Park v. Commissioner

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

_____________________

No. 93-5339
_____________________

HAROLD L. PARK, Deceased, and
ALICE P. JONES, formerly ALICE P. PARK,

Petitioner-Appellant,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

_________________________________________________________________

Appeal from A Decision of the United States Tax Court
_________________________________________________________________
(June 30, 1994)

Before GOLDBERG, KING, and WIENER, Circuit Judges.

KING, Circuit Judge:

Alice P. Jones appeals the decision of the United States Tax

Court denying her innocent spouse relief under 26 U.S.C.

§ 6013(e) and § 6004 of the Technical and Miscellaneous Revenue

Act of 1988. Finding no error, we affirm.

I. BACKGROUND

A. FACTUAL BACKGROUND

Harold Park and Alice Jones were married in 1978. Park was

a certified public accountant and chief financial officer for

Thomas Petroleum Products. Jones is a high school graduate, who

completed four or five courses in real estate and is a licensed
real estate agent. In 1981, Park left Thomas Petroleum and

became the chief financial officer for a large concern known as

B.P.M., Ltd.

Park and Jones maintained two joint checking accounts, one

at Spring Branch Bank and the other at Town and Country Bank.

Although Park referred to the Town and Country account as his

business account, funds from that account were sometimes used to

pay personal expenses. Jones opened the family mail and paid the

family's bills from these two checking accounts, including those

in connection with an oil and gas exploration venture (Hadl Oil)

in which she and Park were involved. She wrote most of the

checks drawn on these accounts, carried the checkbooks with her

most of the time, and reconciled the checkbook balances for these

accounts on a monthly basis.

In December 1980, Park opened an individual investment

account with Financial Securities Corp. (FSC), with an initial

investment of $7,500SQpaid by check from the Town and Country

account. Under the terms of the investment agreement, FSC

purchased and sold, on Park's behalf, Government National

Mortgage Association (GNMA) securities and related forward

delivery contracts. FSC then mailed Park monthly statements of

account, which listed inter alia the amounts FSC had received

from Park, the GNMA contracts FSC bought or sold on Park's

behalf, and Park's open trade equity. Jones would see these

statements when she opened the family mail and, on occasion,

would question Park about them. Park, however, was evasive when

2
responding to Jones' questions and told her that their accountant

had recommended the FSC investment as a tax investment, that it

should make them money, and that he or their accountant would

take care of it. Jones filed these monthly statements in a shoe

box with other financial records, which were turned over to an

accountant at tax filing time for preparation of their tax

return.

In June 1981, Park received a letter from FSC stating that

the balance in the margin account was deficient by $13,000 and

that payment had to be made by June 15 to prevent the liquidation

of the investment and the closing of the account. Because Park

was out of town at the time the letter arrived, Jones phoned Park

about the letter. He instructed her to mail a check to FSC for

$13,000, which she did on June 9, 1981.

Charles Randolph, a certified public accountant, prepared

the joint federal income tax return for 1981 at issue in this

case for Park and Jones after Jones delivered to Randolph the

records needed to prepare the return. On the return, Park and

Jones reported losses totaling $107,456 from the FSC investment

(an amount that was more than five times their total cash

investment of $20,500SQi.e., the initial $7,500 investment plus

the later $13,000 margin call). They also claimed a total refund

of $36,829, which was deposited in the Town and Country account

and used to pay off bills incurred in connection with Hadl Oil.

Park and Jones were divorced in April 1986. Park died in

August 1991.

3
 B. PROCEDURAL HISTORY

The Commissioner issued a notice of deficiency to Park and

Jones on August 22, 1984, disallowing the FSC investment loss

deduction claimed for 1981. Park and Jones petitioned the tax

court for a redetermination of the deficiency, which the

Commissioner had asserted was $266,582. Jones subsequently

amended the petition to assert that she was an innocent spouse

under either § 6013(e) or, in the alternative, under § 6004 (the

transitional rule) of the Technical and Miscellaneous Revenue Act

of 1988 (TAMRA). The parties then filed a stipulation on

September 25, 1989, in which Park and Jones agreed that they were

not entitled to the investment loss claimed ($107,456) but that

they were instead entitled to a loss deduction of $13,000SQtheir

net investment in FSC for 1981. Park further agreed that he was

liable for a $40,065 deficiency in 1981 tax, and he waived

further restrictions on assessment and collection of the

deficiency.

The tax court determined that Jones had "reason to know" of

the substantial understatement on the joint 1981 tax return. The

court accordingly found that Jones did not qualify for "innocent

spouse" relief under either § 6013(e) or the transitional rule.

Jones then filed a timely notice of appeal.

