T.C. Summary Opinion 2013-34
UNITED STATES TAX COURT
HARRY E. COLE AND DEBORAH L. COLE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14402-11S. Filed April 29, 2013.
Harry E. Cole and Deborah L. Cole, pro sese.
Nancy M. Gilmore, for respondent.
SUMMARY OPINION
GUY, Special Trial Judge: This case was heard pursuant to the provisions of
section 7463 of the Internal Revenue Code in effect when the petition was
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filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by
any other court, and this opinion shall not be treated as precedent for any other case.
Respondent determined deficiencies in petitioners’ Federal income tax,
additions to tax, and accuracy-related penalties for the years and in the amounts as
follows:
Addition to tax Penalty
Year Deficiency sec. 6651(a)(1) sec. 6662(a)
2006 $9,640 $1,408 $1,928
2007 8,604 --- 1,721
2008 7,405 664 1,481
Petitioners filed a timely petition for redetermination with the Court pursuant to
section 6213(a). At the time the petition was filed, petitioners resided in Maryland.
1
Section references are to the Internal Revenue Code (Code), as amended,
and Rule references are to the Tax Court Rules of Practice and Procedure. All
monetary amounts are rounded to the nearest dollar.
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After concessions,2 the issues remaining for decision are whether: (1)
petitioners are entitled to deductions for casualty losses of $2,284 and $18,668 for
2006 and 2008, respectively, related to flooding in their basement; (2) petitioners
are entitled to a deduction for a casualty loss of $18,818 for 2007 related to damage
to their car; (3) petitioners are liable for accuracy-related penalties under section
6662(a) for the years in issue; and (4) Mrs. Cole is entitled to relief from joint and
several liability under section 6015 for the years in issue.
Background
Some of the facts have been stipulated and are so found. The stipulation of
facts and the accompanying exhibits are incorporated herein by reference.
Petitioners were married in 1985 and have two adult children. Although
petitioners testified at trial that they consider themselves to be separated, they have
never been divorced or legally separated, and they continued to reside in the same
household at all times relevant to this case.
2
The parties agree that petitioners: (1) did not receive any rental income and
they are not entitled to deduct any of the various expenses reported on Schedules C,
Profit or Loss From Business, for the years in issue; (2) are not entitled to
deductions of $28,434 and $9,460 for “other expenses” reported on Schedules A,
Itemized Deductions, for 2007 and 2008, respectively; and (3) are entitled to claim
one of their adult sons as a dependent and claim an education credit for his qualified
tuition expenses for 2006. For the sake of clarity, other concessions are described
in the text that follows. To the extent not discussed herein, other issues are
computational and flow from our decision in this case.
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During the years in issue neither petitioner was self-employed, and petitioners
did not own any business or income-producing property.
Petitioners maintained separate bank accounts and shared household
expenses. Mr. Cole made monthly mortgage payments while Mrs. Cole paid
grocery, utility, and other expenses. Petitioners also maintained a joint credit union
account which they used as a repository for tax refund checks. The funds in the
credit union account were used for household expenses.
I. Mrs. Cole’s Education and Employment
Mrs. Cole graduated from high school and is working toward a bachelor’s
degree. From 1986 to 2006 she worked in the finance department at Bally Total
Fitness, serving as a supervisor of telemarketers. She began to work in the customer
service department for the Baltimore Orioles in 2007.
II. Mr. Cole’s Employment and Related Business Expenses
During the years in issue Mr. Cole worked as a railroad conductor and
engineer for Norfolk Southern Corp. The parties stipulated that Mr. Cole qualified
for “the special employee business expense rules for transportation workers” during
the years in issue, and they agree that he is entitled to deductions for unreimbursed
employee business expenses as follows:
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Year Vehicle expenses Parking/tolls Meals 1
2006 $1,530 $130 $5,563
2007 675 130 2,754
2008 843 360 1,710
1
The parties stipulated that the expenses for meals listed in this
schedule represent Mr. Cole’s expenditures “before the 50%
reduction”. Sec. 274(n)(1) prescribes the general rule that the amount
allowable as a deduction for meal and entertainment expenses is
limited to 50% of the amount of these expenses. However, consistent
with the parties’ stipulation that Mr. Cole qualifies for the special rule
for transportation workers prescribed in sec. 274(n)(3), petitioners are
allowed a deduction equal to 75% of these expenses for 2006 and 2007
and 80% of these expenses for 2008. Sec. 274(n)(3)(B). Consistent
with the agreement of the parties, deductions that petitioners otherwise
claimed for employee business expenses in excess of those set forth in
the schedule are disallowed.
