T.C. Memo. 2001-325
UNITED STATES TAX COURT
JOHN A. ROWE AND DONNA L. ROWE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 20890-93, 21346-94. Filed December 28, 2001.
Rodney S. Klein, for petitioner Donna L. Rowe.
John A. Rowe, pro se.
Stephen R. Takeuchi, for respondent.
MEMORANDUM OPINION
RUWE, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes, additions to tax, and
penalties as follows:1
1
The fraud additions to tax pursuant to sec. 6653(b) for the
taxable years 1987 and 1988, and the fraud penalty pursuant to
(continued...)
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Additions to Tax and Penalties
Year Deficiency Sec. 6653(b)(1)(A) Sec. 6653(b)(1)(B) Sec. 6661
1
1987 $173,817 $130,363 $43,454
Sec. 6653(b)(1) Sec. 6661
1988 53,937 $40,453 $13,484
Sec. 6651(a)(1) Sec. 6663
1989 73,279 $13,792 $54,959
Sec. 6654 Sec. 6662(c)
1990 124,891 $8,057 $24,978
1
50 percent of the interest due on $173,817.
After concessions,2 the primary issue for decision is whether
petitioner Donna A. Rowe is entitled to relief from joint
liability pursuant to section 60153 with respect to the following
omitted income and erroneous deduction items giving rise to
deficiencies: (1) Distribution proceeds from a retirement
account in petitioner’s name; (2) capital gain income from the
sale of jointly titled property; (3) mortgage interest deductions
on jointly titled property; (4) losses related to a farming
activity; and (5) charitable contribution deductions.
Additionally, we must decide whether petitioner Donna A. Rowe is
1
(...continued)
sec. 6663 for the taxable year 1989, relate only to petitioner
John A. Rowe.
2
See appendix.
3
References to sec. 6015 are to that section as added to the
Internal Revenue Code by the Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec. 3201,
112 Stat. 734. Unless otherwise indicated, all other 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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liable for any additions to tax or penalties. For purposes of
clarity, after a brief general background and overview of
applicable law, each of the issues submitted for our
consideration is set forth below with separate background and
discussion.
General Background
Some of the facts have been stipulated and are so found.
The stipulation of facts, first supplemental stipulation of
facts, stipulations of agreed issues, stipulation of settled
issues, and the attached exhibits are incorporated herein by this
reference. Petitioners, John A. Rowe (Mr. Rowe) and Donna L.
Rowe (hereinafter petitioner), resided in Florida at the time
they filed their petitions.
Mr. Rowe graduated from the University of Tennessee in 1969
with a degree in dental science. Thereafter, he attended the
University of Tennessee Dental School and received a degree in
dental surgery in 1972 and a degree in oral surgery in 1975.
Petitioner graduated from the University of Tennessee in 1971
with a degree qualifying her as a registered dental hygienist.
Petitioners were married in Kingsport, Tennessee, on June 27,
1971, and they had two children during their marriage,
Christopher and Elizabeth.
From 1971 to 1977, petitioners lived in Memphis, Tennessee,
where Mr. Rowe conducted an oral surgery practice. From 1977 to
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1982, petitioners lived in Bristol, Tennessee, where Mr. Rowe
also conducted an oral surgery practice. In 1981, Mr. Rowe
became licensed to practice oral surgery in the State of Florida.
In 1982, Mr. Rowe was suspended by the Board of Dentistry in
Tennessee and, as a result, Mr. Rowe stopped practicing dentistry
in Tennessee. In 1983, petitioners moved to Madisonville,
Kentucky, where Mr. Rowe worked in a dental clinic. In late
1984, petitioners moved from Kentucky to Osceola County, Florida,
where they resided during the years in issue.
From October 1984 through October 1989, Mr. Rowe was
employed as a dentist and oral surgeon by the Central Florida
Dental Association (CFDA) in Kissimmee, Florida, and St. Cloud,
Florida. Mr. Rowe’s annual salary while at the CFDA was
approximately $240,000, and he also shared in the profits of the
business. Dr. Frank Murray (Dr. Murray) was the president of the
CFDA during the years in issue. In 1989, Dr. Murray suspected
that Mr. Rowe was improperly handling payments from clients and
insurance companies. Mr. Rowe’s employment with the CFDA was
subsequently terminated. The local prosecuting attorney was
informed of Dr. Murray’s suspicions regarding the improper
handling of payments, and Mr. Rowe was investigated and
eventually arrested for embezzling funds. Mr. Rowe was indicted
on charges of grand theft and computer fraud; however, the
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charges were dropped because of insufficient evidence of criminal
intent.
After his employment with the CFDA ended, Mr. Rowe started
his own dental practice, and he also provided dental services
through another business. In April 1995, Mr. Rowe was convicted
of Federal money laundering. He was sentenced to 33 months in
prison and ordered to make restitution of $359,452.17 to the Bank
of New York. In November 1997, Mr. Rowe pleaded guilty to 51
counts of unlawful compensation under Florida State Medicaid laws
and one count of organized fraud. He was sentenced to 8 months
in prison and ordered to make restitution of $5,051.45 to the
Department of Health and Human Services. The 1997 conviction
stemmed from unlawful acts performed by Mr. Rowe in connection
with providing dental services.
During her marriage to Mr. Rowe, petitioner was primarily a
housewife. She engaged in occasional work as a substitute
teacher, did some office filing, and volunteered at church.
Petitioner’s personal income during the years in issue was
minimal. Petitioner has no background in accounting, tax, or
other financial matters. During the years in issue, petitioner
did not have expensive jewelry, drive a luxurious car, or wear
designer clothes. Petitioners’ primary residence during the
years in issue was sparsely furnished with old office furniture
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from Mr. Rowe’s business, and the walls were decorated with arts
and crafts which were handmade by petitioner.
While petitioner was primarily responsible for the household
duties, Mr. Rowe controlled all aspects of petitioners’ financial
matters. Mr. Rowe regularly prepared petitioners’ joint tax
returns, occasionally with the assistance of other individuals.4
During the years in issue, petitioners maintained a joint
checking account (NCNB account) at NCNB National Bank. Deposits
totaling approximately $624,286, $383,557, $26,176, and $7,086,5
respectively, were made into the NCNB account in 1987, 1988,
1989, and 1990. Mr. Rowe deposited money into the NCNB account
at irregular intervals and in amounts necessary to cover
household expenses. Petitioner and Mr. Rowe both wrote checks on
the NCNB account. The majority of the amount paid by checks from
the NCNB account in 1987 and 1988 was related to the purchase of
property and the construction of a residence thereon, and the
checks were written by or at the direction of Mr. Rowe.
Mr. Rowe also maintained separate bank accounts which
petitioner was unaware existed. Petitioner did not have access
4
Richard Danley (Mr. Danley), an accountant, assisted Mr.
Rowe in preparing petitioners’ 1990 Federal income tax return.
5
Approximately $4,102 of the deposit total for 1990
represented petitioner’s earnings from her employment as a
substitute teacher.
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to Mr. Rowe’s separate accounts, and he did not provide her with
information regarding these accounts. Mr. Rowe opened accounts
in petitioner’s name without her knowledge and also signed
petitioner’s name on several occasions without her knowledge.
Petitioner and Mr. Rowe’s divorce was finalized in June
1996. The Final Judgment for Dissolution of Marriage between
petitioner and Mr. Rowe states that petitioner’s “standard of
living and financial circumstances have been devastated by * * *
[Mr. Rowe’s] wrong-doing and incarceration.” The final judgment
also notes that petitioner “does not have the present financial
resources to support herself and * * * [petitioners’ daughter,
Elizabeth] adequately, but that * * * [Mr. Rowe] does not have
the present ability to pay alimony.” As a result of Mr. Rowe’s
criminal activities, petitioner had to move out of the family’s
residence in Florida and back to Kingsport, Tennessee, to live
with her parents. At the time of trial, petitioner was employed
full time as a dental hygienist, and she was paid by commission
only.
For the taxable years 1987, 1988, 1989, and 1990,
petitioners filed joint Federal income tax returns which were
received by respondent on October 19, 1988, October 17, 1989,
July 31, 1991, and October 18, 1991, respectively. On June 25,
1993, respondent issued a notice of deficiency to petitioners for
their taxable years 1987, 1988, and 1989. On August 18, 1994,
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respondent issued a notice of deficiency to petitioners for their
taxable year 1990. Petitioners timely filed petitions seeking
redeterminations. Petitioners subsequently moved to have their
cases consolidated, and we ordered the cases consolidated for
trial, briefing, and opinion.
Petitioner subsequently made valid elections for relief
under section 6015(b), (c), and (f). Respondent granted
petitioner relief from joint liability with respect to some of
the items giving rise to deficiencies; however, respondent denied
relief with respect to other items.
Overview of Applicable Law
If a joint return is filed, the liability with respect to
the tax is normally joint and several. Sec. 6013(d)(3). In
1971, Congress enacted section 6013(e) to correct perceived
inequities resulting from the imposition of joint and several
liability in certain circumstances. S. Rept. 91-1537, at 2
(1970), 1971-1 C.B. 606, 607. As amended,6 section 6013(e)
provided that a spouse could be relieved of tax liability if the
spouse proved: (1) A joint return was filed; (2) the return
contained a substantial understatement of tax attributable to
6
Sec. 6013(e) initially provided relief only in cases
involving an omission of income. The scope of sec. 6013(e) was
expanded in 1984 to provide relief in cases involving erroneous
deductions. Deficit Reduction Act of 1984, Pub. L. 98-369, sec.
424, 98 Stat. 494, 801-803; H. Conf. Rept. 98-861, at 1119
(1984), 1984-3 C.B. (Vol. 2) 1, 373.
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grossly erroneous items of the other spouse; (3) in signing the
return, the spouse seeking relief did not know, and had no reason
to know, of the substantial understatement; and (4) under the
circumstances it would be inequitable to hold the spouse seeking
relief liable for the substantial understatement.
Relief under section 6013(e) was difficult for many
taxpayers to obtain. In 1998, Congress repealed section 6013(e)
and enacted section 6015 in order to make relief from joint
liability more accessible. Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.
3201(a), 112 Stat. 734; H. Conf. Rept. 105-599, at 249 (1998),
1998-3 C.B. 747, 1003. Section 6015 provides three avenues of
relief from joint and several liability: (1) Section 6015(b)(1)
(which is similar to former section 6013(e)) allows a spouse to
escape joint and several liability; (2) section 6015(b)(2) and
(c) allows a spouse to be relieved from a portion of the
understatement or deficiency; and (3) section 6015(f) confers
upon the Secretary discretion to grant equitable relief in
situations where relief is unavailable under section 6015(b) or
(c). Section 6015 generally applies to any liability for tax
arising after July 22, 1998, and any liability for tax arising on
or before July 22, 1998, that remains unpaid as of such date. H.
