T.C. Memo. 1996-542
UNITED STATES TAX COURT
FRANCINE ACQUAVIVA, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14981-94. Filed December 17, 1996.
Richard J. Sapinski, for petitioner.
Julia Ann Roy, Frank A. Racaniello, and William S. Garofalo,
for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined deficiencies in, and
additions to, the Federal income taxes of petitioner and her
husband (Mr. Acquaviva) as follows:
Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(a)(1)1 6653(a)(2) 6661
2
1985 $38,708 -0- $1,935 $9,677
2
1986 776,716 -0- 38,836 194,250
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2
1987 7,826 $391 391 9,135
1
Respondent determined the additions to tax for negligence or
intentional disregard of rules or regulations for 1986 and 1987 under sec.
6653(a)(1)(A).
2
50 percent of the interest due on the portion of the deficiency
attributable to negligence as provided by sec. 6653(a)(2) for 1985 and sec.
6653(a)(1)(B) for 1986 and 1987.
Mr. Acquaviva did not join in the petition filed by
petitioner and thus is not a party in this case. After
concessions,1 we must decide: (1) Whether petitioner tacitly
consented to the filing of joint Federal income tax returns for
each of the 3 years in issue; (2) whether payments made by Magnum
Development Corp. (Magnum), Mr. Acquaviva's real estate
development corporation, during the 1986 and 1987 taxable years
were constructive dividends; (3) whether petitioner is relieved
from joint Federal income tax liability as an "innocent spouse"
by operation of section 6013(e);2 (4) whether petitioner is
liable for an addition to tax under section 6651(a)(1) for the
taxable year 1987; (5) whether petitioner is liable for the
additions to tax for negligence under section 6653(a)(1) and (2)
for 1985 and section 6653(a)(1)(A) and (B) for 1986 and 1987; and
1
Petitioner conceded before trial that the gain
attributable to a 1986 condemnation award which her husband
received was not properly deferred under sec. 1033. On brief,
petitioner conceded that the proceeds from a 1985 involuntary
conversion were also not properly deferred under sec. 1033.
Petitioner concedes that these amounts are properly taxable to
Mr. Acquaviva.
2
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.
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(6) whether petitioner is liable for the additions to tax for
substantial understatement of tax under section 6661 for 1985,
1986, and 1987.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
incorporated herein by this reference. At the time the petition
was filed, petitioner resided in Holmdel, New Jersey.
A. Background
Petitioner and her husband have known each other for most of
their lives; they grew up across the street from one another in a
lower middle class neighborhood in Hoboken, New Jersey.
Petitioner married Mr. Acquaviva in 1960 at the age of 17. Mr.
Acquaviva was the breadwinner; petitioner was a housewife who
stayed at home to take care of their four sons. Mr. Acquaviva
was a residential real estate developer and, during the 1986 and
1987 taxable years, an officer-shareholder in Magnum. Petitioner
and Mr. Acquaviva enjoyed a harmonious and close family
relationship with each other and their sons.
Shortly after they were married, the Acquavivas moved into a
tenement apartment in Hoboken, New Jersey. The couple's standard
of living improved throughout their marriage as Mr. Acquaviva's
businesses prospered. By the early 1980's, the family lived in a
large five-bedroom home, which Mr. Acquaviva built, in an upscale
neighborhood located in Holmdel, New Jersey. The couple had a
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housekeeper, enjoyed giving gifts of expensive jewelry and furs,
drove expensive automobiles, took family vacations, and
maintained a summer home on the New Jersey shore. Petitioner
maintained an affluent lifestyle throughout the years in issue.
Throughout their marriage, petitioner and Mr. Acquaviva have
kept their household responsibilities separate. Mr. Acquaviva
managed the family finances and made all of the important
financial and investment decisions for the family without input
from petitioner. Petitioner managed their household, purchased
the family's groceries, clothing, and personal items, and cared
for the children when they were young. Petitioner paid her
personal expenses and those related to running the household by
personal check drawn on a joint checking account that she
maintained with her husband. However, petitioner relied on Mr.
Acquaviva to pay the majority of the family's living expenses.
Expenses such as the mortgage, homeowner's insurance, real estate
taxes, life insurance, automobile payments, automobile insurance,
State and Federal taxes, political contributions, and expenses
for live-in help were all paid out of Mr. Acquaviva's personal
account. Petitioner was not a signatory on her husband's
personal checking account. Petitioner never asked Mr. Acquaviva
how much money was in his personal checking account. Mr.
Acquaviva made funds available to petitioner through the couple's
joint checking account by depositing funds drawn from his
personal checking account. Petitioner never asked how much she
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could spend; if she needed additional funds, she simply asked her
husband to deposit more money into their joint account.
