*30 H & W filed a joint Federal income tax return for 1994. R
disallowed losses attributable equally to H & W. As a result of
the disallowance of the losses, R also disallowed a deduction
for medical/dental expenses claimed on the return. The parties
agree that W is entitled to relief from liability pursuant to
the portion of the deficiency properly allocable to her under
the deficiency and the
penalty for 1994 that are to be allocated to W under sec.
1. Held: The disallowed medical/dental expenses are
erroneous items that gave rise to a portion of the deficiency
and must be allocated between H & W in determining the portion
of the deficiency properly allocable to W under
I.R.C.
2. Held, further,
the portion*31 of the deficiency properly allocable to W to the
amount of tax W would have owed had she filed a separate return.
3. Held, further,
the portion of the deficiency properly allocable to W to W's
proportionate share of the taxable income properly reported on
the joint return.
4. Held, further, the erroneous items attributable to W
are allocable to W under
W's taxable income properly included on the joint return.
5. Held, further, the alternative allocation method set
forth in
apply because erroneous deductions are not "erroneous items that
are subject to tax at different rates".
6. Held, further, computation of the portions of the
deficiency and the
penalty allocable to W for 1994 under
determined.
*212 OPINION
JACOBS, Judge: Respondent determined the following deficiency in petitioners' Federal income tax and accuracy-related penalties for 1994: 1
Accuracy-Related Penalty
__________________________________________
Sec. Sec. Sec. Sec.
Deficiency 6662(h) 6662(e) 6662(d) 6662(c)
__________ _______ _______ _______ _______
$ 17,059 $ 6,823 $ 3,411 $ 3,411 $ 3,411
In the second amendment to petition, Ingrid Capehart (petitioner) elected and requested relief from tax liability under
The parties have filed a stipulation of settled issues and a stipulation*33 of facts. In the stipulation of settled issues the parties have settled the substantive issues for determining the deficiency and the penalties. The parties agree that petitioners have a Federal income tax deficiency of $ 8,225 and are liable for an accuracy-related penalty under
The sole issue for decision concerns the computation of the portion of the deficiency and the accuracy-related penalty for 1994 allocable to petitioner under
Background
The facts in this case have been stipulated and are found accordingly. The stipulation of settled issues, the stipulation of facts, and the exhibits submitted therewith are incorporated herein by this reference.
When the petition in this case was filed, petitioner and her husband, Robert J. Capehart (Mr. Capehart), resided in *213 Sparks, Nevada. Mr. Capehart died on January 23, 2002, after the petition in this case was filed. The Estate of Robert J. Capehart, Deceased, has been substituted as a party. Petitioner is the*34 personal representative of Mr. Capehart's estate.
On April 15, 1995, Mr. Capehart and petitioner filed a joint Federal income tax return for 1994 on which they reported the following:
Item Amount
____ ______
Income
Wages, salaries, tips, etc. $ 52,071
Interest 473
Dividends 135
State tax refund 373
Capital gain 190
Other gain or loss (Form 4797) (37,239)
Pension 12,426
Gambling income 2,458
Adjustments to income
Mr. Capehart's IRA deduction (1,200)
Petitioner's IRA deduction (1,200)
_________
Adjusted gross income *35 $ 28,487
Itemized deductions (Schedule A)
Medical/dental n1 1,143
State income taxes 442
Real estate taxes 907
Personal property taxes 504
Mortgage interest 4,164
Charitable gifts 180
Theft loss 4,183
Gambling losses 2,458
Total (13,981)
__________
Net income 14,506
Exemptions (4,900)
__________
Taxable income *36 9,606
Tax 1,444
Federal income tax withheld 2 7,132
Refund 5,688
n1 Petitioner and Mr. Capehart reported total medical/dental expenses of $ 3,280 and deducted the excess over $ 2,137 (7.5 percent of their $ 28,487 adjusted gross income).
n2 Petitioner had Federal income tax of $ 2,164 withheld from her wages. Mr. Capehart had Federal income tax of $ 4,968 withheld from his wages and retirement income.
*214 Respondent did not refund the $ 5,688 overpayment reflected on the joint return but instead issued a "pre-filing notification letter" that the refund was "suspended".
Respondent issued petitioner and Mr. Capehart a notice of deficiency dated March 28, 1997. In the notice of deficiency, respondent, inter alia, disallowed the $ 37,239 loss claimed on Form 4797, Sale of Business Property (the Form 4797 loss), and the $ 4,183 theft loss claimed on the return. Petitioners now agree that they are not entitled*37 to deduct these losses in 1994. The Form 4797 loss and the theft loss are related to petitioner's and Mr. Capehart's participation in a partnership formed, promoted, and operated by Walter J. Hoyt III. These losses are attributable equally to petitioner and Mr. Capehart.
