TAX COURT OPINION

Case: Lillian Paul, Petitioner, and Timothy Paul, Intervenor
Docket Number: 5446-10
Judge: Gustafson
Opinion Type: bench
Filed: 04/12/2011
Pages: 14

DEM UNITED STATES TAX COURT WASHINGTON, DC 20217 LILLIAN PAUL, PETITIONER, AND TIMOTHY PAUL, INTERVENOR, Petitioner, v. ) Docket No. 5446-10. COMMISSIONER OF INTERNAL REVENUE, Respondent O R D E R Pursuant to Rule 152 (b) , Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith the transcript of the trial to intervenor, and to respondent a copy of to petitioner, pages of Judge David Gustafson at Boston, Massachusetts, on March 22, 2011, containing his oral at the in the above case before the conclusion of the trial. findings of fact and opinion rendered In accordance with the oral findings of fact and opinion, decision will be entered for respondent. (Signed) David Gustafson Judge Dated: Washington, D.C. April 12, 2011 SERVEDApr132011 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 3 Bench Opinon by Judge David Gustafson Paul v. Commissioner Docket No. 5446-10 March 22, 2011 The Court has decided to render oral Findings of Fact and Opinion in this case. The following represents the Court's oral Findings of Fact and Opinion, which shall not be relied on as precedent in any other case. This Bench Opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code of 1986, as amended, and Rule 152 of the Tax Court Rules of Practice and Procedure. Procedural background - By a notice of deficiency to Timothy and Lillian Paul dated December 4, 2009 (Ex. 3-J), the Internal Revenue Service (IRS) determined a deficiency of $6,370 in tax and an accuracy-related penalty of $1,274 pursuant to section 6662(a) for the year 2007. On February 2, 2010, the Court received from Mr. Paul a letter that the Court treated as a timely but defective petition. We ordered Mr. Paul to pay the filing fee and to file an amended petition containing the information required by the rules. When he failed to do so, the Court dismissed his petition. (We take judicial notice of our brief record in Timothy Paul v. Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 4 Commissioner, Docket No. 3161-10.) Ms. Paul timely filed her own petition in this Court on March 2, 2010 (and an amended petition on April 22, 2010), seeking so-called "innocent spouse" relief from joint liability, pursuant to section 6015 of the Internal Revenue Code (26 U.S.C.). (On April 15, 2010, Ms. Paul filed with the IRS a Form 8857, "Request for Innocent Spouse Relief" (Ex. 5-P)), which the IRS did not grant.) On July 26, 2010, Mr. Paul filed a "Notice of Intervention", asking the Court not to relieve Ms. Paul of joint liability. At the time Ms. Paul filed her petition and Mr. Paul filed his notice of intervention, they both resided in New Hampshire. Trial of this case was conducted on March 21, 2010, in Boston, Massachusetts. Mr. and Ms. Paul testified, and they were both candid and credible. Despite their contrary interests, their testimony was remarkably consistent. The parties' Stipulation of Facts, with Exhibits 1-J through 3-J, was admitted into evidence, as were Exhibits 4-P, 5-P, and 6-I. Findings of fact From 1993 to 2009, Mr. Paul was employed by Reinauer Transportation as a merchant marine. His work required him to travel to various ports and work Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 5 on oil barges. Ms. Paul worked as a medical assistant. Mr. and Ms. Paul were married in April 2000. Mr. Paul executed a power of attorney in favor of Ms. Paul, apparently because he was often out to sea for his work, and his frequent absences made it expedient for Ms. Paul to be able to conduct business on his behalf. After they married, Mr. and Ms. Paul filed joint Federal income tax returns. Sometime before they filed their first joint return (for 2001), Reinauer gave its employees a letter, written by a lawyer or accountant named Martin Kaplan, that advised them they could claim employee business expense deductions for various items--such as travel (i.e., mileage and food), cell phone, uniforms, and dues. We find that Mr. Paul did regularly incur such expenses in connection with his work, but in amounts that have not been shown, neither to the IRS during the audit, nor in his deficiency suit (Docket No. 3161-10), nor in this suit. Mr. Paul brought the Kaplan letter home and shared it with Ms. Paul. On their joint returns beginning with 2001 (and on amended single returns that they prepared for Mr. Paul's 1998, 1999, and 2000 years), Mr. and Ms. Paul claimed such deductions. For each year, Mr. Paul made a list showing his Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 