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