Discussion
As a general rule, spouses filing joint Federal income tax returns are jointly and severally liable for all taxes due.
Under
The parties agree that petitioners have a deficiency in their 1994 Federal income tax of $ 8,225 and are liable for an accuracy- related penalty under
Generally the portion of the deficiency on a joint return allocated to an individual is the amount that bears the same ratio to the deficiency as the net amount of items taken into account in computing the deficiency and allocable to the individual under
The parties agree that the Form 4797 loss and the theft loss are "erroneous items" that are attributable equally to Mr. Capehart and petitioner; i.e., had petitioner and Mr. Capehart filed separate returns, they would each have reported one-half of the losses on their respective separate returns. See
The parties' computations reveal that petitioners are not entitled to any deduction for medical or dental expenses. Petitioner and Mr. Capehart reported total medical/dental expenses of $ 3,280 and deducted*40 $ 1,143 on the joint return on account of the 7.5-percent floor. See
The parties have not informed the Court as to how petitioner and Mr. Capehart would have reported the $ 1,143 of medical/dental expenses if they had filed separate returns. The regulations provide that deduction items such as medical and dental expenses that are unrelated to a business or investment are generally allocated 50 percent to each spouse unless the evidence shows that a different allocation is appropriate.
The erroneous items giving rise to the 1994 tax deficiency total $ 42,565 ($ 37,239 Form 4797 loss + $ 4,183 theft loss + $ 1,143 medical/dental expenses) and are attributed equally to petitioner and Mr. Capehart; i.e., $ 21,282.50 to each. We refer to the erroneous items attributed to petitioner and Mr. Capehart respectively as her or his erroneous items. Since all erroneous items giving rise to the deficiency for 1994 are attributed equally to petitioner and Mr. Capehart, under the general rule, *42 petitioner would be liable for one-half of the deficiency ($ 4,112.50). See
The Secretary has promulgated regulations prescribing such rules. 3
Example (5). Requesting spouse receives a benefit on
the joint return from the nonrequesting spouse's erroneous
item. (i) In 2001, H reports gross income of $ 4,000 from his
business on Schedule C, and W reports $ 50,000 of wage income. On
their 2001 joint Federal income tax return, H deducts $ 20,000 of
business expenses resulting in a net loss from his business of
$ 16,000. H and W divorce in September 2002, and on May 22, 2003,
a $ 5,200 deficiency is assessed with respect to their 2001 joint
return. W elects to allocate the deficiency. The deficiency on
the joint return results from a disallowance of all of H's
$ 20,000 of deductions.
(ii) Since H used only $ 4,000 of the disallowed deductions to
offset gross income from*44 his business, W benefitted from the
other $ 16,000 of the disallowed deductions used to offset her
wage income. Therefore, $ 4,000 of the disallowed deductions are
allocable to H and $ 16,000 of the disallowed deductions are
allocable to W. W's liability is limited to $ 4,160 (4/5 of
$ 5,200). * * *
In sum,
The parties agree that, for purposes of
Item Petitioner Mr. Capehart Total
____ __________ ____________ _____
Income
Wages $ 20,146.00 $ 31,925.00 $ 52,071
Interest 236.50 236.50 473
Dividends 67.50 67.50 135
State income*46 tax 186.50 186.50 373
Capital gains 95.00 95.00 190
Pension -0- 12,426.00 12,426
Gambling income 1,229.00 1,229.00 2,458
Adjustments to income
IRA deductions (1,200.00) (1,200.00) (2,400)
__________ ___________ ________
Adjusted gross income 20,760.50 44,965.50 65,726
Itemized deduction
State income tax -0- 442.00 442
Real estate taxes 453.50 453.50 907
Personal property 252.00 252.00 504
Mortgage interest 2,082.00 2,082.00 4,164
Charitable 90.00 90.00 180
Gambling loss 1,229.00 1,229.00 2,458
Exemption*47 amount 2,450.00 2,450.00 4,900
_________ __________ _______
Total deductions 6,556.50 6,998.50 13,555
Taxable income 14,204.00 37,967.00 52,171
========= ========== =======
In accordance with
3. Proportionate Allocation of Deficiency
Pursuant to
net amount of erroneous items
X = deficiency x allocable to the spouse
_________________________________
net amount of all erroneous items
where Xis the portion of the deficiency allocable to petitioner. See
Under the proportionate allocation method, $ 2,744.69 is the portion of the $ 8,225 deficiency allocable to petitioner, computed as follows:
$ 2,744.69 = $ 8,225 x $ 14,204
_______
$ 42,565
a. Respondent's Computation