Conf. Rept. 105-599, supra at 251, 1998-3 C.B. at 1005.
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A spouse seeking relief from joint liability is not limited
to seeking relief under only one subsection; rather, the spouse
may make simultaneous claims for relief under all provisions. In
the instant case, the parties have treated petitioner’s claim for
relief from joint liability as elections pursuant to section
6015(b), (c), and (f).
A. Section 6015(b)
Section 6015(b) provides, in pertinent part:
SEC. 6015(b). Procedures for Relief From
Liability Applicable to All Joint Filers.--
(1) In general.--Under procedures prescribed
by the Secretary, if--
(A) a joint return has been made for a
taxable year;
(B) on such return there is an
understatement of tax attributable to
erroneous items of 1 individual filing the
joint return;
(C) the other individual filing the
joint return establishes that in signing the
return he or she did not know, and had no
reason to know, that there was such
understatement;
(D) taking into account all the facts
and circumstances, it is inequitable to hold
the other individual liable for the
deficiency in tax for such taxable year
attributable to such understatement; and
(E) the other individual elects (in
such form as the Secretary may prescribe) the
benefits of this subsection not later than
the date which is 2 years after the date the
Secretary has begun collection activities
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with respect to the individual making the
election,
then the other individual shall be relieved of
liability for tax (including interest, penalties,
and other amounts) for such taxable year to the
extent such liability is attributable to such
understatement.
(2) Apportionment of relief.--If an
individual who, but for paragraph (1)(C), would be
relieved of liability under paragraph (1)
establishes that in signing the return such
individual did not know, and had no reason to
know, the extent of such understatement, then such
individual shall be relieved of liability for tax
(including interest, penalties, and other amounts)
for such taxable year to the extent that such
liability is attributable to the portion of such
understatement of which such individual did not
know and had no reason to know.
Section 6015(b)(1) is similar to former section 6013(e)(1). We
may look at cases interpreting former section 6013(e)(1) for
guidance when analyzing section 6015(b)(1). Butler v.
Commissioner, 114 T.C. 276, 283 (2000); Braden v. Commissioner,
T.C. Memo. 2001-69.
B. Section 6015(c)
Section 6015(c) provides relief from joint liability for
spouses either no longer married, legally separated, or living
apart. Generally, this avenue of relief allows a spouse to elect
to be treated, for purposes of determining tax liability, as if
separate returns had been filed. Section 6015(c) provides, in
pertinent part:
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SEC. 6015(c). Procedures to Limit Liability for
Taxpayers No Longer Married or Taxpayers Legally
Separated or Not Living Together.--
(1) In general.–-Except as provided in this
subsection, if an individual who has made a joint
return for any taxable year elects the application
of this subsection, the individual’s liability for
any deficiency which is assessed with respect to
the return shall not exceed the portion of such
deficiency properly allocable to the individual
under subsection (d).
(2) Burden of proof.–-Except as provided in
subparagraph (A)(ii) or (C) of paragraph (3), each
individual who elects the application of this
subsection shall have the burden of proof with
respect to establishing the portion of any
deficiency allocable to such individual.
(3) Election.--
* * * * * * *
(C) Election not valid with respect to
certain deficiencies.–-If the Secretary
demonstrates that an individual making an
election under this subsection had actual
knowledge, at the time such individual signed
the return, of any item giving rise to a
deficiency (or portion thereof) which is not
allocable to such individual under subsection
(d), such election shall not apply to such
deficiency (or portion). * * *
1. Allocation of Items
In enacting section 6015, Congress intended that the
election for relief from joint liability “be available to limit
the liability of spouses for tax attributable to items of which
they had no knowledge.” S. Rept. 105-174, at 55 (1998), 1998-3
C.B. 537, 591. Generally, an item giving rise to a deficiency on
a joint return is allocated between the electing spouse and
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former spouse in the same manner as it would have been allocated
if they had filed separate returns for the taxable year.7 Sec.
6015(d)(3)(A); Grossman v. Commissioner, 182 F.3d 275, 278 (4th
Cir. 1999), affg. T.C. Memo. 1996-452; Charlton v. Commissioner,
114 T.C. 333, 342 (2000); see also S. Rept. 105-174, supra at 56,
1998-3 C.B. at 592; H. Conf. Rept. 105-599, supra at 250, 1998-3
C.B. at 1004. The electing spouse has the burden of proof with
respect to establishing the portion of any deficiency allocable
to the electing spouse. Sec. 6015(c)(2). The allocation is made
without regard to community property laws. Sec. 6015(a) (flush
language); Charlton v. Commissioner, T.C. Memo. 2001-76. The
statute provides two exceptions to the general rule of section
6015(d)(3)(A). Section 6015(d)(3)(B) provides that an item
otherwise allocable to one spouse under section 6015(d)(3)(A)
7
Sec. 6015(d) provides, in pertinent part:
SEC. 6015(d). Allocation of Deficiency.--For
purposes of * * * [section 6015(c)]--
* * * * * * *
(3) Allocation of Items Giving Rise to the
Deficiency.-For purposes of * * * [section
6015(c)]-
(A) In general.--Except as provided in
paragraphs (4) and (5), any item giving rise
to a deficiency on a joint return shall be
allocated to individuals filing the return in
the same manner as it would have been
allocated if the individuals had filed
separate returns for the taxable year.
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shall be allocated to the other spouse filing the joint return to
the extent the item gave rise to a tax benefit on the joint
return to the other spouse. Section 6015(d)(3)(C) permits the
Secretary to allocate items other than in the manner described in
6015(d)(3)(A) if the Secretary establishes that such allocation
is appropriate due to fraud of one or both spouses.
Congress has authorized the Secretary to prescribe
regulations providing methods of allocation other than the
methods provided in section 6015(d)(3). Sec. 6015(g)(1); see
also S. Rept. 105-174, supra at 56-57, 1998-3 C.B. at 592-593; H.
Conf. Rept. 105-599, supra at 251, 1998-3 C.B. at 1005. Congress
provided the following guidance regarding the types of
alternative methods of allocating items between spouses:
Under the bill, allocation of items of income and
deduction follows the present-law rules determining
which spouse is responsible for reporting an item when
the spouses use the married, filing separate filing
status. The Secretary of the Treasury is granted
authority to prescribe regulations providing simplified
methods of allocating items.
In general, apportionment of items of income are
expected to follow the source of the income. Wage
income is allocated to the spouse performing the job
and receiving the Form W-2. Business and investment
income (including any capital gains) is allocated in
the same proportion as the ownership of the business or
investment that produces the income. Where ownership
of the business or investment is held by both spouses
as joint tenants, it is expected that any income is
allocated equally to each spouse, in the absence of
clear and convincing evidence supporting a different
allocation.
The allocation of business deductions is expected
to follow the ownership of the business. Personal
deduction items are expected to be allocated equally
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between spouses, unless the evidence shows that a
different allocation is appropriate. For example, a
charitable contribution normally would be allocated
equally to both spouses. However, if the wife provides
evidence that the deduction relates to the contribution
of an asset that was the sole property of the husband,
any deficiency assessed because it is later determined
that the value of the property was overstated would be
allocated to the husband.
Items of loss or deduction are allocated to a
spouse only to the extent that income attributable to
the spouse was offset by the deduction or loss. Any
remainder is allocated to the other spouse.
Income tax withholding is allocated to the spouse
from whose paycheck the tax was withheld. Estimated
tax payments are generally expected to be allocated to
the spouse who made the payments. If the payments were
made jointly, the payments are expected to be allocated
equally to each spouse, in the absence of evidence
supporting a different allocation.
The allocation of items is to be made without
regard to the community property laws of any
jurisdiction.
If the electing spouse establishes that he or she
did not know, and had no reason to know, of an item
and, considering all the facts and circumstances, it is
inequitable to hold the electing spouse responsible for
any unpaid tax or deficiency attributable to such item,
the item may be equitably reallocated to the other
spouse. In cases where the IRS proves fraud, the IRS
may distribute, apportion, or allocate any item between
spouses. [S. Rept. 105-174, supra at 56-57, 1998-3
C.B. at 592-593.]
On January 17, 2001, the Secretary issued proposed
regulations under section 6015.8 Sec. 1.6015-1, Proposed Income
8
On Mar. 29, 2001, minor corrections were made to the
proposed regulations. Sec. 1.6015-1, Proposed Income Tax Regs.,
66 Fed. Reg. 17130 (Mar. 29, 2001). The proposed regulations
provide that erroneous items are generally allocated between
spouses as if separate returns are filed, subject to four
exceptions. Sec. 1.6015-3(d)(2), Proposed Income Tax Regs., 66
Fed. Reg. 3888, 3898 (Jan. 17, 2001). The exceptions cover
situations where: (1) One spouse receives a tax benefit on the
(continued...)
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Tax Regs., 66 Fed. Reg. 3888 (Jan. 17, 2001). To date, no final
regulations have been issued.
2. Actual Knowledge
If the Commissioner demonstrates that an individual making
the election under section 6015(c) had “actual knowledge”, at the
time such individual signed the return, of any item giving rise
to a deficiency (or portion thereof) which is not allocable to
such individual under section 6015(d), the election under section
6015(c) will not apply to such deficiency (or portion). Sec.
6015(c)(3)(C). In the context of omitted income, the
Commissioner must show that the electing spouse had an “actual
and clear awareness of the omitted income.” Cheshire v.
Commissioner, 115 T.C. 183, 195 (2000). In the context of a
disallowed deduction, the Commissioner must show that the
electing spouse had “actual knowledge of the factual
circumstances which made the item unallowable as a deduction.”
King v. Commissioner, 116 T.C. 198, 204 (2001). In either
context, actual knowledge on the part of the electing spouse as
8
(...continued)
joint return, (2) one or both spouses commit fraud, (3) erroneous
items of income are present, and (4) erroneous deduction items
are present. Sec. 1.6015-3(d)(2)(i)-(iv), Proposed Income Tax
Regs., supra. With respect to situations involving omitted
income and erroneous deduction items, the proposed regulations
provide language similar to that contained in the legislative
history. Sec. 1.6015-3(d)(2)(iii), (iv), Proposed Income Tax
Regs., supra. The proposed regulations omit Congress’s reference
to the equitable reallocation of an item where the electing
spouse did not know, or have reason to know, of an item.
