Marianne Hopkins v. Commissioner

121 T.C. No. 5UNITED STATES TAX COURT
MARIANNE HOPKINS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 363-01. Filed July 29, 2003.
P and H filed joint returns for 1982, 1983, 1984,
1988, and 1989. Adjustments to partnership deductions
and NOL deductions resulted in tax deficiencies for
1982, 1983, and 1984. The partnership deductions are
attributable to H’s partnership. The NOL deductions
are attributable to P’s property. P and H reported
taxes due on their joint returns for 1988 and 1989;
however, they failed to pay those amounts. After P and
H were separated, P filed a request for relief under
sec. 6015, I.R.C., with respect to her joint and
several tax liabilities for 1982, 1983, 1984, 1988, and
1989.
Held: P is not entitled to relief under sec.
6015(b), I.R.C., for 1982, 1983, and 1984 because the
NOL deductions are P’s tax items and because she has
not established that in signing the returns she had no
reason to know that there were understatements
attributable to H’s partnership deductions.
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Held, further, P is entitled to relief under sec.
6015(c), I.R.C., to the extent the deficiencies for
1982, 1983, and 1984 are allocable to H under sec.
6015(d), I.R.C. For purposes of applying sec. 6015(d),
I.R.C., items are generally allocated as if P and H had
filed separate returns. Thus, deficiencies resulting
from H’s erroneous partnership deductions are generally
allocated to H, and deficiencies resulting from P’s
erroneous NOL deductions are generally allocable to P.
See sec. 6015(d)(3)(A), I.R.C. However, pursuant to
sec. 6015(d)(3)(B), I.R.C., an item otherwise allocable
to an individual shall be allocated to the other
individual filing the joint return to the extent the
item gave rise to a tax benefit to the other
individual. As a result, P is relieved of liability
for deficiencies attributable to H’s erroneous
partnership deductions except for the portion, if any,
that offsets her income. Likewise, P is liable for
deficiencies attributable to her erroneous NOL
deductions to the extent they offset her income, and
she is relieved of liability for any remaining portion
of the deficiencies attributable to the NOL that
offsets H’s income.
Held, further, P is not entitled to relief under
sec. 6015(f), I.R.C., for the remaining portions of the
deficiencies for 1982, 1983, and 1984.
Held, further, P is not entitled to relief under
sec. 6015(b), (c), or (f), I.R.C., for the underpay-
ments of tax in 1988 and 1989.
Sandra G. Scott, for petitioner.
Thomas M. Rohall, for respondent.
RUWE, Judge: The issue for decision is whether petitioner
is entitled to relief from joint and several liability under
section 6015(b), (c), or (f)1 for her 1982, 1983, 1984, 1988, and
1
Unless otherwise indicated, all section references are to
(continued...)
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1989 income tax liabilities. Those tax liabilities, which
include deficiencies, interest, penalties, and underpayments, are
as follows:
Year Liability
1982 $216,040.49
1983 154,412.96
1984 21,181.26
1988 2,496.38
1989 3,598.37
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time of filing the
petition, petitioner resided in Kentfield, California.
Petitioner was born in Germany. While in Germany,
petitioner completed the equivalent of a ninth-grade education.
She has never taken any business or tax classes. Her native
language is not English.
In February 1967, petitioner married Donald K. Hopkins.
Petitioner and Mr. Hopkins were separated on February 1, 1989,
and subsequently divorced. Mr. Hopkins was an airline pilot
during the relevant periods, and he earned a substantial salary.
Petitioner did not work outside her home during her marriage.
1
(...continued)
the Internal Revenue Code as amended, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
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Petitioner has resided in a house located at 111 Diablo
Drive, Kentfield, California, since 1967. Petitioner was the
sole owner of the house during the tax years at issue.2
Petitioner filed joint income tax returns with Mr. Hopkins
from 1978 to 1997.3 They reported Mr. Hopkins’s wages of
$141,683, $166,906, and $162,654 as income on their joint returns
for 1982, 1983, and 1984, respectively. They reported income
from a State tax refund of $5,039 on their joint return for 1982.
The refund matches the amount of State income taxes withheld from
Mr. Hopkins’s wages for 1981. They reported interest income of
$8,148, $5,192, and $2,107 on their joint returns for 1982, 1983,
and 1984, respectively. The evidence does not show who owned the
principal that generated the interest. Petitioner and Mr.