III. Flooded Basement
The basement in petitioners’ home was damaged because of flooding in 2006
and 2008. Petitioners did not file a claim for reimbursement under their
homeowner’s insurance policy for the damage incurred in either 2006 or 2008.
Petitioners instead filed suit against the City of Baltimore, asserting that the flooding
was attributable to malfunctions in the City’s main water line and seeking
reimbursement of some or all of the damages. At the time of the trial in this case,
petitioners’ suit was still pending, and petitioners testified that they were actively
prosecuting the case.
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IV. Damaged Mercedes
In 2001 petitioners purchased a preowned 1999 Mercedes-Benz (Mercedes).
In February 2007 the Mercedes was damaged and petitioners received a payment of
$15,376 from their insurance company for the “total loss” of the vehicle. At the
time petitioners submitted their insurance claim, the Mercedes had been driven
82,685 miles. Petitioners failed to offer any evidence of their adjusted basis in or
the fair market value of the Mercedes as of the date it was damaged in 2007.
V. Tax Returns
On August 14, 2008, petitioners filed joint Federal income tax returns for
2006 and 2007. The parties agree that petitioners have additional wage income of
$10,603 and additional income tax withholding of $851 for 2006. The record does
not reflect whether the additional wage income is attributable to Mr. or Mrs. Cole or
both of them. Petitioners filed a joint Federal income tax return for 2008 on January
22, 2010. Petitioners concede that they are liable for additions to tax under section
6651(a)(1) for late filing for 2006 and 2008.
Petitioners claimed deductions on Schedules A for casualty losses of $2,284
and $18,668 for 2006 and 2008, respectively, attributable to flood damage to their
basement. Petitioners claimed a deduction for a casualty loss of $18,818 on line 14
(“Other gains or (losses)”) of their 2007 return. Petitioners computed the loss,
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which related to the damaged Mercedes, on section B of Form 4684, Casualties and
Thefts, reserved for casualty gains or losses for business and income-producing
property. Specifically, petitioners computed the $18,818 loss by subtracting
$16,000 (approximate insurance reimbursement) from $34,818 (estimated adjusted
basis).
Petitioners claimed refunds of $4,008, $4,721, and $4,751 on their returns for
the taxable years 2006, 2007, and 2008, respectively.
VI. Tax Return Preparation
Petitioners’ tax returns for 2006 and 2007 were prepared by MBA Financial
Services, and their return for 2008 was prepared by Okojie Associates, Inc. It was
Mr. Cole’s practice to deliver the couple’s tax records to the return preparer and,
after the returns were prepared, present them to Mrs. Cole for her signature. After
the returns were prepared, petitioners routinely signed them without reviewing them
in any detail. Although Mrs. Cole had never been introduced to the return preparer,
she trusted that the returns were accurate.
VII. Mrs. Cole’s Claim for Spousal Relief
After filing the petition in this case, Mrs. Cole requested spousal relief under
section 6015 for the years in issue. Respondent concedes that Mrs. Cole is entitled
to relief from joint and several liability only in respect of so much of the
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deficiencies, additions to tax, and accuracy-related penalties as is attributable to Mr.
Cole’s disallowed employee business expenses.
Discussion
As a general rule, the Commissioner’s determination of a taxpayer’s liability
in a notice of deficiency is presumed correct, and the taxpayer bears the burden of
proving that the determination is incorrect. Rule 142(a); Welch v. Helvering, 290
U.S. 111, 115 (1933).
