T.C. Memo. 2005-72
UNITED STATES TAX COURT
PATRICIA A. HENDRICKS AND JOHN J. HENDRICKS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11416-03L. Filed April 5, 2005.
Randall M. Willard, for petitioners.
John A. Weeda, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: The petition and amended petition in this
case were filed in response to Notices of Determination
Concerning Collection Action(s) Under Section 6320 and/or 6330
(notices of determination) sent separately to Patricia A.
Hendricks (petitioner) and John J. Hendricks (Mr. Hendricks). In
the notice of determination sent to petitioner, respondent denied
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her request for relief from joint and several liability pursuant
to section 6015. After concessions, the sole issue for decision
is whether respondent abused his discretion in denying
petitioner’s request for relief from joint and several tax
liability pursuant to section 6015 as to 1983.
Unless otherwise noted, all section references are to the
Internal Revenue Code in effect at all relevant times, and
amounts are rounded to the nearest dollar.
FINDINGS OF FACT
Some facts have been stipulated and are so found. The
stipulation of facts, with accompanying exhibits, is incorporated
herein by this reference.
Petitioner and Mr. Hendricks (collectively, the Hendrickses)
were residents of the State of Colorado at all times relevant to
this case. The Hendrickses have been married for more than 45
years and have at all times filed joint Federal income tax
returns; i.e., Form 1040, U.S. Individual Income Tax Return.
Both petitioner and Mr. Hendricks are more than 70 years of age
and are retired. Before the Hendrickses married, they agreed to
separate their responsibilities, deciding that petitioner would
run the household while Mr. Hendricks would be responsible for
their finances.
Mr. Hendricks worked as a farm manager and a farm and ranch
real estate broker, and he invested in real estate. Mr.
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Hendricks did not discuss business matters with petitioner, nor
was petitioner ever an employee of any of Mr. Hendricks’s
businesses.
Mr. Hendricks maintained several separate business bank
accounts to which petitioner had no access. The Hendrickses
maintained only one joint checking account from which petitioner
paid personal and household expenses.
Petitioner completed 2 years of college, where she studied
art. Petitioner did not take any business courses or classes on
income taxation or preparation of income tax returns. After
marrying Mr. Hendricks, petitioner stayed at home to raise their
five children and run their household. Petitioner’s only
involvement in family finances was to pay the monthly household
expenses. Petitioner relied upon Mr. Hendricks for financial,
business, and tax decisions.
The Hendrickses have led frugal lifestyles. There is no
evidence that during the relevant years they made any lavish or
unusual expenditures.
On November 18, 1980, Mr. Hendricks met with the
Hendrickses’ certified public accountant, Kurt Grosser (Mr.
Grosser), and a broker for a partnership called Boulder Oil and
Gas Associates, 1980 (Boulder Oil and Gas). Despite its being
the first he had heard of the partnership, during the meeting Mr.
Hendricks agreed to invest $94,002 in Boulder Oil and Gas and
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gave the broker an initial installment check from one of his
business checking accounts. Mr. Hendricks completed the purchase
by paying two additional installments over the next 2 years by
checks drawn on his business accounts. The partnership interest
in Boulder Oil and Gas was placed in Mr. Hendricks’s name alone.
Petitioner had no knowledge that Mr. Hendricks was making an
investment in Boulder Oil and Gas. Mr. Hendricks did not consult
petitioner about making the investment. Petitioner did not
receive any mail regarding Boulder Oil and Gas because all mail
from the partnership was sent to Mr. Hendricks’s business
address.
Just prior to Mr. Hendricks’s investment in Boulder Oil and
Gas, on January 31, 1980, Mr. Hendricks traded various pieces of
farmland that the Hendrickses had previously owned for 10
condominiums in Fort Collins, Colorado. The condominiums were
not acquired from proceeds made available through Mr. Hendricks’s
investment in Boulder Oil and Gas. The condominiums were owned
jointly by the Hendrickses.