Hopkins reported ordinary income of $68,452 from San Sierra
Investment #11 on their joint return for 1983. The evidence does
not show who owned the partnership interest. They reported
ordinary income of $2,751 from ECC Leveraged Drilling on their
joint return for 1984. The evidence does not show who owned the
2
The real property located at 111 Diablo Drive consists of
two parcels. Petitioner and Mr. Hopkins acquired parcel 1 in
1967. On Apr. 2, 1973, Mr. Hopkins quitclaimed his interest in
parcel 1, which included the house, to petitioner. Petitioner is
still the sole owner of parcel 1. Parcel 2 has been held by
petitioner and Mr. Hopkins as joint tenants since it was acquired
in 1973.
3
On the joint returns for 1980 through 1984, petitioner’s
occupation is listed as “investor”.
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interest in this entity. They reported a $951 section 1231 gain
from Shelter Associates III on their joint return for 1984.4
Petitioner and Mr. Hopkins’s reported income for 1980
through 1984 was significantly offset by partnership losses,5 a
casualty loss, and net operating loss (NOL) carrybacks and
carryforwards that they claimed as deductions.
Petitioner and Mr. Hopkins claimed deductions on their joint
returns for 1982 and 1983 which related to Far West Drilling
partnership.6 The Far West Drilling partnership deductions were
attributable to Mr. Hopkins’s investment in that partnership.
The deductions related to the Far West Drilling partnership were
erroneous. Petitioner and Mr. Hopkins signed a closing agreement
under section 7121 in which they agreed to adjustments to the Far
West Drilling partnership deductions. In a separate opinion,
Hopkins v. Commissioner, 120 T.C. ___ (2003), we held that
4
A Schedule K-1, Partner’s Share of Income, Credits,
Deductions, etc., for 1984 reports petitioner as a partner in
Shelter Associates III.
5
Petitioner and Mr. Hopkins deducted substantial losses from
various partnership activities on their 1980, 1982, and 1983
joint income tax returns: The first page of each of the 1980,
1982, and 1983 joint returns showed losses on Schedule E,
Supplemental Income and Loss, of $119,408, $88,383, and $26,844,
respectively. The partnership activities included Circle T
Racing Stable, Shelter Associates III, San Sierra Investment #11,
ECC Leveraged Drilling #3, and Far West Drilling.
6
They claimed a loss deduction of $83,402 on their joint
return for 1982. They claimed a loss deduction of $91,086 and a
depletion deduction of $2,126 on their joint return for 1983.
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petitioner is not precluded by the closing agreement, which was
entered into before the enactment of section 6015, or the
doctrines of res judicata and collateral estoppel from claiming
relief under section 6015 with respect to the tax liabilities
attributable to the disallowance of deductions related to the Far
West Drilling partnership.
Petitioner and Mr. Hopkins reported a casualty loss of
$280,661 on their joint return for 1981. The casualty loss was
attributable to a mudslide that destroyed petitioner’s house.
Petitioner and Mr. Hopkins erroneously claimed NOL carryforward
deductions for 1982 and 1984 which were attributable to the
casualty loss. Petitioner agrees that the erroneous 1982 and
1984 NOL carryforward deductions are her items.
Respondent assessed deficiencies in petitioner and Mr.
Hopkins’s taxes for 1982, 1983, and 1984. Those deficiencies
were attributable to the disallowance of the Far West Drilling
partnership deductions and the disallowance of the NOL
carryforward deductions that petitioner and Mr. Hopkins claimed
on their joint returns for 1982, 1983, and 1984.7
7
Petitioner and Mr. Hopkins’s tax liability for 1982 is
attributable to adjustments to the NOL carryforward deduction
resulting from the casualty loss and the Far West Drilling
partnership deduction for that year. The tax liability for 1983
is attributable solely to the Far West Drilling adjustments for
that year. The tax liability for 1984 arises solely from the
disallowance of the NOL carryforward deduction for that year.
Those deficiencies are not in issue.
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Petitioner and Mr. Hopkins reported, but did not pay, taxes
due of $1,571 and $3,326 on their joint income tax returns for
1988 and 1989, respectively. Respondent assessed those amounts.
On May 24, 1999, petitioner filed with respondent a Form
8857, Request for Innocent Spouse Relief, with respect to her
1982, 1983, 1984, 1988, and 1989 joint tax liabilities. On
January 8, 2001, petitioner filed a petition for relief from
joint and several liability with this Court. At the time the
petition was filed, respondent had not made a determination with
respect to petitioner’s request.8
OPINION
A. Tax Liabilities for 1982, 1983, and 1984
Petitioner claims that she is entitled to relief from joint
and several liability under section 6015(b), (c), or (f) for the
tax liabilities attributable to the disallowance of the Far West
Drilling partnership deductions and the disallowance of the NOL
carryforward deductions for 1982, 1983, and 1984.