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to the tax laws or legal consequences of the operative facts is
not required. King v. Commissioner, supra, at 204; Cheshire v.
Commissioner, supra, at 195.
C. Section 6015(f)
Section 6015(f) permits the Secretary to relieve a spouse of
liability if, taking into account all the facts and
circumstances, it is inequitable to hold the spouse liable for
any unpaid tax or deficiency (or any portion of either) and
relief is not otherwise available under section 6015(b) or (c).
Sec. 6015(f); Cheshire v. Commissioner, supra at 197.
Respondent’s denial of equitable relief is reviewed under an
abuse of discretion standard. Cheshire v. Commissioner, supra at
198; Butler v. Commissioner, 114 T.C. at 292. This is a question
of fact. Cheshire v. Commissioner, supra.
On the basis of the circumstances of this case, we initially
consider the merits of petitioner’s claims for relief with
respect to income and deduction items under section 6015(c). The
parties agree that petitioner made a valid election under section
6015(c), she was no longer married to Mr. Rowe at the time of the
election, and petitioner and Mr. Rowe filed joint returns for the
years in issue. To the extent petitioner fails to qualify for
relief under subsection (c), we address her claim for relief
under section 6015(b). To the extent petitioner fails to qualify
for relief under section 6015(b) or (c), we address her claim for
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equitable relief under section 6015(f). Finally, we address
whether petitioner is liable for any additions to tax or
penalties for the years in issue.
I. Retirement Account Distributions
A. Background
In 1990, lump-sum distributions were made from various
pension, profit sharing, and retirement accounts bearing the name
of either petitioner or Mr. Rowe. The taxable amount distributed
from the accounts in Mr. Rowe’s name totaled $112,979. The
taxable amount distributed from an individual retirement account
(IRA) in petitioner’s name totaled $3,426. These amounts were
not reported on petitioners’ 1990 Federal income tax return.
Respondent concedes that petitioner is entitled to be relieved
from joint liabilities attributable to the amount distributed
from Mr. Rowe’s accounts.
B. Discussion
1. Allocation of Item
Petitioner argues that the distributions from the IRA in her
name are allocable to Mr. Rowe because he concealed the account
from petitioner and she was not aware of the account or the
distributions until after she signed the return for the year in
issue. Respondent contends that the distributions from the IRA
are allocable to petitioner because the account was in her name
and she received the distributions.
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In analyzing relief from joint liability under section
6015(c), items are generally allocated as if petitioner and Mr.
Rowe had filed separate returns. Sec. 6015(d)(3)(A). The first
principle of income taxation is that income must be taxed to him
who earns it. Commissioner v. Culbertson, 337 U.S. 733, 739-740
(1949); Schuster v. Commissioner, 84 T.C. 764, 773 (1985), affd.
800 F.2d 672 (7th Cir. 1986). Married individuals filing
separate returns are required to report their own income.
Charlton v. Commissioner, T.C. Memo. 2001-76.
Petitioner testified that before 1995 she was not aware of
any retirement accounts or plans established in her name. She
could not recall signing any papers to open a retirement account,
authorizing withdrawals, signing distribution checks, or
receiving any funds from a retirement account. Mr. Rowe
testified that he personally established the retirement account
and that he could have opened it in petitioner’s name without her
knowledge. Mr. Rowe also testified that he believed funds were
borrowed from the account, but that he did not consult petitioner
regarding the loan. Mr. Rowe further testified that he provided
no information to petitioner regarding retirement planning.
The process of distilling truth from falsehood from the
testimony of witnesses, whose demeanor and credibility we
observe, is the daily grist of judicial life. Diaz v.
Commissioner, 58 T.C. 560, 564 (1972). After watching petitioner
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at trial and observing her demeanor, we found her to be a
credible and earnest witness, and we are satisfied that her
testimony was truthful. Additionally, Mr. Rowe’s testimony was
consistent with petitioner’s claim that she was not aware of the
IRA or the distributions before 1995. The evidence in the record
indicates that Mr. Rowe opened the IRA in petitioner’s name and
concealed the account and the distributions from her.
Consequently, petitioner’s only apparent connection to the IRA
was that her name was listed as the owner of the account.
In the instant case, this item is allocable to Mr. Rowe, and
petitioner will be entitled to relief from joint liability under
section 6015(c), unless respondent shows that she had actual
knowledge of this item.9 We note Congress’s desire regarding
allocation in certain situations:
If the electing spouse establishes that he or she
did not know, and had no reason to know, of an item
and, considering all the facts and circumstances, it is
inequitable to hold the electing spouse responsible for
any unpaid tax or deficiency attributable to such item,
the item may be equitably reallocated to the other
spouse. * * * [S. Rept. 105-174, supra at 57, 1998-3
C.B. at 593.]
9
On the basis of Mr. Rowe’s control and concealment of the
retirement account and the distributions, it appears that Mr.
Rowe, not petitioner, would have been required to report this
item if he had filed a separate return. See, e.g., James v.
United States, 366 U.S. 213, 219 (1961) (holding that embezzled
funds must be included in the embezzler’s gross income for
Federal income tax purposes in the year in which they were
misappropriated); Yerkie v. Commissioner, 67 T.C. 388, 390 (1976)
(same).
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In our opinion, the extreme facts and circumstances presented
represent just such a situation envisioned by Congress.
2. Actual Knowledge
Respondent argues that even if this item were allocable to
Mr. Rowe, petitioner still had actual knowledge and reason to
know of the item because she testified that she sorted the mail
and opened letters addressed to her. Respondent claims that
petitioner must have known about the IRA because periodic
statements from the financial institution managing the account
were addressed to her individually at her home address.
As we mentioned earlier, petitioner credibly testified that
before 1995 she was not aware of the existence of any retirement
accounts or plans in her name. Petitioner testified that she
usually collected the mail, but that she never saw any letters
notifying her of the existence of the IRA or the distributions.
Mr. Rowe testified that sometimes he picked up the mail, and
petitioners’ son, Christopher, testified that whoever got home
first would pick up the mail. Additionally, Mr. Rowe testified
that he provided petitioner with no information regarding
retirement planning. Whether petitioner had an actual and clear
awareness of the omitted income is an essential fact respondent
is required to establish under section 6015(c)(3)(C). Respondent
has failed to establish this fact. Accordingly, we hold that
- 22 -
petitioner is entitled to relief from joint liability under
section 6015(c) with respect to this item.
II. Capital Gain from the Sale of Real Property
A. Background
From late 1984 until May 1987, petitioners lived in Osceola
County, Florida, and resided at certain property known as Lots 22
and 27. Petitioners eventually purchased Lots 22 and 27 and the
property was titled jointly in their names.
On May 11, 1987, petitioners sold lots 22 and 27 to Harry
and Shelby Justice for a total sale price of $367,900.
Petitioners’ basis in the property at the time of the sale was
$310,000, and the commission paid on the sale was $25,753. The
gain on the sale was $32,147. In connection with the sale, a
check for $89,210.53 representing the proceeds of the sale was
issued payable to “John A. & Donna L. Rowe”. Petitioner signed
the settlement statement for the property and endorsed the
check.10 The check was deposited into petitioners’ NCNB account
on May 11, 1987. Petitioners’ 1987 Federal income tax return
listed a capital gain of $30,159. The capital gain reported on
the return did not include any portion of the $32,147 gain from
the sale of Lots 22 and 27.
10
Petitioner’s name is signed “Donna L. Rowe” on the
settlement statement and the check.
- 23 -
In 1987, certain real property (Anorada property) was
purchased in the names of petitioner and Mr. Rowe.11 On
September 30, 1988, the Anorada property was sold to Mohamed and
Nabila Mohamed for a total sale price of $25,000. Before the
sale, the property was titled jointly in the names of petitioner
and Mr. Rowe. The basis in the Anorada property at the time of
the sale to the Mohameds was $20,000, and the commission paid on
the sale was $2,500. The gain on the sale was $2,500. In
connection with the sale, a check for $13,552.31 representing the
sale proceeds was issued payable to “John Rowe and Donna Rowe”.
Petitioner’s name is signed on both the settlement statement and
the check.12 The check was deposited into petitioners’ NCNB
account on September 30, 1988. Petitioners’ 1988 return listed a
capital gain of $20,695. The capital gain reported on the return
did not include the $2,500 gain from the sale of the Anorada
property.
B. Discussion
1. Allocation of Items
Petitioner argues that Mr. Rowe’s secretive nature regarding
his personal and financial activities supports allocating these
11
Copies of a deed and a settlement statement list
petitioner and Mr. Rowe as the purchasers of the Anorada
property; however, neither petitioner’s nor Mr. Rowe’s signature
appears on the copies of the documents.
12
Petitioner’s name is signed “Donna Rowe” on the settlement
statement and check.
- 24 -
items to him because petitioner did not know, or have any reason
to know, that the gains were not reported on the 1987 and 1988
tax returns. Respondent contends that the capital gain income is
allocable evenly between petitioner and Mr. Rowe because the
properties were jointly titled, and petitioner would have been
required to report half of the proceeds from the sales had she
filed separate returns.
Petitioner claims that she was often required to sign
documents by Mr. Rowe under conditions where she was not allowed
to question the contents of the documents. Petitioner maintains
that Mr. Rowe did not tell her that she was listed as an owner of
assets on any of the documents she signed. Petitioner
acknowledges on brief that she and Mr. Rowe purchased properties;
however, she claims that she was unaware of the disposition of
many of the properties. Petitioner has not specifically asserted
that she unknowingly signed documents related to the Anorada
property or that she was unaware that her name was listed as a
joint owner of the property.
Lots 22 and 27 and the Anorada property were titled jointly
in the names of petitioner and Mr. Rowe. Petitioner testified
that she was aware that she was listed as joint owner of Lots 22
and 27, and she remembered the approximate purchase price of the
property. Petitioner’s testimony also reflected that she was
- 25 -
aware that loans were obtained to finance the purchase of the
property.
The evidence in the record reflects that petitioner knew
that Lots 22 and 27 and the Anorada property were purchased, and
she knew that she was listed as a joint owner of the property.
Petitioner has failed to establish that the items should be
allocated in a manner other than in proportion to petitioner’s
and Mr. Rowe’s respective ownership interests. Accordingly,
these items are allocable evenly between petitioner and Mr. Rowe.
