A recent summary opinion in Tax Court highlights some of the procedural twists that can turn in cases where an ex seeks to challenge a former spouse’s entitlement to relief from joint and several liability. The case has some added interest because the spouse seeking and getting relief is an IRS revenue agent.
As guest poster Professor Scott Schumacher discussed a few years ago, some times tax cases turn into a “he said she said” dispute. In the tax context, he said/she usually involve cases with disputes over credits or deductions determined with reference to attachment to children and in innocent spouse cases when former spouses disagree about the other’s entitlement to relief from joint and several liability.
Merlo v Comm’r is a recent Tax Court case that involves the latter scenario. In this case, the ex-husband (Mr. Merlo) is an IRS revenue agent. He prepared the return, and his former spouse (Ms. Nelson) claimed that he had knowledge of $4,629 of disability income she received and they omitted from their 2011 joint return, which was filed on extension in October 2012, when the soon to be divorced Merlos were separated.
read more...The joint return omitted the disability income that had been reported on a W-2. IRS picked up the omission, and issued a stat notice. Mr. Merlo petitioned Tax Court, asserting Section 6015(c) relief as an affirmative defense to the deficiency based on his lack of knowledge of Ms. Nelson’s receipt of the disability income. IRS granted him relief from the liability. Ms. Nelson joined the Tax Court case as an intervenor, and she argued that Mr. Merlo should not be entitled to relief because he had knowledge of her omitted disability income and that he intentionally left it off the return to cause her problems with the IRS.
This involves Section 6015(c), which generally allows a separated or divorced spouse to elect to limit the liability for any deficiency assessed with respect to a joint return to the portion of the deficiency that is properly allocable to the electing individual under Section 6015(d).
Section 6015(c)(3)(C) denies relief to the electing spouse if it is shown that he or she “had actual knowledge, at the time such individual signed the return, of any item giving rise to a deficiency (or portion thereof) which is not allocable to such individual under subsection (d)”
One of the challenges for the IRS in these cases is that the burden on showing actual knowledge rests with the IRS, and the level of proof the Commissioner needs to establish is a preponderance of the evidence. Here, the Commissioner conceded the issue and agreed that Mr. Merlo did not have actual knowledge of the existence of the disability income.
So how does the court address the issue of burden of proof when the IRS agrees that one of the exes is entitled to relief but the other does not? The opinion notes that the “[c]ourt has resolved this problem by determining whether actual knowledge has been demonstrated by a preponderance of the evidence as presented by all three parties.”
Typically I suspect that Counsel attorneys let the ex spouses duke it out at trial. That is what seemed to happen in this case, with Ms. Nelson testifying that her ex knew about the omitted disability income and Mr. Merlo claiming that the first time he heard about it was when the IRS sent correspondence after they filed the return.
This required the court to dig into the circumstances of the joint filing. As is not unusual with freshly separated and a soon to be divorced couple the communications between the two were not ideal—the opinion notes that Ms. Nelson moved out of the marital residence in May of 2012 and they “seldom spoke, lived in separate households, and communicated primarily through their divorce counsel.”
The 2011 return was on extension and as the October filing deadline neared Mr. Merlo presented evidence that demonstrated to the court that he did not know about the disability income that was left off the return, including a series of emails and a text message and the existence of separate bank accounts. The messages include an exchange where Ms. Nelson proposed to correct the return after a draft return Mr. Merlo prepared included as a gross amount of Ms. Nelson’s income the disability income and about $1,182 in wages from another source, Ethan Allen:
Early on the morning of October 15, 2012, the due date for filing the 2011 return, Mr. Merlo emailed Ms. Nelson the draft Federal return and draft Michigan return for her to review for accuracy. Ms. Nelson responded by text, informing Mr. Merlo that he had misstated her wages from Ethan Allen on the draft returns as equal to $5,811 rather than $1,182, the correct figure. Mr. Merlo, now believing the draft returns to be incorrect, revised them by reducing Ms. Nelson’s wage income from $5,811 to $1,182, a $4,629 difference. Mr. Merlo thereafter emailed Ms. Nelson a revised draft Form 1040 worksheet for her to review at 7:20 a.m. The worksheet listed the Merlos’ wage income as $108,045, consisting of $106,863 in wages from the Department of the Treasury and $1,182 in wages from Ethan Allen.