Petitioners have not complied with the Code’s substantiation requirements.
Therefore, the burden of proof as to any relevant factual issue does not shift to
respondent under section 7491(a). See sec. 7491(a)(1) and (2); Higbee v.
Commissioner, 116 T.C. 438, 442-443 (2001).
Deductions are a matter of legislative grace, and the taxpayer generally bears
the burden of proving entitlement to any deduction claimed. Rule 142(a);
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934). A taxpayer must substantiate deductions by
keeping and producing adequate records that enable the Commissioner to determine
the taxpayer’s correct tax liability. Sec. 6001; Hradesky v. Commissioner, 65 T.C.
87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); Meneguzzo v.
Commissioner, 43 T.C. 824, 831-832 (1965). A taxpayer claiming a deduction on a
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Federal income tax return must demonstrate that the deduction is allowable pursuant
to a statutory provision and must further substantiate that the expense to which the
deduction relates has been paid or incurred. Sec. 6001; Hradesky v. Commissioner,
65 T.C. at 89-90.
When a taxpayer establishes that he or she paid or incurred a deductible
expense but fails to establish the amount of the deduction, the Court normally may
estimate the amount allowable as a deduction. Cohan v. Commissioner, 39 F.2d
540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743
(1985). There must be sufficient evidence in the record, however, to permit the
Court to conclude that a deductible expense was paid or incurred in at least the
amount allowed. Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957).
I. Casualty Losses
Under section 165(a), a taxpayer generally is allowed as a deduction any loss
sustained during the taxable year that is not compensated for by insurance or
otherwise. However, in the case of an individual, and as is relevant here, section
165(c)(3) limits the deduction to losses of property arising from fire, storm,
shipwreck or other casualty, or from theft. The amount of a casualty loss is
generally the lesser of the taxpayer’s adjusted basis in the property or the diminution
in the fair market value of the property caused by the casualty.
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Sec. 1.165-7(b)(1), Income Tax Regs.; see Lamphere v. Commissioner, 70 T.C.
391, 395 (1978) (and cases cited thereat).3 In the case of a loss described in section
165(c)(3), the loss is allowed only to the extent that the amount of the loss arising
from each casualty exceeds $100 and then only to the extent that the aggregate
amount of such losses exceeds 10% of the taxpayer’s adjusted gross income. Sec.
165(h)(1), (2)(A).
If, in the year of the casualty, there exists a claim for reimbursement with
respect to which there is a reasonable prospect of recovery, the loss is not sustained
until it can be ascertained with reasonable certainty whether such reimbursement
will be received. Sec. 1.165-1(d)(2)(i), Income Tax Regs. Whether a reasonable
prospect of recovery exists is determined by an examination of the facts and
circumstances. Id. Whether reimbursement will be received may be ascertained
with reasonable certainty, for example, by settlement, adjudication, or abandonment
of the claim. Id.
3
In determining the amount of loss deductible under section 165, the
taxpayer’s adjusted basis in the property is the amount of the adjusted basis
prescribed in sec. 1.1011-1, Income Tax Regs., for determining the loss from the
sale or other disposition of the property involved. Sec. 1.165-7(b)(1)(ii),
Income Tax Regs.; see sec. 1.165-1(c)(1), Income Tax Regs. Also in determining
the amount of loss deductible under sec. 165, fair market value generally shall be
ascertained by competent appraisal. Sec. 1.165-7(a)(2)(i), Income Tax Regs.; see
Gay v. Commissioner, T.C. Memo. 1980-19.
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A. Flood Damages
Petitioners claimed deductions for casualty losses related to damages
sustained when their basement was flooded in 2006 and 2008. However, petitioners
filed suit against the City of Baltimore seeking reimbursement for those damages,
and they confirmed at trial that the litigation is ongoing.
Given that petitioners continue to prosecute their claim against the City of
Baltimore, and in the absence of any evidence suggesting that the prospect of a
recovery is unlikely, they have not sustained a casualty loss and no loss can be
calculated for 2006 or 2008 until it can be ascertained with reasonable certainty
whether they will be reimbursed for the damages in question. See id.
