The Right Instincts and the Wrong Decision Leads to No Relief as an Innocent Spouse – An Adam and Eve Story

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In a memorandum opinion released on October 7, Judge Lauber held that taxpayer husband was not entitled to innocent spouse relief that focused on his knowledge of the information on the jointly filed tax return. As I read the headnote, the case seemed familiar. Reading the opinion, I realized that I had watched the trial with my students and we had analyzed it in class reaching the same conclusion as Judge Lauber but still feeling sad for the individual who sought relief. The facts of the case are unusual enough to warrant a discussion of the case on the blog.

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The first thing about the case that was unusual was that the husband and wife were both at petitioner’s table and were obviously on good terms. While innocent spouse cases occasionally involve couples who remain together through adversity, it seemed as I watched them and watched the case that the very adverse circumstances that had led to this case had brought them closer together rather than farther apart. I do not often observe that in innocent spouse cases.

The problem arose because the wife worked for an attorney who had an alternative view of tax compliance. After graduation from high school, the wife began work as a secretary. During the 1990s she ended up working as a secretary for a tax attorney who created a scheme for evading taxes by running income through a shell corporation. The husband had a couple of years of college education. He held a series of different types of jobs that seemed to involve management of small businesses or just work in small businesses. One day the wife came home from her job and presented the tax plan being used by the attorney for whom she worked. The attorney suggested that she have her salary diverted to one of the shell corporations used for evading taxes. The husband rejected the plan and they continued to file their returns as they always had.

The wife in this story comes off a little bit like Eve and the attorney a little bit like the Serpent in the story from Genesis. Although the case did not chronicle every discussion the couple must have had on the topic of whether to engage in the scheme, I picture that the topic must have come up more than once as she continued to work for the attorney and her husband continued to resist the temptation to participate in the tax scheme being offered. Of course the longer this scheme lasted with no apparent adverse consequences, the more it appeared to the husband and wife that the scheme which seemed fishy might actually work. In this regard the circumstances are not unlike the circumstances of James Taylor, I wrote about recently. Something that your instincts might tell you should not work can seem to work if the IRS does not get to it quickly to stop the scheme. Many reasons exist why the IRS would not act quickly here, and this is not an effort to criticize the IRS, but the fact that the scheme went on for a few years without apparent trouble must have made it harder for the husband to continue saying no to the idea. This is one of many reasons why the IRS needs sufficient resources in order to police the beat.

One day the husband’s resistance was low, and he agreed to talk to the attorney about the appropriateness of the device the attorney was peddling to reduce taxes. He asked the attorney if the plan was legal. The attorney said that it was and so began the sad tale that led to the Tax Court trial I observed. The husband did not go and ask anyone else about the plan but unlike James Taylor who apparently got his tax advice from a friend, the husband here got his tax advice from a tax lawyer.

The husband agreed to allow the wife’s income to go into the shell corporation. Then for the next few years he filed a separate return because he was still concerned about the scheme. It was not until several years after she originally brought it up that he finally ate the apple. He signed a joint return where her income no longer appeared although they still received the income and he knew they received the income. This went on for a few years until the day of reckoning arrived in the form of the Criminal Investigation Division of the IRS. The attorney was investigated and so were those who worked in his office including the wife. She was charged with one count of 7206(1). I can only imagine the anguish in the household during the ordeal of the criminal investigation. As a part of that investigation she was asked to amend her returns to reflect the correct amount of that income. She wanted to do that in order to be as cooperative as possible and avoid losing the benefits in the sentencing guidelines that come with lack of cooperation. He signed the joint amended return reporting the corrected tax.

The amount of tax and fraud penalty the husband and wife owe for the four year life of their participation in the scheme from 2000-2003 is over $50,000. With interest from those years it must now be over $80,000. The tax and interest can never be discharged in bankruptcy because of the fraud. The couple did not appear likely to have the kind of assets sitting around to pay this debt but they probably have a home which will make an offer in compromise difficult or impossible if they want to keep the home.

Judge Lauber went through the factors set out in Rev. Proc. 2013-34 though notes the Tax Court merely consults those guidelines and is not bound by the IRS’s approach and factors that it sets out in the procedure. Most of the factors were neutral. The critical factor here was knowledge. Husband testified that he thought the corporate shell was paying the taxes on the diverted income. The judge was not buying what he was selling and he explained why. Because the case essentially turned on the taxpayer’s knowledge the Court’s view of his credibility on the knowledge issue caused it to determine that he did not deserve relief.  The Court looked, inter alia, to the husband’s history of preparing the tax returns and awareness of the scheme.  It also refers to his signing the Form 4549 consenting to the assessment as supporting a finding that he had knowledge.  The reference to the signing of Form 4549 is somewhat puzzling because a taxpayer’s signature on that form does not signal an agreement with the IRS determinations on the form but only a consent to allow assessment.  If the Tax Court starts treating consents to assess as admissions against interest in making its fact findings, representatives may need to adjust their advice to clients.  After signing the Form 4549, a taxpayer is free to pay the tax and contest the liability in a refund suit.  Signing the form consenting to assessment should have no bearing on the outcome of the refund suit and similarly would seem not to support a finding in an innocent spouse case of knowledge.

I remember the class discussion of the case because of the failure to call the attorney who peddled the bad advice. I do not know whether the attorney was available to testify or what factors led the husband’s counsel not to call the attorney. The way the case set up for the Court it turned on the credibility of the husband and seemed like a loser to those of us watching it. Yet, another way to approach the case might have been to call the attorney and seek to make the trial about his scheming rather than about the husband’s ultimate capitulation to participation in the scheme. Of course, the result may have been the same but I felt that putting the attorney on trial rather than the husband would have made a better presentation.

The case shows again how instincts should trump advice of a professional when the advice just seems too good to be true. The couple is now banished from the Garden of Eden. I hope they have a place to land because I found them very sympathetic as I watched their case. The serpent did not appear in the courtroom that day and from the taxpayer’s perspective, his presence may have made a difference.

Comments

  1. Robert Nassau says

    Looks like the evil lawyer is at Schuylkill FCI until January 6, 2018 (serving a 10-year stint: http://articles.philly.com/2010-06-17/news/24967594_1_federal-tax-tax-system-income-tax

    .

  2. Bob Kamman says

    As the French say, “Cherchez l’avocat.”

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