II. STANDARD OF REVIEW

We review the decision of the tax court under the same

standards that apply to district court decisions. Thus, issues

4
of law are reviewed de novo, and findings of fact are reviewed

for clear error. McKnight v. Commissioner, 7 F.3d 447, 450 (5th

Cir. 1993). The tax court's determination that a spouse is not

entitled to relief as an "innocent spouse" is reviewable under

the clearly erroneous standard. Buchine v. Commissioner, 20 F.3d

173, 181 (5th Cir. 1994); see McGee v. Commissioner, 979 F.2d 66,

69 (5th Cir. 1992); Sanders v. United States, 509 F.2d 162, 170-

71 (5th Cir. 1975).

III. DISCUSSION

Jones contends that the tax court clearly erred in finding

that she was not entitled to innocent spouse relief under either

§ 6013(e) or the transitional rule. She argues that the innocent

spouse tests set forth in each of these statutes are

substantially different, even though both contain similar

language such that the spouse applying for innocent spouse relief

must establish that the spouse either did not know or had no

reason to know that there was a substantial understatement of

income on the joint tax return in question. We discuss each of

these statutes in turn.

A. SECTION 6013(e): THE INNOCENT SPOUSE RULE

Spouses who file joint tax returns are generally jointly and

severally liable for tax due on their combined incomes, including

interest and penalties. See 26 U.S.C. § 6013(d)(3). This

general rule is mitigated to some extent by § 6013(e), known as

the "innocent spouse rule," which Congress first implemented in

5
1971. See Act of Jan. 12, 1971, § 1, Pub. L. No. 91-679, 84

Stat. 2063 (1971). The original provision provided relief only

to those innocent spouses who were otherwise subject to liability

because of an understatement due to an omission of taxable

income.1 Id. In 1984, Congress expanded the scope of the

provision, bringing within its ambit deficiencies arising from

invalid deductions or credits. See Tax Reform Act of 1984, Pub.

L. No. 98-369, § 424, 98 Stat. 494, 801-03 (1984). In discussing

the purpose of the 1984 amendments, the House Ways and Means

Committee explained that

the present law rules relieving innocent spouses from
liability for tax on a joint return are not sufficiently
broad to encompass many cases where the innocent spouse
deserves relief. Relief may be desirable, for example,
where one spouse claims phony business deductions in order
to avoid paying tax and the other spouse has no reason to
know that the deductions are phony and may be unaware that
there are untaxed profits from the business which the other
spouse has squandered.

1
At that time, § 6013(e)(1) read in pertinent part that if
(A) a joint return has been made under this section for
a taxable year and on such return there was omitted from
gross income an amount properly includable therein which is
attributable to one spouse . . . ,
(B) the other spouse establishes that in signing the
return he or she did not know of, and had no reason to know
of, such omission, and
(C) taking into account whether or not the other spouse
significantly benefited directly or indirectly from the
items omitted from gross income and taking into account all
other facts and circumstances, it is inequitable to hold the
other spouse liable for the deficiency in tax for such
taxable year attributable to such omission,then the other
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 such omission
from gross income.

6
H.R. REP. NO. 432, 98th Cong., 2d Sess., at 1502, reprinted in

1984 U.S.C.A.A.N. 697, 1143. Congress also determined that this

amended version of the provision was to be applied retroactively

to all open tax years to which the Internal Revenue Code of 1954

applies. Id. at 1503.

The innocent spouse provision now reads in pertinent part

that if

(A) a joint return has been made under this section for
a taxable year,
(B) on such return there is a substantial
understatement of tax attributable to grossly erroneous
items of one spouse,
(C) the other spouse establishes that in signing the
return he or she did not know, and had no reason to know,
that there was such substantial understatement, and
(D) taking into account all the facts and
circumstances, it is inequitable to hold the other spouse
liable for the deficiency in tax for such taxable year
attributable to such substantial understatement,

then the other spouse shall be relieved of liability for tax
. . . for such taxable year to the extent such liability is
attributable to such substantial understatement.

26 U.S.C. § 6013(e)(1); see Buchine, 20 F.3d at 180. Failure to

prove any one of the four elements set forth in § 6013(e)(1)

prevents a taxpayer from qualifying for relief under the

"innocent spouse rule." Purificato v. Commissioner, 9 F.3d 290,

293 (3d Cir. 1993), cert. denied, 114 S. Ct. 1398 (1994); Stevens

v. Commissioner, 872 F.2d 1499, 1504 (11th Cir. 1989); Purcell v.