Petitioner's education ended with high school. Petitioner
had no training or background in accounting, business, or
finance, with the exception of running a retail clothing business
called "Unique Boutique", which Mr. Acquaviva set up as an
amusement for her.3 Petitioner's participation in her husband's
business was limited to decorating some of the model houses which
he built. Petitioner was otherwise unemployed during the
relevant years.
B. Mr. Acquaviva's Business Activities
During the years in issue, Mr. Acquaviva did not conceal his
business activities or the family's financial affairs from
petitioner. However, Mr. Acquaviva generally did not discuss his
investments or the family's financial affairs with petitioner.
Mr. Acquaviva usually did not conduct business at home.
Petitioner did not question her husband's decisions. Petitioner
trusted her husband and believed he would do what was best for
the family.
Shortly after his marriage to petitioner in 1960, Mr.
Acquaviva took over his father's refrigerator repair service. He
3
Although petitioner was the owner/operator of this dress
shop, she left all of the business decisions to her husband.
During the 4 years that petitioner's dress shop was in operation
from 1982 through 1985, the business incurred a net loss of
$27,455.
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eventually developed it into a commercial heating and air
conditioning business. Sometime during the early 1980's, Mr.
Acquaviva and Frank DiMisa (Mr. DiMisa), a real estate developer
from Staten Island, New York, entered into a venture to develop a
residential subdivision. Mr. Acquaviva eventually changed his
business from mechanical contracting to residential real estate
development.
Mr. Acquaviva became a successful real estate developer. In
the years following his initial project with Mr. DiMisa, Mr.
Acquaviva's real estate activities expanded to encompass over 25
different ventures. Over the years, Mr. Acquaviva reinvested the
proceeds from his development activities in additional land
purchases and, in turn, future development projects.
Mr. Acquaviva's primary source of credit for his real estate
activities was City Federal Savings Bank (City Federal). City
Federal was declared insolvent and taken over by the Office of
Thrift Supervision in December of 1989. Mr. Acquaviva's primary
source of credit thus disappeared, and he no longer was able to
meet his debt obligations. An investigation of City Federal by
the U.S. Attorney's Office and the Resolution Trust Corporation
(RTC) revealed that in 1985 Mr. Acquaviva and Mr. DiMisa paid
$75,000 to a senior lending officer at City Federal in order to
obtain approval of a development loan. Mr. Acquaviva was charged
with, and pleaded guilty to, conspiracy to commit bribery in
1992. Mr. Acquaviva did not tell petitioner about the
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investigation until 2 weeks before he pleaded guilty. In
settlement of the RTC's claims, Mr. Acquaviva and his sons paid
$7,825,000 in 1993. This payment was partially funded by
borrowing and was secured by the family's remaining assets which
included the Acquavivas' home.
1. 1985 Involuntary Conversion
Mr. Acquaviva purchased a multistory commercial building
located in Hoboken, New Jersey (Hoboken property), in 1973. The
Hoboken property was destroyed by fire in January 1985. Mr.
Acquaviva received $1 million from his insurance carrier in late
1985 as a settlement of the damage caused by the fire. At the
time of the fire, Mr. Acquaviva's adjusted basis in the Hoboken
property was $806,464. On the Acquavivas' 1985 Federal income
tax return, Mr. Acquaviva did not report any gain from this
conversion, electing instead to defer the gain pursuant to
section 1033.4 No statement was attached to the couple's 1987
4
Sec. 1033 provides that, under certain circumstances, a
taxpayer may defer the taxation of gain realized on an
involuntary conversion. Sec. 1033(a)(1). Where condemnation
proceeds are received in the form of money, replacement with
like-kind property must be made within 2 years after the close of
the year in which the landowner first receives the proceeds, in
this case, by the end of the calendar year 1987. The
Commissioner's regulations direct that the details of an
involuntary conversion of property resulting in a gain should be
reported on the return for the year in which the gain is realized
(in this case 1985) but that an election to defer recognition of
gain will be deemed to have been made by a failure to include the
gain in gross income in the year received. Sec. 1.1033(a)-
2(c)(2), Income Tax Regs. The failure of the Acquavivas to
report and pay tax on the gain from the involuntary conversion on
(continued...)
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return identifying that the Hoboken property had been replaced,
nor did they file an amended 1985 return reporting the gain.
Petitioner conceded that the Hoboken property was not properly
replaced pursuant to section 1033.
2. 1986 Condemnation
Mr. Acquaviva and Mr. DiMisa formed the Holmdel Golf &
Country Club partnership (HGCC) in 1984 to develop land located
in Monmouth County, New Jersey, into an exclusive residential
community of luxury homes with an adjacent golf course and
country club. Mr. Acquaviva and Mr. DiMisa each owned a 50-
percent interest in HGCC.