8
Pursuant to sec. 6015(e)(1)(A), a petition may be filed
with this Court after the passage of 6 months from the date the
taxpayer elected sec. 6015 relief if the Commissioner has made no
determination regarding the election.
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1. Section 6015(b)
To qualify for relief under section 6015(b)(1), the electing
spouse must establish, inter alia, that: (A) A joint return has
been made for a taxable year; (B) there is an understatement of
tax on the return which is attributable to the erroneous items of
the nonelecting spouse; (C) in signing the return, the electing
spouse did not know, and had no reason to know, that there was
such an understatement; and (D) taking into account all the facts
and circumstances, it is inequitable to hold the electing spouse
liable for the deficiency in tax for the taxable year
attributable to the understatement. See Alt v. Commissioner, 119
T.C. 306, 313 (2002).
Petitioner is not entitled to relief under section 6015(b)
with respect to the understatements attributable to the
disallowed NOL carryforward deductions. Those items are
attributable to the residence at 111 Diablo Drive, which she
owned. Petitioner agrees that the casualty loss and the NOL
carryforward deductions are her tax items for purposes of section
6015(b). Petitioner cannot be granted relief under section
6015(b) for understatements that are attributable to her own
erroneous items. See sec. 6015(b)(1).
The Far West Drilling partnership deductions are Mr.
Hopkins’s tax items. With respect to those deductions,
petitioner bears the burden of proving that in signing the joint
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returns she had no reason to know that there were understatements
attributable to those items. See sec. 6015(b)(1)(C); Mora v.
Commissioner, 117 T.C. 279, 285 (2001). An individual has reason
to know of the 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 understatement. See Price
v. Commissioner, 887 F.2d 959, 965 (9th Cir. 1989); Mora v.
Commissioner, supra at 287.
Petitioner claims that in signing the returns she had no
reason to know of the understatements on the returns because she
was unaware of Mr. Hopkins’s investments in Far West Drilling and
the other partnerships. Petitioner’s testimony at trial did not
convince us that she was unaware that those investments were made
or that Mr. Hopkins concealed his investments from her.9
Further, even a cursory review of the joint returns for 1980,
1982, and 1983 would reveal that there were investments in
partnerships for those years and that large partnership
deductions were claimed. The partnership deductions
substantially reduced petitioner and Mr. Hopkins’s tax
liabilities for those years and, together with other deductions,
9
Petitioner’s testimony suggests that none of the
partnership investments reported on the joint returns were her
own. However, a Schedule K-1 for Shelter Associates III lists
petitioner as a partner in that entity in 1984.
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reduced their reported tax liabilities to zero.10 The losses
from the partnership activities for 1982 and 1983 were largely
attributable to the Far West Drilling deductions. The joint
return for 1982 showed a Far West Drilling partnership deduction
of $83,402. The joint return for 1983 showed a Far West Drilling
partnership deduction of $91,086 and a depletion deduction of
$2,126. Those amounts far exceeded other partnership deductions
which were claimed in the joint returns.
Petitioner, at the very least, understood the general
concepts of Federal income taxation,11 and she demonstrated to us
no discernible difficulty in understanding English. Petitioner
was involved in the audit process with respect to the 1982 and
1983 joint returns. At some point during the Internal Revenue
Service (IRS) audit of those returns, petitioner and Mr. Hopkins
were represented by John E. Lahart.12 Mr. Lahart spoke with
petitioner on more than one occasion, and he testified that she
10
However, in prior years, petitioner and Mr. Hopkins
reported relatively large tax liabilities, $24,229 in 1978 and
$22,684 in 1979, but reported insignificant partnership
deductions.
11
An individual cannot rely solely on ignorance of the
attendant tax or legal consequences of an item giving rise to a
deficiency to satisfy his or her burden under sec. 6015(b)(1)(C).
See Price v. Commissioner, 887 F.2d 959, 964 (9th Cir. 1989).
12
Petitioner and Mr. Hopkins signed a Form 2848, Power of
Attorney and Declaration of Representative, dated Sept. 22, 1988,
in which they appointed Mr. Lahart to represent them before the
Internal Revenue Service (IRS).
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did not appear confused about the subject matter that was being
discussed and that she did not appear to have a problem with
English. Petitioner subsequently hired David M. Hellman to
represent her and Mr. Hopkins in prior Tax Court litigation
concerning the disallowance of the NOLs related to the casualty
loss.13 Petitioner, Mr. Hopkins, their tax return preparer, and
Mr. Hellman had a face-to-face meeting to discuss the issues
involved in that case. In an October 25, 1990, letter to
respondent’s counsel in that case, Mr. Hellman represented that
“The records concerning the 1980 investment in San Sierra
Investment #II apparently were lost in the mud slide. Mrs.
