T.C. Memo. 1995-523

UNITED STATES TAX COURT

ESTATE OF MARK R. WOODWARD, DECEASED, LILLIAN H. WOODWARD,

EXECUTRIX, AND LILLIAN H. WOODWARD, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10137-88. Filed November 6, 1995.

Victor F. Keen, for petitioners.

John Aletta, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

DAWSON, Judge: This case was assigned to Special Trial

Judge Robert N. Armen, Jr., pursuant to the provisions of section

7443A(b)(4) of the Internal Revenue Code of 1986, as amended, and
 

1 Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the taxable years in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

 

2 Petitioner Estate of Mark R. Woodward, Deceased, concedes

all of the determinations set forth in the notice of deficiency

except for the additions to tax under sec. 6659(a) for the

taxable years 1980 and 1981. For the taxable years 1980 and

1981, petitioner Lillian H. Woodward (petitioner) concedes that

if petitioner is not an innocent spouse, then she is liable for

the deficiencies in tax and additions to tax under secs. 6653(a),

6653(a)(1), and 6653(a)(2), and the increased rate of interest

under sec. 6621(c) as determined by respondent. For the taxable

years 1982 and 1983, petitioner concedes that she is liable for

the deficiencies in tax and additions to tax as determined by

respondent. For the taxable years 1980 and 1981, respondent

concedes that petitioners are not liable for the addition to tax

under sec. 6659(a). 

Rules 180, 181, and 183.1 The Court agrees with and adopts the

Opinion of the Special Trial Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

ARMEN, Special Trial Judge: Respondent determined

deficiencies in petitioners' Federal income taxes and additions

to tax for the taxable years as follows:

 Additions to Tax 

 Sec. Sec. Sec. Sec. 

Year Deficiency 6653(a) 6653(a)(1) 6653(a)(2) 6659(a)

1980 $10,180 $509 --- --- $3,054

1981 9,620 --- $481 1 2,886

1982 700 --- 35 

2 ---

1983 755 --- 38 

3 ---

1 50 percent of the interest due on $9,620.

2 50 percent of the interest due on $700.

3 50 percent of the interest due on $755.

Respondent also determined that petitioners are liable for

the increased rate of interest under section 6621(c) for the

taxable years 1980 and 1981.

After concessions by the parties,2 the only issue remaining
for decision is whether petitioner Lillian H. Woodward

(petitioner) qualifies for relief as an innocent spouse under

section 6013(e) for the taxable years 1980 and 1981.

FINDINGS OF FACT

Some of the facts have been stipulated, and they are so

found. Petitioners resided in Shaker Heights, Ohio, at the time

their petition was filed with the Court. 

1. General Background

Petitioners were married at all relevant times. From 1980

to 1983, petitioners timely filed joint individual Federal income

tax returns.

Petitioner received a bachelor's degree in history from the

University of California at Los Angeles. Thereafter, petitioner

worked for a suburban newspaper for approximately 2 years. 

Petitioner then entered the U.S. Coast Guard. At some point

petitioner married Mark R. Woodward and remained married to him

until his death in 1991. Petitioner and Mr. Woodward had three

children. Although petitioner did not work outside the home

while she raised her children, she resumed working in 1970 as a

customer service representative for the Higbee Company, a

department store in Cleveland, Ohio. Petitioner worked for the

Higbee Co. until 1985. Her duties as a customer service

representative included tracing deliveries and answering

customers' questions that could not be handled on the floor by a

salesperson. Petitioner earned $14,118.36 in 1983 working as a

customer service representative.
 

3 See Schillinger v. Commissioner, T.C. Memo. 1990-640,

affd. per order 1 F.3d 954 (9th Cir. 1993) (discussing the Saxon

Energy program in some detail).

Mr. Woodward attended the University of Illinois for 3

years, but did not obtain a college degree. During the taxable

years at issue, Mr. Woodward worked as a district sales manager

for the Master Builders division of the Martin-Marietta Corp. 

Mr. Woodward retired in 1982.

Petitioner and Mr. Woodward maintained a joint checking

account for the taxable years 1980 through 1983. Prior to Mr.