Mr. Acquaviva purchased two tracts of farm land located in
Monmouth County and contributed them to HGCC in 1984.
Petitioner's signature appears on various documents of title,
mortgages, and closing statements related to this transaction.5
HGCC acquired additional land in Monmouth County in January and
October 1985.
4
(...continued)
their 1985 income tax return thus constituted an election to
defer the recognition of the gain under sec. 1033. See Cerny v.
Commissioner, T.C. Memo. 1987-599.
5
It was necessary for petitioner to attend occasional
real estate closings and personally sign various documents.
Petitioner's signature was required along with her husband's as a
guarantor and/or to release or convey any marital interest she
may have had in the property being conveyed in connection with
her husband's real estate development activity.
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During 1985, the Monmouth County Board of Freeholders was
considering the purchase and conversion of 457 acres of farmland
into a public park, 366 acres of which was owned by HGCC. In
July 1986, Monmouth County filed a declaration of taking against
279 acres of land owned by HGCC and deposited $14,524,600, the
property's estimated fair market value, with the Superior Court
of New Jersey. The condemnation proceedings, including the
amount of the condemnation award, were reported in local
newspapers; petitioner read some of these articles and attended a
few of the public hearings concerning the condemnation.
Mr. Acquaviva consulted his accountant, Louis Defalco (Mr.
Defalco), regarding the tax implications of the condemnation
award. Mr. Acquaviva and Mr. DiMisa were advised by Mr. Defalco
that they had the option of replacing the property and deferring
the recognition of any gain or of recognizing the gain currently.
Mr. DiMisa also suggested that Mr. Acquaviva and he discuss the
matter with Herbert Gannette (Mr. Gannette), a tax attorney. In
the interim, HGCC reported a gain in the amount of $7,678,378
from the condemnation on its 1986 Form 1065, U.S. Partnership
Return of Income. HGCC issued checks to each partner for
$3,869,244, which represented each partner's share of the
proceeds from the condemnation award after deduction of expenses.
Mr. Acquaviva deposited his share into his personal checking
account. However, HGCC subsequently filed an amended Form 1065,
electing to defer this gain pursuant to section 1033.
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Mr. Acquaviva intended to reinvest the proceeds from the
condemnation into another venture with Mr. DiMisa. In the fall
of 1987, Mr. Acquaviva and Mr. DiMisa sought legal advice from
Mr. Gannette regarding the 1986 condemnation gain. Mr. Gannette
advised the partners that in seeking the benefits of section
1033, HGCC would be regarded as an entity separate from its
partners, and, as such, it was incumbent upon HGCC, not the
partners individually, to acquire and hold replacement property
in its trade or business. Mr. DiMisa, however, decided not to
enter into another venture with Mr. Acquaviva through HGCC; he
decided to report his share of the taxable income related to the
1986 condemnation. Thus, the 1986 condemnation proceeds were
never reinvested by HGCC. Mr. Defalco prepared an amended 1986
individual income tax return which reported Mr. Acquaviva's
proportionate share of HGCC's gain from the 1986 condemnation.
Mr. Defalco delivered the amended return to Mr. Acquaviva for
filing. Mr. Acquaviva never filed this amended return. Mr.
Acquaviva explained that he could not afford to pay his share of
the tax liability because he had used the condemnation proceeds
to, among other things, purchase other properties in
contemplation of either contributing or selling them to HGCC.
Mr. Acquaviva never told petitioner of his discussions with Mr.
DiMisa, Mr. Defalco, or his tax attorney concerning the
involuntary conversion, nor did he discuss with her his decision
to ignore the advice of his professional advisers. Petitioner
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concedes that the gain realized on the 1986 condemnation award
should have been reported on an amended 1986 return.
3. Magnum Development Corp.
During the 1986 and 1987 taxable years, Magnum was a
closely held real estate development corporation owned by Mr.
Acquaviva and three of his sons. Magnum functioned as the
general contractor on Mr. Acquaviva's residential real estate
development projects. Mr. Acquaviva occasionally made cash
advances to Magnum. No promissory notes were executed and Magnum
did not pay interest on the funds advanced.
Magnum paid some of Mr. Acquaviva's personal expenses.
During 1986, Magnum paid $23,890 for the installation of a
swimming pool at the Acquavivas' home and $20,000 for home
improvements. In 1987, Magnum paid $23,552 for landscaping
services benefiting the Acquavivas' home and, in addition, issued
a check in the amount of $4,400 directly to Mr. Acquaviva.
Magnum accounted for these transactions on its books as
reductions in the amount it owed Mr. Acquaviva. Magnum never
declared a dividend during 1986 or 1987. Respondent determined
that these amounts paid on behalf of or directly to Mr. Acquaviva
were dividends.