During the relevant years, the Hendrickses relied upon Mr.
Grosser, who had promoted Boulder Oil and Gas, to prepare their
tax returns. Petitioner’s only involvement in preparing the tax
returns for the relevant years at issue was to complete a
questionnaire about personal and household expenses. Petitioner
relied on Mr. Hendricks to communicate with Mr. Grosser for the
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preparation of their tax returns. When Mr. Hendricks brought
home the income tax returns prepared and signed by Mr. Grosser,
petitioner would sign them in reliance on the accountant’s and
her husband’s recommendations to sign. Except for the years they
reported loss activity from Boulder Oil and Gas, i.e., 1980-83,
the Hendrickses have neither had their Federal tax returns
examined, nor have they had taxes in excess of the amount
reported on their returns assessed. The Hendrickses claimed
$158,521 in losses arising from Boulder Oil and Gas on their
joint 1983 tax return on Schedule E, Supplemental Income and
Loss. This amount did not appear on the face of the return, but
was listed on Schedule E, combined with the income and expenses
of at least 11 other properties, including the condominiums and
an office building.
On September 10, 1985, respondent sent the Hendrickses a
Form 4549, Income Tax Examination Changes, which reflected
proposed changes to the Hendrickses’ joint Federal income tax
returns for 1980-83. This was the first time petitioner learned
of Mr. Hendricks’s investment in Boulder Oil and Gas. On October
11, 1985, the Hendrickses received a notice of deficiency for
1980-82. The Hendrickses failed to petition the Court for
redetermination of the deficiencies set out in the notice of
deficiency and consented to an extension of the assessment date.
On June 10, 1987, respondent assessed the following amounts as
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determined in the notice of deficiency with respect to 1980-82:
Additions to tax and increased interest
Year Deficiency Sec. 6659 Sec. 6661 Sec. 6621(d)
1980 $27,920 -- -- $33,970
1981 $45,294 $13,588 -- $67,177
1982 $70,920 $15,918 $4,465 $53,749
With respect to 1982, respondent subsequently abated the
additions to tax under sections 6659 and 6661.
The Hendrickses began making payments shortly after the
assessment was made, paying the balance due for 1980 in full by
October 13, 1987. The liability for 1981 was paid in full by
December 1, 1989, and the liability for 1982 was paid in full by
August 27, 1993. Over the years 46 payments in varying amounts
were made totaling $387,903, the moneys being derived, in part,
from the sale of several of the condominiums.
On October 11, 1985, the same day the Hendrickses received
the notice of deficiency for 1980-82, respondent sent a letter to
Mr. Hendricks with respect to 1983, informing him that Boulder
Oil and Gas was being examined under the administrative
procedures enacted by the Tax Equity and Fiscal Responsibility
Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 324. Mr. Hendricks
received this letter at his place of business and did not take
the letter home. On April 25, 1988, respondent mailed a letter
to the Hendrickses at their home address, which stated that
respondent was proposing adjustment to their joint 1983 tax
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return. The only other correspondence sent to the Hendrickses
was a Notice of Final Partnership Administrative Adjustments
(FPAA) mailed to the Hendrickses on February 6, 1989.
On April 20, 1989, Boulder Oil and Gas filed a petition with
the Court in response to the FPAA (Boulder Oil and Gas case).
On October 31, 1997, Mr. Hendricks transferred his jointly
held interest in the remaining condominiums to petitioner. For 2
years before the transfer of his interest in the remaining
condominiums, Mr. Hendricks had been advised by his attorney and
John Angeli (Mr. Angeli), the Hendrickses’ new certified public
accountant, to transfer his interest in the condominiums to
petitioner in order to protect the condominiums from any
creditors of Mr. Hendricks in the substantial farming enterprise
Mr. Hendricks was engaged in at the time. Mr. Hendricks’s actual
intent in making the transfers was to protect the investment in
the condominiums because they constituted the Hendrickses’ only
financial resource for their retirement outside of Social
Security. At the time of the transfer, the Hendrickses
mistakenly believed that they had settled the 1983 tax year and
did not owe any tax liabilities associated with 1983 or any other
years.