The opinion noted that a text message from Ms. Nelson specifically identified the wage income she had received from Ethan Allen and made no mention of any disability income, resulting in Mr. Merlo changing the return to reflect only Ms. Nelson’s $1,182 in wages and not the taxable disability income.
Ms. Nelson also testified that her ex had a copy of the W2 that showed the disability income; that would have meant that he had the knowledge necessary to defeat the relief he was seeking.
The opinion then provides more context as to why the court sided with Mr. Merlo’s version of the facts:
Ms. Nelson testified that when she moved out of the marital residence she left copies of all of her Forms W-2, including those from Ethan Allen and Prudential [Prudential is the source of the disability payments], in a tax file maintained there by Mr. Merlo, retaining the originals for herself. Her testimony is uncorroborated, and it is contradicted by Mr. Merlo’s contemporaneous email of October 12, 2012, in which he stated that he did not have a Form W-2 from her. Moreover, we are not persuaded that Mr. Merlo, an IRS revenue agent, would have prepared worksheets that listed Ms. Nelson’s Ethan Allen wages as $5,811 if he in fact had copies of her Forms W-2 showing that her wage income, while in total equal to $5,811, actually consisted of $1,182 from Ethan Allen and $4,629 from Prudential. Finally, we note that Ms. Nelson, having been provided Mr. Merlo’s worksheet accompanying the draft Federal return that made no mention of the Prudential income, had ample opportunity to alert Mr. Merlo to the omission but failed to do so, even though by her own admission she had the originals of the Forms W-2 that had been issued to her. Her silence tended to confirm Mr. Merlo’s belief that he had merely overstated her Ethan Allen wages in the worksheet and had not omitted income from another source.
Conclusion
Spousal relief and intervenor cases in particular are often tough cases. Context matters greatly. In this case, Mr. Merlo’s work as a revenue agent contributed to the court’s conclusion that it found his version of the facts more likely to be true, as the opinion noted that given his “familiarity with IRS procedures, it is not reasonable to believe he deliberately failed to report Form W-2 income for which he had actual knowledge, as he would have been aware that he was creating the same problems with the IRS for himself as Ms. Nelson speculates he intended to cause for her.”
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Speaking of IRS agents and seeking relief, we should note a 9th Circuit decision earlier this month involving events that took place twelve years ago.
The IRS lost out on an attempt to toss a lawsuit filed by a woman who claims an IRS agent violated her right to bodily privacy by following her into her home bathroom and insisted on watching her relieve herself.
The U.S. Court of Appeals for the Ninth Circuit found that the IRS agent was not entitled to qualified immunity for claims relating to the incident, which occurred in 2006 while she and other IRS agents were serving a search warrant during a criminal tax fraud and conspiracy investigation targeting the woman’s husband.
Circuit Judge Mary Murguia found that the agent hadn’t put forth a plausible reason to follow the woman into the bathroom under the circumstances. Murguia found that the agent’s contention that she was concerned that the woman might destroy evidence was belied by the fact that she and her husband initially had been told that they could leave the house while agents conducted the search. The judge found the agent’s alternative reason—that she was concerned the woman might be concealing something dangerous under her clothing—was unconvincing, since agents hadn’t conducted a pat-down of either resident for weapons during the 30 minutes that preceded the bathroom visit.
Summary based on story from Law.com. Opinion is at
http://cdn.ca9.uscourts.gov/datastore/opinions/2018/09/10/16-16089.pdf
I wonder what the dispute is. The recipient of the income should be perfectly willing to pay tax on it (this not being a case involving double taxation or excessive burden of paperwork).
If there were a dispute over penalties, he-says v. she-says is a problem.
When it’s she-with-signed-return-receipt-for-certified-mail (the server resides in the US) v. he-says-the-court-didn’t-receive-it (he’s the judge), there’s a problem too, but we know who wins that one.
Wait, I see it now. At her level of income, her US tax should have been zero. I wonder why she agreed to do a joint return.