Woodward's retirement, petitioner and Mr. Woodward shared the

clerical tasks concerning household expenses. For example, both

Mr. Woodward and petitioner paid the mortgage and utility bills. 

However, Mr. Woodward was responsible for the family's financial

planning, including tax preparation. After his retirement, Mr.

Woodward managed the family's financial affairs, including paying

household expenses, without the help of petitioner. Mr. Woodward

recorded family financial matters on his computer. Petitioner

did not know how to operate the computer. 

On December 8, 1983, Mr. Woodward invested in a tax shelter

promoted by Saxon Energy Corp. (Saxon).3 Thomas Graham of Graham

& Associates introduced Mr. Woodward to the Saxon Energy

investment. Petitioner knew Mr. Woodward was considering making

an investment with Graham & Associates, but did not know anything

specifically about the Saxon tax shelter. When petitioner's

signature was needed on the investment documents, Mr. Woodward
 

4 Mr. Woodward signed petitioner's name on most of the Saxon

documents including the lease application, the business adviser's

questionnaire, the lease agreement, and the election to pass

investment tax credit from lessor to lessee. 

signed her name.4 Petitioner was not aware that her husband was

signing the Saxon documents on her behalf. Mr. Woodward's

actions were consistent, however, with petitioners' arrangement

for Mr. Woodward to manage the financial planning. Although Mr.

Woodward did not discuss the Saxon investment with petitioner, he

did not conceal his business activities or the family's financial

affairs from her.

On their joint income tax return for the taxable year 1983,

petitioners reported the putative income tax consequences of

their Saxon investment including claimed Schedule C deductions

totaling $14,168, and a claimed investment tax credit in the

amount of $20,500. Concurrently with the filing of their return,

petitioners filed Form 1045, Application For Tentative Refund,

which generated refunds by carrying back unused investment tax

credits of $10,180, $9,620, and $700 to the taxable years 1980,

1981, and 1982, respectively. Mr. Woodward prepared the joint

returns for 1980 and 1981. Graham & Associates prepared the

joint returns for 1982 and 1983.

Petitioner signed each of the income tax returns that she

and Mr. Woodward filed with the Internal Revenue Service (IRS). 

Petitioner also signed the Form 1045, Application For Tentative

Refund, filed with the IRS. Petitioner trusted Mr. Woodward to

handle their financial matters, including tax return preparation. 
Thus, when Mr. Woodward requested that petitioner sign the income

tax returns and application for refund, she did so without

examining them and without hesitation.

Mr. Woodward died in 1991. Petitioner was the sole

beneficiary of his estate.

During their marriage, petitioner and Mr. Woodward did not

live extravagantly, nor did their standard of living vary

dramatically over the course of their marriage. In 1983

petitioners sold their home and rented an apartment. Petitioners

did not purchase any "big ticket" items in 1983, 1984 or 1985. 

At some point in 1983 or 1984, petitioners leased a Chevrolet

Nova automobile.

2. The Income Tax Returns

On their joint income tax returns for 1980 through 1983,

petitioner and Mr. Woodward reported total income and income tax

as follows:

Year Total income Income tax

1980 $48,585.21 

 1$10,180

1981 47,598.00 

29,620

1982 47,388.00 

35,233

1983 1,568.00 ---

1 Without regard to the claimed investment credit carryback from

1983 in the amount of $10,180.

2 Without regard to the claimed investment credit carryback from

1983 in the amount of $9,620.

3 Without regard to the claimed investment credit carryback from

1983 in the amount of $700.

a. 1983 Return

Petitioner and Mr. Woodward attached a Schedule C to their
 

5 The business name of the investment was not disclosed. 

However, the Form 3468 relates to Saxon.

income tax return for 1983. The Schedule C revealed that the

proprietorship's main business activity was "investments" and

reported negative gross income in the amount of $7,455 in respect

of "Frozen Confection of Ohio 1983-1". The Schedule C claimed

total deductions in the amount $14,576. Of the $14,576 claimed

deductions, at least $14,168 were claimed in respect of the Saxon

investment. In this regard, petitioners claimed a $13,500

deduction as an equipment lease expense and $668 for management

expenses. A net loss in the amount of $22,031 was then claimed

on the Schedule C and was used to dramatically reduce income

reported from other sources. Petitioners ultimately reported

negative taxable income in the amount of $5,702 and claimed a

refund of all of the income tax withheld from their compensation.

