JOYCE PURCELL, PETITIONER V. COMMISSIONER OF INTERNAL REVENUE

   No. 87-1140

   In the Supreme Court of the United States

   October Term, 1987

   On Petition For A Writ Of Certiorari To The United States Court Of
Appeals For The Sixth Circuit

   Memorandum For The Respondent In Opposition

   Petitioner contends that the court of appeals erred in rejecting
her claim for "innocent spouse" relief under Section 6013(e) of the
Internal Revenue Code.  /1/

   1. Petitioner filed joint tax returns for 1977 and 1978, the tax
years in issue, with W. Bruce Purcell, who was her husband from 1952
until their divorce in 1982 (Pet. App. 27-28).  The Purcells each
owned 25% of the outstanding stock of International Demolition and
Salvage Company, Inc., a corporation formed in 1974 of which
petitioner was the treasurer and a director.  The corporation, which
had a sustained history of losses, was in financial straits in 1977
and 1978, and ultimately it failed.  In 1976, 1977, and 1978, Bruce
Purcell and other shareholders made advances to International
Demolition, which were treated on the corporate books as loans to the
corporation.  In 1980, Bruce Purcell transferred his stock in
International Demolition to a third party for $10, pursuant to an
agreement providing that the third party would assume the
corporation's management and debts.  Id. at 29, 61.

   A certified public accountant prepared the Purcells' joint income
tax returns for 1977 and 1978.  Petitioner furnished the accountant
with information relating to medical expenses, charitable
contributions, and other types of personal items.  The accountant
received most of the other information used in preparing the returns
from the comptroller of International Demolition, but he occasionally
requested information from Bruce Purcell if the comptroller could not
furnish the information.  Although the accountant did not audit the
records furnished to him, he believed that he had sufficient
information to prepare the returns correctly.  Pet. App. 29-30.

   On their joint returns, the Purcells claimed deductions for
nonbusiness bad debts with respect to International Demolition in the
respective amounts of $144,411 for 1977 and $95,185 for 1978.  They
also claimed a long-term capital loss during 1977 in the amount of
$26,905 due to the asserted worthlessness of their stock in
International Demolition (see I.R.C. Section 165(g)).  On audit, the
Commissioner disallowed these deductions for failure to establish that
the debts and stock became worthless during the years in issue.  Pet.
App. 31.

   2. Petitioners sought redetermination of the deficiencies in the
Tax Court.  While the case was pending, Congress retroactively amended
the "innocent spouse" provision of Section 6013(e) of the Code.  That
provision permits a spouse who files a joint return to escape
liability for understatement of tax on the return under certain
circumstances.  Under the amended version applicable here, one
relevant factor is whether the understatement is "attributable to
grossly erroneous items of one spouse" (I.R.C. Section 6013(1)(B)).
"Grossly erroneous items" are defined to include "any claim of a
deduction * * * in an amount for which there is no basis in fact or
law" (I.R.C. Section 6013(e)(2)(B)).  /2/ Petitioner sought relief
under the amended statute.  Conceding the correctness of the
Commissioner's adjustments, she argued that the deductions constituted
"grossly erroneous items."

   The Tax Court denied petitioner innocent spouse relief with respect
to the worthless stock and bad debt deductions, though it granted that
relief with respect to certain other items (Pet. App. 55-97;  86 T.C.
228).  /3/ The court held that the various stock and bad debt
deductions could not form the basis for innocent spouse relief because
they were not "grossly erroneous items" (Pet. App. 85-89).  The court
explained that the fact that petitioner had now conceded the
correctness of the Commissioner's adjustments was "not sufficient to
establish that the claimed deductions were in an amount for which
there was no basis in fact or law" (id. at 85), and that petitioner
had made no other showing to establish that statutory requirement (id.
at 88).  Noting that the company was in bad financial condition in the
years in which the deductions were taken and that the accountant
believed that he had sufficient information to justify the deductions,
the court concluded that the deductions were not "phony" or "grossly
erroneous" (id. at 88-89).

