Tax Court in Brief | Freman v. Comm’r | Innocent Spouse Relief Under Section 6015(b), (c), and (f)

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Tax Litigation:  The Week of January 23rd, 2022, through January 27th, 2023

Freman v. Comm’r, T.C. Memo. 2023-10| January 23, 2023 |Jones, J. | Dkt. No. 8895-20

Summary:  This Freman opinion is a 33-page analysis of, essentially, whether or not Ms. Freman is entitled to all or partial relief from tax liability pursuant to section 6015, the innocent spouse relief statute.

The Marriage. Kari Freman and Rodney Freman married in 1998. They had a child together. Ms. Freman has a high school education, was not employed outside of the home during the tax years at issue, and primarily took care of the couple’s child. Mr. Freman was employed as a commodities trader. Finances were often a source of contention. They maintained joint checking and savings accounts. Mr. Freman had a retirement account through his employer. Mr. Freman was solely responsible for making all financial decisions and for handling the preparation and filing of tax returns. Ms. Freman was not given an opportunity to review the contents of their returns before signing them. Ms. Freman was hospitalized for a time in 2015 and was prescribed narcotics to help her with pain management. In 2012, Mr. Freman was diagnosed with an autoimmune disease that required him to obtain disability leave. The disability insurance was not enough to make ends meet. So, in tax year 2012 he took a taxable distribution from his retirement account. For the distribution, Ms. Freman signed a spousal consent form, thereby waiving her rights to the Qualified Annuity Benefit otherwise available under the retirement plan. Because of the limitations imposed by the plan, Mr. Freman was not permitted to borrow against his retirement account. So, Mr. Freman terminated his employment to take the distribution. Mr. Freman was rehired by the same company in 2014, and he continued his employment through at least 2015.

The Tax Liabilities – 2012, 2014, and 2015. For tax year 2012, the Fremans failed to timely file a return. The IRS prepared a substitute for return (SFR) that asserted a deficiency of $85,238 and withholding of $36,057. All income was attributable to Mr. Freman, including $172,342 of income for the taxable distribution from Mr. Freman’s retirement account. After receiving the SFR, the Fremans filed Form 1040A. However, the Form 1040A did not report the taxable distribution from the retirement account or the taxes withheld. The IRS issued a revised examination report showing adjustments. The IRS issued a notice of deficiency, and neither filed a petition to challenge the notice. Later, the IRS assessed a deficiency of $60,953 and additions to tax and penalties. The Fremans established an installment plan but ultimately stopped making payments.

For tax year 2014, the Fremans filed an untimely joint return. It showed income tax liability of $6,789. Because of the untimeliness and the failure to make payment, the IRS assessed additions to tax.

For tax year 2015, the Fremans filed an untimely joint return. The 2015 tax return reported income tax liability of $8,064. The return did not report $11,883 in cancellation of indebtedness income attributable to Ms. Freman’s credit card expenditures. Because of the untimeliness and the failure to make payment, the IRS assessed additions to tax.

The Divorce. Ms. Freman filed for divorce in 2017. A little later, Ms. Freman and the child moved into an RV. A judgment of dissolution was entered in or about July 2021.

Ms. Freman’s Form 8857, Request for Section 6015 Spousal Relief. On February 21, 2019, the IRS’s Cincinnati Centralized Innocent Spouse Operation (CCISO) received Ms. Freman’s Form 8857, claiming she was unaware of her and Mr. Freman’s tax liabilities. She reported that Mr. Freman (1) physically harmed or threatened her (specifically for financial matters), her children, or other family members, (2) made her afraid to disagree with him, (3) criticized or insulted her or frequently put her down, (4) withheld money for food, clothing, or other basic needs, and (5) made most or all of the decisions for her, including financial decisions. Ms. Freman’s Form 8857 indicated that she had a checking account with $300, total monthly income of $1,160, and total monthly expenses of $1,910. Ms. Freman did not attach any supporting documentation to her Form 8857.

Mr. Freman’s Response Form 12508, Questionnaire for Non-Requesting Spouse. In response to Ms. Freman’s request, Mr. Freman filed Form 12508. Mr. Freman alleged that Ms. Freman (1) prepared or helped prepare their returns, (2) gathered receipts and canceled checks, (3) gave tax documents to the person who was preparing the returns, (4) asked the person who prepared the returns to explain any items or amounts, and (5) reviewed the returns before filing them. He stated that Ms. Freman was “[a]lways!” aware of any financial problems.