Respondent computed petitioner's share of the deficiency to be $ 2,820. Respondent computed petitioner's share of the deficiency by applying the proportionate allocation method required by
b. Petitioner's Computation
i. Separate Return Liability
Petitioner asserts that her liability should be limited to $ 2,134, the amount she would have paid on taxable income of $ 14,204 had she filed a separate return. Petitioner's theory assumes that erroneous items cannot be allocated in a way that would result in a spouse's owing more tax than if separate returns had been filed. Neither the statute nor the regulations provide for such a limitation. The statute and the regulations allocate all of petitioner's erroneous items to her except for those items that provided a tax benefit to Mr. Capehart on the joint return. If petitioner's liability were limited to $ 2,134, then only $ 11,044 (not $ 14,204) of her erroneous *220 items would be allocated to her for purposes of
deficiency allocated
to petitioner ($ 2,134)
X = _____________________ x total erroneous items ($ 42,565)
deficiency ($ 8,225)
where X is the portion of the erroneous items allocable*50 to petitioner. Essentially, petitioner argues that Mr. Capehart received a tax benefit on the joint return from $ 10,238.50 of petitioner's erroneous items.
Under petitioner's theory, Mr. Capehart's $ 37,967 taxable income would have been offset by his erroneous items ($ 21,282.50) plus $ 10,238.50 of petitioner's erroneous items. The $ 9,606 of taxable income reported on the return would have consisted of $ 3,160 ($ 14,204 - $ 11,044) of petitioner's taxable income and $ 6,446 of Mr. Capehart's taxable income.
Petitioner's theory is flawed. Had petitioner and Mr. Capehart filed separate returns that included the erroneous items, petitioner would have reported no taxable income because $ 14,204 of her $ 21,282.50 erroneous items would have offset all of her income, and $ 7,078.50 of her erroneous items would have been unused in 1994. Consequently, she received the tax benefit of $ 14,204 of her erroneous items. Moreover, Mr. Capehart would have reported taxable income of $ 16,684.50, the excess of his taxable income over his erroneous items ($ 37,967 - $ 21,282.50). Consequently, if petitioner and Mr. Capehart had filed separate returns, on a pro forma basis their combined taxable*51 income would be $ 16,684.50 that would be solely attributable to Mr. Capehart. Since petitioner and Mr. Capehart reported $ 9,606 of taxable income on their joint return for 1994, Mr. Capehart's share of the taxable income was offset by $ 7,078.50 ($ 16,684.50 - $ 9,606) of petitioner's erroneous items that were reported on the joint return. Therefore, $ 7,078.50, not $ 10,238.50, of petitioner's erroneous items gave rise to a tax benefit on the 1994 joint return to Mr. Capehart. Consequently, only $ 7,078.50, not $ 10,238.50, of petitioner's erroneous items is allocated to Mr. Capehart under
*221 ii. Benefit of Lower Tax Rate
Petitioner posits that the proportionate allocation method provided in
Mr. Capehart's $ 37,967 of taxable income was offset by $ 21,282.50 of erroneous items attributed to him. The $ 16,684.50 excess was taxable at 15 percent. The amount of*53 that excess plus petitioner's $ 14,204 of taxable income totaled $ 30,888.50. For married individuals who filed a joint return for 1994, only taxable income in excess of $ 38,000 would have been taxed at a rate greater than 15 percent rate. Thus, contrary to petitioner's assertions, it was not her erroneous items that reduced Mr. Capehart's tax rate, but rather it was Mr. Capehart's erroneous items that reduced his tax rate.
Because petitioner was unable to compute the portion of her erroneous items that provided the asserted benefit to Mr. Capehart, and because Mr. Capehart's tax rate was not reduced by petitioner's erroneous items that were allocated to Mr. Capehart pursuant to the formula set forth in
iii. Proportionate to Taxable Income
*222 Petitioner also complains that, while her 1994 taxable income was only 27 percent of the total taxable income for 1994, the proportionate allocation method provided in
(6) Alternative allocation methods. -- (i) Allocation
based on applicable tax rates. -- If a deficiency arises
from two or more erroneous items that are subject to tax at
different rates (e.g., ordinary income and capital gain items),
the deficiency will be allocated after first separating the
erroneous items into categories according to their applicable
tax rate. After all erroneous items are categorized, a separate
allocation is made with respect to *223 each tax rate category using
the proportionate allocation method of paragraph (d)(4) of this
section.