C. Tax Return Preparation
Mr. Acquaviva did not discuss tax matters with his wife.
She expected him to take care of such matters. During the years
in issue, Mr. Acquaviva or his son Christopher ensured that tax
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returns were filed. During 1985, 1986, and 1987, Mr. Acquaviva
had joint returns prepared. He did not present these returns to
petitioner for her review or signature but rather filed the 1985
and 1987 returns without her signature and signed her name to the
1986 return. Petitioner did not file separate returns for any of
the years in issue. Petitioner knew that there was a
responsibility to file returns but assumed that "my husband would
have taken care of that." Petitioner filed joint income tax
returns with her husband during their marriage but could not
recall for which taxable years.
Mr. Acquaviva used the accounting firm of Defalco & Co. for
tax and accounting services for more than 20 years. In addition
to advising Mr. Acquaviva on tax matters concerning his
enterprises, Mr. Defalco also advised Mr. Acquaviva on personal
tax matters. Defalco & Co. prepared the Acquavivas' income tax
returns during the years in issue. Mr. Acquaviva filed Federal
income tax returns electing the status of "Married filing joint
return" for all of the years in issue.
Petitioner knew that Mr. Defalco had a longstanding
professional relationship with her husband. Petitioner was not
involved in the preparation of the couple's income tax returns.
Neither Mr. Acquaviva nor Mr. Defalco discussed the returns with
petitioner. They did not discuss the advantages or possible
disadvantages of filing a joint return with petitioner.
Petitioner did not give her husband express consent to file the
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returns on her behalf, although she knew that the returns had
been prepared by the same accountant for many years and was
confident in his abilities. Petitioner never asked to review the
returns. Petitioner trusted her husband and relied on his
judgment. Petitioner executed a Form 2848, Power of Attorney and
Declaration of Representative, designating her husband's
accountant to represent her concerning the IRS audit of the 1986
and 1987 returns.
OPINION
A. Joint Returns
We must first decide whether petitioner filed a joint return
for each of the taxable years in issue. If petitioner did not
file a joint return for the taxable years 1985 through 1987, then
she is not liable for the deficiencies determined by respondent,
and the question of petitioner's innocent spouse status becomes
moot. See Davenport v. Commissioner, 48 T.C. 921 (1967).
Generally, a nonsigning spouse is not liable for taxes shown to
be due on a return or later determined as a deficiency.
Januschke v. Commissioner, 48 T.C. 496, 500 (1967). We have,
however, recognized that joint liability arising from a return is
not necessarily defeated because one spouse did not sign the
return. Estate of Campbell v. Commissioner, 56 T.C. 1, 12-13
(1971); Federbush v. Commissioner, 34 T.C. 740, 757 (1960), affd.
per curiam 325 F.2d 1 (2d Cir. 1963). Rather, the determining
factor is whether the spouses "intended to file and be bound by
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the particular return in question." Shea v. Commissioner, 780
F.2d 561, 567 (6th Cir. 1986), affg. in part, revg. in part, and
remanding T.C. Memo. 1984-310; Januschke v. Commissioner, supra
at 500. Whether petitioner intended to file a joint return is a
question of fact. O'Connor v. Commissioner, 412 F.2d 304, 309
(2d Cir. 1969), affg. in part and revg. in part on another issue
T.C. Memo. 1967-174. In the instant case, petitioner did not
sign the returns; the burden therefore is on respondent to
produce evidence of petitioner's intent to file a joint return
with Mr. Acquaviva. Id.
Petitioner knew that her husband's longtime accountant, Mr.
Defalco, prepared the subject returns, and she was confident in
his abilities. Petitioner designated Mr. Defalco to represent
her during the audit of the 1986 and 1987 returns. Thus, she had
the opportunity to raise an objection to the joint filing of the
returns with the examining agent at the audit level but chose not
to do so. Cf. Estate of Campbell v. Commissioner, supra at 14.
Income from petitioner's dress shop was reported on Schedule
C of the 1985 return. Gain from the sale of the real property
used by her dress shop, which she held as a joint owner with her
husband, was included on the 1986 return. Although not
conclusive, the inclusion of a spouse's income on a return has
been regarded as a factor supporting the conclusion that the
particular return in question was intended as a joint return.
Federbush v. Commissioner, supra at 756. Petitioner testified
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that she was aware of her duty to file, having done so in past
years. Petitioner also testified that she had filed joint
returns with her husband during their marriage, though she did
not recall which joint returns she may have signed. We also find
it significant that petitioner never filed a separate return, nor
did she ever object to the filing of joint returns either to her
husband or his accountant.