Consequently, we sustain respondent’s determination disallowing deductions for
casualty losses for 2006 and 2008 related to flooding in petitioners’ basement.
B. Damaged Mercedes
Petitioners claimed a deduction for a casualty loss related to the damaged
Mercedes. Considering the parties’ stipulation that petitioners did not own any
business or income-producing property during the years in issue, it is clear that
petitioners erred in computing the loss related to the Mercedes on Form 4684 and
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reporting the item “above the line”, i.e., on line 14 of their 2007 return.4 In any
event, petitioners did not offer any evidence of their adjusted basis in or the fair
market value of the Mercedes immediately before it was damaged that would permit
the Court to accurately measure or even estimate the amount of the casualty loss
(after accounting for petitioners’ insurance recovery of $15,376). It is well
established that if a taxpayer fails to prove his or her adjusted basis in the property
involved, no casualty loss is allowable. Zmuda v. Commissioner, 79 T.C. 714, 727
(1982), aff’d, 731 F.2d 1417 (9th Cir. 1984). On the record presented, we sustain
respondent’s determination disallowing the deduction for the casualty loss
petitioners reported in 2007 in respect of the Mercedes.
II. Accuracy-Related Penalties
Section 6662(a) and (b)(1) imposes a penalty equal to 20% of the amount of
any underpayment attributable to negligence or disregard of rules or regulations.
4
A deduction reported “above the line” is subtracted from gross income in
computing adjusted gross income (AGI). Sec. 62(a). In contrast, “below-the-line”
deductions (including itemized deductions and the standard deduction, see sec.
63(b), (d), (e)) are subtracted from AGI in computing taxable income. Above-the-
line deductions typically may be claimed in addition to itemized deductions or the
standard deduction and offer the added benefit of reducing AGI which in turn is
used as a measure to limit other tax benefits. See, e.g., Calvao v. Commissioner,
T.C. Memo. 2007-57, slip op. at 5 n.6.
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The term “negligence” includes any failure to make a reasonable attempt to comply
with tax laws, and “disregard” includes any careless, reckless, or intentional
disregard of rules or regulations. Sec. 6662(c). Negligence also includes any failure
to keep adequate books and records or to substantiate items properly. Sec. 1.6662-
3(b)(1), Income Tax Regs.; see Olive v. Commissioner, 139 T.C. ____, ____ (slip
op. at 40) (Aug. 2, 2012).
Section 6664(c)(1) provides an exception to the imposition of the accuracy-
related penalty if the taxpayer establishes that there was reasonable cause for, and
the taxpayer acted in good faith with respect to, the underpayment. Sec. 1.6664-
4(a), Income Tax Regs. The determination of whether the taxpayer acted with
reasonable cause and in good faith is made on a case-by-case basis, taking into
account the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax
Regs. Reliance on a tax professional may demonstrate that the taxpayer had
reasonable cause and acted in good faith where the taxpayer establishes that: (1) the
adviser was a competent professional with sufficient expertise to justify the
taxpayer’s reliance; (2) the taxpayer provided the adviser with necessary and
accurate information; and (3) the taxpayer actually relied in good faith on the
adviser’s judgment. 3K Inv. Partners v. Commissioner, 133 T.C. 112, 117 (2009);
DeCleene v. Commissioner, 115 T.C. 457, 477 (2000).
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With respect to a taxpayer’s liability for any penalty, section 7491(c) places
on the Commissioner the burden of production, thereby requiring the Commissioner
to come forward with sufficient evidence indicating that it is appropriate to impose
the penalty. Higbee v. Commissioner, 116 T.C. at 446-447. Once the
Commissioner meets his burden of production, the taxpayer must come forward
with persuasive evidence that the Commissioner’s determination is incorrect. Id. at
447; see Rule 142(a); Welch v. Helvering, 290 U.S. at 115.
Respondent has discharged his burden of production under section 7491(c) by
showing that petitioners failed to keep adequate records and properly substantiate
their claimed deductions. See sec. 1.6662-3(b)(1), Income Tax Regs.