The farming enterprise Mr. Hendricks was engaged in at the
time of the transfer to petitioner involved a 10-year lease-
purchase of 12,270 acres of Colorado farmland between him as
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lessee and Colmeno of Colorado, Inc., as lessor. The lease
commenced in January 1994, and was to run until 2003. The
arrangements required Mr. Hendricks to make annual payments
totaling $350,550 consisting of payments for the land lease, an
equipment lease, a loan of $655,600 from a firm called Menotex, a
prior mortgage, and real property taxes. The farming enterprise
failed because Mr. Hendricks was unable to meet the income
projections needed to service the payments. On February 21,
2001, he liquidated the farming enterprise and sold its assets at
an auction. It took Mr. Hendricks until January 2004 to finally
pay off all creditors from that undertaking.
On June 18, 1998, we issued an Order to Show Cause why the
Boulder Oil and Gas case should not be decided in accordance with
several test cases. On November 23, 1998, we issued an Order and
Decision granting respondent’s Motion for Entry of Decision,
making adjustments to the partnership items of Boulder Oil and
Gas for the 1983 tax year.
On October 14, 1999, respondent sent a letter to the
Hendrickses transmitting a Form 4549A-CG, Income Tax Examination
Changes, explaining how the adjustments made during the TEFRA
proceeding affected their individual income tax return for 1983.
Respondent assessed the Hendrickses’ deficiency for 1983 on
February 16, 2000.
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On June 27, 2000, and July 17, 2000, Mr. Angeli faxed
correspondence to respondent alleging that the Hendrickses had
settled the 1983 tax liabilities and questioned the propriety and
timeliness of the 1983 assessment. Respondent sent a letter to
the Hendrickses dated October 26, 2000, explaining the origin of
the 1983 tax liability in the TEFRA proceeding and attaching
copies of the various notices sent to the Hendrickses over the
years from the time the proceeding began. Respondent included
transcripts of account showing that while the 1980-82 tax
liabilities had been assessed and paid, the 1983 deficiency had
not been assessed until February 16, 2000, because of the stay on
assessment caused by the TEFRA proceeding.
Respondent filed a Notice of Federal Tax Lien in Larimer
County, Colorado, for the assessed 1983 tax liability and sent
the Hendrickses a Notice of Federal Tax Lien and Your Right to a
Hearing Under IRC 6320 on November 20, 2000.
On December 20, 2000, petitioner and Mr. Hendricks submitted
their separate Forms 12153, Request for a Collection Due Process
Hearing, and petitioner submitted a Form 8857, Request for
Innocent Spouse Relief. A hearing was held by telephone on
February 11, 2003. Respondent issued separate notices of
determination to petitioner and Mr. Hendricks on June 6, 2003,
sustaining the filing of notices of Federal tax lien and denying
relief to petitioner under section 6015.
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The Hendrickses have made payments totaling approximately
$110,150 against the balance due on their 1983 tax liabilities.
The deficiency attributable to Mr. Hendricks’s investment in
Boulder Oil and Gas for 1983 was $63,176. After accounting for
the payments previously made, the Hendrickses’ current balance
due for 1983 is approximately $300,000.
The main source of the Hendrickses’ current income consists
of monthly Social Security checks and approximately $1,000 in
rental income per month from the remaining condominiums. The
Hendrickses’ monthly living expenses exceed their income by about
$1,100. They are able to meet their living expenses only through
financial assistance from their children.
OPINION
Pursuant to section 6330, petitioner sought relief from
respondent’s notice of determination sustaining the proposed
collection action. Section 6330 allows a taxpayer to raise
appropriate spousal defenses under section 6015. Sec.
6330(c)(2)(A)(i); sec. 301.6330-1(e)(2), Proced. & Admin. Regs.