Therefore, to the extent petitioner lacked actual knowledge of
these items, she will qualify for relief from joint liability
under section 6015(c) for the portion of the item allocable to
Mr. Rowe.13
2. Actual Knowledge
Respondent maintains that petitioner had actual knowledge of
the capital gain income from the sales of Lots 22 and 27 and the
Anorada property because petitioner was a co-owner of the
properties, she signed the settlement statements, and she
endorsed the settlement checks. Petitioner claims that she was
unaware of any gain on the sale of Lots 22 and 27 because she did
not have access to financial records, and she relied on Mr.
13
Because petitioner cannot qualify for relief under sec.
6015(c) for the portions of items which are allocable to her, we
analyze her ability to qualify for relief for such portions in
our later discussion under sec. 6015(b) and (f). See infra pp.
53-61.
- 26 -
Rowe’s determination that there was no gain. Additionally,
petitioner contends that she was unaware that the Anorada
property was sold in 1988 and that it should have been reported
on the 1988 return.
In Charlton v. Commissioner, 114 T.C. 333 (2000), we found
that although the electing spouse had actual knowledge of income
from a particular source and knew generally of the source of the
income, he had no knowledge that all income from that source had
not been accounted for as reported. Thus, we held that the
electing spouse qualified for relief under section 6015(c)
because “respondent has not shown that Charlton had actual
knowledge of the item causing the deficiency”. Id. at 341. A
few months later, in Cheshire v. Commissioner, 115 T.C. 183
(2000), we held that where the spouse claiming relief under
section 6015(c) had actual knowledge of the omitted income but
did not have knowledge “whether the entry on the return is or is
not correct”, relief was not available. Id. at 195. In Martin
v. Commissioner, T.C. Memo. 2000-346, we discussed generally our
decisions in Charlton v. Commissioner, supra, and Cheshire v.
Commissioner, supra. We concluded that actual knowledge of a
disputed item of income and the amount thereof prevents a
taxpayer from claiming relief from joint liability under section
6015(c). Id. We noted that where an electing spouse has actual
knowledge of an income source, but no knowledge of the amount of
- 27 -
the financial gain, the electing spouse may still qualify for
relief under section 6015(c). Id. With those principles in
mind, we now consider whether petitioner had actual knowledge of
the omitted capital gains income.
i. Lots 22 and 27
With respect to Lots 22 and 27, petitioner testified that
she was aware that the property was sold to Harry and Shelby
Justice in 1987. Petitioner signed the settlement statement for
the property and endorsed the check representing the proceeds
from the sale. However, the evidence in the record supports
petitioner’s claim that she did not know the actual amount of
gain on the sale. Petitioner testified that she simply signed
loan and deed documents and nobody explained them to her. She
testified she did not see any type of financial statements at the
closing of any real estate, and she did not have access to any
statements or documents identifying the amount of interest paid
on any mortgages.14
The testimony of petitioner and Mr. Rowe reflects that when
petitioners filed their Federal income tax returns for the years
in issue, petitioner was given the first two pages only of the
tax returns when signing the returns, and she was not afforded
the opportunity to see or review any attachments, schedules, or
14
We note that the settlement statement does not identify
petitioners’ basis in the property at the time of sale.
- 28 -
other documents pertaining to the returns. Petitioner testified
that Mr. Rowe assured her he had records for petitioners’ tax
returns. Petitioner claims that she was unaware of any gain from
the sale of real estate and that she believed that all income,
capital gains or otherwise, was included on petitioners’ tax
returns.15
Petitioner has admitted that she knew Lots 22 and 27 were
sold in 1987. However, respondent has not proven that petitioner
knew the amount of the gain on the sale, or even that any gain
was made on the sale. Therefore, respondent has failed to
establish that petitioner had actual knowledge of this item
giving rise to a deficiency. Accordingly, we hold that
petitioner is entitled to relief from joint liability under
section 6015(c) for the portion of this item allocable to Mr.
Rowe.
ii. Anorada Property
Petitioner maintains that she was unaware that the Anorada
property was sold in 1988. In connection with the sale of the
Anorada property, a settlement check dated September 30, 1988,
for $13,552.31 was written payable to “John Rowe and Donna Rowe”.
Petitioner claims that she did not endorse the settlement check
because the signature does not look like hers and because she
15
We note that the first page of the 1987 return lists a
capital gain of $30,159, which is almost the same amount of gain
realized on the sale of Lots 22 and 27.
- 29 -
signs her name “Donna L. Rowe”, not “Donna Rowe”. Mr. Rowe
testified that he signed petitioner’s name on different
documents, and he supposed he might have done so on a settlement
statement. Although Mr. Rowe initially testified that he did not
sign petitioner’s name on the settlement statement or the check
for the Anorada property, he then testified that “there’s no
telling what I might have done.”
Petitioner’s testimony that she was unaware of the sale of
the Anorada property was credible and persuasive. Mr. Rowe’s
testimony regarding whether he signed petitioner’s name on the
settlement statement and check was unclear. Indeed, Mr. Rowe
admitted that he had signed petitioner’s name in the past without
her knowledge and that he generally did not provide her with
information regarding real estate transactions. Overall, we find
that respondent has not satisfied his burden of proving that
petitioner had actual knowledge of this item giving rise to a
deficiency. Accordingly, we hold that petitioner is entitled to
relief from joint liability under section 6015(c) for the portion
of this item allocable to Mr. Rowe.
III. Mortgage Interest
A. Background
In May 1987, petitioners sold Lots 22 and 27 and purchased
two adjoining 5-acre lots (Albritton property) across the street
from Lots 22 and 27. One lot was fenced and on it were a horse
- 30 -
barn, a maintenance shed, and a larger building. A sign on the
road indicated that the lot was the Lake Gentry Horse Farm. On
the adjoining lot, petitioners constructed a new residence. From
May 1987 until late 1988, petitioners temporarily resided at
property known as Acorn Court while their new home was being
constructed. In the summer of 1988, petitioners moved into their
new residence. The total cost for the Albritton property and the
new residence exceeded $1 million. The residence was jointly
titled in the names of petitioner and Mr. Rowe.
On the Schedule A, Itemized Deductions, attached to their
1987 return, petitioners claimed a home mortgage interest
deduction of $62,545. Petitioners substantiated $50,376 of this
amount. Respondent disallowed the remaining $12,169 of the
claimed deduction on the basis of a lack of substantiation.
On the Schedule A attached to their 1988 return, petitioners
claimed a home mortgage interest deduction of $97,341. On the
attached Schedule A, the notation “84,186 + 13,155" appears next
to the figure $97,341. The Schedule E, Supplemental Income
Schedule, attached to the return lists $13,155 as mortgage
interest paid on rental property identified as “Bayview House”.
Petitioners substantiated $84,186 of the amount claimed for the
home mortgage interest deduction. The remaining $13,155 of the
home mortgage interest deduction was
- 31 -
disallowed by respondent because it was a duplicate deduction of
interest paid on the Bayview House.16
On the Schedule A attached to their 1990 return,
petitioners’ claimed a home mortgage interest deduction of
$122,526. Additionally, an interest expense of $60,564 was
listed on the Schedule F, Farm Income and Expenses, attached to
the return. In the notice of deficiency for 1990, respondent
allowed a mortgage interest deduction of $66,105 and disallowed
the remaining $56,421 claimed on the Schedule A. The notice of
deficiency provided the following explanation:
(h)(I) It is determined that the Schedule A Itemized Deductions
claimed on the 1990 return for Interest Expense is only allowable
to the extent of $66,105.00. Since you claimed $122,526.00, your
taxable income is increased in the amount of $56,421.00 as shown
below:
16
In the notice of deficiency for the years 1987, 1988, and
1989, respondent provided the following explanation:
1.f.II. It is determined that $13,155 of home
mortgage interest expense claimed on Schedule
A in the 1988 tax year is disallowed because
this amount relates to one of your rental
properties and has already been deducted on
Schedule E. Thus, this mortgage interest
must be disallowed from Schedule A to prevent
it from being deducted twice.
Accordingly, your taxable income for the 1988
tax year is increased by $13,155.
- 32 -
Substantiated Interest Expense
Household Finance $69,770
Farmers Bank and Trust 9,671
Home Savings of America 11,417
Central Fidelity 7,922
Allowable Interest Expense 98,780
Factor (33.1% for Schedule F & 66.9%
for Schedule A) x .669
1
Allowable Schedule A Itemized Deduction 66,105
Claimed on the 1990 Tax Return 122,526
2
Increase in Taxable Income 56,421
1
We note that 98,780 x .669 yields a result of 66,083.82, not 66,105.
2
After factoring in respondent’s previously mentioned mathematical
error, the actual increase in taxable income would be $56,442.18. Thus,
respondent’s mathematical error benefits petitioners.
B. Discussion
1. Allocation of Items
Petitioners’ 1987, 1988, and 1990 tax returns overstated
itemized deductions for home mortgage interest. Generally, this
personal deduction item is allocated evenly between individuals.
Sec. 6015(d)(3)(A); S. Rept. 105-174, supra at 57, 1998-3 C.B. at
593. Petitioner bears the burden of proving that a different
allocation is appropriate. Sec. 6015(c)(2); S. Rept. 105-174,
supra at 57, 1998-3 C.B. at 593.
During the years in issue, petitioners resided at Lots 22
and 27, Acorn Court, and the Albritton property. These
residences and the corresponding mortgages were in the joint
names of petitioner and Mr. Rowe. Petitioner testified that she
was aware that the residences were jointly titled, and she knew
that loans were acquired on these properties. Petitioner
acknowledged signing the loan and deed documents for the
- 33 -
properties. Under these circumstances, these items are allocable
evenly between petitioner and Mr. Rowe. Therefore, to the extent
petitioner lacked actual knowledge of these items, she will
qualify for relief from joint liability under section 6015(c) for
the portion of the item allocable to Mr. Rowe.17
2. Actual Knowledge
Respondent argues that petitioner had actual knowledge of
the erroneous mortgage interest deductions. In order to prove
actual knowledge in the context of an erroneous deduction,
respondent must show that petitioner had “actual knowledge of the
factual circumstances which made the item unallowable as a
deduction.” King v. Commissioner, 116 T.C. at 204.
i. 1987 Mortgage Interest
Respondent disallowed $12,169 of the claimed mortgage
interest deduction for 1987 on the basis of a lack of
substantiation. Thus, respondent must show that petitioner knew
or believed that the mortgage interest for 1987 was overstated by
$12,169. See id.
Respondent claims that petitioner had actual knowledge of
the existence and amount of the home mortgage interest payments
in 1987 because she wrote the checks to pay the mortgage
17
Because petitioner cannot qualify for relief under sec.