6 calculation of the amounts to be deducted for these various items. He and Ms. Paul would then review the list together, either in person or (if he was away) over the phone. Ms. Paul would then take to the return preparer either Mr. Paul's list (with her own corrections and clarifications) or else a more legible rewriting of his list. One year she noted that he had listed the entire amount of their cell phone bill (including the charge allocable to her phone), rather than listing only the portion allocable to him, which they believed to be deductible. She therefore corrected the cell phone amount by hand on the list that she gave to the preparer. With the exception of the corrections she made, Ms. Paul never disputed or doubted the accuracy of the figures Mr. Paul listed. The expenses deducted in 2007 were somewhat larger than in prior years. Those expenses totaled $30,460 in 2007 (Ex. 1-J, Sched. A), compared to $19,258 in 2002 (Ex. 6-I). The record does not show the amounts claimed in 2003 through 2006; but if the increases were even over time, the expenses increased about $2,000 per year. The cost of these items must have increased to some extent over the years, but neither Mr. Paul nor Ms. Paul had an explanation for the quantum of the increase in the claimed expenses. Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 7 Nonetheless, even today they both remain of the opinion that the expense amounts were correct and that the deductions were properly claimed (notwithstanding the IRS's eventual disallowance of deductions on the 2007 return). When the list of expenses was ready, Ms. Paul would take it to their return preparer ("BCOB" in the earlier years, and Sharon Lindsey at H&R Block in the later years). The return preparer never challenged the deduction amounts on their list but entered them without question onto the return. The IRS processed the refunds that Mr. Paul claimed on his amended returns for 1998, 1999, and 2000. Until it examined the 2007 return, the IRS made no adjustment to the deductions claimed on the Pauls' joint returns. The IRS initially processed the 2007 return (Ex. 1-J) and allowed the refund claimed, which was direct-deposited into a joint checking account from which they paid household bills. (Ms. Paul testified that the refund was approximately $4,100, but the return actually claims a refund of $5,006. For present purposes the discrepancy is not material.) The Pauls separated in April 2008 (apparently after the joint return for 2007 had been filed and the refund had been issued). After contentious Heritage Reporting Corporation (202) 628-4888 1 8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 proceedings, their divorce was finalized by a Decree of Divorce entered in March 2009 (Ex. 2-J). Paragraph 13 of the decree provides, "The Respondent [Mr. Paul] shall be responsible for the payment of the joint debts [and] for the debts in his name." The IRS subsequently examined the Pauls' return for 2007, apparently after the Pauls' marriage began to be troubled. When the IRS requested substantiation . of the claimed deductions, Mr. Paul was unable to provide it. In December 2009 the IRS issued to both Mr. and Ms. Paul a notice of deficiency that stated: "Since you did not establish that the business expense shown on your return was paid or incurred during the taxable year and that the expense was ordinary and necessary to your business, we have disallowed the amount shown." The IRS thus determined the deficiency because of a lack of documentation that could substantiate the expenses. In March 2010 Ms. Paul filed her petition seeking to be relieved from the joint liability. Heritage Reporting Corporation (202) 628-4888 1 | 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Opinion. 9 By the time of trial, Ms. Paul's sole contention was that she is entitled to relief under subsection (c) of section 6015. The parties' only dispute in that connection was whether Ms. Paul had "actual knowledge" of the items giving rise to the deficiency, for purposes of section 6015(c) (3) (C); and this was the issue that was the subject of trial. For the reasons explained hereafter, we find that she did have such actual knowledge and that she is therefore not entitled to relief from joint liability. I. Standard and scope of review When determining whether a taxpayer is entitled to relief under section 6015, we conduct a trial de novo, in which we may consider evidence introduced at trial which was not included in the administrative record. Porter v. Commissioner, 130 T.C. 115, 117 (2008). We do not review for abuse of discretion but instead employ a de novo