Hopkins recalls a 1980 payment to them of approximately $40,000.”
Also, in a May 17, 1990, letter to this Court, he represented
that “From what I understand preliminarily upon brief discussions
with Mrs. Hopkins, it appears the position taken on their income
tax returns for the years in question was a correct position.”
Petitioner was actively involved in the prior Tax Court
litigation concerning the disallowance of the NOLs related to the
casualty loss. She was the only person other than her expert to
13
Respondent issued notices of deficiency to petitioner and
Mr. Hopkins for their 1978, 1979, 1981, and 1982 taxable years on
the basis of the disallowance of the NOLs related to the casualty
loss that they had claimed on their joint return for 1981.
Petitioner and Mr. Hopkins filed a petition with the Tax Court,
and the matter went to trial. During the trial, the parties
agreed to settle the case. That case did not involve a claim for
relief from joint and several liability.
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testify on her behalf in that proceeding. Also, she was the
person who dealt with the insurance company after it initially
denied coverage for the loss of her house in 1982.
The record reflects that petitioner dealt with third parties
with respect to her family’s financial, tax, and legal matters.
For example, respondent’s revenue officer who was assigned to the
collection of the income tax liabilities of petitioner and Mr.
Hopkins testified that, except for one occasion, he dealt almost
exclusively with petitioner. When he would request information
or a response from petitioner and Mr. Hopkins, it was always
petitioner who would respond.
Petitioner performed numerous financial functions within her
family, exercised considerable discretion, and was ultimately
responsible for the family’s principal asset, the house at 111
Diablo Drive. She spent considerable sums in remodeling the
house before 1982 and in rebuilding the house after the mudslide
in 1982.14 Petitioner directed the remodeling and rebuilding.
She hired contractors, and she paid those individuals by check or
in cash.
Given the size of the partnership deductions, the change in
petitioner and Mr. Hopkins’s reported taxes in 1980, 1982, and
1983, and petitioner’s involvement in the family’s financial
14
The rebuilt residence included four bedrooms and four
baths and occupied 4,976 square feet with a four-car, 920-square-
foot carport.
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affairs, we believe that she, as a reasonably prudent taxpayer,
should have at least made inquiries concerning the large
partnership deductions. “‘Tax returns setting forth large
deductions, such as tax shelter losses offsetting income from
other sources and substantially reducing or eliminating the
couple’s tax liability, generally put a taxpayer on notice that
there may be an understatement of tax liability.’” Mora v.
Commissioner, 117 T.C. at 289 (quoting Hayman v. Commissioner,
992 F.2d 1256, 1262 (2d Cir. 1993), affg. T.C. Memo. 1992-228).
We are not convinced that Mr. Hopkins exercised such
dominance over petitioner that she could not question the
reporting of significant deductions. Petitioner has failed to
establish that she did not have reason to know of the
understatements attributable to the Far West Drilling deductions
for 1982 and 1983.15 Petitioner is not entitled to relief under
section 6015(b) for the tax liabilities attributable to those
items.
2. Section 6015(c)
Under section 6015(c)(1), if an individual who has made a
joint return for any taxable year elects the application of this
subsection, the individual’s liability for any deficiency which
is assessed with respect to the return shall not exceed the
15
Petitioner and Mr. Hopkins have maintained close ties to
one another. He still uses a portion of petitioner’s house as an
office, and he also performs maintenance services.
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portion of the deficiency properly allocable to the individual
under section 6015(d).16 The purpose of section 6015(c) is to
allocate the tax liability between the individuals who filed a
joint return in approximately the same way it would have been had
the individuals filed separately.
An individual shall be eligible to elect the application of
section 6015(c) only if: (1) At the time the election is filed,
the electing individual is no longer married to, or is legally
separated from, the other individual who filed the joint return;
or (2) the electing individual was not a member of the same
household as the other individual at any time during the 12-month
period ending on the date the election is filed. Sec.
6015(c)(3)(A)(i). Respondent concedes that petitioner has met
the requirements of section 6015(c)(3)(A)(i).
Pursuant to section 6015(c)(3)(B), an election under section
6015(c) for any taxable year may be made at any time after a
16
Sec. 6015(c)(1) provides:
SEC. 6015(c). Procedures To Limit Liability for
Taxpayers No Longer Married or Taxpayers Legally
Separated or Not Living Together.
(1) In general.--Except as provided in this
subsection, if an individual who has made a joint
return for any taxable year elects the application
of this subsection, the individual’s liability for
any deficiency which is assessed with respect to
the return shall not exceed the portion of such
deficiency properly allocable to the individual
under subsection (d).