6015(c) for the portions of items which are allocable to her, we
analyze her ability to qualify for relief for such portions in
our later discussion under sec. 6015(b) and (f). See infra pp.
53-61.
- 34 -
interest. Petitioner agrees that she knew of the mortgage;
however, she claims that she was unaware of the amount of
interest paid or that it was incorrectly reported on the tax
return.
The evidence in the record demonstrates that petitioner
wrote the checks for the mortgage payments in 1987 and 1988.
However, there is no evidence that petitioner knew what portion
of the payments for 1987 constituted interest or the total amount
of interest paid in that year. The testimony of both petitioner
and Mr. Rowe indicates that petitioner was given only the first
two pages of the tax return when signing the return and she was
not afforded the opportunity to see or review any attachments,
schedules, or other documents pertaining to the return.
Therefore, respondent has failed to show that petitioner knew or
believed that the 1987 mortgage interest was overstated.
Accordingly, we hold that petitioner is entitled to relief from
joint liability under section 6015(c) for the portion of this
item allocable to Mr. Rowe.
ii. 1988 Mortgage Interest
Petitioners claimed a home mortgage interest deduction of
$97,341 in 1988. Petitioners substantiated $84,186 of the amount
claimed for the home mortgage interest deduction. The notice of
deficiency for 1987, 1988, and 1989, provided the following
- 35 -
explanation for disallowing the remaining $13,155 claimed as
deductible home mortgage interest:
It is determined that $13,155 of home mortgage interest
expense claimed on Schedule A in the 1988 tax year is
disallowed because this amount relates to one of your
rental properties and has already been deducted on
Schedule E. Thus, this mortgage interest must be
disallowed from Schedule A to prevent it from being
deducted twice.
Accordingly, your taxable income for the 1988 tax year
is increased by $13,155.
Thus, in order to establish actual knowledge, respondent must
show that petitioner knew or believed that $13,155 of the claimed
mortgage interest was unallowable because it was already listed
on Schedule E.
Respondent claims that petitioner had actual knowledge of
the existence and the amount of the home mortgage interest
payments in 1988 because she also wrote the checks to pay the
mortgage interest for that year. Petitioner agrees that she knew
of the mortgage; however, she claims that she was unaware of the
amount of interest paid or that it was incorrectly reported on
the tax return. Petitioner testified that she received the first
two pages only of the tax return and that she did not see any
attached schedules or other documentation. Respondent failed to
present evidence showing that petitioner had actual knowledge
that the 1988 mortgage interest was overstated because the
$13,155 had already been listed as a rental expense on Schedule
E. Therefore, we find that petitioner did not have actual
- 36 -
knowledge of the factual circumstances which made $13,155
unallowable as a Schedule A itemized deduction. Accordingly, we
hold that petitioner is entitled to relief from joint liability
under section 6015(c) for the portion of this item allocable to
Mr. Rowe.
iii. 1990 Mortgage Interest
Petitioners claimed a home mortgage interest deduction of
$122,526 in 1990. Respondent determined that petitioners’
allowable interest expenses was $98,780 but that 33.1 percent of
this amount should have been reported on Schedule F.18 On the
basis of this determination, respondent allowed a mortgage
interest deduction of $66,105 and disallowed $56,421.19 Thus, in
order to establish actual knowledge, respondent must show that
18
The notice of deficiency provides no explanation as to how
this allocation was determined or why 33.1 percent of the
allowable interest expense should have been reported on Schedule
F. At trial, Robert Bamber (Mr. Bamber), the revenue agent
assigned to the examination of petitioners’ 1990 tax return,
testified that he examined the interest expense claimed on
Schedule F, $60,564, and the mortgage interest deduction claimed
on Schedule A, $122,526, and calculated the proportion claimed on
each Schedule in relation to the overall interest amount claimed,
$183,090. On the basis of information reported by other sources,
Mr. Bamber determined that petitioners’ allowable interest
related deduction was $98,780, and he allocated this amount
between the Schedule A and the Schedule F in the same proportion
as the amounts claimed on the 1990 return. Consequently,
respondent limited petitioners’ Schedule A mortgage interest
deduction to $66,105.
19
As previously mentioned, the notice of deficiency contains
a mathematical error which benefits petitioners by approximately
$21. For purposes of this issue, we shall use the amounts
determined by respondent in the notice of deficiency.
- 37 -
petitioner knew or believed that petitioners’ home mortgage
interest was limited to $66,105.
Respondent’s sole contention is that because petitioner had
actual knowledge of the amount of interest payments in 1987 and
1988, petitioner also had actual knowledge of the amount of
interest paid on the mortgage in 1990. Petitioner agrees that
she knew of the mortgages; however, she claims that she was
unaware of the amount of interest paid or that it was incorrectly
reported on the tax returns. Petitioner claims that the interest
payments for 1990 were deducted on Schedule A as home mortgage
interest and on Schedule F as farm interest expense. Petitioner
contends that she did not know how much interest was paid on the
mortgage, and, because she was allowed to review the first two
pages only of the 1990 return and not the corresponding
schedules, she was unaware that the interest payments were
deducted twice.
No evidence was presented establishing what funds were used
to make the mortgage interest payments in 1990. Our review of
the bank statements for 1990 for the NCNB account reveals that
the opening balance was approximately $1,855 and that deposits
totaling only approximately $7,086 were made during that year.
Thus, it appears that little, if any, funds were used from the
- 38 -
NCNB account to make the mortgage interest payments in 1990.20
As we mentioned earlier, the record indicates that petitioner saw
the first two pages only of the tax returns, and she was not
afforded the opportunity to see or review any attachments,
schedules, or other documents pertaining to the returns. Thus,
petitioner would not have known that a portion of the interest
payments was deducted as both a Schedule A itemized deduction and
a Schedule F interest expense. Respondent has not established
that petitioner had actual knowledge of the factual circumstances
which limited the 1990 Schedule A mortgage interest to $66,105.
Accordingly, we hold petitioner is entitled to relief from joint
liability under section 6015(c) for the portion of this item
allocable to Mr. Rowe.
IV. Farming Activity Losses
A. Background
During the years in issue, Mr. Rowe owned and showed horses.
Petitioner had little or no involvement in this horse activity.
In 1987, Mr. Rowe employed Joseph and Patricia Shortino (the
Shortinos) as horse trainers, and they showed and stabled Mr.
Rowe’s horses during the years in issue.21 The Shortinos had
20
We note that Mr. Rowe testified that at some point during
the years in issue he took over the responsibility of making the
mortgage payments.
21
Mr. Rowe first met Joseph and Patricia Shortino (the
Shortinos) in 1985, and they became personal friends of
(continued...)
- 39 -
been in the horse business since 1979, and they operated an S
corporation called Showcase Farm, Inc. Mr. Rowe purchased a
horse trailer for the Shortinos to use in connection with the
horse activity. Mr. Rowe and petitioners’ son, Christopher, also
participated in showing horses during the years in issue. For
the years in issue, the income and expenses of the
horse activity were reported on a Schedule F attached to
petitioners’ tax returns.
At some point in time during the years in issue, Mr. Rowe
became involved in raising fish. The income and expenses for the
horse and fish activities (collectively, farming activity) were
combined for tax reporting purposes. Petitioner was not involved
in the fish activity.
For the years in issue, the following losses from the
farming activity were reported on the Schedules F:
Year Loss Amount
1987 $143,650
1988 117,278
1989 139,448
1990 184,221
For the taxable years 1987, 1988, and 1989, petitioner and Mr.
Rowe were listed on the Schedules F as the proprietors of the
farming activity. For the taxable year 1990, Mr. Rowe alone was
21
(...continued)
petitioners.
- 40 -
listed on the Schedule F as the proprietor of the farming
activity.
B. Discussion
1. Allocation of Item
Petitioner argues that the farming activity is allocable to
Mr. Rowe because petitioner had little or no involvement in
either the horse activity or the fish activity. However,
respondent contends that the farming activity is still allocable
evenly between petitioner and Mr. Rowe. Respondent relies on the
fact that petitioner’s name is listed on the tax returns for
1987, 1988, and 1989 as a proprietor of the farming activity to
support his contention. Additionally, respondent argues that the
horse activity was a family affair that petitioner participated
in by attending different events.
Petitioner testified that she watched Christopher
participate in horse shows “less than half a dozen times” during
the years in issue. Contrary to respondent’s argument,
petitioner testified that only Christopher was involved in
showing horses during the years in issue and that Elizabeth did
not become involved until later. Mr. Shortino corroborated
petitioner on this point, testifying that Elizabeth did not begin
showing horses until sometime around 1992. Petitioner claims she
did not know the extent of the horse activity, played no role in
the decision to acquire the farm property, and only saw the
- 41 -
horses in the possession of the Shortinos. Christopher testified
that petitioner was not involved in the horse activity and that
she did not make any decisions relating to the activity.
Mr. Rowe testified that he made the original decision to
start the horse activity and that he did not discuss it with
petitioner. Mr. Rowe considered the activity principally his,
and he included his children in the activity. Mr. Rowe testified
that he made all decisions regarding the horse activity and told
petitioner nothing about the horse activity. Additionally, Mr.
Rowe testified that he did not consult petitioner before starting
the fish activity, and he did not believe she wrote any checks in
connection with the fish farm. With respect to the fact that
petitioner’s name was listed as a proprietor on the 1987, 1988,
and 1989 tax returns, Mr. Rowe testified that the 1987 and 1988
returns were filled out by another individual and he simply
signed them without reviewing their contents. As we have
mentioned previously, the record indicates that petitioner was
given the first two pages only of the tax returns when signing
the returns, and she was not afforded the opportunity to see or
review any attachments, schedules, or other documents pertaining
to the returns.
The Shortinos testified that the checks they received for
their services as horse trainers while employed by Mr. Rowe
always came from him and never from petitioner. Our review of
- 42 -
the checks written on petitioners’ joint account during the years
in issue confirms that petitioner’s signature does not appear on
any of the checks written to Showcase Farms, Inc., the Shortinos’
S corporation.22 The Shortinos also testified that they
consulted only with Mr. Rowe regarding the horses. Mr. Shortino
testified that he never saw petitioner’s name listed as an owner
of any of the horses and that petitioner was not involved in the
activity. Mr. Shortino testified that petitioner did not know
Mr. Rowe had purchased the horse trailer, and Mrs. Shortino
testified that Mr. Rowe specifically told her not to tell
petitioner about the horse trailer.