Petitioner and Mr. Woodward also attached Form 3468,

Computation of Investment Credit, to their income tax return for

1983. In Part II of Form 3468, petitioner and Mr. Woodward

claimed an unadjusted basis in their investment property in the

amount of $205,000.5 Based upon this value, petitioners claimed

an investment credit in the amount of $20,500. Of this amount,

petitioners used $0 in 1983, and carried back $10,180, $9,620,

and $700 to 1980, 1981, and 1982, respectively.

3. The Application for Tentative Refunds

In or about early March 1984, petitioner and Mr. Woodward

filed Form 1045, Application For Tentative Refund. The Form 1045
claimed refunds in the amount of $10,180, $9,620, and $700 for

the taxable years 1980, 1981, and 1982, respectively.

4. The Notice of Deficiency

In the notice of deficiency, respondent disallowed the Saxon

deductions claimed by petitioners on their Schedule C for

equipment leasing and management expenses in the amount of

$14,168.

In the notice of deficiency, respondent also disallowed the 

investment tax credit claimed by petitioners on Form 3468 in the

amount of $20,500.

ULTIMATE FINDING OF FACT

In signing the joint income tax return for 1983 and the

application for refund, petitioner had reason to know that there

were substantial understatements of tax attributable to grossly

erroneous items.

OPINION

1. Background

The parties have resolved all of the issues in this case

except whether petitioner qualifies for relief as an innocent

spouse under section 6013(e) for the 2 taxable years in issue. 

Section 6013(a) permits a husband and wife to file a joint

income tax return. This is a valuable privilege because the

filing of a joint return generally serves to decrease the

spouses' overall tax liability. Sec. 1.

The privilege of filing a joint income tax return does not

come without a price, however. Thus, as a general rule, spouses
who file joint income tax returns are jointly and severally

liable for the full amount of tax due on the combined incomes. 

Sec. 6013(d)(3).

Joint and several liability applies even under circumstances

where "one spouse may be far less informed about the contents of

the return than the other". Sonnenborn v. Commissioner, 57 T.C.

373, 381 (1971). However, the general rule is somewhat mitigated

by the innocent spouse provisions of section 6013(e). 

Section 6013(e) relieves a spouse of liability, to the

extent provided by the statute, for tax (including interest,

penalties, and other amounts) if each of the following four

requirements is satisfied: (1) A joint Federal income tax return

was filed by the spouses; (2) there is a substantial

understatement of tax attributable to grossly erroneous items of

the other spouse; (3) in signing the return, the putative

innocent spouse neither knew, nor had reason to know, of such

substantial understatement; and (4) taking into account all the

facts and circumstances, it would be inequitable to hold the

putative innocent spouse liable for the deficiency attributable

to the understatement. Sec. 6013(e)(1). If the substantial

understatement is attributable to any claim of a deduction,

credit, or basis by the other spouse in an amount for which there

is no basis in fact or law, then an additional requirement must

be satisfied; namely, the substantial understatement must exceed

a specified percentage of the putative innocent spouse's adjusted

gross income for the "preadjustment year". Sec. 6013(e)(4). 
The putative innocent spouse has the burden of proving that

each of the foregoing requirements is satisfied. Rule 142(a);

Bokum v. Commissioner, 94 T.C. 126, 138 (1990), affd. 992 F.2d

1132 (11th Cir. 1993). Failure to satisfy any of the

requirements will preclude a holding that the putative innocent

spouse is entitled to relief under section 6013(e). Stevens v.

Commissioner, 872 F.2d 1499, 1504 (11th Cir. 1989), affg. T.C.

Memo. 1988-63.

The parties agree that petitioner and Mr. Woodward filed

joint income tax returns for the taxable years 1980 through 1983. 

The parties also agree that the credits claimed by petitioner and

Mr. Woodward for the taxable years 1980 and 1981 are grossly

erroneous items giving rise to understatements of tax for those

years. Although it is far from apparent, we shall proceed on the

basis that the grossly erroneous items were items of Mr.