   3. The court of appeals affirmed (Pet. App. 26-54).  With respect
to the worthless stock and bad debt deductions, the court agreed with
the Tax Court that these were not "grossly erroneous items" (id. at
39-49).  Pointing to the evidence of the severe financial straits in
which International Demolition found itself in 1977 and 1978 --
including the facts that it stopped paying salaries to its officers
and that many of its assets were liquidated -- the court concluded
that "there was both an arguable factual and legal basis for claiming
(the deductions) in the tax year in which they were taken" (id. at
48-49).  /4/ The court rejected petitioner's contention that, under
Shenker v. Commissioner, 804 F.2d 109 (8th Cir. 1986), cert. denied,
No. 86-1247 (May 26, 1987), a deduction is "grossly erroneous" as a
matter of law whenever the deduction is invalidated on the ground that
it was not taken in the correct year.  The court explained that
petitioner's contention was based on a "misread(ing)" of Shenker,
which held no more than that there was no basis in fact or law for the
contention that the loss in that case occurred during the year in
which the deduction was claimed (Pet. App. 42-43).  /5/

   4. Petitioner contends (Pet. 18-24) that the court of appeals erred
in concluding that she was not entitled to innocent spouse relief in
connection with the worthless stock and bad debt deductions.  The
basis for this contention appears to be the view that any deduction
that is found to be taken in the wrong year must be held to be
"grossly erroneous." Petitioner does not attempt to justify that
interpretation of Section 6013, but she maintains that it has been
adopted by the Eighth Circuit in Shenker and that this Court should
grant certiorari to resolve the conflict in the circuits between this
case and Shenker.  The court of appeals correctly rejected both
petitioner's interpretation of Shenker and her claim for innocent
spouse relief.  There is no conflict in the circuits and no basis for
review by this Court.

   a. There can be no doubt that the court of appeals correctly
interpreted Section 6013 in holding that innocent spouse relief is not
available in a case where the taxpayer had some basis for claiming a
worthless stock deduction in a particular year.  Congress's intent,
embodied in the plain language of the statute and in its legislative
history, was to limit innocent spouse relief to instances where the
deficiencies stem from "grossly erroneous items".  /6/ When the items
do not fall into this category because they are supported by an
arguable factual or legal basis, "it is likely that a fully informed
spouse would have joined in the return" and thus there has been no
"overreaching or dishonesty" by one spouse that needs to be addressed
by innocent spouse relief (Pet. App. 44).  When taxpayers on their
joint return take a loss deduction for stock that actually became
worthless and there is a factual and legal basis for taking the
deduction in the year claimed, the deduction claim is not "grossly
erroneous" or "phony," and the statute plainly precludes innocent
spouse relief.  Petitioner's suggestion to the contrary simply seeks
to read the word "grossly" out of the statute;  Congress could easily
have made innocent spouse relief apply whenever a deduction is
"erroneous," but it did not choose to do so.  /7/

   b. Petitioner's claim that there exists a conflict in the circuits
is equally without merit.  In Shenker, the Tax Court rejected two
claims for innocent spouse relief in connection with two distinct
deductions on the theory that the deductions were not "grossly
erroneous." A deduction for certain business expenses was disallowed
on the ground that those expenses were attributable to a corporation,
not to the taxpayer.  And a deduction for worthless stock was
disallowed on the ground that the stock did not become worthless in
the year in which the deduction was claimed.  With respect to the
latter deduction, the Tax Court ruled that, since the loss had in fact
occurred at some point and the issue was merely one of timing, it
could not be said that the deduction had "no basis in fact or law"
(see 804 F.2d at 115).