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deficiency for such year is asserted but not later than 2 years
after the date on which the Secretary has begun collection
activities with respect to the individual making the election.
The applicable 2-year election period shall not expire before the
date that is 2 years after the first collection activity taken by
the IRS after the date of enactment. Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.
3201(g)(2), 112 Stat. 740. Petitioner elected relief on May 24,
1999, within the specified period.
a. Allocation of the Items Making Up the Deficiency
Section 6015(c)(1) provides that the allocation of a
deficiency should be made as provided in section 6015(d). Under
section 6015(d)(1), the portion of any deficiency on a joint
return allocated to an individual shall be the amount which bears
the same ratio to such deficiency as the net amount of items
taken into account in computing the deficiency and allocable to
the individual under section 6015(d)(3) bears to the net amount
of all items taken into account in computing the deficiency.17
17
Sec. 6015(d)(1) provides:
SEC. 6015(d). Allocation of Deficiency.--For
purposes of subsection (c)--
(1) In general.--The portion of any
deficiency on a joint return allocated to an
individual shall be the amount which bears the
same ratio to such deficiency as the net amount of
items taken into account in computing the
(continued...)
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Each individual who elects the application of section 6015(c)
shall have the burden of proof with respect to establishing the
portion of any deficiency allocable to such individual. Sec.
6015(c)(2).
Respondent argues that a portion of the Far West Drilling
deductions is attributable to petitioner. He relies upon
petitioner’s testimony in a prior Tax Court case that did not
concern petitioner’s or Mr. Hopkins’s investments in
partnerships. Petitioner testified under cross-examination in
that case:
Q Isn’t it a fact, Mrs. Hopkins, that during 1980
you invested money into Far West Drilling?
A Yes.
Q And wasn’t that at least $22,000?
A Yes.
In the instant case, petitioner testified that she misunderstood
the question; that she understood the question to refer to both
her and Mr. Hopkins; and that she personally invested nothing in
Far West Drilling. Petitioner’s testimony is supported by
correspondence from Far West Drilling and a note that Mr. Hopkins
signed in favor of the partnership, which indicates that Mr.
Hopkins invested in Far West Drilling. The record also contains
17
(...continued)
deficiency and allocable to the individual under
paragraph (3) bears to the net amount of all items
taken into account in computing the deficiency.
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a Schedule K-1, Partner’s Share of Income, Credits, Deductions,
etc., for 1985, which reports Mr. Hopkins as a partner in Far
West Drilling. We find that the Far West Drilling deductions are
Mr. Hopkins’s items.
On brief, respondent argues that “Petitioner is not entitled
to relief under I.R.C. § 6015(c) for the disallowed casualty
losses due to the fact that petitioner owned the residence.
Thus, the deficiencies arising from the disallowed casualty
losses were due to her own item and she remains liable.”
Section 6015(c) requires an allocation of the items giving
rise to a deficiency to be made under section 6015(d)(3).
Generally, any item giving rise to a deficiency on a joint return
shall be allocated to individuals filing the return in the same
manner as it would have been allocated if the individuals had
filed separate returns for the taxable year. Sec.
6015(d)(3)(A).18 However, section 6015(d)(3)(B) provides an
18
Sec. 6015(d)(3) provides in part:
SEC. 6015(d). Allocation of Deficiency.--For
purposes of subsection (c)--
* * * * * * *
(3) Allocation of items giving rise to the
deficiency.--For purposes of this subsection--
(A) In general.--Except as provided in
paragraphs (4) and (5), any item giving rise
to a deficiency on a joint return shall be
allocated to individuals filing the return in
(continued...)
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exception to this general rule where the other individual
receives a tax benefit from the item giving rise to a deficiency.
Section 6015(d)(3)(B) provides:
(B) Exception where other spouse benefits.--Under
rules prescribed by the Secretary, an item otherwise
allocable to an individual under subparagraph (A) shall
be allocated to the other individual filing the joint
return to the extent the item gave rise to a tax
benefit on the joint return to the other individual.
Section 6015(d)(3)(B) provides an alternative method of
allocating items giving rise to a deficiency between the
individuals filing a joint return, regardless of whether the
items would otherwise be allocable to one individual. Its
purpose is to allocate liability between the individuals who
filed a joint return on the basis of the extent to which each
individual received the tax benefit of an erroneous deduction.