Woodward. Further, the parties agree that the substantial

understatements of tax exceeded the requisite percentage of

income in 1987, the preadjustment year. Therefore, in order to

be relieved of liability as an innocent spouse, petitioner must

prove: (1) In signing the income tax return for 1983 and the

application for refund, she neither knew, nor had reason to know,

of the substantial understatements of tax on her refund claims

for 1980 and 1981; and (2) it would be inequitable to hold her

liable for the deficiencies attributable to such understatements. 

Sec. 6013(e)(1)(C) and (D).
2. Knowledge or Reason to Know of the Substantial

Understatement

Petitioner must show that she did not know or have reason to

know of the substantial understatements attributable to her

husband's tax shelter investment when she signed the 1983 return

and application for refund filed in 1984.

a. Actual Knowledge

We must first decide whether petitioner had actual knowledge

of the understatements when she signed the 1983 return and the

application for refund. Respondent does not contend that

petitioner knew about the understatements at that time. The

record does not contain any evidence indicating that petitioner

had actual knowledge of the understatements. Thus, we find that

petitioner did not have actual knowledge of the understatements

when she signed the 1983 return and application for refund. 

b. Reason to Know

We must next decide whether petitioner had reason to know of

the substantial understatements of income tax when she signed the

1983 return and application for refund filed in 1984. Respondent

contends that petitioner had reason to know of the

understatements caused by the Saxon investment tax credit

carrybacks. For the following reasons, we agree with respondent

that petitioner had reason to know of the substantial

understatements of tax at the critical time, and that, therefore,

petitioner does not qualify for relief as an innocent spouse.

The standard to be applied in determining whether a taxpayer

"had reason to know" is whether a reasonably prudent person under
the circumstances of the person claiming innocent spouse relief

at the time of signing the return or other relevant document

could be expected to know that the tax liability was erroneous or

that further investigation was warranted. Shea v. Commissioner,

780 F.2d 561, 566 (6th Cir. 1986), affg. in part, revg. in part

and remanding T.C. Memo. 1984-310; Sanders v. United States, 509

F.2d 162, 166-167 (5th Cir. 1975); Bokum v. Commissioner, supra

at 148; Terzian v. Commissioner, 72 T.C. 1164, 1170 (1979).

Whether a reasonable person under the circumstances of the

taxpayer at the time of signing the return or other relevant

document could be expected to know of a substantial

understatement is a question of fact. Clevenger v. Commissioner,

826 F.2d 1379 (4th Cir. 1987), affg. T.C. Memo. 1986-149. 

Courts have considered a variety of factors in deciding whether a

taxpayer had reason to know of a substantial understatement. 

These factors may also give a taxpayer a duty to inquire as to

the existence of an understatement which, if not satisfied, may

lead to the conclusion that the taxpayer had reason to know of

the understatement. Pettinato v. Commissioner, T.C. Memo. 1995-

85. No single factor controls. Id. Accordingly, we consider

the following factors in deciding whether petitioner had reason

to know of or a duty to inquire with respect to the

understatements of income tax at issue here.

(i) Petitioner's level of education

In the instant case, petitioner is a college graduate. An

individual with petitioner's education and experience can
reasonably be expected to question an application for refund that

purports to eliminate all Federal income tax liability for 2

previous taxable years. We conclude that petitioner's

educational level was such that, if she had examined the 1983

income tax return or application for refund, she would have

recognized that substantial understatements might exist or that

further investigation was warranted.

(ii) Petitioner's involvement in the family's financial

affairs

Another factor to consider is petitioner's involvement in

the family's financial affairs. Petitioner and Mr. Woodward

maintained a joint checking account. Prior to Mr. Woodward's

retirement, petitioner shared responsibilities in matters

relating to household expenses such as paying bills. After his

retirement, and for the year in question, 1983, Mr. Woodward was

responsible for both the family's financial planning and for all

matters concerning household expenses. Mr. Woodward did not

prevent petitioner from taking part in financial matters; rather,

petitioner chose not to participate in the financial affairs and

trusted her husband to handle them. As petitioner shifted the

responsibility for financial matters to Mr. Woodward, she cannot

claim a lack of knowledge of these affairs as a basis for

receiving innocent spouse protection where she was under a duty

to inquire into the legitimacy of the tax deductions and credits

claimed. 