Commissioner, 826 F.2d 470, 473 (6th Cir. 1987), cert. denied,

485 U.S. 987 (1988); see Buchine, 20 F.3d at 180.

In the instant case, the parties stipulated that a joint

return was filed and that the return contained a substantial

understatement attributable to a grossly erroneous deduction of

7
Park's. Jones now asserts that the tax court erroneously

determined that she did not qualify for innocent spouse relief

because she failed to establish that she, in signing the 1981

joint return, did not know or had no reason to know of this

substantial understatement. She specifically argues that in

making this determination, the tax court used the approach set

forth in Bokum v. Commissioner, 94 T.C. 126 (1990), aff'd on

other grounds, 992 F.2d 1132 (11th Cir. 1993). She points out

that this approachSQwhich focuses on whether she knew or had

reason to know of the transaction which gave rise to the

substantial understatement and has heretofore generally been used

in omission-from-income casesSQwas expressly rejected in a

deduction case by the Ninth Circuit in Price v. Commissioner, 887

F.2d 959 (9th Cir. 1989), in favor of an approach which focuses

on the taxpayer's knowledge or reason to know that the deduction

in question gave rise to a substantial understatement. She

contends that when applied to a deduction case, such as hers, the

very narrow transaction approach espoused in Bokum contradicts

Congress's intent that innocent spouse provisions should be

applied liberally.

We must point out that the tax court determined that Jones

had "reason to know" of the substantial understatement under

either Price or Bokum. We thus review the tax court's

determination for clear error, after an overview of the

transaction approach adopted in omission cases and the views

8
taken by the Price and Bokum courts as to the applicability of

that approach in a deduction case.

1. Omissions from Income

This court articulated the standard by which a court was to

determine whether a spouse claiming innocent spouse relief had

"reason to know" of the substantial understatement of tax

liability because of an omission from income in Sanders v. United

States, 509 F.2d 162 (5th Cir. 1975). In Sanders, we first

recognized that because Congress had intended the innocent spouse

provision to "remedy a perceived injustice," we should not give

the provision an unduly narrow or restrictive meaning. Id. at

166-67. We also explained, however, that Congress did not intend

the provision "to provide wholesale relief from joint and several

liability" and that we could not "ignore the benefits that both

spouses ordinarily derive from the reduction in tax that results

when a joint return is filed." Id. at 167 n.6 (citing Sonneborn

v. Commissioner, 57 T.C. 373, 380 (1971)). Accordingly, we

stated that the proper inquiry in an omission case was whether a

reasonably prudent taxpayer under the circumstances of the

alleged innocent spouse at the time of signing the return could

be expected to know that the tax liability stated was erroneous

or that further investigation was warranted. See id. at 166-67 &

n.5. We explained that

we do not interpret this test as excluding consideration of
the taxpayer's subjective condition when assessing the
reasonableness of her actions. But neither does it preclude
the setting of judicially-defined minima of reasonable
prudence for individual taxpayers or classes of taxpayers.
Hence, in some circumstances it might be possible for a

9
 court to conclude as a matter of law that a given taxpayer
had reason to know of omissions from gross income.

Id. at n.5. In establishing a "duty of inquiry" on the part of

the alleged innocent spouse, we focused our analysis on whether

the spouse had sufficient knowledge of the facts underlying the

transaction which formed the basis of the omitted income such

that a reasonably prudent person in the spouse's position would

seriously question the gross income as stated on the joint

return. See id. at 167. Factors relevant to such a

determination included the spouse's level of education, the

spouse's involvement in the family's business and financial

affairs, unusual or lavish expenditures made by the family, and

the "culpable" spouse's refusal to be forthright about the

couple's income. Id. at 167-70.

We rejected, however, the argument that a spouse had "no

reason to know" of a substantial understatement merely because

she had no knowledge of the tax consequences of an omission,

finding that such an argument was indistinguishable from the

argument that ignorance of the law is an element of the innocent

spouse defense. Id. at 169 & n.14. In so doing, we adopted the

tax court's reading of the statute to say that "if a spouse knows

or has reason to know of a transaction that the IRS later

determines resulted in income to the couple, that spouse cannot

claim the benefit of the innocent spouse provision even though he

or she had no reason whatever to suspect that they had received

taxable income." Id. at 169 (emphasis added). As we explained:

10
 This is perhaps a permissible reading of § 6013(e)(1)(A)-(B)
in light of Congress's general intent to extend relief only
where equity demands it, but it is difficult to square with
a literal reading of the statutory language. Subparagraph
(B) mentions "such omission," which obviously refers back to
(e)(1)(A) where omissions are described as "an amount
properly included . . ." (emphasis added). Since the
propriety of including a given sum can finally be determined
only by the IRS or the courts, subparagraph (B) seemingly
makes ignorance of the fact that known receipts constitute
taxable income a valid justification for not knowing or
having reason to know of omissions from gross income.
Nevertheless, the practical problems that have always
prevented acceptance of an ignorance of the law defense in
the criminal law area arguably apply just as forcefully
here. (internal citation omitted)

Id. at 169 n.14.