There was a general understanding between petitioner and her
husband that he would handle the family's financial and business
matters, including the preparation and filing of tax returns.
Petitioner never asked to review the subject returns because she
believed it was not necessary. Petitioner trusted her husband
and relied on his judgment. We believe that her reliance on Mr.
Acquaviva's judgment is indicative of petitioner's intent; in
other words, "She intended the returns to be filed as he chose."
Estate of Campbell v. Commissioner, supra at 13. Based on the
foregoing, we conclude that petitioner intended to file, and did
file, joint returns for each of the 3 taxable years in issue.
B. Constructive Dividends
Petitioner contends that the payments made by Magnum in 1986
and 1987 to, or on behalf of, her husband were repayments of
loans that he made to Magnum. Respondent determined that Magnum
did not have a bona fide debt to Mr. Acquaviva; any payments,
therefore, were dividends to Mr. Acquaviva.
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The characterization of these payments depends upon whether
Mr. Acquaviva and Magnum intended to create a bona fide debtor-
creditor relationship. Williams v. Commissioner, 627 F.2d 1032
(10th Cir. 1980), affg. T.C. Memo. 1978-306; Commissioner v.
Makransky, 321 F.2d 598, 600 (3d Cir. 1963), affg. 36 T.C. 446
(1961). If a bona fide debtor-creditor relationship existed,
then the payments by Magnum may be properly characterized as the
repayment of that debt. See, e.g., Schaefer v. Commissioner,
T.C. Memo. 1994-444. If however, as respondent contends, there
was no bona fide debtor-creditor relationship, then the payments
may be characterized as dividends to Mr. Acquaviva. See Fin Hay
Realty Co. v. United States, 398 F.2d 694, 697 (3d Cir. 1968);
Commissioner v. Makransky, supra. The proper characterization is
a question of fact to be determined on the basis of all of the
facts and circumstances. Gilbert v. Commissioner, 262 F.2d 512,
513 (2d Cir. 1959), affg. T.C. Memo. 1958-8; Georgia-Pac. Corp.
v. Commissioner, 63 T.C. 790, 795 (1975). The burden is on
petitioner to show that there existed a bona fide indebtedness
and that the amounts in question were the repayment of that debt.
Rule 142(a).
Courts have considered various factors in determining
whether shareholder advances are debt or contributions to
capital.6 In making our determination, we recognize that
6
The Court of Appeals for the Third Circuit, to which
(continued...)
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transactions between shareholders and their closely held
corporations require special scrutiny because of the apparent
lack of a true arm's-length relationship between the two. Fin
Hay Realty Co. v. United States, supra at 697; J.A. Tobin Constr.
Co. v. Commissioner, 85 T.C. 1005, 1022 (1985). This scrutiny is
particularly applicable where a shareholder advances funds to a
corporation and characterizes the transaction as creating a
corporate obligation instead of a contribution to capital. Fin
Hay Realty Co. v. United States, supra at 697.
Petitioner argues that the requisite intent to create a bona
fide debt existed between Mr. Acquaviva and Magnum. In support
6
(...continued)
appeal in this case lies, uses the following nonexclusive list of
16 factors:
(1) the intent of the parties; (2) the identity between
creditors and shareholders; (3) the extent of participation
in management by the holder of the instrument; (4) the
ability of the corporation to obtain funds from outside
sources; (5) the "thinness" of the capital structure in
relation to debt; (6) the risk involved; (7) the formal
indicia of the arrangement; (8) the relative position of the
obligees as to other creditors regarding the payment of
interest and principal; (9) the voting power of the holder
of the instrument; (10) the provision of a fixed rate of
interest; (11) a contingency on the obligation to repay;
(12) the source of the interest payments; (13) the presence
or absence of a fixed maturity date; (14) a provision for
redemption by the corporation; (15) a provision for
redemption at the option of the holder; and (16) the timing
of the advance with reference to the organization of the
corporation. [Fin Hay Realty Co. v. United States, 398 F.2d
694, 696 (3d Cir. 1968); fn. ref. omitted.]
These factors are only aids to be used in determining
whether a bona fide debtor-creditor relationship existed between
Mr. Acquaviva and Magnum. See id. at 697.
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of her position, petitioner offered the testimony of Mr.
Acquaviva, her son Christopher, who during the years in issue
served as Magnum's treasurer, and their accountant, Mr. Defalco.
Petitioner also presented copies of Magnum's automated general
ledger and accounting records as evidence of a bona fide debt.
Respondent contends that petitioner has not met her burden
of proof. Statements of intent must be considered in the context
of the surrounding circumstances. Williams v. Commissioner,
supra at 1034. What few formal indicia surrounded Mr.
Acquaviva's advances were minimized by the lack of other
objective factors to support the conclusion that they were loans.