The evidence in the record reflects that petitioner’s
involvement in the farming activity during the years in issue was
minimal and purely social in nature. Other than infrequent
attendance at horse shows to support her son, petitioner’s only
apparent link to the activity is that her name is listed as a
proprietor on the 1987, 1988, and 1989 tax returns. In this
regard, the evidence reflects that petitioner was unaware she was
22
No checks from petitioners’ joint account were written to
either Joseph Shortino or Patricia Shortino. Only Mr. Rowe’s
signature is listed on various checks payable to Showcase Farms,
Inc., dated during the years in issue. Additionally, only Mr.
Rowe’s signature is listed on two other checks with memo
notations of “Horse show” and “Stable”. Our review of all the
checks written on petitioners’ joint account reveals that
petitioner’s signature is not listed on any checks which, on the
basis of the payee and the memo notation, indicate payment in
connection with any horse or fish activity.
- 43 -
listed as a proprietor, and we decline to allocate any portion of
this item to her simply because her name was listed as such on
the tax returns. See, e.g., Bokum v. Commissioner, 94 T.C. 126,
140-141 (1990), affd. 992 F.2d 1132 (11th Cir. 1993); Buchine v.
Commissioner, T.C. Memo. 1992-36, affd. 20 F.3d 173 (5th Cir.
1994). Accordingly, this item is allocable to Mr. Rowe.
Consequently, petitioner will be entitled to complete relief from
joint liability under section 6015(c) unless respondent can show
that petitioner had actual knowledge of this item.
2. Actual Knowledge
In the notice of deficiency for the years 1987, 1988, and
1989, respondent determined that petitioners were not entitled to
the claimed Schedule F losses because the farming activity was
not engaged in for profit. In the notice of deficiency for 1990,
respondent determined that petitioners were not entitled to the
claimed Schedule F loss because it had not been established that
the farming activity was engaged in as a trade or business within
the meaning of section 162 or as a means of holding property for
the production of income within the meaning of section 212.
Respondent’s primary position under section 6015(c)(3)(C) is that
petitioner had actual knowledge that Mr. Rowe was not engaged in
the farming activity for profit.23 In order to prove actual
23
As an alternative ground for disallowing the Schedule F
losses, respondent determined that petitioners failed to
(continued...)
- 44 -
knowledge, respondent must show that petitioner had “actual
knowledge of the factual circumstances which made the item
unallowable as a deduction.” King v. Commissioner, 116 T.C. at
204. In the instant case, this requires that respondent prove
that petitioner knew or believed that Mr. Rowe was not engaged in
the farming activity for profit. See King v. Commissioner, supra
at 205.
Section 183 provides that expenses incurred in conducting an
activity which is “not engaged in for profit” are not deductible,
except as otherwise provided in section 183(b). Section 183(c)
defines an activity not engaged in for profit as “any activity
other than one with respect to which deductions are allowable for
the taxable year under section 162 or under paragraph (1) or (2)
of section 212.” This case is appealable to the Court of Appeals
for the Eleventh Circuit. In determining whether an activity is
engaged in for profit, the Court of Appeals for the Eleventh
Circuit has stated that the relevant inquiry is whether the
taxpayer’s actual and honest objective in engaging in the
activity is to make a profit. Osteen v. Commissioner, 62 F.3d
23
(...continued)
substantiate the claimed losses. On brief, respondent limits his
sec. 6015(c) argument to the contention that petitioner had
actual knowledge that the horse and fish activities were not
engaged in for profit. While respondent asserts that petitioners
have failed to prove that the losses were actually incurred,
respondent has not proven that the losses were not incurred and
makes no allegation that petitioner had actual knowledge that
such losses were not incurred.
- 45 -
356, 358 (11th Cir. 1995), affg. in part and revg. in part T.C.
Memo. 1993-519; Zarins v. Commissioner, T.C. Memo. 2001-68.
While a reasonable expectation of profit is not required, the
objective facts and circumstances must indicate that the
taxpayer’s intent was to make a profit. Osteen v. Commissioner,
supra at 358. Whether a taxpayer is engaged in an activity for
profit is a question of fact to be resolved from all relevant
facts and circumstances. Hulter v. Commissioner, 91 T.C. 371,
393 (1988). In resolving this factual question, greater weight
is given to objective facts than to the taxpayer’s mere statement
of his intent. Siegel v. Commissioner, 78 T.C. 659, 699 (1982);
sec. 1.183-2(a), Income Tax Regs.
The regulations under section 183 contain a nonexclusive
list of nine objective factors to be taken into account when
deciding whether an activity is engaged in for profit. These
factors are: (1) The manner in which the taxpayer carries on the
activity; (2) the expertise of the taxpayer or his advisers; (3)
the time and effort expended by the taxpayer in carrying on the
activity; (4) the expectation that assets used in the activity
may appreciate in value; (5) the success of the taxpayer in
carrying on other similar or dissimilar activities; (6) the
taxpayer’s history of income or losses with respect to the
activity; (7) the amount of occasional profits, if any, which are
earned; (8) the financial status of the taxpayer; and (9) the
- 46 -
elements of personal pleasure or recreation involved. Sec.
1.183-2(b), Income Tax Regs. No single factor is controlling.
Osteen v. Commissioner, supra at 358; Brannen v. Commissioner,
722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C. 471 (1982);
sec. 1.183-2(b), Income Tax Regs. The factors are relevant in
the context of this case to the extent they may indicate whether
petitioner knew or believed that Mr. Rowe was or was not engaged
in the farming activity for profit. See King v. Commissioner,
supra at 205.
Respondent argues that petitioner knew that the farming
activity was not engaged in for profit. Respondent bases his
argument on petitioner’s testimony that the horse activity was a
fun thing for Mr. Rowe to do with his son on the weekends and
that petitioner did not consider the activity an “operation” but
rather her husband just “had a couple of horses in Tampa”.
Respondent contends that petitioner understood that the horse
activity was a fun family recreational activity, and this
understanding establishes that she had actual knowledge that the
horse activity was not engaged in for profit. Additionally,
respondent claims that petitioner had actual knowledge of both
the horse and fish activities, as well as actual knowledge of the
claimed Schedule F losses.
As we noted earlier, petitioner had little or no involvement
in the farming activity. Additionally, she testified that she
- 47 -
saw the first two pages only of the tax returns; thus, she was
not afforded the opportunity to review the Schedules F listing
the income and expenses attributable to the farming activity.
Petitioner also testified that she trusted Mr. Rowe when she
signed the tax returns because he told her the returns were
correct, and he assured her he had appropriate records.24
The evidence in the record indicates that Mr. Rowe
controlled all aspects of the farming activity, and he conducted
the activity without any assistance from petitioner. He
testified that he did not consult with petitioner before making
decisions concerning the farming activity, and he did not provide
her with any information about the activity. In fact, Mr. Rowe
testified that he felt that he was operating the horse activity
as a business. He also testified that he started the fish
activity in order to make the farming activity a more viable
business. The testimony of Mr. Danley and the Shortinos, as well
as the testimony and affidavit of Mr. Murray, all indicates that
Mr. Rowe acted as if he was engaged in the farming activity for
profit. There is no evidence that Mr. Rowe acted in such a
manner that would cause petitioner to know or believe that Mr.
Rowe was not engaged in the farming activity for profit.
24
Petitioner testified that she did not know whether
parentheses around a number on a tax return indicated a loss or a
profit.
- 48 -
Respondent has failed to establish that petitioner knew or
believed that her former spouse was not engaged in the farming
for profit. Accordingly, we hold petitioner is entitled to
relief under section 6015(c) from the tax liability arising out
of this activity.
V. Charitable Contributions
A. Background
On their 1987 return, petitioners claimed a charitable
contribution deduction of $5,556. Of this amount, $4,059 was
listed as contributed to “1st United Methodist”. In 1987,
petitioner wrote five checks to the St. Cloud First United
Methodist Church on the NCNB account totaling $5,500. Respondent
allowed the $5,556 charitable contribution deduction claimed on
the 1987 return.
On their 1988 return, petitioners claimed a charitable
contribution deduction of $8,165. On the attached Schedule A,
the claimed contribution was identified as “ERS-106, 1st United
Meth. 8,059". Respondent disallowed the entire amount claimed as
a charitable contribution deduction for 1988 on the ground that
petitioners had failed to substantiate the charitable
contribution. In 1988, neither petitioner nor Mr. Rowe wrote any
checks on the NCNB account to the St. Cloud First United
Methodist Church.
- 49 -
On their 1989 return, petitioners claimed a charitable
contribution deduction of $8,111. The Schedule A attached to the
return did not identify any organization to which a contribution
was made. Respondent disallowed the entire amount claimed as
charitable contribution deduction for 1989 on the ground that
petitioners had failed to substantiate the charitable
contribution. No evidence was presented establishing whether any
checks were written on the NCNB account to the St. Cloud First
United Methodist Church in 1989.
B. Discussion
1. Allocation of Items
Petitioner claims that this item is allocable to Mr. Rowe
because he controlled the amount contributed to the church and he
represented to her that the contributions had been made.
Respondent argues that this item should be allocated evenly
between petitioner and Mr. Rowe because the contributions were to
a church which they both attended and in which petitioner was
actively involved.
Congress intended for personal deduction items to generally
be allocated equally between spouses, unless the electing spouse
establishes that a different allocation is appropriate. Sec.
6015(c)(2); S. Rept. 105-174, supra at 57, 1998-3 C.B. at 593.25
25
The legislative history of sec. 6015 provides the
following example of an allocation of charitable contributions:
(continued...)
- 50 -
Petitioner testified that she regularly attended the St. Cloud
First United Methodist Church during the years in issue and that
she was very involved in church activities. Petitioner testified
that she and Mr. Rowe had tithed regularly during their entire
married life. In 1987, petitioner wrote five checks totaling
$5,500 to the church on the NCNB account, and respondent allowed
the $5,556 charitable contribution deduction claimed on the 1987
return. The Schedule A attached to the 1988 return indicates
that most, if not all, of the claimed contribution deduction
related to the church. The Schedule A attached to the 1989
return does not indicate whether the claimed deduction related to
the church; however, petitioner’s testimony indicates that she
believed that the claimed deduction for 1989 also related to the
church that she regularly attended and was very active in. In
the instant case, petitioner has failed to show that it is
appropriate to allocate the charitable contribution items for
1988 and 1989 other than equally between her and Mr. Rowe.
25
(...continued)
Personal deduction items are expected to be allocated
equally between spouses, unless the evidence shows that
a different allocation is appropriate. For example, a
charitable contribution normally would be allocated
equally to both spouses. However, if the wife provides
evidence that the deduction relates to the contribution
of an asset that was the sole property of the husband,
any deficiency assessed because it is later determined
that the value of the property was overstated would be
allocated to the husband. [S. Rept. 105-174, at 57
(1998), 1998-3 C.B. 537, 593.]