Courts have generally agreed that in innocent spouse cases

involving the omission of income, relevant inquiry is whether the

spouse claiming innocent spouse relief knew or should have known

of an income-producing transaction that the other spouse failed

to report on their joint return. See, e.g., Hayman v.

Commissioner, 992 F.2d 1256, 1261 (2d Cir. 1993); Erdahl v.

Commissioner, 930 F.2d 585, 589 (8th Cir. 1991); Guth v.

Commissioner, 897 F.2d 441, 444 (9th Cir. 1990); Quinn v.

Commissioner, 524 F.2d 617, 626 (7th Cir. 1975). Hence,

knowledge or reason to know of the underlying transaction which

produced the omitted income is sufficient to deny innocent spouse

relief.

2. Deductions

Some courts, however, have determined that the "underlying

transaction" inquiry used in omission cases is inappropriate in

deduction cases. The leading case in this regard is the Ninth

Circuit's decision in Price, whose approach to deduction cases

11
has been expressly adopted by the Second and Eighth Circuits.

See Hayman, 992 F.2d at 1261; Erdahl, 930 F.2d at 589. The tax

court in Bokum, however, expressly declined to adopt the approach

taken in Price. We now turn to the decisions in Price and Bokum.

a. The Price approach

In Price, the Ninth Circuit concluded that the statutory

innocent spouse provision requires a spouse to establish that he

had no reason to know that the deduction in question, and not the

underlying transaction, gave rise to a substantial

understatement. In reaching this conclusion, the Price court

noted that although the transaction approach was workable in

omission cases, that same approach in a deduction case would

"wipe out innocent spouse protection" and would "hinder

Congress's broader purpose in enacting section 6013(e) . . . by

giving the section an unduly narrow and restrictive reading."

Id. at 963 n.9.

The court explained that the transaction approach was

workable in an omission case because "the understatement is

caused by includable income being left off a return. Therefore,

it is considerably easier for a spouse to show that she was

unaware of the transaction giving rise to the omission, and thus

to qualify for relief." Id. Further, the court explained that

because a deduction was necessarily recorded on the return, a

spouse reading the return would automatically

be put on notice that some transaction allegedly has
occurred to give rise to the deduction. As a result, if
knowledge of the transaction, operating of itself, were to
bar relief, a spouse would be extremely hard-pressed ever to

12
 be able to satisfy the lack of actual and constructive
knowledge element . . . in a deduction case."

Id.

Despite its reluctance to embrace the transaction approach

in a deduction case, the Price court emphasized that it did not

mean to say that a spouse's knowledge of the transaction

underlying the deduction was irrelevant. Id. Rather, the court

stressed that

the more a spouse knows about a transaction, ceteris
paribus, the more likely it is that she will know or have
reason to know that the deduction arising from that
transaction may not be valid. We merely conclude that
standing by itself, such knowledge does not preclude relief.

Id. The court also made it clear that ignorance of the legal or

tax consequences of the deduction giving rise to the deficiency

was no defense for a taxpayer seeking innocent spouse relief.

Id. at 964. Further, the court explained that if a spouse knew

virtually all of the facts pertaining to the transaction which

underlies a deduction in question, that spouse's defense "in

essence is premised solely on ignorance of the law." Id.

(emphasis added). According to the court,

[i]n such a scenario, regardless of whether the spouse
possesses knowledge of the tax consequences of the item at
issue, she is considered as a matter of law to have reason
to know of the substantial understatement and thereby is
effectively precluded from establishing to the contrary.

Id.

The Price court then set out to use its approach in the

deduction case before it. Patricia Price, the spouse requesting

innocent spouse relief, knew of the existence of her husband's

investment and of its rather unusual nature, i.e., Columbian gold

13
mining. Id. at 960. More specifically, her husband, Charles

Price, had informed her that he had acquired several shares of

Cal-Columbian Mines, Ltd. (CCM), that he had flown to Columbia to

check on the mine's development, and that the mining operation

was a viable investment. Id. at 960-61. However, Charles

handled all of the family's investment decisions and maintained a

separate checking account for investments, which he controlled.

Id. at 960.

On the tax return in question, the couple had reported

approximately $103,000 in net income which the two of them had

earned during the year; they also had claimed a $90,000 deduction

for exploration and development expenses related to the

investment in the CCM mine. Id. at 961. Their total federal

income tax liability for the year in question was $391 in self-

employment tax. Id. Patricia had signed the return, reviewing

it cursorily and thinking that the $90,000 "was a bit much." Id.