Petitioner offered no evidence of indebtedness, e.g., loan
agreements, promissory notes, repayment schedules, or collateral
posted to secure the alleged loans. There was no interest
reflected in any of the 1986 and 1987 payments, nor was there any
evidence that these payments were made to satisfy a debt between
Magnum and Mr. Acquaviva. Petitioner did not introduce Magnum's
corporate minutes into evidence. Furthermore, Mr. Acquaviva, a
25-percent shareholder in Magnum, did not get formal
authorization from the other shareholders for the loans.
Petitioner has failed to prove that Magnum owed a bona fide debt
to Mr. Acquaviva.
Petitioner has not argued that Magnum lacked earnings and
profits during 1986 and 1987. See secs. 301, 316. We sustain
respondent's determination on this issue.
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C. Innocent Spouse
Section 6013(a) provides that spouses may elect to file a
joint Federal income tax return. If a husband and wife file a
joint return, the tax is computed on their aggregate income and
the liability with respect to such tax is joint and several.
Sec. 6013(d)(3); Gordon v. United States, 757 F.2d 1157, 1160
(11th Cir. 1985). Section 6013(e)(1), however, relieves a spouse
of this joint and several liability for tax if he or she can show
that (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 claimed "innocent spouse" did not
know, and had no reason to know, of the substantial
understatement; and (4) taking into account all the facts and
circumstances, it would be inequitable to hold this claimed
"innocent spouse" liable for the deficiency attributable to the
understatement. Sec. 6013(e)(1). A spouse seeking relief under
section 6013(e) has the burden of proving that each requirement
has been satisfied. Because the statute is phrased in the
conjunctive, petitioner's failure to satisfy any one of these
elements will preclude "innocent spouse" relief. Purificato v.
Commissioner, 9 F.3d 290, 293 (3d Cir. 1993), affg. T.C. Memo.
1992-580.
We have found that petitioner filed a joint return for each
of the years in issue, and respondent concedes that there was a
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substantial understatement of tax attributable to Mr. Acquaviva.
Accordingly, we must decide whether: (1) Petitioner lacked
actual and constructive knowledge of the understatements; and
(2) it would be inequitable to hold her liable for the
deficiencies.
1. Knowledge or Reason To Know
Courts have consistently held that the knowledge
contemplated by section 6013(e)(1)(C) is knowledge of the
underlying transaction and not of the tax consequences of that
transaction. Purcell v. Commissioner, 86 T.C. 228, 237-238
(1986), affd. 826 F.2d 470 (6th Cir. 1987). Petitioner must show
a lack of actual knowledge as well as that she had no reason to
know of the substantial understatement. In determining whether
petitioner had reason to know within the meaning of section
6013(e)(1)(C), we must inquire whether a reasonably prudent
person, under petitioner's circumstances, could have been
expected to know at the time of signing each of the returns that
the returns contained a substantial understatement. Bokum v.
Commissioner, 94 T.C. 126, 148 (1990), affd. 992 F.2d 1132 (11th
Cir. 1993).
We look to the following factors to determine whether or not
petitioner had reason to know that the returns in question
contained a substantial understatement: (1) Petitioner's level
of education; (2) petitioner's involvement in the family's
business and financial affairs; (3) whether there was a
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substantial unexplained increase in the family's standard of
living; and (4) the conduct of petitioner's husband in concealing
the true state of the family's finances. Hayman v. Commissioner,
992 F.2d 1256, 1261 (2d Cir. 1993), affg. T.C. Memo. 1992-228.
a. Education
Petitioner possessed only a high school education.
Petitioner lacked meaningful business experience and knowledge
pertaining to finances or tax return preparation.
b. Family Business
Petitioner's knowledge of the family's financial affairs and
her husband's business affairs was minimal. Petitioner's
participation in her family's financial affairs was limited to
access to the couple's joint bank account which she used to pay
incidental household and family expenses.7 Mr. Acquaviva
dominated the couple's financial affairs throughout their
marriage. Mr. Acquaviva completely insulated petitioner from the
family's financial picture as well as his business activities.
We are convinced that petitioner had no voice in the family's
financial and business decisions. Petitioner was not in a
position to know how much income her husband generated from his
7
Cf. Price v. Commissioner, 887 F.2d 959, 965 (9th Cir.
1989) (wife had limited involvement in family finances despite
responsibility of paying mortgage); Hinds v. Commissioner, T.C.
Memo. 1988-426 ("innocent spouse" relief allowed for wife whose
participation in family's financial affairs was limited to
accepting money from husband to pay household expenses and
purchase family's food and clothing).