CCISO Review. The IRS reviewing agent believed that Ms. Freman should receive a full grant of spousal relief. For 2012, the agent granted preliminary relief under section 6015(c), finding that Ms. Freman did not have actual knowledge of the understatement. For 2014 and 2015, the agent granted preliminary relief under section 6015(f), finding that Ms. Freman met the streamlined factors for relief because, among other things, Mr. Freman maintained exclusive control over the household finances.

Mr. Freman’s Disagreement. In response, Mr. Freman submitted Form 12509, Statement of Disagreement, and requested reconsideration from the IRS Office of Appeals. Appeals issued a notice of final determination, denying Ms. Freman’s request for relief for the tax years at issue. Appeals determined that Ms. Freman’s actual knowledge of the items of income made her ineligible for relief under section 6015(b) or (c). Appeals found that Ms. Freman met the threshold requirements for relief under 6015(f), but she did not meet the streamlined factors for relief because she had knowledge of the omitted items and did not have a reasonable expectation that Mr. Freman would pay the taxes. Appeals also determined that Ms. Freman was not entitled to relief under the full equitable relief analysis for the same reason.

Key Issues:  Whether Ms. Freman was entitled to relief from joint and several liability under section 6015(b), (c), and (f) for the understatement for taxable year 2012 and under section 6015(f) for the underpayment for taxable years 2014 and 2015?

Primary Holdings: Ms. Freman is entitled to partial relief under section 6015(f). Since she knew (by her own testimony) of at least $90,000 distribution from the retirement account in 2012, the Court found it to be “not inequitable” to hold Ms. Freman liable for tax on the $90,000. The Court found, however, that it would be inequitable to hold Ms. Freman liable for tax on any amounts above the $90,000 for the taxable year 2012 understatement, and for the underpayments for taxable years 2014 and 2015. This is because Mr. Freman’s financial control negated Ms. Freman’s reason to know of the amounts of the distribution above the $90,000 amount and her knowledge of Mr. Freman’s inability to pay, among other factors that weigh in favor of relief.

Key Points of Law:

Evidentiary Considerations and Standard of Review. The scope of review in this case was limited to the administrative record established at the time of the determination, and any additional newly discovered or previously unavailable evidence. See Soler v. Commissioner, T.C. Memo. 2022-78, at *5–6.  The Tax Court applies a de novo standard of review to any determination made by the IRS under section 6015. § 6015(e)(7). The requesting spouse generally bears the burden of proving that he or she is entitled to relief. See Rule 142(a).

Section 6015—Innocent Spouse Relief. Married taxpayers may elect to file a joint federal income tax return. § 6013(a). If a joint return is made, the tax is computed on the spouses’ aggregate income, each spouse is fully responsible for the accuracy of the return, and each spouse is jointly and severally liable for the entire amount of tax shown on the return or found to be owing. § 6013(d)(3). But, section 6015 provides three potential avenues and procedures for relief from joint and several liability: (1) full or partial relief for an understatement of tax under section 6015(b), (2) proportionate relief for an understatement of tax under section 6015(c), and (3) full or partial relief for an understatement or underpayment of tax under section 6015(f).

Joint Return Requirement, Generally. The availability of each type of relief under section 6015 depends upon the filing of a joint return. See § 6015(a)(1), (b)(1)(A), (c)(1); Treas. Reg. §§ 1.6015-2(a)(1), 1.6015 3(a), 1.6015-4(a), (c); see also Rev. Proc. 2013-34, § 4.01, 2013 43 I.R.B. 397, 399. To file jointly, both spouses must intend to make a joint return.

Section 6015(b). To qualify for relief under section 6015(b), the requesting spouse must satisfy all of the following conditions: (A) a joint return was filed for the taxable year; (B) there was an understatement of tax attributable to erroneous items of the non-requesting spouse on the return; (C) the requesting spouse did not know and had no reason to know of the understatement at the time that the return was signed; (D) taking into account all of the facts and circumstances, it is inequitable to hold the requesting spouse liable for the deficiency in tax attributable to such understatement; and (E) the requesting spouse made a timely election for relief under section 6015(b). § 6015(b)(1). A failure to meet any one of them precludes relief under section 6015(b). However, a requesting spouse may receive partial relief if they satisfy every requirement except the lack of knowledge requirement. See § 6015(b)(2).