- 51 -
Therefore, to the extent petitioner lacked actual knowledge of
these items, she will qualify for relief from joint liability
under section 6015(c) for the portion of the item allocable to
Mr. Rowe.26
2. Actual Knowledge
Respondent argues that petitioner had actual knowledge that
the charitable contributions were not made in 1988 and 1989. In
order to prove actual knowledge, respondent must show that
petitioner had “actual knowledge of the factual circumstances
which made the item unallowable as a deduction.” King v.
Commissioner, 116 T.C. at 204. In the instant case, respondent
disallowed the charitable contribution deductions because
petitioners failed to substantiate the claimed deductions. Thus,
the relevant inquiry is whether petitioner knew or believed that
charitable contributions in the amounts reported on petitioners’
1988 and 1989 tax returns were not made.
In the instant case, Mr. Rowe was in charge of petitioners’
financial and business affairs. Petitioner testified that the
amount petitioners’ tithed to the church was Mr. Rowe’s decision.
Petitioner further testified that she was “told when to write
checks to the church”, and she wrote checks only when directed to
26
Because petitioner cannot qualify for relief under sec.
6015(c) for the portions of items which are allocable to her, we
analyze her ability to qualify for relief for such portions in
our later discussion under sec. 6015(b) and (f). See infra pp.
53-61.
- 52 -
by Mr. Rowe. Petitioner credibly testified that she was not
surprised by the amounts of charitable contributions deductions
claimed in 1988 and 1989, and she believed that contributions
were made during those years.
Respondent maintains that if only petitioner wrote checks to
the church from the joint account in 1987, then the fact that no
checks were written to the church from the joint account in 1988
demonstrates that petitioner had actual knowledge that no
contributions were made in either 1988 or 1989.27 However,
petitioner testified that, beginning in 1988, her role in paying
bills and writing checks diminished because Mr. Rowe began to
take over those duties. Mr. Rowe corroborated this point by
testifying that at some point during the years in issue he took
over the responsibility of paying certain bills, such as mortgage
payments, car payments, and credit card payments. Mr. Rowe
further testified that he had various other accounts which he
used to transfer money and that petitioner did not have knowledge
of these accounts.
The fact that no checks were written on petitioners’ joint
account in 1988 does not establish that petitioner had actual
knowledge that no contributions were made to the church in either
1988 and 1989. Mr. Rowe testified that he did not know whether
27
As previously mentioned, no evidence was presented
establishing whether any checks were written on the NCNB account
to the St. Cloud First United Methodist Church in 1989.
- 53 -
he provided petitioner with any information regarding charitable
contributions. In the instant case, petitioner had no reason to
believe that Mr. Rowe had not contributed to the church in 1988
and 1989 in the same manner as petitioners contributed in prior
years. Under the circumstances presented in this case,
respondent has failed to show that petitioner had actual
knowledge that the charitable contributions were not made in 1988
and 1989. Accordingly, we hold that petitioner is entitled to
relief from joint liability under section 6015(c) for the portion
of this item allocable to Mr. Rowe.
VI. Application of Section 6015(b)
Petitioner claims that she is entitled to complete relief
from liability under section 6015(b) with respect to the items
giving rise to the deficiency. One requirement of section
6015(b) is that the understatement of tax be attributable to
erroneous items of the nonelecting spouse. Sec. 6015(b)(1)(B).
We previously granted petitioner complete relief under section
6015(c) for the IRA distributions and farming activity losses.
We also granted petitioner partial relief under section 6015(c)
for the half of the capital gains, mortgage interest, and
charitable contributions items which we found are allocable to
Mr. Rowe. Thus, the only items remaining are the half of the
capital gains, mortgage interest, and charitable contributions
which are allocable to petitioner. Consequently, petitioner is
- 54 -
not entitled to relief under section 6015(b) for the capital
gains, mortgage interest, and charitable contributions which are
allocable to her because these are not erroneous items “of” Mr.
Rowe.
VII. Application of Section 6015(f)
Petitioner claims that, to the extent she fails to qualify
for relief under section 6015(b) or (c), she is entitled to
equitable relief under section 6015(f). We previously found that
the capital gains, mortgage interest, and charitable
contributions items are allocable evenly between petitioner and
Mr. Rowe for purposes of section 6015(c). We also held that
petitioner did not have actual knowledge of any of these items,
and, thus, she is entitled to relief under section 6015(c) for
the portions of the items allocable to Mr. Rowe. Thus, the
question is whether petitioner is entitled to equitable relief
under section 6015(f) for the portion of the capital gains,
mortgage interest, and charitable contributions items giving rise
to deficiencies which are allocable to her.
Petitioner’s claim for relief from joint liability was
initiated in her amended petition to this Court. Before trial,
respondent conceded that petitioner was entitled to relief with
respect to certain items contained in the notices of deficiency.
We must presume that “before doing so, respondent followed
standard procedures by reviewing his administrative files and
- 55 -
considered petitioner’s contentions.” Cheshire v. Commissioner,
115 T.C. at 198. Respondent argues that, considering all facts
and circumstances, the determination that petitioner was not
entitled to equitable relief is consistent with Rev. Proc. 2000-
15, 2000-5 I.R.B. 447, the Internal Revenue Service’s published
guidelines on when equitable relief should be granted.
We have previously found that petitioner did not have actual
knowledge under section 6015(c) of the items giving rise to the
deficiency. The evidence also reflects that petitioner’s
involvement with the Federal income tax returns and corresponding
audits was minimal. Mr. Rowe regularly prepared petitioners’
joint tax returns, and he testified that petitioner had no role
in providing information for the returns. Petitioner testified
that Mr. Rowe provided her with only the first two pages of the
returns, assured her he had records for the returns, and she
trusted him when he said the returns were correct. Mr. Danley,
the accountant who assisted with the preparation of petitioners’
1990 return, testified that he never discussed the 1990 return
with petitioner, she did not provide him with any information,
and she did not have any involvement in the preparation of that
return.
Petitioner also testified that she was unaware of the audits
of petitioners’ taxable years 1987 through 1990 until late 1995
and that she never received any correspondence from the Internal
- 56 -
Revenue Service. Mr. Rowe could not remember who received the
notices of deficiency, and he could not remember discussing or
giving petitioner copies of them. However, Mr. Rowe testified
that he, not petitioner, would have opened up any correspondence
from the Internal Revenue Service. Mr. Danley testified that
when petitioners where audited, he never spoke to petitioner
about the audit. At trial, the revenue agent assigned to the
examination of petitioners’ 1987, 1988, and 1989 tax returns,
testified that he did not talk with petitioner during the
examination. Moreover, he did not recognize petitioner in the
courtroom at trial.28 The revenue agent assigned to the
examination of petitioners’ 1990 tax return testified that he had
never met petitioner.29
Petitioner testified that she did not sign the tax returns
under duress. However, petitioner did testify that Mr. Rowe
28
The revenue agent originally testified that he had met
petitioner when he issued a summons because he personally went to
petitioners’ home and gave copies of the notice to the woman who
answered the door. However, the revenue agent then testified
that he had assumed petitioner was the woman who answered the
door but that petitioner was presently “not the least bit
familiar to me”.
29
There is other evidence in the record to support
petitioner’s claims that Mr. Rowe did not keep her informed about
their financial affairs. For example, petitioner and John
Albers, the police officer who arrested Mr. Rowe in 1989 in
connection with the embezzlement charges related to Mr. Rowe’s
employment at the Central Florida Dental Association, both
testified that petitioner was not aware that Mr. Rowe was
arrested for embezzlement until she read about it in the
newspaper.
- 57 -
would get “verbally ugly” if she questioned him about business
documents and that she was only provided with information when
Mr. Rowe wanted her to know. Christopher testified that there
were several arguments between petitioner and Mr. Rowe, and they
usually centered around the discussion of financial matters.
Christopher further testified that when petitioner asked Mr. Rowe
questions concerning financial matters, Mr. Rowe would either
ignore her and leave or become angry and tell her it was none of
her business.
The record also reflects that petitioner will suffer
economic hardship if relief is not granted. In 1995, Mr. Rowe
was convicted of Federal money laundering. He was sentenced to
33 months in prison and ordered to make restitution to the Bank
of New York in the amount of $359,452.17.30 Petitioner testified
that in 1995 she moved from Florida back to Kingsport, Tennessee,
to live with her parents because she was destitute and had no
funds to provide a home for herself. Petitioner and Mr. Rowe’s
divorce was finalized in June 1996. The final judgment for
Dissolution of Marriage between petitioner and Mr. Rowe states
that petitioner’s “standard of living and financial circumstances
have been devastated by * * * [Mr. Rowe’s] wrong-doing and
30
Mr. Rowe was subsequently convicted in 1997 of 51 counts
of unlawful compensation under Florida State Medicaid laws and
one count of organized fraud. He was sentenced to 8 months in
prison and ordered to make restitution of $5,051.45 to the
Department of Health and Human Services in the amount.
- 58 -
incarceration.” The Final Judgment also notes that petitioner
“does not have the present financial resources to support herself
and * * * [petitioners’ daughter, Elizabeth] adequately, but that
* * * [Mr. Rowe] does not have the present ability to pay
alimony.”31 On the basis of the factual circumstances present,
Mr. Rowe was ordered to pay petitioner $1 of permanent alimony
per year, although the court reserved jurisdiction to modify the
amount upon Mr. Rowe’s release from incarceration and re-entry
into the job market.
Petitioner testified that after the divorce there was very
little money left in a college fund to pay for Elizabeth’s
undergraduate education. Petitioner testified that she and
Elizabeth had to supplement the fund with student loans and
whatever money petitioner could contribute from her own income.
At the time of trial, petitioner was employed full time as a
dental hygienist, and she was paid by commission only.
Finally, the evidence in the record demonstrates that
petitioner has not significantly benefited, either during or
after her marriage, from the items giving rise to the
deficiencies. Petitioner did not have expensive jewelry, drive a
luxurious car, or wear designer clothes. In fact, petitioner
testified that she generally made clothes for herself and her
31
The final judgement also found that petitioner did not
have the financial ability to accept collect calls from Mr. Rowe.
- 59 -
daughter. Mr. Rowe testified that petitioner did not expend
money lavishly. Petitioner testified that the only trip the
family went on contemporaneous to the years in issue was a 1986
trip to Hawaii, and the testimony indicates that the trip was
inexpensive and not lavish.32
Although the purchase price of the Albritton property and
construction of a residence at that location exceeded $1 million,
the inside of the residence was sparsely furnished with old
office furniture from Mr. Rowe’s business, and the walls were
decorated with arts and crafts which were handmade by petitioner.