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real estate activities, which activities generated that income,
or how he invested that income.
c. Family Lifestyle
Petitioner enjoyed an affluent lifestyle during the years in
issue, but that lifestyle was consistent with that of preceding
years. The record reflects that the family lived in the same
five-bedroom home located in an upscale neighborhood of Holmdel,
New Jersey, prior to and during the years in issue. The record
also indicates that items of jewelry, luxury automobiles,
household help, family vacations, and a summer home had all been
a part of the family's lifestyle since at least the mid-1970's.
Respondent points out that Mr. Acquaviva gave his wife
several items of expensive jewelry in 1985, focusing on the value
of the gifts in relation to the family's adjusted gross income.
We are mindful that "one person's luxury can be another's
necessity, and the lavishness of an expense must be measured from
each family's relative level of ordinary support." Sanders v.
United States, 509 F.2d 162, 168 (5th Cir. 1975). We note that
these items were given to petitioner in conjunction with the
couple's 25th wedding anniversary and, though expensive, were not
disproportionate to the Acquavivas' standard of living.
d. Evasiveness
Mr. Acquaviva, while not evasive, did not share information
about his financial decisions or his business activities with
petitioner. Mr. Acquaviva considered all matters related to his
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business and family finances to be his domain. We are convinced
that petitioner was unaware of her husband's discussions with Mr.
DiMisa, Mr. Defalco, or his tax attorney concerning the
involuntary conversions. Further, we do not believe that Mr.
Acquaviva told petitioner, or that she knew, of his decision to
ignore the advice of his advisers with regard to the 1986
condemnation.
Respondent contends that petitioner had a duty to inquire
and that she failed to do so. Specifically, respondent argues
that because petitioner knew of the 1985 fire and the 1986
condemnation and the substantial amounts involved, petitioner had
a duty to inquire as to the proper tax treatment of the 1985 and
1986 involuntary conversion proceeds and the constructive
dividends. We think that, under the circumstances presented
here, it was reasonable that petitioner did not ask her husband
about the tax consequences of the involuntary conversion proceeds
and the corporate distributions.8 Petitioner trusted her husband
to do what was best for her and their family, including ensuring
that the family's tax returns were properly prepared and filed.
Petitioner also knew that her husband had a long-standing
8
We also note that, contrary to respondent's belief,
failure to inspect a Federal income tax return does not
automatically preclude innocent spouse relief. See, e.g.,
Terzian v. Commissioner, 72 T.C. 1164, 1171 (1979) ("the fact
that * * * [the taxpayer] signed the return without reading it
does not require the conclusion that she had reason to know of
the omitted income").
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professional relationship with his accountant, Mr. Defalco, and
that he prepared the couple's tax returns as well as the returns
for the entities that Mr. Acquaviva controlled. Petitioner had
no reason to question Mr. Defalco's ability. Moreover, when the
1985 and 1986 returns were filed, there was no substantial
understatement of tax attributable to the involuntary
conversions. By operation of respondent's regulations, the
Acquavivas were treated as having elected the provisions of
section 1033 with the filing of the 1985 and 1986 returns. See
sec. 1.1033(a)-(2)(c)(2), Income Tax Regs.
Based on our review of the record as a whole, we hold that
petitioner did not know, and had no reason to know, of any
substantial understatement of income on the couple's Federal
income tax returns for the taxable years 1985, 1986, 1987.
2. Equity of Holding Petitioner Liable
The final requirement for innocent spouse relief is that,
given all of the facts and circumstances, it would be inequitable
to hold petitioner liable for the deficiency attributable to the
substantial understatement. Sec. 6013(e)(1)(D). Although
section 6013(e)(1)(D), as amended, no longer requires us to
determine whether petitioner significantly benefited as a result
of the omitted income, this factor is still considered in
determining whether it is inequitable to hold petitioner liable.
Purificato v. Commissioner, 9 F.3d at 296; sec. 1.6013-5(b),
Income Tax Regs. Any significant benefit received by petitioner
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must be considered in the totality of the circumstances.
Purificato v. Commissioner, supra at 293; sec. 1.6013-5(b),
Income Tax Regs.
a. 1985 Taxable Year
Petitioner has not demonstrated that she did not realize a
significant benefit from the 1985 insurance proceeds. Petitioner
failed to produce the couple's joint checking account records for
the 1985 tax year as she did for the 1986 and 1987 tax years.
The failure of a party to produce relevant evidence within its
possession or control gives rise to the presumption that, if
produced, it would be unfavorable. Wichita Terminal Elevator Co.
v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513
(10th Cir. 1947).