Lack of Knowledge Requirement. A requesting spouse has knowledge or reason to know of an understatement if he or she actually knew of the understatement or if a reasonable person in similar circumstances would have known of the understatement. Jacobsen v. Commissioner, T.C. Memo. 2018-115, at *11, *14, aff’d, 950 F.3d 414 (7th Cir. 2020). A taxpayer who signs a return is generally charged with constructive knowledge of its contents. Porter v. Commissioner, 132 T.C. 203, 210-11 (2009), superseded in part by statute, Taxpayer First Act § 1203, 133 Stat. at 988). A taxpayer seeking to establish they had no reason to know of an understatement “must show that she was unaware of the circumstances that gave rise to the error and not merely unaware of the tax consequences. . . . Section 6015 does not protect a spouse who turns a blind eye to facts readily available to her.” Id. at 212. But, a requesting spouse may receive partial relief if they establish that he or she did not know and had no reason to know the full extent of the understatement. See § 6015(b)(2).

Actual Knowledge. A spouse lacks actual knowledge if he or she is unaware of the circumstances that give rise to the error on the tax return, a determination based on all facts and circumstances. See Treas. Reg. §§ 1.6015-2(c), 1.6015-3(c)(2)(iv). In the case of omitted income, actual knowledge generally means knowledge of receipt of the income. Treas. Reg. §§ 1.6015-2(c), 1.6015-3(c)(2)(i)(A).

Reason to Know – Constructive Knowledge. A requesting spouse has reason to know of an understatement if a reasonable person in similar circumstances would have known of the understatement. Treas. Reg. § 1.6015-2(c). This standard is not abstract, however, as the prudent taxpayer must be placed in the particular circumstances of the taxpayer requesting relief under section 6015. See Resser v. Commissioner, 74 F.3d 1528, 1536 (7th Cir. 1996), rev’g and remanding T.C. Memo. 1994-241. A taxpayer has reason to know of an understatement if the taxpayer had constructive knowledge. “Courts have interpreted the reason-to-know element to encompass two separate types of constructive knowledge.” Greer v. Commissioner, 595 F.3d 338, 345 (6th Cir. 2010), aff’g T.C. Memo. 2009-20.

A requesting spouse has constructive knowledge if either (1) they know facts sufficient to give him or her reason to know of an understatement reflected on the return, or (2) even if they do not have reason to know of an understatement, the requesting spouse may know facts sufficient to place him or her on notice of a possible understatement, giving rise to a duty of inquiry. Jacobsen, T.C. Memo. 2018-115, at *14–15; see Treas. Reg. § 1.6015-2(c). Relevant considerations include: (1) the requesting spouse’s level of education; (2) the requesting spouse’s involvement in the financial and business activity of the family; (3) the presence of expenditures that appear lavish or unusual when compared with the family’s past levels of income, standard of living, and spending patterns; and (4) the culpable spouse’s evasiveness and deceit about the family’s finances. Price v. Commissioner, 887 F.2d 959, 965 (9th Cir. 1989).

Section 6015(c) Relief. To qualify for relief under section 6015(c), the requesting spouse must satisfy all of the following conditions: (1) a joint return was filed for the taxable year; (2) at the time of the election, the requesting spouse was separated or divorced from the non-requesting spouse or was not a member of the same household as the non-requesting spouse at any time during the 12 month period ending on the date of the request for relief; and (3) the requesting spouse made a timely election for relief. § 6015(c)(1), (3). If the IRS demonstrates that, at the time of signing the return, a requesting spouse had actual knowledge of the item giving rise to a deficiency (or a portion thereof), the requesting spouse shall be ineligible for relief under this section for the deficiency (or portion thereof). § 6015(c)(2), (3)(C).

Separated, Divorced, or Living Apart.  The determination of “legally separated or divorced” is made at the time the election for spousal relief is filed. See Treas. Reg. § 1.6015-3(b)(1). An individual shall not be considered married if they are legally separated from their spouse under a decree of divorce or of separate maintenance. § 7703(a)(2). State law is relevant to this legal issue. In regard to the determination of “living apart,” spouses who reside in the same dwelling are considered members of the same household. Treas. Reg. § 1.6015-3(b)(3)(ii); Rev. Proc. 2013-34, § 4.03(2)(a)(iv), 2013-43 I.R.B. at 400–01. 21 See Vetrano v. Commissioner, 116 T.C. 272, 282–83 (2001), supplementing T.C. Memo. 2000-128.