The language of section 6015(d)(3)(B) does not limit its
application to only one of the individuals who filed a joint
return. It does not refer to items of a “requesting” or
“electing” individual or to items of a “nonrequesting” or
“nonelecting” individual. It uses the terms “an individual” and
“the other individual filing the joint return”. Section
6015(d)(3)(B) requires an allocation between individuals who
filed a joint return no matter who is requesting or electing
18
(...continued)
the same manner as it would have been
allocated if the individuals had filed
separate returns for the taxable year.
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relief. Indeed, under section 6015(c), either or both of the
individuals who filed a joint return may elect relief.19
The Senate report discussing the allocation rule in section
6015(d)(3)(B) states: “Items of loss or deduction are allocated
to a spouse only to the extent that income attributable to the
spouse was offset by the deduction or loss. Any remainder is
allocated to the other spouse.” S. Rept. 105-174, at 57 (1998),
1998-3 C.B. 537, 593. The conference report likewise states:
If the deficiency arises as a result of the denial of
an item of deduction * * *, the amount of the
deficiency allocated to the spouse to whom the item of
deduction * * * is allocated is limited to the amount
of income * * * allocated to such spouse that was
offset by the deduction * * *. The remainder of the
liability is allocated to the other spouse to reflect
the fact that income * * * allocated to that spouse was
originally offset by a portion of the disallowed
deduction * * * [H. Conf. Rept. 105-599, at 252
(1998), 1998-3 C.B. 747, 1006.]
See Mora v. Commissioner, 117 T.C. at 293. The examples in the
Senate and conference reports illustrate the application of
section 6015(d)(3)(B) and divide the liability for a deficiency
in proportion to the amount of income offset for each individual.
S. Rept. 105-174, supra at 58, 1998-3 C.B. at 594; H. Conf. Rept.
19
The final regulations issued under sec. 6015 provide that
“Relief may be available to both spouses filing the joint return
if each spouse is eligible for and elects the application” of
sec. 6015(c). Sec. 1.6015-3(a), Income Tax Regs. However, only
a requesting spouse may receive relief under sec. 6015(c); a
spouse who does not also elect relief under sec. 6015(c) remains
liable for the entire amount of the deficiency. Sec. 1.6015-
3(d)(1)(ii), Income Tax Regs.
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105-599, supra at 252-253, 1998-3 C.B. at 1006-1007. The
following examples are provided in the conference report:
For example, a married couple files a joint return
with wage income of $100,000 allocable to the wife and
$30,000 of self employment income allocable to the
husband. On examination, a $20,000 deduction allocated
to the husband is disallowed, resulting in a deficiency
of $5,600. Under the provision, the liability is
allocated in proportion to the items giving rise to the
deficiency. Since the only item giving rise to the
deficiency is allocable to the husband, and because he
reported sufficient income to offset the item of
deduction, the entire deficiency is allocated to the
husband and the wife has no liability with regard to
the deficiency, regardless of the ability of the IRS to
collect the deficiency from the husband.
If the joint return had shown only $15,000
(instead of $30,000) of self employment income for the
husband, the income offset limitation rule discussed
above would apply. In this case, the disallowed $20,000
deduction entirely offsets the $15,000 of income of the
husband, and $5,000 remains. This remaining $5,000 of
the disallowed deduction offsets income of the wife.
The liability for the deficiency is therefore divided
in proportion to the amount of income offset for each
spouse. In this example, the husband is liable for 3/4
of the deficiency ($4,200), and the wife is liable for
the remaining 1/4 ($1,400). [H. Conf. Rept. 105-599,
supra at 252-253, 1998-3 C.B. at 1006-1007.]
The allocation in the above example is made without reference to
whether the husband, the wife, or both elect relief under section
6015(c).
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On July 18, 2002, the Commissioner published final
regulations under section 6015.20 Section 1.6015-3(d)(2), Income
Tax Regs., of the final regulations provides in part:
(2) Allocation of erroneous items. For purposes
of allocating a deficiency under this section,
erroneous items are generally allocated to the spouses
as if separate returns were filed, subject to the
following four exceptions:
(i) Benefit on the return.--An erroneous
item that would otherwise be allocated to the
nonrequesting spouse is allocated to the
requesting spouse to the extent that the
requesting spouse received a tax benefit on the
joint return.
While the above-quoted portion of the regulations does not
specifically address the situation at issue, where an erroneous
item of deduction of the electing individual offsets income of
the nonelecting individual, it does not purport to preclude
application of section 6015(d)(3)(B) to that situation.