Petitioner failed to meet her burden of proving that it
would be inequitable, within the meaning of section
6013(e)(1)(D), to hold her liable for that portion of the
deficiency related to 1985. Therefore, she is not an "innocent
spouse" in 1985.
b. 1986 Taxable Year
With respect to the 1986 condemnation award, a check
representing Mr. Acquaviva's share of the condemnation award was
deposited into his personal checking account. The bulk of the
condemnation award was used in Mr. Acquaviva's real estate
ventures, which failed in subsequent years. In this regard, we
believe petitioner did not receive any of the benefits of
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ownership from the condemnation award. Furthermore, we are
satisfied that petitioner's lifestyle did not change on account
of her husband's receipt of the condemnation award. Although
petitioner may have received some benefit from the 1986
condemnation award, we believe that such a benefit did not exceed
her normal level of support, which is not a significant benefit.
Flynn v. Commissioner, 93 T.C. 355, 367 (1989).
We conclude that petitioner did not derive a significant
benefit from Mr. Acquaviva's omission of the 1986 condemnation
award. Accordingly, under the facts and circumstances of this
case, we find that it would be inequitable to hold petitioner
liable for that portion of the deficiencies in tax arising from
Mr. Acquaviva's understatement of income attributable to the 1986
condemnation award.
The same cannot be said of the 1986 constructive dividends.
Here the evidence demonstrates that petitioner benefited from the
constructive dividends paid to Mr. Acquaviva. During 1986,
Magnum paid $23,890 for the installation of a swimming pool at
the Acquavivas' home and $20,000 for home improvements.
Petitioner's lifestyle was enhanced by these home improvements.
We find that the 1986 constructive dividend was used to benefit
petitioner beyond normal support. We hold that it is not
inequitable to hold petitioner liable for the portion of the
deficiency attributable to the 1986 constructive dividends; thus,
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she is not entitled to relief as an innocent spouse with respect
to this item.
c. 1987 Taxable Year
With respect to the 1987 taxable year, Magnum paid $23,552
for landscaping services to the Acquavivas' home and, in
addition, issued a check in the amount of $4,400 directly to Mr.
Acquaviva. Again, petitioner's lifestyle was enhanced by these
landscaping services to her home. We find that the 1987
constructive dividend attributable to landscaping services
benefited petitioner beyond normal support. With regard to the
$4,400 check to Mr. Acquaviva, petitioner did not present any
evidence on how it was used. Therefore, as to the $4,400, she
has failed to establish that it would be inequitable to hold her
liable for the deficiency. We hold that it is not inequitable to
hold petitioner liable for the portion of the deficiency
attributable to the 1987 constructive dividend; thus, she is not
entitled to relief as an innocent spouse under section 6013(e)
with respect to this item.
For the foregoing reasons, we hold that petitioner is
entitled to "innocent spouse" relief under section 6013(e) for
the portion of the deficiency for 1986 attributable to the
condemnation award, but she is not entitled to "innocent spouse"
relief with respect to the deficiency for 1985 or with respect to
the portions of the deficiencies for 1986 and 1987 attributable
to the constructive dividends.
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D. Additions to Tax
Section 6651(a)(1) imposes an addition to tax for failure to
file a return on the date prescribed (determined with regard to
any extension of time for filing) unless it is shown that such
failure is due to reasonable cause and not due to willful
neglect. The taxpayer has the burden of showing the addition is
improper. United States v. Boyle, 469 U.S. 241, 245 (1985).
If any part of the underpayment is due to negligence or
disregard of rules or regulations, there shall be added to the
tax an amount equal to 5 percent of the underpayment. Sec.
6653(a)(1) (for 1985); sec. 6653(a)(1)(A) (for 1986 and 1987).
There is a further addition to tax in an amount equal to 50
percent of the interest payable with respect to the portion of
the underpayment that is attributable to negligence. Sec.
6653(a)(2) (for 1985); sec. 6653(a)(1)(B) (for 1986 and 1987).
Section 6661 provides for a 25-percent addition to tax on
any substantial understatement. Pallottini v. Commissioner, 90
T.C. 498 (1988). A substantial understatement is one that
exceeds the greater of 10 percent of the tax required to be shown
on the return or $5,000. Sec. 6661(b)(1). The amount of the
understatement, for purposes of section 6661, is to be reduced by
the portion attributable to any item for which there was
substantial authority or any item that was adequately disclosed.
Sec. 6661(b)(2)(B).
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Respondent determined that petitioner is liable for the
additions to tax discussed above. Petitioner has offered no
evidence with regard to any of the additions to tax. In fact,
petitioner's briefs fail to address the additions to tax. The
burden rests with petitioner to prove that respondent's
determinations are in error. Rule 142(a). We cannot be sure
that petitioner intended to abandon the issue, but in any case
respondent's determination of the applicable additions to tax
must be sustained with respect to any underpayment of tax or
substantial understatement resulting from the omission of income
in 1985 and from the constructive dividends in 1986 and 1987.
To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.