Although petitioners relied on paid tax preparers, there is no evidence in the
record regarding the preparers’ respective experience or qualifications that would
support the conclusion that petitioners reasonably relied on them. There is no
indication that the preparers took the time to review the returns with petitioners, and
petitioners admitted that they did not undertake to thoroughly review them on their
own.
Taxpayers have a duty to review their tax returns before signing and filing
them, and the duty of filing accurate returns cannot be avoided by placing
responsibility on a tax return preparer. Metra Chem Corp. v. Commissioner, 88
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T.C. 654, 662 (1987); Magill v. Commissioner, 70 T.C. 465, 479-480 (1978), aff’d,
651 F.2d 1233 (6th Cir. 1981).
Petitioners failed to establish that their reliance on the return preparers was
reasonable or in good faith. Thus, on the record presented, we are unable to
conclude that petitioners acted with reasonable cause and in good faith within the
meaning of section 6664(c)(1). Accordingly, petitioners are liable for the accuracy-
related penalty under section 6662(a) for each year in issue.
III. Spousal Relief
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 for the entire tax due. Sec. 6013(d)(3); Butler v. Commissioner, 114 T.C.
276, 282 (2000). If certain requirements are met, however, an individual may be
relieved of joint and several liability under section 6015. Except as otherwise
provided in section 6015, the taxpayer bears the burden of proving his or her
entitlement to relief. Rule 142(a); Porter v. Commissioner, 132 T.C. 203, 210
(2009); Alt v. Commissioner, 119 T.C. 306, 311 (2002), aff’d, 101 Fed. Appx. 34
(6th Cir. 2004).
There are three types of relief available under section 6015. In general,
section 6015(b) provides full or apportioned relief from joint and several liability for
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understatements of tax on a return, section 6015(c) provides apportioned relief in
respect of a deficiency to taxpayers who are divorced or separated,5
and in certain circumstances section 6015(f) provides equitable relief from joint and
several liability if relief is not available under subsection (b) or (c).
A. Section 6015(b)
To be eligible for relief under section 6015(b), the requesting spouse must
establish, inter alia, that the understatement of tax is attributable to erroneous items
of the nonrequesting spouse and, in signing the return, the requesting spouse “did
not know, and had no reason to know” of the understatement of tax. Sec.
6015(b)(1)(B) and (C).
The understatements of tax on petitioners’ joint returns for the years in issue
are in large part attributable to the disallowance of substantial deductions for
casualty losses and “other expenses” petitioners reported on Schedules A and
business expenses they reported on Schedules C.6 On the record presented, we
5
Petitioners were not divorced or legally separated at the time Mrs. Cole
elected to claim spousal relief, and they were continuously residing in the same
household during all relevant periods. Therefore, Mrs. Cole is not eligible for relief
under sec. 6015(c). See sec. 6015(c)(3)(A)(i).
6
As previously mentioned, petitioners concede that they are not entitled to
deductions for various expenses reported on Schedules C for each of the years in
issue, and they are not entitled to deductions for “other expenses” reported on
(continued...)
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cannot say that the understatements are attributable in whole or in part to erroneous
items of Mr. Cole alone. In short, Mrs. Cole was a participant in the ongoing
litigation with the City of Baltimore in which petitioners were seeking damages
related to flooding in their basement, and she did not offer any testimony or other
evidence that she was unaware of the transactions giving rise to any of the
disallowed deductions reported on Schedules A and C. Thus, we conclude that the
erroneous items are attributable to both petitioners.
Moreover, we conclude that Mrs. Cole had reason to know of the
understatements of tax within the meaning of section 6015(b)(1)(C). A spouse
seeking relief under section 6015(b) has reason to know of the understatement “if a
reasonably prudent taxpayer in her position at the time she signed the return could
be expected to know that the return contained the * * * understatement.” Price v.
Commissioner, 887 F.2d 959, 965 (9th Cir. 1989). A taxpayer has reason to know
of an understatement if she had a duty to inquire and failed to satisfy that duty. Id.