* * * * * * *
(iii) Example. -- The following example illustrates the
rules of this paragraph (d)(6):
Example. Allocation based on applicable tax rates.
H and W timely file their 1998 joint Federal income tax return.
H and W divorce in 1999. On July 13, 2001, a $ 5,100 deficiency
is assessed with respect to H's and W's 1998 return. Of this
deficiency, $ 2,000 results from unreported capital gain of
$ 6,000 that is attributable*56 to W and $ 4,000 of capital gain that
is attributable to H (both gains being subject to tax at the 20%
marginal rate). The remaining $ 3,100 of the deficiency is
attributable to $ 10,000 of unreported dividend income of H that
is subject to tax at a marginal rate of 31%. H and W both timely
elect to allocate the deficiency, and qualify under this section
to do so. There are erroneous items subject to different tax
rates; thus, the alternative allocation method of this paragraph
(d)(6) applies. The three erroneous items are first categorized
according to their applicable tax rates, then allocated. Of the
total amount of 20% tax rate items ($ 10,000), 60% is allocable
to W and 40% is allocable to H. Therefore, 60% of the $ 2,000
deficiency attributable to these items (or $ 1,200) is allocated
to W. The remaining 40% of this portion of the deficiency ($ 800)
is allocated to H. The only 31% tax rate item is allocable to H.
Accordingly, H is liable for $ 3,900 of the deficiency
($ 800+$ 3,100), and W is liable for the remaining $ 1,200.
*57 The alternative method applies when the erroneous items are subject to tax at different rates. The erroneous items in this case are the Form 4797 loss, the theft loss, and the medical/dental expenses. Those items are not subject to tax at different rates. Rather, they are all deductions used by petitioner and Mr. Capehart on their joint return to offset ordinary income. Accordingly,
For purposes of
In the case at bar, the parties calculated the underpayment by subtracting the $ 5,688 overpayment (the $ 7,132 withholding tax paid less the $ 1,444 tax liability reported on the return) claimed on the joint return, which was not refunded to petitioners, from the $ 8,225 deficiency; i.e., a $ 2,537 balance of tax remaining unpaid. 6
1. Respondent's Computation
Respondent allocated $ 209 of the accuracy-related penalty to petitioner. In so doing, respondent allocated $ 1,774 of the refund claimed to petitioner. Respondent explained his computation as follows:
*59 In computing the underpayment for purposes of the accuracy
related penalty, respondent gave petitioner Ingrid Capehart
credit for a frozen refund in the amount of $ 1,774.00. The
frozen refund relates to Ingrid Capehart's Federal income tax
withholdings (prepayment credits) in the amount of $ 2,164.00
that were taken from her wages, reported on the return, and not
refunded. In arriving at the $ 1,774.00 figure, respondent
subtracted from Ingrid Capehart's withholdings of $ 2,164.00 her
allocable share of the $ 1,444.00 of tax liability reported on
the 1994 return. Petitioner Ingrid Capehart's allocable share of
the $ 1,444.00 tax liability reported on the 1994 return is 27
percent of $ 1,444.00 or $ 390.00 ($ 1,444.00 x .27 = $ 4390.00). 27
percent is used because this is the percentage of the total
taxable income reported on the return that would have been
allocated to Ingrid Capehart if the parties had filed separate
returns. * * * Accordingly, the $ 1,774.00 figure was arrived at
as follows:
$ 2,164.00 Withholding credits
*60 -$ 390.00 Ingrid Capehart's allocable share
of the $ 1,444.00 liability report
on the return
$ 1,774.00 Frozen Refund Credit
*225 Respondent computed petitioner's share of the accurracy-related penalty as follows:
related penalty as follows:
Petitioner's share of deficiency as
computed by respondent $ 2,820
Petitioner's frozen refund credit (1,774)
Petitioner's underpayment upon which ________
the accuracy-related penalty applies 1,046
Accuracy-related penalty percentage x 0.20
________
209
2. Petitioner's Position
Petitioner erroneously refers to the $ 1,444 tax shown on the return as the tax "paid" on the return and complains that respondent allocated only $ 390 of that tax to her in computing her share of the accuracy-related penalty. The gist of petitioner's complaint is that the $ 390 of tax allocated to her represents 27 percent of the tax "paid" on the return ($ 1,444), *61 whereas the $ 209 of the
3. Computation of Petitioner's Share of the Accuracy-Related
Penalty
Any portion of the tax shown on the return that is allocated to petitioner reduces the amount of her withholding credits to be applied toward her portion of the tax deficiency and increases her share of the underpayment. Consequently, allocating a portion of the tax shown on the return to*62 petitioner *226 increases her portion of the accuracy-related penalty. Taking into account the proper allocation of the erroneous items, we do not think that it is proper to allocate any of the tax shown on the return to petitioner.