Indeed, the final regulations provide an example which
supports our application of the alternative allocation method in
section 6015(d)(3)(B). In section 1.6015-3(d)(5), Example (5),
Income Tax Regs., both individuals who filed a joint return elect
relief under section 6015(c). The erroneous deduction is
initially H’s item; however, in the example, only a portion of
20
These regulations are applicable for all elections or
requests for relief filed on or after July 18, 2002. Washington
v. Commissioner, 120 T.C. 137, 154 n.9 (2003); sec. 1.6015-9,
Income Tax Regs. Petitioner’s election was filed on May 24,
1999, before the effective date of the regulations.
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H’s deduction is used to offset H’s income; the remaining portion
offsets W’s income. The example limits W’s liability to the
portion of the deficiency attributable to her income offset.
However, with respect to H, the regulations conclude that H’s
election to be relieved of the portion of the deficiency
attributable to W’s income offset “would be invalid because H had
actual knowledge of the erroneous items.”21 If the final
regulations were intended to limit application of section
6015(d)(3)(B) to erroneous deductions of a nonrequesting spouse,
21
Sec. 1.6015-3(d)(5), Example (5), Income Tax Regs.,
provides:
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 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). If H also elected to allocate the deficiency,
H’s election to allocate the $4,160 of the deficiency
to W would be invalid because H had actual knowledge of
the erroneous items. [Emphasis added.]
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as respondent argues, the regulations could have simply said
that.
But Example (5) of the final regulations indicates that the
alternative allocation method of section 6015(d)(3)(B) is applied
to both W and H, even though the erroneous deduction is initially
H’s item. This is illustrated by the fact that H is denied
relief under the actual knowledge exception. The actual
knowledge exception contained in section 6015(c)(3)(C) denies
relief only if the Commissioner proves that the electing
individual had actual knowledge of an item allocable to the other
individual.22 Thus, before the actual knowledge exception can be
applied, there must be an allocation of the items giving rise to
a deficiency. In Example (5), actual knowledge would have no
relevance if the erroneous deduction was an item entirely
allocable to H. The example makes sense only if a portion of H’s
item is reallocated to W pursuant to section 6015(d)(3)(B).
Unless respondent establishes that petitioner had actual
knowledge of the items giving rise to the deficiencies,
petitioner is entitled to relief to the extent the deficiencies
are attributable to Mr. Hopkins.
22
The actual knowledge exception contained in sec.
6015(c)(3)(C) applies only in the case of “any item giving rise
to a deficiency (or portion thereof) which is not allocable to
such individual under subsection (d)”.
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b. Actual Knowledge Exception Does Not Apply to
Petitioner
As previously indicated, if the Commissioner demonstrates
that an individual making the election under section 6015(c) 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 section
6015(d), the election under section 6015(c) will not apply to
such deficiency (or portion). Sec. 6015(c)(3)(C). The
Commissioner must prove actual knowledge by a preponderance of
the evidence. Culver v. Commissioner, 116 T.C. 189, 196 (2001).
Actual knowledge in the case of disallowed deductions consists of
“actual knowledge of the factual circumstances which made the
item unallowable as a deduction.” King v. Commissioner, 116 T.C.
198, 204 (2001). Actual knowledge of the tax laws or legal
consequences of the operative facts are not required. Id.;
Cheshire v. Commissioner, 115 T.C. 183, 196-197 (2000), affd. 282
F.3d 326 (5th Cir. 2002).
Respondent concedes that he has not proven actual knowledge
with respect to the Far West Drilling adjustments that are
allocable to Mr. Hopkins. Respondent makes no argument on brief
with respect to petitioner’s actual knowledge of the NOL
carryforward deductions for 1982 and 1984 attributable to the
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casualty loss.23 We hold that respondent has not proven that
petitioner had actual knowledge of the factual circumstances
which made the NOL carryforward and the Far West Drilling
deductions unallowable.
c. Conclusion
We hold that petitioner is relieved of liability for
deficiencies attributable to Mr. Hopkins’s erroneous partnership
deductions except for the portion, if any, of the erroneous
partnership deductions that offsets her income. We also hold
that petitioner is liable for deficiencies attributable to her
erroneous NOL deductions to the extent the NOL deductions may
have offset her income, and she is relieved of liability for any
portion of the deficiencies attributable to the erroneous NOL
deductions which offset Mr. Hopkins’s income. Most of the income
for the years 1982, 1983, and 1984 was Mr. Hopkins’s income.
However, the record is not clear about some of the items of
income, such as interest. We expect the parties to resolve this
uncertainty as part of the Rule 155 computation.
23
The NOL deductions were disallowed because of
overstatements of the NOL carryback and carryforward deductions
attributable to the casualty loss. A certified public accountant
prepared the joint tax returns for 1981, 1982, and 1984. He
testified that he dealt with Mr. Hopkins and could not recall
whether he discussed the tax returns with petitioner. He did not
testify regarding what petitioner did or did not know in signing
the joint returns.