A joint tax return reporting a large deduction that significantly reduces a couple’s
tax liability generally puts both spouses on notice that the return may contain an
understatement. See Levin v. Commissioner, T.C. Memo. 1987-67.
6
(...continued)
Schedules A for 2007 and 2008.
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Although Mrs. Cole did not review the returns in any detail when they were
presented to her for signature, she nevertheless is charged with constructive
knowledge of their contents. See Price v. Commissioner, 887 F.2d at 965-966; see
also Von Kalinowski v. Commissioner, T.C. Memo. 2001-21. A spouse cannot
obtain relief under section 6015 in a case involving disallowed deductions “‘by
simply turning a blind eye to--by preferring not to know of--facts fully disclosed on
a return, of such a large nature as would reasonably put such spouse on notice that
further inquiry would need to be made’”. Price v. Commissioner, 887 F.2d at 965
(quoting Levin v. Commissioner, T.C. Memo. 1987-67).
Petitioners claimed large deductions for each of the years in issue which
served to offset their wage income and resulted in claims for refunds. Considering
all the facts and circumstances, we conclude that Mrs. Cole was obliged to inquire
further and she failed to do so. See, e.g., Wiener v. Commissioner, T.C. Memo.
2008-230. As a result, we hold that Mrs. Cole does not meet the requirements of
section 6015(b)(1)(B) and (C), and she does not qualify for relief from joint and
several liability under section 6015(b).
B. Section 6015(f)
Section 6015(f) grants the Commissioner discretion to relieve an individual
from joint liability, where relief is not available under section 6015(b) or (c), if,
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taking into account all the facts and circumstances, it is inequitable to hold the
individual liable for any unpaid tax or deficiency. As directed by section 6015(f),
the Commissioner has prescribed guidelines in Rev. Proc. 2003-61, 2003-2 C.B.
296, modifying Rev. Proc. 2000-15, 2000-1 C.B. 447, that are used in determining
whether it is inequitable to hold a requesting spouse liable for all or part of the
liability for any unpaid tax or deficiency. Although the Court consults these
guidelines when reviewing the Commissioner’s denial of relief, see Washington v.
Commissioner, 120 T.C. 137, 147-152 (2003), we are not bound by them inasmuch
as our analysis and determination ultimately turns on an evaluation of all the facts
and circumstances, see Pullins v. Commissioner, 136 T.C. 432, 438-439 (2011).7
Rev. Proc. 2003-61, sec. 4.01, 2003-2 C.B. at 297, sets forth seven threshold
conditions that must generally be satisfied before the Commissioner will consider a
request for equitable relief under section 6015(f). Rev. Proc. 2003-61, sec. 4.01(7),
7
On January 5, 2012, the Commissioner issued Notice 2012-8, 2012-4 I.R.B.
309, announcing that a proposed revenue procedure updating Rev. Proc. 2003-61,
2003-2 C.B. 296, will be forthcoming. That proposed revenue procedure, if
finalized, will revise the factors that the Commissioner will use to evaluate requests
for equitable relief under sec. 6015(f). Consistent with the Court’s approach in
Sriram v. Commissioner, T.C. Memo. 2012-91, we have evaluated the record in this
case against the factors set forth in Rev. Proc. 2003-61, supra, in view of the fact
that the revenue procedure proposed in Notice 2012-8, supra, is not final.
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requires that the income tax liability from which the requesting spouse seeks relief
be attributable to an item of the “nonrequesting spouse”, unless one of the
enumerated exceptions applies, which none does in this case.
As discussed above, Mrs. Cole failed to show that the understatements of tax
for the years in issue are attributable to erroneous items of Mr. Cole or that he was
evasive or somehow attempted to deceive her with regard to the disputed
deductions. In the light of all the facts and circumstances, we conclude that Mrs.
Cole is not entitled to relief from joint and several liability for the years in issue
pursuant to section 6015(f).
To reflect the foregoing,
Decision will be entered under
Rule 155.