Section 6015(f) Relief. Section 6015(f) provides relief from joint and several liability if it is inequitable to hold the requesting spouse liable for any unpaid tax or any deficiency (or any portion thereof) after taking into account all the facts and circumstances. § 6015(f)(1)(A); Porter, 132 T.C. at 206; Treas. Reg. § 1.6015-4(a). Treasury Regulation § 1.6015-4(c) directs us to Revenue Procedure 2013-34 for relevant guidance. Revenue Procedure 2013-34 sets forth a three-step analysis for evaluating section 6015(f) claims for relief: (1) the requesting spouse must satisfy the seven threshold requirements, Rev. Proc. 2013-34, § 4.01; (2) the requesting spouse must satisfy the three-part test for streamlined relief, id. § 4.02, 2013-43 I.R.B. at 400; or (3) if a requesting spouse does not satisfy the test for streamlined relief, the requesting spouse may still qualify for relief from joint and several liability if it would be inequitable to hold them liable in the light of the nonexclusive list of factors outlined in Revenue Procedure 2013-34, § 4.03.

Threshold Requirements for Section 6015(f) Relief. The requesting spouse must meet seven threshold requirements: (a) the requesting spouse filed a joint return for the taxable year for which relief is sought; (b) relief is not available to the requesting spouse under section 6015(b) or (c); (c) the claim for relief is timely filed; (d) no assets were transferred between the spouses as part of a fraudulent scheme; (e) the non-requesting spouse did not transfer disqualified assets to the requesting spouse; (f) the requesting spouse did not knowingly participate in the filing of a fraudulent joint return; and (g) absent certain enumerated exceptions, the tax liability from which the requesting spouse seeks relief is attributable to an item of the non-requesting spouse. See Rev. Proc. 2013 34, § 4.01.

Streamlined Determination Elements. Revenue Procedure 2013-34, § 4.02 sets forth circumstances under which the IRS will make a streamlined determination granting equitable relief to the requesting spouse. These include that he or she establishes that he or she (a) is no longer married to the non-requesting spouse, (b) would suffer economic hardship if not granted relief, and (c) did not know or have reason to know that there was an understatement or deficiency on the joint income tax return or did not know or have reason to know that the non-requesting spouse would not or could not pay the underpayment of tax reported on the joint income tax return. Id. The requesting spouse must establish that he or she satisfies each of the three elements to receive a streamlined determination granting relief. Id.

Streamlined Determination Elements – Marital Status Requirement. This factor is met if the requesting spouse is no longer married to the non-requesting spouse. Id. § 4.02(1).

Streamlined Determination Elements – Economic Hardship Requirement. This factor is met when a failure to grant relief from joint and several liability would cause the requesting spouse to be unable to pay reasonable basic living expenses. Id. § 4.02(2), 4.03(2)(b). If denying relief would not cause the requesting spouse economic hardship, this factor is neutral. Id. Generally, a requesting spouse would suffer economic hardship if (1) the requesting spouse’s income is less than 250% of the federal poverty guidelines, or if the requesting spouse’s monthly income exceeds reasonable basic living expenses by $300 or less, and (2) the requesting spouse does not have assets from which the requesting spouse can make payments towards the tax liability and still meet reasonable basic living expenses. Id. Additionally, if neither of the foregoing tests is met, then the Tax Court will consider additional factors such as (1) the taxpayer’s age and earning potential, (2) an amount reasonably necessary for food, clothing, housing, medical expenses, and transportation, (3) the amount of assets available to pay the taxpayer’s expenses, (4) the cost of living in the geographical area in which the taxpayer lives, and (5) any other factors bearing on economic hardship. Rev. Proc. 2013-34, § 4.02(2). A hypothetical hardship is insufficient to justify relief, and a taxpayer must demonstrate that imposing joint and several liability is inequitable in fact based on present terms.