When she had questioned her husband about the deduction, he

assured her that "'if there had been any problems the CPA would

. . . never have drawn the papers for us to sign and put his name

on them.'" Id.

The Price court began its analysis by explaining, just as we

had in Sanders, 509 F.2d at 167, that a spouse has "reason to

know" of the substantial 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 substantial

understatement. Price, 887 F.2d at 965. In using the same

14
factors this court has used to determine if a spouse had "reason

to know" in an omission case, see, e.g., Sanders, 509 F.2d at

167-68, the Price court determined that a reasonably prudent

person in Patricia's position did not have reason to know that

the CCM deduction gave rise to a substantial understatement.2

Price, 887 F.2d at 965.

Having made that determination, the court then addressed

whether Patricia nonetheless knew enough facts to put her on

inquiry noticeSQi.e., that a reasonably prudent taxpayer in her

position would be led to question the legitimacy of the

deduction. Id. The court explained that in such a scenario, a

duty of inquiry arises, "which, if not satisfied by the spouse,

may result in constructive knowledge of the understatement being

imputed to her." Id. The court agreed with the tax court that

the size of the deduction ($90,000) viz-a-viz the total income

reported on the return (just more than $100,000), when considered

in light of the fact that Patricia knew of the CCM investment,

was enough to put her on inquiry notice. Id. at 965-66.

However, the court ultimately determined that Patricia had

satisfied her duty of inquiry because she had questioned her

husband about the deduction and had refused to sign the return

2
These factors included (1) that Patricia had limited
involvement in the financial affairs of her marriage in general
and none whatsoever in the CCM investment in particular, (2) that
her husband kept a separate checking account for his investments
to which Patricia did not have ready access, (3) that the couple
had made no unusually lavish expenditures during the time period
in question, and (4) that her husband took advantage of
Patricia's lack of understanding of their financial affairs and
misled her. Price, 887 F.2d at 965.

15
until Charles assured her that a reputable CPA had prepared it.

Id. at 966. Thus, constructive knowledge of the understatement

was not to be imputed to her. Id.

b. The Bokum approach

The Bokum court expressly declined to follow Price.

Instead, the court concluded that the more general transaction

approach was applicable to both omission and deduction cases.

Bokum, 94 T.C. at 148-51.

In reaching this conclusion, the Bokum court specifically

looked to the decision in Sonneborn v. Commissioner, 57 T.C. 373

(1971), which was decided "with the legislative process still

fresh" the same year in which the innocent spouse provisions were

first enacted. Bokum, 94 T.C. at 151. The court considered the

Sonneborn court's comments concerning Congress's enactment of the

innocent spouse rule in conjunction with Congress's enforcement

of joint and several liability in general for jointly filed tax

returns:

"The filing of a joint return is a highly valuable privilege
to husband and wife since the resulting tax liability is
generally substantially less than the combined taxes that
would be due from both spouses if they had filed separate
returns. This circumstance gives particular emphasis to the
statutory rule that liability with respect to tax is joint
and several, regardless of the source of income or of the
fact that one spouse may be far less informed about the
contents of the return than the other . . . . However, some
highly inequitable results were called to the attention of
Congress, particularly where . . . such liability grew out
of income attributable only to the husband, unknown to the
wife, and where she had not enjoyed any benefit therefrom.
It was in an effort to eliminate the unfairness of the joint
and several liability provisions in such circumstances that
section 6013(e) was enacted. . . . [Thus,] it must be kept
in mind that Congress still regards joint and several
liability as an important adjunct to the privilege of filing

16
 joint returns, and that if there is to be any relaxation of
that rule the taxpayer must comply with the carefully
detailed conditions set forth in section 6013(e)."

Id. at 151-52 (quoting Sonneborn, 57 T.C. at 380). The court

then determined that the same perspective still applied: by

filing a joint tax return, taxpayers received benefits but

accepted accompanying burdens, such as joint and several

liability in most cases.

The court went on to explain that the reasoning in Price was

flawed for a number of reasons. Specifically, the court stated

that although Price purportedly utilized a "plain meaning"

analysis of the innocent spouse statute, the conclusion in Price

that if a spouse knew "virtually all of the facts" pertaining to

the underlying transaction the spouse was considered as a matter

of law to have "reason to know" of the substantial understatement

belied such analysis. Moreover, the court emphasized the general

rule that exemptions from taxation were to be construed narrowly

and pointed out that were it to follow Price, the result in the

case before it or in many other cases would not change. Id. at

155.

The Bokum court then set out to analyze the case before it.

Richard and Margaret Bokum, who had filed the joint tax return in

question, were married in 1941. Id. at 128. Margaret was a high

school graduate, had attended college for two years, and was

generally not involved in her husband's business affairs. Id.