Generally, married taxpayers may elect to file a joint
Federal income tax return. Sec. 6013(a). After making the
election, each spouse is jointly and severally liable to pay the
entire tax due. Sec. 6013(d)(3). A spouse (requesting spouse)
may, however, seek relief from joint and several liability under
section 6015(b), or if eligible, may allocate liability according
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to provisions under section 6015(c). Sec. 6015(a). If relief is
not available under section 6015(b) or (c), an individual may
seek equitable relief under section 6015(f).
To qualify for relief from joint and several liability under
section 6015(b)(1), a requesting spouse must establish:
(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 with respect to the individual making the
election, * * *.
The requirements of section 6015(b)(1) are stated in the
conjunctive. Accordingly, a failure to meet any one of them
prevents a requesting spouse from qualifying for the relief
offered therein. Alt v. Commissioner, 119 T.C. 306, 313 (2002),
affd. 101 Fed. Appx. 34 (6th Cir. 2004).
Respondent does not dispute that petitioner satisfies the
requirements of subparagraphs (A), (B), and (E) of section
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6015(b)(1). Therefore, the controversy arising from the
deduction of the Boulder Oil and Gas losses focuses on: (1)
Whether petitioner, in signing the joint 1983 tax return, knew or
had reason to know of the understatement; and (2) taking into
account all the facts and circumstances, whether it would be
inequitable to hold petitioner liable for the resulting
deficiency.
The requirement of section 6015(b)(1)(C) is similar to the
requirement of former section 6013(e)(1)(C) in that both
provisions require the requesting spouse to establish “in signing
the return, he or she did not know, and had no reason to know” of
the understatement. Because of their similarities, analysis in
opinions concerning former section 6013(e)(1)(C) remains
instructive to our analysis for section 6015(b)(1)(C). Jonson v.
Commissioner, 118 T.C. 106, 115 (2002), affd. 353 F.3d 1181 (10th
Cir. 2003); Butler v. Commissioner, 114 T.C. 276, 283 (2000).
An examination of the record reveals that only Mr. Hendricks
executed the investment papers in Boulder Oil and Gas and that
the partnership interest was placed in his name alone. Mr.
Hendricks paid for the Boulder Oil and Gas investment with checks
drawn from one of his business accounts, to which petitioner had
no access. All mail from Boulder Oil and Gas was sent to Mr.
Hendricks’s business address. Petitioner did not see any mail
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from Boulder Oil and Gas, because Mr. Hendricks did not bring any
of this mail home.
Petitioner’s lack of knowledge regarding the transaction is
corroborated by the Hendrickses’ testimonies at trial. Mr.
Hendricks testified that he did not discuss business or financial
matters, including his investment in Boulder Oil and Gas, with
petitioner and that he did not consult petitioner when he decided
to make the investment.
Having observed the Hendrickses’ appearances and demeanors
at trial, we find their testimonies to be honest, forthright, and
credible. In view of their testimonies, we find that petitioner
did not have actual knowledge of Mr. Hendricks’s investment in
Boulder Oil and Gas at the time the joint 1983 tax return was
signed.
Section 6015(b)(1)(C) also requires that petitioner
establish that she did not have reason to know that there was an
understatement. Whether petitioner had reason to know of an
understatement is a question of fact which must be determined
based upon the entire record. Guth v. Commissioner, 897 F.2d
441, 442 (9th Cir. 1990), affg. T.C. Memo. 1987-522; Terzian v.
Commissioner, 72 T.C. 1164, 1170-1172 (1979). Petitioner had
reason to know of an understatement if a reasonably prudent
taxpayer under her circumstances could be expected to know that
the tax liability stated was erroneous or that further
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investigation was warranted. Stevens v. Commissioner, 872 F.2d
1499, 1505 (11th Cir. 1989), affg. T.C. Memo. 1988-63; Shea v.