Full Equitable Relief Analysis. Under the full equitable relief analysis of section 6015(f), the Tax Court will consider the following factors: (a) current marital status; (b) whether the requesting spouse would suffer economic hardship if relief were not granted; (c) in understatement cases, whether the requesting spouse knew or had reason to know of the understatement, or in underpayment cases, whether the requesting spouse knew or had reason to know that the non-requesting spouse would not or could not pay the tax liability, and in either case, the effect of any spousal abuse or financial control; (d) whether either spouse has a legal obligation to pay the outstanding federal income tax liability; (e) whether the requesting spouse significantly benefited from the understatement or underpayment; (f) whether the requesting spouse has made a good faith effort to comply with the income tax laws in the years following the tax years for which relief is sought, and (g) whether the requesting spouse was in poor mental or physical health at the time the joint return was filed. Rev. Proc. 2013-34, § 4.03(2).

Abuse and Financial Control Notwithstanding a taxpayer’s knowledge or reason to know of an understatement or underpayment of tax, both analyses are subject to an exception. Knowledge may be negated if the non-requesting spouse abused the requesting spouse or maintained control of the household finances by restricting the requesting spouse’s access to financial information such that the non-requesting spouse’s actions prevented the requesting spouse from questioning or challenging the understatement on the return or the underpayment of the liability. Rev. Proc. 2013-34, § 4.02(3)(a), 4.03(2)(c)(i) and (ii). “Abuse comes in many forms and can include physical, psychological, sexual, or emotional abuse, including efforts to control, isolate, humiliate, and intimidate the requesting spouse, or to undermine the requesting spouse’s ability to reason independently and be able to do what is required under the tax laws.” Id. § 4.03(2)(c)(iv). The Tax Court requires substantiation, or at a minimum, specificity, with regard to allegations of abuse. Rev. Prov. 2013-34, § 4.01. A taxpayer’s knowledge may be negated, in whole or in part, by a spouse’s financial control. See, e.g., Robinson v. Commissioner, T.C. Memo. 2020-134, at *28–29.

Legal Obligation Factor. This factor weighs in favor of relief when the non-requesting spouse, through a divorce decree or other legally binding agreement, bears the sole legal obligation to pay the outstanding liability. Rev. Proc. 2013-34, § 4.03(2)(d). This factor weighs against relief if the requesting spouse has the legal obligation to pay, and it is neutral if the divorce decree is silent as to tax liabilities or the spouses are not separated. Id.

No Significant Benefit Factor. This factor weighs in favor of relief if the requesting spouse did not receive a significant benefit, that is, a benefit in excess of normal support, due to the understatement or underpayment of tax. Soler, T.C. Memo. 2022-78, at *12–13; Rev. Proc. 2013-34, § 4.03(2)(e). This factor weighs against relief if the requesting spouse received a significant benefit due to the understatement or underpayment of tax. Rev. Proc. 2013-34, § 4.03(2)(e).

Compliance Factor. This factor weighs in favor of relief if the requesting spouse is in compliance with the tax laws for the tax years after being divorced from the non-requesting spouse. Id. § 4.03(2)(f)(i). This factor weighs against relief if the requesting spouse is not in compliance for the tax years after being divorced from the non-requesting spouse. Id. This factor is neutral if the requesting spouse has made a good faith effort to comply with the tax laws but was unable to fully comply. Id.

Mental or Physical Health Factor. This factor weighs in favor of relief if the requesting spouse was in poor physical or mental health at the time the returns from which she seeks relief were filed, or at the time she requested relief. Rev. Proc. 2013-34, § 4.03(2)(g). If the requesting spouse was in neither poor mental nor physical health, this factor is neutral. Id.

Insights: This case illustrates the challenges a taxpayer faces when requesting innocent spouse relief pursuant to section 6015. Most Tax Court opinions regarding innocent spouse relief are lengthy and detailed. The analysis for each factor, many of which are required for relief, dives deep into the requesting taxpayer’s personal affairs, marital state and environment, knowledge, education status, and other. This Freman opinion can serve as a roadmap for most factors and statutory elements involved in these types of cases. And, Ms. Freman almost erred completely when she alleged that she did not sign the returns for the tax years at issue and that Mr. Freman forged her signatures. Had the Tax Court no other evidence to find that she did indeed sign and submit the joint returns, her self-defeating testimony would have eliminated a basis for relief since filing a joint return is a prerequisite to obtaining relief from joint and several liability under section 6015. See § 6015(a).