Richard, a geologist, was the founder and president of Bokum

17
Resources Corp., a company that was established to engage in the

mining and milling of uranium. Id.

In 1971, Richard formed Quinta Land & Cattle Co. (Quinta), a

corporation formed for the purpose of entering the cattle and

ranch business through the purchase of an 11,000-acre cattle

ranch in Montana. Id. at 129. In forming this corporation,

Richard transferred some of his shares in Bokum Resources to

Quinta in exchange for all of Quinta's stock. Id. Quinta then

transferred the Bokum Resources shares and cash to Charles Kyd in

exchange for all the shares of Kyd Cattle Co., which had title to

the ranch. Id. After Quinta bought the ranch, Richard made

various improvements to the ranch property, including building a

home on the ranch, where Margaret spent summers. Id.

In 1977, Quinta sold a substantial portion of the ranch for

$3,800,000, resulting in a gain of $3,119,045. Id. Although

Margaret knew of this sale, she did not participate in the

business decision to sell the ranch, did not know how much Quinta

received on the sale, and did not know what Richard did with the

$2,095,000 in net sales proceeds, which were distributed to him.

Id.

Quinta distributed a total of $3,553,678 in dividend

distributions in 1977 to Richard as its sole shareholder, which

included proceeds from the sale of the ranch. Id. at 130. On

their joint return, Richard and Margaret (1) reported $2,605,272

of those distributions as long-term capital gain and then reduced

that amount by $2,087,057, which was purportedly Richard's basis

18
in his Quinta stock, (2) reported another $516,215 as long-term

capital gain from dividend distributions from Quinta, and (3)

reported $25,132 as their share of net long-term gain from a

trust. Id. at 131.

Neither Richard nor Margaret played any role in the

preparation of their 1977 tax return, which was prepared by

Richard's accountants. Id. at 132. Both Richard and Margaret

signed the return without reviewing its contents. Id. However,

when the return was filed, the signature block did not include

the signatures or any of the information required from paid

preparers of tax returns. Id.

Richard and Margaret later received a notice of deficiency,

in which the Commissioner informed them that they had understated

their taxable income (1) by $606,684 on account of a relocation

from long-term capital gain to recapture ordinary income of some

of Quinta's gain on the sale of the ranch and a flowthrough of

that reallocation to Richard and (2) by an additional $1,054,607

on account of a disallowance of their claim of basis. Id. at

133. The parties stipulated to adjustments to their taxable

income and to a deficiency of $513,755.37, but Richard and

Margaret later petitioned the tax court for a redetermination of

their deficiency and moved to be relieved of their stipulations.

Id. at 134. Margaret also petitioned the tax court for innocent

spouse relief.

At issue in determining whether Margaret was entitled to

innocent spouse relief was whether she had reason to know of one

19
of the adjustments to taxable income made on the 1977 return:

the reduction of Richard's dividend income by Richard's claimed

basis in Quinta's stock. Id. at 139. In beginning its analysis,

the Bokum court first explained that although it was clear that

to qualify for innocent spouse relief Margaret must not have had

reason to know of the underlying circumstances which gave rise to

the adjustment in issue, it was unclear what the underlying

transaction was in this case. Id. at 146. The court then

concluded that if the underlying transaction was the sale of the

ranch, then because Margaret knew of this transaction, she was

disqualified from obtaining innocent spouse statue under

§ 6013(e). Id.

The court nonetheless went on to determine whether a

reasonably prudent taxpayer in Margaret's position was expected

to know that a "further investigation" was warranted. Id. at

147-48. Noting (1) that the distribution Richard received from

Quinta and the tax treatment of that distribution were not hidden

in the recesses of the tax return, (2) that one did not have to

be a tax expert to see that most of the distribution reported was

being subtracted as basis, and (3) that any one signing the tax

return could not have helped but notice that the tax preparer's

block was not filled in, thus making one question whether the

accountant was really standing behind his preparation of the

return, the court concluded that Margaret had a duty to inquire

about the correctness of the size of the basis amount subtracted.

See id. at 147-48. The court then determined that Margaret did

20
not fulfill her duty of inquiry and hence did not qualify for

innocent spouse relief, stating that

Margaret did not examine the tax return that she signed.
She cannot obtain the benefits of section 6013(e) by simply
turning a blind eyeSQby preferring not to know ofSQfacts
fully disclosed on a tax return, of such a numerical
magnitude as would reasonably put her on notice that further
inquiry would need be made. Margaret undertook
responsibilities when she signed the 1977 joint tax return.
She cannot escape these responsibilities by simply ignoring
the contents of this tax return.

