan and the life insurance

policies. No evidence indicates to the contrary. Petitioner

derived no actual benefit from either the defined benefit plan or

the life insurance, and the defined benefit plan and the life

insurance policies were forfeited under the forfeiture agreement.

We conclude that, for purposes of the grossly erroneous

requirement of the innocent spouse provision, the $585,000

erroneously claimed Keogh deduction is attributable solely to

Martin and not to petitioner.

With regard to the second element of the innocent spouse

provision (namely, whether the claimed innocent spouse had reason

to know of the understatement), among the factors that are

generally relevant are the following: (1) The alleged innocent

spouse's level of education; (2) the alleged innocent spouse's

involvement in the relevant business and financial affairs;

(3) the presence of expenditures that appear lavish or unusual

when compared to the taxpayer’s and the family’s level of income,

standard of living, and spending patterns in prior years; and

(4) the culpable spouse's evasiveness and deceit concerning the
 - 16 -

couple's finances. See Friedman v. Commissioner, 53 F.3d 523,

531 (2d Cir. 1995), affg. in part and revg. in part T.C. Memo.

1993-549; Hayman v. Commissioner, supra at 1261 (citing Erdahl v.

Commissioner, 930 F.2d 585 (8th Cir. 1991), and Price v.

Commissioner, 887 F.2d 959 (9th Cir. 1989)); Stevens v.

Commissioner, 872 F.2d 1499, 1505 (11th Cir. 1989), affg. T.C.

Memo. 1988-63; Levin v. Commissioner, T.C. Memo. 1987-67.

With regard specifically to large deductions resulting in

substantial understatements, the Court of Appeals to which appeal

in this case lies has stated that a taxpayer claiming innocent

spouse status must establish that he or she was "unaware of the

circumstances that gave rise to the error on the tax return".

Hayman v. Commissioner, supra at 1262. A duty to inquire also

exists as to the propriety of large deductions reported on joint

tax returns. Friedman v. Commissioner, supra; Hayman v.

Commissioner, supra; Levin v. Commissioner, supra.

We believe that petitioner has met her burden of proof under

the "reason to know" test of section 6013(e) as to both the

embezzlement income and the $585,000 erroneously claimed Keogh

deduction. The evidence indicates that petitioner’s

participation in the family finances was very limited and that

Martin was extremely autocratic and private in handling his and

the family’s financial affairs. Martin admitted that he

disclosed very little to petitioner regarding his financial

activities. Martin generally concealed information from
 - 17 -

petitioner regarding his income and expenditures and his illegal

activities. Neither petitioner's actual knowledge, nor her

education and experience alerted petitioner to or gave petitioner

reason to know of the existence of Martin’s embezzlement income.

With regard specifically to the $585,000 erroneously claimed

Keogh deduction, no evidence indicates that petitioner had actual

knowledge of or had reason to know of the erroneous nature of

this claimed deduction for 1983 or of the transactions underlying

the deduction. During the years in issue, nothing occurred in

Martin and petitioner’s lifestyle to put petitioner on notice of

the circumstances giving rise to the erroneously claimed Keogh

deduction.

We conclude, on the facts of this case, that petitioner met

her duty to inquire as to the information reported by Martin on

his and petitioner's Federal income tax returns for the years in

issue and specifically as to the Keogh deduction claimed for

1983. Petitioner did make inquiries of Martin about the family's

costs of living, was not allowed to participate in Martin's

business affairs or the family's financial affairs, was not given

any meaningful opportunity to review the tax returns for the

years in issue, knew that Martin and she had successfully

survived several audits of their returns, including a TCMP audit

for 1979, wherein very low tax liabilities were determined, and

she was subjected to Martin's autocratic and dominating

personality.
 - 18 -

We conclude that petitioner had no actual knowledge of and

had no reason to know of either the omitted embezzlement income

or of the erroneous nature of the $585,000 claimed Keogh

deduction.

With regard to the last element of the innocent spouse

provision (namely, whether it would be inequitable to hold

petitioner liable for the income tax deficiencies and additions

to tax relating to the embezzlement income and to the $585,000

erroneously claimed Keogh deduction), a key factor in the

analysis is whether the person seeking relief significantly

benefited, directly or indirectly, from the tax savings that

resulted from the omitted income and from the erroneous

deduction.

In determining whether a taxpayer significantly benefited

from omitted income and from erroneous deductions, normal support

received from a spouse will not be regarded as a significant

benefit. Sec. 1.6013-5(b), Income Tax Regs. Further, in

considering whether a benefit is to be regarded as normal

support, the lifestyle to which the taxpayer is accustomed is

taken into account. Belk v. Commissioner, 93 T.C. 434, 440

(1989).

Petitioner has met her burden of proving that she received

no significant benefit, directly or indirectly, either from

Martin's embezzlement activity or from the $585,000 erroneously

claimed Keogh deduction. During the years in issue, petitioner
 - 19 -

received only customary spousal and family support. Martin

appears to have used the majority of the embezzled funds to

finance his speculative investments, in which petitioner did not

participate and from which she did not benefit. Even were we to

assume that the defined benefit retirement plan and the luxury

cars were purchased with embezzled funds, such property was

forfeited to the U.S. Government pursuant to the forfeiture

agreement, and petitioner appears to have derived no benefit

therefrom.

The evidence in this case regarding the King's Point

residence, luxury cars, jewelry, and vacation trips simply

reflects petitioner's continuing, if not diminished, lifestyle

during the years in issue.

Respondent speculates that Martin's transfer, after his

conviction, to petitioner of title in the Kings Point residence

reflected: (1) An attempt to place the Kings Point residence out

of reach of the forfeiture agreement; and (2) an intent on

petitioner's behalf to interfere with the collection of criminal

penalties imposed upon Martin. Respondent thus suggests that it

would be inequitable for petitioner not to be held liable for the

income tax deficiencies and additions to tax at issue herein. We

disagree. Respondent's speculations are not supported by the

record.

We conclude that petitioner is not liable for the deficiency

in income tax and additions to tax for each year attributable to
 - 20 -

Martin's embezzlement activity and to the erroneously claimed

Keogh deduction.

Because of our conclusion as to petitioner’s status as an

innocent spouse, petitioner’s alternative argument that the fraud

additions to tax that are at issue in this case should not apply

to petitioner is moot, and we decline to address that alternative

argument.

Decision will be entered

under Rule 155.