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3. Section 6015(f)
After we grant relief to petitioner under section 6015(c),
she may still have some liability for portions of the
deficiencies for 1982, 1983, and 1984 that are allocable to her
under section 6015(d). We will therefore consider her
eligibility for relief under section 6015(f). Under section
6015(f), the Secretary is authorized to grant equitable relief
where: (1) The taxpayer is not entitled to relief under section
6015(b) or (c), and (2) “taking into account all the facts and
circumstances, it is inequitable to hold the individual liable
for any unpaid tax or any deficiency (or any portion of either)”.
See Cheshire v. Commissioner, 282 F.3d at 338. We review for an
abuse of discretion the Commissioner’s decision not to grant
equitable relief. Butler v. Commissioner, 114 T.C. 276, 292
(2000).
The Far West Drilling deductions and the overstated NOL
carryforward deductions greatly reduced petitioner and Mr.
Hopkins’s joint tax liabilities in 1982, 1983, and 1984. In or
about those years, considerable amounts were spent to rebuild
petitioner’s house at 111 Diablo Drive. Petitioner was, and
still is, the sole owner of that residence, and she was the
person who received the most comfort and benefit from the use of
that residence before and after those years. The reduced tax
liabilities for 1982, 1983, and 1984 enhanced petitioner’s
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ability to rebuild the residence. Petitioner did not present
evidence regarding her inability to pay her reasonable basic
living expenses, see sec. 301.6343-1(b)(4)(i), Proced. & Admin.
Regs., or any other unique circumstances which might lead us to
conclude that she will suffer economic hardship if, after
application of section 6015(c), she remains jointly and severally
liable for any remaining portions of the liabilities for 1982,
1983, and 1984. We hold that respondent did not abuse his
discretion in deciding that it is not inequitable to hold
petitioner jointly and severally liable for any remaining
portions of the joint income tax liabilities for 1982, 1983, and
1984. Petitioner is not entitled to relief for those liabilities
under section 6015(f).
B. Underpayments in 1988 and 1989
Petitioner claims relief under section 6015(b), (c), or (f)
for her joint and several tax liabilities for 1988 and 1989.
Subsections (b) and (c) of section 6015 apply only in the case of
“an understatement of tax” or “any deficiency” in tax and do not
apply in the case of underpayments of taxes reported on joint tax
returns. Sec. 6015(b)(1)(B) and (c)(1); see also Block v.
Commissioner, 120 T.C. 62, 66 (2003); Ewing v. Commissioner, 118
T.C. 494, 497, 498 n.4 (2002). We hold that petitioner is not
entitled to relief under section 6015(b) or (c) for her 1988 and
1989 tax liabilities.
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In determining an individual’s entitlement to relief under
section 6015(f) for an underpayment, the Commissioner considers
the requesting spouse’s knowledge, or reason to know, that the
liability would be unpaid at the time the return was signed, as a
factor weighing against relief. Rev. Proc. 2000-15, sec.
4.03(2)(b), 2000-1 C.B. 447, 449.
Petitioner has not shown to our satisfaction that she had no
knowledge, or reason to know, that the taxes reported on the
joint returns for 1988 and 1989 would not be paid. The record
indicates that she was involved in the preparation of the returns
for those years. Indeed, the 1989 joint tax return contains an
attached Form 2688, Application for Additional Extension of Time
to File U.S. Individual Income Tax Return, dated August 14, 1990,
which states:
At present we are not able to meet more demands of the
IRS than we have already on hand. We are physically
ill and emotionally sick. All of us are suffering from
POST TRAUMATIC STRESS SYNDROMS.
In spite of our conditions, we are currently dealing
with the IRS on a major scale: our casualty loss
investigation. Our home and all of our belongings were
destroyed by a huge mudslide. We barely escaped with
our lives. We are financially devastated. We can not
do more.
Please honor our request for an extension of this
matter until the casualty loss investigation is
concluded.
Thank you! * * * [signed Marianne Hopkins].
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Petitioner has not established that she did not know, or had
no reason to know, that the reported tax liabilities on the 1988
and 1989 joint tax returns would be unpaid at the time she signed
those joint tax returns. See Rev. Proc. 2000-15, sec.
4.03(1)(d), 2000-1 C.B. at 449. Petitioner has not established
that she will suffer economic hardship if relief is not granted.
On the record before us, petitioner has not demonstrated that
respondent’s failure to grant equitable relief for the unpaid
1988 and 1989 joint tax liabilities was an abuse of discretion.
Decision will be
entered under Rule 155.