   On appeal, the Eighth Circuit affirmed with respect to the business
expense deductions, /8/ but it reversed the Tax Court's denial of
innocent spouse relief in connection with the worthless stock
deduction.  The court explained that, since Section 165(g) permits a
deduction only for losses "sustained during the taxable year," "there
must be some basis not only for claiming that a loss occurred, but
also for claiming that it was sustained during the taxable year in
question" (804 F.2d at 115).  Because the Tax Court's findings "ma(d)e
clear that there was simply no basis upon which Mr. Shenker could
claim that the loss of his stock occurred in 1971, rather than some
later year," the court concluded that it was "grossly erroneous" to
have taken the deduction in 1971 (ibid.).

   The Eighth Circuit in Shenker thus held that the mere fact that a
deduction is disallowed solely on the ground of timing does not
preclude a finding that it was "grossly erroneous." But, contrary to
petitioner's apparent contention, the court manifestly did not adopt
the converse rule as an absolute -- namely, that a deduction that is
disallowed on timing grounds is always "grossly erroneous." Rather, as
the court of appeals below correctly observed (Pet. App. 43), the
Eight Circuit merely held that Section 6013 also requires a court to
consider whether there was any basis for the timing of the deduction
claimed by the taxpayer.  In Shenker, the court of appeals concluded,
on the facts there, that there was no basis for the timing claimed by
the taxpayer.  In this case, by contrast, the court correctly
concluded that the accountant's independent judgment and the evidence
of the precarious financial condition of the corporation in the years
in question provided some basis for the timing claimed by the Purcells
on their joint returns (Pet. App. 48-49).  Plainly, the two cases turn
on their individual facts, and there is no conflict between them.

   It is therefore respectfully submitted that the petition for a writ
of certiorari should be denied.

   CHARLES FRIED

      Solicitor General

   MARCH 1988

   /1/ Unless otherwise noted, all statutory references are to the
Internal Revenue Code, as amended (26 U.S.C.) (the Code or I.R.C.).

   /2/ Section 424 of the Deficit Reduction Act of 1984, Pub. L. No.
98-369, 98 Stat. 803, renders the amendment effective retroactively
(for the benefit of taxpayers) for all taxable years to which the
Internal Revenue Code of 1954 applies.  Under prior law, relief under
Section 6013(e) had been limited to instances in which understatments
of tax were caused by omissions from gross income, which would not
cover this case where the understatement was due to deductions that
were disallowed.  See, e.g., Resnick v. Commissioner, 63 T.C. 524, 527
(1975).  The spouse seeking relief under the amended statute must also
establish that in signing the return he or she did not know or have
reason to know that there was a substantial understatement of tax and
that it would be inequitable to hold him or her liable for the
deficiency.  I.R.C. Section 6013(e)(1).

   /3/ The court granted relief with respect to unreported
constructive dividends arising out of the corporation's payment of
certain personal expenses incurred by the Purcells (Pet. App. 80-81,
89-97), and the Commissioner did not appeal.  The court denied
innocent spouse relief with respect to the failure to report income
allocable to a covenant not to compete (id. at 81-84).

   /4/ The court also affirmed the denial of the requested innocent
spouse relief in connection with the covenant not to compete (Pet.
App. 37-39).  Petitioner does not challenge that aspect of the court's
decision in this Court.

   /5/ Judge Jones filed a concurring opinion in which he agreed with
the majority's interpretation of the statute, but stated his view that
petitioner had correctly read the Shenker decision (Pet. App. 50-54).

   /6/ The House Report gives as an example of the type of situation
that Congress was intending to address a case 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." H.R. Rep.
98-432, 98th Cong., 2d Sess. Pt. 2, at 1502 (1984).

   /7/ Petitioner is clearly mistaken in asserting (Pet. 23) that the
effect of the decision below is to require a taxpayer to establish
"fraudulent intent" on the part of the non-innocent spouse in order to
qualify for innocent spouse treatment.  A deduction may be
"groundless" or "phony," even if there is no intent to defraud.  See,
e.g., Douglas v. Commissioner, 86 T.C. 758 (1986);  Sivils v.
Commissioner, 86 T.C. 79 (1986).

   /8/ The petition for certiorari in Shenker was filed by the
taxpayer to seek review of this portion of the court of appeals'
decision.