Id. at 148 (citations omitted).

3. The Tax Court's Determination

In the instant case, the tax court determined that Jones had

"reason to know" of the substantial understatement under either

the Bokum or the Price approach. We conclude that this

determination was not clearly erroneous.

Under either approach, Jones' lack of familiarity with the

tax consequences of the deduction that gave rise to the

substantial understatement would not be sufficient to entitle her

to innocent spouse relief under § 6013(e). See Price, 887 F.2d

at 964; Bokum 94 T.C. at 145. Moreover, the general standard of

inquiry in either approach is that which we stated in Sanders,

509 F.2d at 167: a spouse has "reason to know" of the

substantial understatement if, at the time the tax return was

signed, a reasonably prudent taxpayer in his or her position

could be expected to know that the stated tax liability was

erroneous or that further investigation was warranted. See

Price, 887 F.2d at 965; Bokum, 94 T.C. at 148.

21
 The tax court found that Jones has a high school education,

that she took four or five real estate courses, and that she is a

licensed real estate agent. The tax court also found that

between 1981 and 1983, Jones and Park made annual trips to

Missouri at Christmas to visit Park's mother, vacationed annually

in Las Vegas, purchased two or three automobilesSQincluding a

Lincoln and a Mercedes 450SLSQand that Park purchased a mink coat

for Jones. Further, the tax court found that although the FSC

investment was a financially complex one on which Park did not

consult her and about which Park was evasive to Jones' questions,

Jones was aware of the investment, had ready access to all of the

documents FSC sent to Park concerning the investment, and knew of

the $7,500 and $13,000 checks written to FSC, having written the

$13,000 check herself. Hence, under Bokum, Jones' knowledge of

the investment with FSCSQthe underlying transaction which gave

rise to the substantial understatementSQindicates that a

reasonably prudent taxpayer in her position had "reason to know"

of the substantial understatement so as to preclude her from

obtaining innocent spouse relief.

This result is not altered under the Price approach. Even

if we assume that under Price Jones was not aware of sufficient

facts to give her reason to know of the substantial

understatement, and hence that Jones' defense is not essentially

premised solely on ignorance of the law, the question still

remains whether she knew sufficient facts such that a reasonably

prudent taxpayer in her position would be led to question the

22
legitimacy of the deduction. We believe that under the facts of

this case, this question must be answered affirmatively. A

cursory glance at the first page of the tax return in question

and Form 4797 attached to it plainly indicates that the size of

the deduction for FSC investment losses ($107,456) is

significantly greater than the amount of the checks that had been

written to FSC ($20,500). The same glance would indicate that

the deduction for these investment losses amounts to

approximately forty-five percent of the gross income reported on

the return ($240,967) and to more than the total income reported

on the return ($94,053). The size of this deduction, considered

in light of the facts that Jones knew of the existence of the FSC

investment and that only $20,500 had been paid to FSC, was enough

to put Jones on inquiry notice. See Price, 887 F.2d at 966.

Although Jones signed the return without reviewing it, by

signing the return she undertook responsibility for it which she

cannot escape by simply ignoring its contents. Hence, even given

her relative lack of experience in and understanding of complex

financial affairs, Jones did not take reasonable steps to

determine the accuracy of the return as had the spouse requesting

innocent spouse relief in Price. As the Price court noted, a

spouse seeking innocent spouse relief cannot turn "a blind eye"

to, by preferring not to know of, a deduction fully disclosed on

a return when the amount of that deduction is so large that it

would reasonably put her on notice that she should inquire

further. See Price, 877 F.2d at 965. Under Price, then, Jones

23
did not satisfy her duty of inquiry. See Hayman, 992 F.2d at

1262 (using the Price approach and explaining (1) that a tax

return setting forth a large deduction which offsets income from

other sources and substantially reduces or eliminates the

couple's tax liability generally puts a taxpayer on notice of the

possibility of understatement of tax liability and (2) that in

any event a taxpayer who signs a return without reading it is

charged with constructive knowledge of its contents); cf. Erdahl,

930 F.2d at 589 ("As Price explains, a taxpayer cannot satisfy

the lack of knowledge requirement by claiming that he or she

failed to review the return before signing it.")

We therefore conclude that the tax court did not err in

determining that under either Bokum or Price, Jones did not

establish that she had no "reason to know" of the substantial

understatement so as to be afforded innocent spouse relief under

§ 6013(e). Although Jones suggests otherwise, we thus have no

occasion to determine whether the Bokum or the Price approach

should govern deduction cases.3

B. SECTION 6004 OF THE TAMRA

Jones also contends that if she failed to satisfy the "no

reason to know" requirement of § 6013(e), she nonetheless

satisfied the "no reason to know" requirement of § 6004 of the

TAMRASQi.e., the transitional rule. We disagree.