Commissioner, 780 F.2d 561, 566 (6th Cir. 1986), affg. in part
and revg. in part on another ground T.C. Memo. 1984-310; Bokum v.
Commissioner, 94 T.C. 126, 148 (1990), affd. 992 F.2d 1132 (11th
Cir. 1993).
When deciding whether petitioner had reason to know of an
understatement, we consider several factors including
petitioner’s level of education, her involvement in the financial
transactions which gave rise to the deductions, the presence of
lavish or unusual expenditures compared to her past standard of
living, and her husband’s openness concerning these transactions.
See Stevens v. Commissioner, supra at 1505; Butler v.
Commissioner, supra at 284; Flynn v. Commissioner, 93 T.C. 355,
365-366 (1989). In making our determination, we must consider
the interplay or balance of the factors, instead of merely
counting the factors in a requesting spouse’s favor. Guth v.
Commissioner, supra at 444.
At the time petitioner signed the returns, petitioner had
completed 2 years of college, where she studied art. She did not
have any education or work experience in tax, financial, or
accounting matters. We find nothing in the record regarding her
education and experiences that would or should have alerted her
to the pitfalls of this situation.
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Mr. Hendricks dominated the financial side of the marriage
with petitioner playing a minor role in the family’s finances.
Petitioner did not participate in any of Mr. Hendricks’s business
activities. Although Mr. Hendricks was not deceitful regarding
their finances, he did not consult with petitioner about making
the investment in Boulder Oil and Gas and did not disclose that
the investment had been made. Moreover, petitioner played a
minimal role in the preparation of the tax returns. The only
information petitioner provided was a list of personal and
household expenses. She relied upon Mr. Hendricks to provide the
remainder of the information.
The Hendrickes have led frugal lifestyles. We find no
evidence in the record that the Hendrickses made any lavish or
unusual expenditures during the relevant years.
Considering all of the circumstances concerning the joint
1983 tax return, a reasonably prudent taxpayer under petitioner’s
circumstances–-living a modest life, raising a family of five
children, uninvolved in the financial affairs of the family, and
without any financial background–-at the time of signing could
not be expected to know about the understatement attributable to
Mr. Hendricks’s investment in Boulder Oil and Gas.
Is there, however, a duty of inquiry? In order for
petitioner’s duty of inquiry to arise, she must first harbor
doubts about the accuracy of the return. Stevens v.
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Commissioner, supra at 1507. Petitioner may be put on notice of
the understatement if a reasonably prudent taxpayer in her
position would be led to question the legitimacy of the
deduction. Id. at 1505. The Court of Appeals for the Second
Circuit has concluded:
Tax returns setting forth large deductions, such
as tax shelter losses offsetting income from other
sources and substantially reducing or eliminating the
couple’s tax liability, generally put a taxpayer on
notice that there may be an understatement of tax
liability.
See Hayman v. Commissioner, 992 F.2d 1256, 1262 (2d Cir. 1993),
affg. T.C. Memo. 1992-228.
Mr. Hendricks was a farm and ranch real estate broker and an
investor, which required him to report his various investment
activities on Schedule E on the Hendrickses’ Federal income tax
return. On their joint 1983 tax return, the Hendrickses claimed
$158,521 in losses arising from Boulder Oil and Gas. This amount
did not appear on the face of the return, but it was listed on
Schedule E, combined with the income and expenses of at least 11
other properties, including the condominiums and an office
building.
Considering all of the circumstances, we conclude that
petitioner was not put “on notice” of the understatement. See
Boyle v. Commissioner, T.C. Memo. 1994-438. We conclude that a
reasonably prudent taxpayer in petitioner’s position, at the time
of signing the return, could not be expected to know about the
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understatement of tax or that further investigation was
warranted. Petitioner has satisfied the section 6015(b)(1)(C)
requirement.
The final question is whether, taking into account all the
facts and circumstances, it would be inequitable to hold
petitioner liable for the deficiency attributable to the
understatement on the joint 1983 tax return. Sec. 6015(b)(1)(D).