Although petitioner could not operate the computer on which

the financial records were kept, she could have asked her husband
to help her gain access to the records. Nothing in the record

indicates that Mr. Woodward would have objected to making the

records more easily available to petitioner.

(iii) Unusual or lavish expenditures in comparison to 

the standard of living in prior years

We accept petitioner's testimony that she and Mr. Woodward

did not live extravagantly nor did their standard of living vary

dramatically over the course of their marriage. We take note,

however, that their standard of living from 1983 forward was

financed, at least in part, by their Federal income tax refunds

from 1980 and 1981.

(iv) The culpable spouse's evasiveness concerning the

family's finances

Although the record shows that Mr. Woodward did not tell

petitioner specifically about the tax shelter investment, he did

not conceal the facts about the business transaction. The

following exchange between petitioners' attorney and petitioner

illustrates the nature of the financial relationship between

petitioner and Mr. Woodward:

Q: * * * With respect to the investments that were made, I

think you've testified that your husband was really

responsible for those matters. Did your husband ever

ask your permission with respect to making investments?

A: No.

Q: Did he ever seek your advice or your approval in making

investments?

A: No. Mostly I didn't understand any financial deals or

whatever you call it.

Q: And the reason -- you may have just answered -- the

reason that he did not ask you for your advice or

necessarily tell you what he was doing was what?
A: Well, because I wouldn't have understood it in the

first place.

Q: So you didn't have a problem with that arrangement,

that he was not hiding things from you, he was just --

A: No. I trusted him and he trusted me.

Petitioner chose to rely on Mr. Woodward regarding financial

matters. 

(v) Large deductions or credits that substantially

eliminate taxable income

This factor is particularly significant in this case. Large

deductions or credits, particularly those that completely or

substantially eliminate taxable income, may give a taxpayer

reason to know that an understatement exists or a duty to inquire

as to the legitimacy of the deduction or credit. Pettinato v.

Commissioner, supra. By failing to examine the 1983 return and

the application for refund, petitioner chose to ignore facts that

would have given her reason to know of the substantial

understatements. Even the most cursory perusal of the

application for refund would have revealed claims for refunds for

all Federal income taxes paid in 1980 and 1981. A reasonably

prudent person in petitioner's position would have certainly

questioned the legitimacy of these refunds. Petitioner, by

declining to do so, failed in her duty of inquiry.

By failing her duty of inquiry, petitioner is charged with

constructive knowledge of the substantial understatements

appearing in the income tax returns. See Park v. Commissioner,

25 F.3d 1289, 1299 (5th Cir. 1994) ("by signing the return * * *

[the putative innocent spouse] undertook responsibility for it
which she cannot escape by simply ignoring its contents"), affg.

T.C. Memo. 1993-252; see also Lauer v. Commissioner, T.C. Memo.

1994-579 ("a taxpayer is not permitted to obtain the benefits of

section 6013(e) by turning a blind eye to--by preferring not to

know of--facts clearly within his or her grasp, or fully

disclosed on a return that the taxpayer signed"); McComb v.

Commissioner, T.C. Memo. 1994-577 ("A spouse may not obtain

protection as an innocent spouse in deduction cases by turning a

blind eye to facts fully disclosed on a return which, if she had

looked at the return, would reasonably have put her on notice

that further inquiry was needed").

3. Conclusion

We hold that petitioner, in signing the 1983 Federal income

tax return and application for refund, had reason to know, within

the meaning of section 6013(e)(1)(C), of the substantial

understatements of income tax for 1980 and 1981. Because we so

hold, we need not address whether it would be equitable or

inequitable to hold petitioner liable for the deficiencies in tax

attributable to those understatements. 

In view of the foregoing, we sustain respondent's

determination that petitioner is liable for the deficiencies in

tax and additions to tax as set forth in the notice of

deficiency. Sec. 6013(d)(3). 
In order to give effect to our disposition of the disputed

issue, as well as the parties' concessions, 

 Decision will be entered 

for respondent, except as to 

the addition to tax under 

section 6659(a) for the 

taxable years 1980 and 1981.