On the basis of the taxable income and erroneous items, the total tax liability and the portion not offset by withholding credits (unpaid taxes) is allocated between petitioner and Mr. Capehart as follows:
Item Petitioner Mr. Capehart Total
____ __________ ____________ _____
Taxable income $ 14,204 $ 37,967 $ 52,171
Erroneous items (14,204) 28,361) (42,565)
________ ________ ? ________
Taxable income on -0- 9,606 9,606
Tax on return 1,444 1,444
Tax deficiency 2,745 5,480 8,225
________ *63 ________ ________
Total tax liability 2,745 6,924 9,669
Withholding (2,164) (4,968) (7,132)
________ ________ ________
Unpaid tax 581 1,956 2,537
Treating the withholding tax paid in excess of the liability as a tax collected without assessment for purposes of
Item Petitioner Mr. Capehart Total
____ __________ ____________ _____
Tax imposed $ 2,745 $ 6,924 $ 9,669
Tax on return -0- (1,444) (1,444)
Tax collected without
assessment (2,164) (3,524) (5,688)
________ _________ _______
Underpayment *64 581 1,956 2,537
We reach the same result by applying respondent's method of computing the underpayment without allocating any portion of the $ 1,444 of tax reported on the return to petitioner, shown as follows:
Petitioner's withholding $ 2,164
Petitioner's allocable share of the
$ 1,444 liability report on the return -0-
______
Petitioner's frozen refund credit 2,164
Petitioner's share of deficiency 2,745
Petitioner's frozen refund credit (2,164)
_______
Petitioner's underpayment upon which
the accuracy-related penalty applies 581
*227 We conclude that the underpayment generated by petitioner's erroneous items is $ 581 and the penalty allocated to petitioner is $ 116 ($ 581 x 0.20).
D. ConclusionWe hold that pursuant to
In accordance with the above,
An appropriate decision will be entered.
Footnotes
1. Unless otherwise indicated, section references are to the Internal Revenue Code in effect at all relevant times.↩
2. We are mindful that because the amounts of the erroneous Form 4797 loss and the theft loss attributed to petitioner exceed her share of the spouses' combined taxable income for 1994, the portion of the deficiency for which petitioner remains liable would be the same if all of the medical/dental expenses were allocated to Mr. Capehart. Failure to include the disallowed medical/dental expenses in the erroneous items, however, would increase the portion of the deficiency for which petitioner would remain liable.↩
3. The regulations are applicable for all elections or requests for relief filed on or after July 18, 2002.
Sec. 1.6015-9, Income Tax Regs.↩ In the case at bar, petitioner elected relief in the second amendment to petition filed on May 22, 2003.4. Petitioner's computation is in error in that it attributes $ 37,677 ($ 19,000 + $ 18,677) of taxable income to Mr. Capehart. Mr. Capehart had $ 37,967 of taxable income. Consequently, $ 18,967 of his income would be taxable at the rate of 28 percent.↩
5.
Sec. 1.6015-3(d)(4)(i)(B), Income Tax Regs. , requires application of the proportionate allocation method to any portion of the deficiency other than any portion of the deficiency (1) attributable to erroneous items allocable to the nonrequesting spouse of which the requesting spouse had actual knowledge, (2) attributable to separate treatment items (as defined insec. 1.6015-3(d)(4)(ii), Income Tax Regs. ), (3) relating to the liability of a child (as defined insec. 1.6015-3(d)(4)(iii), Income Tax Regs. ) of the requesting spouse or nonrequesting spouse, (4) attributable to alternative minimum tax undersec. 55 ,(5) attributable to accuracy- related or fraud penalties, or (6) allocated pursuant to alternative allocation methods authorized undersec. 1.6015-3(d)(6), Income Tax Regs.↩ 6. Essentially, the parties treat the claimed refund amount of withholding tax as a tax collected without assessment.↩