Respondent argues that it would not be inequitable for
petitioner to be held liable for the understatement on the joint
1983 tax return because title to the remaining condominiums was
transferred in 1997 to her name alone. The Hendrickses acquired
the condominiums before Mr. Hendricks invested in Boulder Oil and
Gas. The condominiums were acquired by exchanging other property
the Hendrickses had previously owned and were not acquired from
proceeds made available through the investment in Boulder Oil and
Gas. Mr. Hendricks transferred his joint interest in the
remaining condominiums to petitioner nearly 3 years before
respondent assessed the deficiency for 1983 and began collection
action against the Hendrickses for that tax year. The
Hendrickses had paid the balances due for 1980-82 with moneys,
derived in part, from the sale of several of the condominiums,
and the Hendrickses mistakenly believed that they had settled the
1983 tax year and did not owe any more tax liabilities.
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Mr. Hendricks and Mr. Angeli testified at trial that the
risks associated with the substantial farming enterprise with
which Mr. Hendricks was engaged at the time were what motivated
the transfer of the remaining condominiums. Petitioner was not
involved in the farming enterprise, and the Hendrickses wanted to
protect their investment in the remaining condominiums because
they constituted the Hendrickses’ only financial resource for
their retirement outside of Social Security. Furthermore,
despite the lack of success with the farming enterprise, Mr.
Hendricks paid all of his debts from the farming enterprise.
There is nothing in the record to indicate that the
Hendrickses’ standard of living increased in comparison to their
standard of living in prior years. Their lifestyle was not
lavish, and they made no unusual expenditures. We find that
petitioner did not significantly benefit from the deduction
attributable to Mr. Hendricks’s investment in Boulder Oil and
Gas. See Hayman v. Commissioner, supra; Jonson v. Commissioner,
118 T.C. 106 (2002), affd. 353 F.3d 1181 (10th Cir. 2003).
As retirees, the Hendrickses rely on the Social Security
checks they receive monthly and depend upon the rents from the
remaining condominiums for income. Their current monthly living
expenses exceed their income by about $1,100. They are able to
meet their living expenses only through financial assistance from
their children. We conclude that petitioner would experience
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considerable economic hardship if relief from the liabilities
were not granted, given the Hendrickses’ current level of income
and assets. See Ewing v. Commissioner, 122 T.C. 32, 47 (2004).
We also consider the fact that the Hendrickses have made a
good faith effort to comply with Federal income tax laws in the
tax years following 1983. Except for the years they reported
loss activity from Boulder Oil and Gas, i.e., 1980-83, the
Hendrickses neither have had their Federal tax returns examined,
nor have they had taxes in excess of the amount reported on their
returns assessed. Furthermore, the Hendrickses have made an
honest attempt to pay their tax liabilities when they were able
and did so as quickly as possible. The Hendrickses paid in full
the balances due for 1980-82 by the end of 1993, and have already
paid more than $110,000 toward the balance due for 1983, $63,176
of which represents the underpayment attributable to Mr.
Hendricks’s investment in Boulder Oil and Gas.
Considering that petitioner did not receive significant
benefit from the understatements, that petitioner would suffer
considerable economic hardship if relief were denied, and that
the Hendrickses have complied with Federal tax laws at least
since 1983, we conclude that on the basis of all the facts and
circumstances it would be inequitable to hold petitioner liable
for the understatement of tax for 1983. Petitioner has satisfied
the section 6015(b)(1)(D) requirement.
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In summary, we find that petitioner has established: (1) In
signing the joint 1983 tax return, she did not know nor did she
have reason to know of the understatement; and (2) taking into
account all the facts and circumstances, it would be inequitable
to hold petitioner liable for the resulting deficiency.
Petitioner has met all the requirements of section 6015(b), and
she is entitled to relief from joint and several tax liability as
to 1983.
To reflect the foregoing,
An appropriate decision
will be entered.