3
We also have no occasion to determine whether the courts
in Price and Bokum actually espoused different approaches. See
Bokum, 94 T.C. at 158 ("[T]he differences in the language used to
describe the tests of section 6013(e)(1)(C) are more a matter of
semantics than of substance.") (Swift, J., concurring).

24
 On November 10, 1988, Congress enacted § 6004 of the TAMRA

as a transitional rule with respect to the innocent spouse

provision of § 6013(e). This rule provides in pertinent part

that if a joint return under § 6013 was filed before January 1,

1985, on which there was an understatement attributable to

disallowed deductions which were attributable to activities of

one spouse, the other spouse is relieved of liability for tax due

from the understatement if

without regard to any determination before October 21, 1988,
the other spouse establishes that in signing the return he
or she did not know, and had no reason to know, that there
was such an understatement, and
. . . the marriage between such spouses terminated and
immediately after such termination the net worth of the
other spouse was less than $10,000 . . . .

See Technical and Miscellaneous Revenue Act of 1988, Pub. L. No.

100-647, 102 Stat. 3685 (1988).

Jones first argues that whatever standard should be applied

to determine whether a spouse had "reason to know" under

§ 6013(e), a "very liberal standard" should be applied to

determine "reason to know" under the transitional rule. Although

Jones does not indicate what precise standard should be applied,

she relies heavily on the phrase in the transitional rule

"without regard to any determination before October 21, 1988" for

support. She contends that by this phrase, Congress intended to

exclude "consideration of any case law [on the 'no reason to

know' requirement] decided prior to October 21, 1988," and that

thus Congress made it clear that the construction of this

25
requirement was "to be written on a clean slate disregarding all

prior precedent."

This argument has little, if any, merit. As written, the

transitional rule reads such that a spouse who falls within the

rule's objective parameters is entitled to a determination of his

tax liability notwithstanding that an earlier determination of

his liability was made prior to the enactment of the rule. Such

a reading squares neatly with the specific language of the rule

which states that the rule applies "notwithstanding any law or

rule of law (including res judicata)." Accord In re Freytag, 93-

2 U.S.T.C. (CCH) ¶ 50,531, pp. 89,682-683 (Bankr. N.D. Tex. 1993)

(presuming, without addressing the issue, that by "determination"

Congress meant determination only of the would-be innocent

spouse's tax liability, not all prior judicial determinations

rendered under the "no reason to know" requirement); Thompson v.

Commissioner, 63 T.C.M. (CCH) 2883, 2886 (1992) (same).

Jones also contends that the "no reason to know" requirement

of the transitional rule is somehow different from the "no reason

to know" requirement of § 6013(e). Again, we find this

contention to have no merit.

The "did not know, and had no reason to know" language of

the transitional rule virtually mirrors that of § 6013(e),

suggesting that Congress intended the "no reason to know"

requirement of both provisions to have the same meaning. See

Freytag, 93-2 U.S.T.C. (CCH) at 89,682 (applying the same "reason

to know" standard under the transitional rule and under

26
§ 6013(e)). Further, a reading of the transitional rule in

conjunction with § 6013(e) reveals that Congress did intend for

the transitional rule to provide broader innocent spouse relief

under limited circumstances to a certain class of spousesSQi.e.,

those who filed joint returns with substantial understatements

prior to January 1, 1985, and whose marriages had since

terminated. See Thompson, 63 T.C.M. (CCH) at 2884. For such

spouses, Congress eliminated the requirement under

§ 6013(e)(1)(D), which required a spouse to show that it would be

inequitable to hold her liable for the understatement. In its

place, Congress instituted a "net worth" test, relieving the

spouse from liability if she met the "no reason to know"

requirement and had a net worth of less than $10,000 immediately

after the termination of the marriage. Thus, under the

transitional rule, unlike under § 6013(e), Congress afforded

innocent spouse relief to a spouse who had benefitted from an

erroneous deduction as long as after the termination of the

marriage her net worth was less than $10,000. The institution of

this "net worth" test in lieu of a required showing that the

spouse did not benefit from the erroneous deduction, however,

gives us no basis for concluding that Congress intended to relax

the "no reason to know" requirement of the transitional rule, as

Jones suggests.

As discussed above, see supra Part III.A.3, Jones has not

established that she had "no reason to know" of the substantial

understatement under either the Bokum or Price approach. We must

27
therefore conclude that the district court did not err in

determining that Jones was not entitled to innocent spouse relief

under the transitional rule.

IV. CONCLUSION

For the foregoing reasons, we AFFIRM the judgment of the tax

court.

28