As a result of Mr. Rowe’s criminal activities, petitioner had to
move out of the Albritton residence and back to Kingsport,
Tennessee, to live with her parents because she was destitute and
had no funds to provide a home for herself.33
Despite the fact that Mr. Rowe was earning substantial
amounts of income during the years in issue, in 1989 and 1990
only $26,176 and $7,086,34 respectively, were deposited into the
32
Joseph Shirah, who accompanied petitioners on the Hawaii
trip, testified that the plane tickets for the trip were at a
discount rate and “it was a very inexpensive trip.”
33
Respondent determined that petitioners had unreported
income of $283,928, $29,924, $94,648, and $82,053, respectively
for the years 1987 through 1990. This unreported income was
attributable solely to Mr. Rowe, and respondent concedes that
petitioner is not liable for any deficiency associated with this
unreported income for the years in issue.
34
Of this deposit total, approximately $4,102, represented
(continued...)
- 60 -
NCNB account, which petitioner testified was the only account she
used during the years in issue. Mr. Rowe testified that he put
almost all the money he earned back into his dental business and
horse activity. Presumably, Mr. Rowe was also depositing most of
his earnings into his separate accounts which petitioner was
unaware existed. In his deposition, Mr. Shirah stated that Mr.
Rowe purchased a house in the name of Mr. Shirah’s business for
another woman.35 Mr. Shirah stated that Mr. Rowe was involved
with the other woman during his marriage to petitioner. At
trial, Mr. Rowe admitted becoming involved with the other woman
in 1993. Petitioner testified that the reason she filed for
divorce was because Mr. Rowe was involved with the other woman
while he was still married to petitioner.36
On the basis of all the facts and circumstances of this
case, we find that compelling reasons existed for respondent to
grant petitioner equitable relief. Consequently, we hold that
respondent abused his discretion in denying petitioner’s claim
for relief under section 6015(f) for the portion of the capital
34
(...continued)
petitioner’s earnings from her employment as a substitute
teacher.
35
Mr. Shirah stated that Mr. Rowe signed the realty contract
and the mortgage on the house. However, Mr. Shirah stated that
Mr. Rowe had no connection to Mr. Shirah’s business.
36
At trial, Mr. Rowe testified that he married the other
woman after he and petitioner were divorced.
- 61 -
gains, mortgage interest, and charitable contributions items
allocable to petitioner.
VIII. Additions to Tax and Penalties
Respondent did not determine that the fraud additions to tax
pursuant to section 6653(b) for the taxable years 1987 and 1988,
and the fraud penalty pursuant to section 6663 for the taxable
year 1989, were applicable to petitioner. On brief, respondent
concedes that to the extent any relief is granted for a portion
of the deficiencies, relief is automatic for the penalties
related to that portion. Petitioner concedes that the estimated
tax penalty pursuant to section 6654 for 1990 should be allocated
proportionally to the allocation of the underlying deficiency.
Petitioner contends that it is inequitable to hold her liable for
any remaining additions to tax or penalties.
We have previously held that we have jurisdiction to review
the denial of relief from joint liability under section 6015(f)
for additions to tax and penalties. Cheshire v. Commissioner,
115 T.C. at 197-199. We review respondent’s refusal to grant
equitable relief for additions to tax or penalties under an abuse
of discretion standard. Id. at 198. In Cheshire v.
Commissioner, supra, we provided the following guidance in
determining whether respondent has abused his discretion in
denying equitable relief in situations involving additions to tax
or penalties:
- 62 -
In our opinion, it is an abuse of discretion to deny
relief under section 6015(f) in an addition to tax or
penalty situation when on an individual basis the
putative innocent spouse meets the statutory standard
generally applied to all taxpayers that shows the
addition to tax or penalty is inapplicable. [Id. at
199.]
A. Addition to Tax for Failure To File Timely
Respondent determined that petitioners were liable for the
addition to tax pursuant to section 6651(a)(1) for 1989. Section
6651(a)(1) imposes an addition to tax for failure to file a
required return on the date prescribed. After factoring in the
parties’ concessions and our decisions in petitioner’s favor,
petitioner does not have an unpaid tax liability for 1989. In
light of respondent’s concession, petitioner is not liable for
the addition to tax for 1989.
B. Substantial Understatement Penalty
For the taxable years 1987 and 1988, respondent determined
that petitioners were liable for the substantial understatement
penalty pursuant to section 6661. However, after taking into
account respondent’s concessions and the issues decided in
petitioner’s favor, petitioner’s sole remaining liability for
those years involves an $85 theft loss adjustment in 1987 which
the parties agree is allocable one-half to petitioner.37 With
the minimal theft loss adjustment remaining as the only issue for
petitioner for 1987, the predicate for the substantial
37
See appendix.
- 63 -
understatement penalty no longer exists. Accordingly, we hold
that petitioner is not liable for this penalty for either taxable
year.
C. Accuracy-Related Penalty
Finally, respondent determined that petitioner was liable
for the accuracy-related penalty pursuant to section 6662(a) for
1990 for negligence. Section 6662(a) imposes a penalty equal to
20 percent of the portion of an underpayment of tax attributable
to a taxpayer’s negligence, disregard of rules or regulations, or
substantial understatement of income tax. Sec. 6662(a), (b)(1)
and (2). “Negligence” has been defined as the failure to do what
a reasonable and ordinarily prudent person would do under the
circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985).
However, section 6662(a) does not apply to “any portion of an
underpayment if it is shown that there was a reasonable cause for
such portion and that the taxpayer acted in good faith with
respect to such portion.” Sec. 6664(c)(1). The Commissioner’s
determination that a taxpayer was negligent is presumptively
correct, and the burden is on the taxpayer to show a lack of
negligence. Hall v. Commissioner, 729 F.2d 632, 635 (9th Cir.
1984), affg. T.C. Memo. 1982-337.
After factoring in the parties’ concessions and our
decisions in petitioner’s favor, petitioner’s tax liability for
1990 stems from $6,253 of omitted W-2, Wage and Tax Statement,
- 64 -
income and $48.50 of omitted interest income. In Cheshire v.
Commissioner, supra, we faced a similar situation wherein the
spouse claiming relief from joint liability relied upon her
husband for the accurate preparation of their income tax return.
In that case, we stated:
Petitioner trusted and relied upon Mr. Cheshire
when it came to the preparation of their tax returns.
She is an elementary school teacher, having taken no
courses in accounting or tax return preparation. She
asked Mr. Cheshire about the potential tax
ramifications of the retirement distributions, and Mr.
Cheshire assured petitioner that he had consulted with
a certified public accountant and had been advised that
the payment of the outstanding mortgage on the family
residence and any amount rolled over into a qualified
account reduced the taxable amount of the retirement
distributions. Mrs. Cheshire had no reason to doubt
the truthfulness of Mr. Cheshire’s statement, and in
fact believed him. Under these circumstances, we do
not believe petitioner had an obligation to inquire
further. [Id. at 199.]
Petitioner has no background in accounting, tax, or other
financial matters, and she was primarily a housewife during her
marriage to Mr. Rowe. Like the spouse claiming relief in
Cheshire v. Commissioner, supra, petitioner trusted and relied
upon her husband when it came to the preparation of their 1990
tax return, and she believed him when he told her the tax return
was correct. For 1990, respondent determined that petitioners
failed to report $4,847 of interest income from various sources.
The amount of $97 related to petitioners’ NCNB account. The
parties stipulated that petitioner is entitled to relief from
joint liability under section 6015(c) for all but $48.50 of the
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interest income. For 1990, petitioners reported business income
of $297,756. Petitioner testified that she believed that her
wage income for 1990 was grouped in with the business income
reported on the return. Petitioner further testified that she
believed the return was correct because it was prepared and
signed by petitioners’ accountant, Mr. Danley.
We find that petitioner had reasonable cause for the
understatement caused by the omitted wage income and omitted
interest income. Furthermore, we believe petitioner acted in
good faith in erroneously concluding that the wage income and
interest income was included in the 1990 return. Given the
extreme facts and circumstances of this case, we believe that
respondent abused his discretion by failing to grant petitioner
relief from joint liability for the accuracy-related penalty for
1990. Accordingly, we hold that petitioner is not liable for
this penalty for 1990.
To reflect the foregoing,
Decisions will be entered
under Rule 155.
- 66 -
Appendix
In stipulations of agreed issues, petitioner John A. Rowe
conceded the following deficiencies in income taxes, additions to
tax, and penalties:38
Additions to Tax and Penalties
Year Deficiency Sec. 6653(b)(1)(A) Sec. 6653(b)(1)(B) Sec. 6661
1
1987 $173,817 $130,363 $43,454
Sec. 6653(b)(1) Sec. 6661
1988 $ 53,937 $40,453 $13,484
Sec. 6651(a)(1) Sec. 6663
1989 $ 73,279 $13,792 $54,959
Sec. 6654 Sec. 6662(c)
1990 $124,891 $8,057 $24,978
1
50 percent of the interest due on $173,817.
In a stipulation of settled issues, respondent and
petitioner Donna L. Rowe agreed to the following disposition of
certain issues:
Ms. Rowe conceded that she is not entitled to relief from
joint liability for an $85 theft loss adjustment in 1987 and a
$6,253 income adjustment in 1990. Ms. Rowe also conceded that
she is not entitled to relief from joint liability for $48.50 of
interest income, still in dispute, which was part of a $4,847
adjustment in 1990.
Respondent conceded that Ms. Rowe is entitled to relief from
joint liability under section 6015(c) for a $6,282 rental income
38
Petitioner John A. Rowe’s concessions encompass all the
determinations made by respondent in the notices of deficiency.
- 67 -
adjustment in 1990 and for $112,979 of the $116,405 lump-sum
distributions adjustment in 1990.
In the stipulation of facts and first supplemental
stipulation of facts, the following concessions were made:
Respondent conceded that, pursuant to section 6015(c), Ms.
Rowe is not liable for any deficiency associated with unreported
income of $283,928, $29,924, $94,648, and $82,053, respectively
for the years 1987 through 1990. Respondent conceded that Ms.
Rowe is entitled to relief from joint liability under section
6015(c) for 1990 with respect to the following adjustments: (1)
Capital gain income of $11,919; (2) Schedule C income of $82,053;
and (3) all but $48.50 of interest income which was part of a
$4,847 adjustment.