standard of review Porter v. Commissioner, 132 T.C. 203 (2009). II. Burden of proof Petitioner has the burden to show her entitlement to recover, sec. 6015(c) (2), except that the IRS has the burden to show "actual knowledge" under section 6015(c) (3) (C). We assume that, in a case like this Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 10 one--where the IRS does not oppose relief but an Intervenor does--the Intervenor takes on that burden of proving "actual knowledge". See Knight v. Commissioner, T.C. Memo. 2010-242. In this case, however, the question of which party bears the burden of proof is insignificant, since there is hardly any dispute about the facts, no material fact is in equipoise, and the facts can all be found by the preponderance of the evidence. III. Joint and several liability and section 6015(c) relief Section 6013(d) (3) provides that if a joint return is filed, the tax is computed on the taxpayers' aggregate income, and liability for the resulting tax is joint and several. That is, each spouse is responsible for the entire joint tax liability. However, section 6015(c)--entitled "Procedures to Limit Liability for Taxpayers No Longer Married or Taxpayers Legally Separated or Not Living Together"-- provides for relief from joint liability for divorced or separated persons. As we have noted, the parties agree that Ms. Paul is eligible for relief, see sec. 6015(c) (3) (A), and that she made a timely election, see sec. 6015(c) (3) (B); but Mr. Paul contends that her claim falls afoul of section Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 6015(c) (3) (C), which provides: 11 If the Secretary demonstrates that an individual making an election under this subsection 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 subsection (d), such election shall not apply to such deficiency (or portion). We agree with Mr. Paul that Ms. Paul did have actual knowledge of each and every item that gave rise to the deficiency--i.e., the expenses that Mr. Paul listed and discussed together with her and that she checked and corrected and provided to the return preparer. She admits she was involved in his original decision to start claiming such expenses (when he received the letter provided by his employer) and that in the year at issue--2007--she knew he was claiming those expenses and she signed the return with that knowledge. The "item[s]" were the expense deductions, and she know about them full well. However, the analysis called for by the statute is a bit more subtle than that. "[A]ctual knowledge" under the statute is more than mere knowledge that an item appears on the return. If a husband falsely Heritage Reporting Corporation (202) 628-4888 1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 12 represents to his wife that he incurred a deductible expense and she dutifully puts it on the return, the wife knows that it is an item on the return but does not know that it is false. In such a situation we inquire whether the wife had "actual knowledge of the factual circumstances which made the item unallowable as a deduction." King v. Commissioner, 116 T.C. 198, 204 (2001). In King the deficiency arose from a husband's cattle-raising expenses that had apparently been incurred but, pursuant to section 183, were not deductible because the activity was not entered into for profit. The wife later claimed innocent spouse relief under section 6015(c), and the Court granted relief because we found that the IRS had failed to show that the wife had actual knowledge of her husband's lack of a profit motive. The Pauls' situation is different, of course. Here the circumstance that gave rise to the disallowance was not that the deductions were for bogus expenses not really incurred (we find that they were incurred, though in undemonstrated amounts), nor that they were necessarily non-deductible, but that the Pauls' records did not substantiate the amounts of the deductions. It is true that, in a case the IRS cites, we granted innocent spouse relief to a husband Heritage Reporting Corporation (202) 628-4888 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 13 where his wife failed to substantiate deductions she had claimed for expenses related to her separate business. McDaniel v. Commissioner, 97 T.C.M. (CCH) 1786 (2009). However, in that case it was also true that the marriage was "short-lived"; that the couple maintained separate finances; that the wife's deductions were overstated; that when the IRS proposed to disallow the majority of the wife's deductions, she "quickly acquiesced"; and that the husband "vehemently denied that at the time of signing the returns he had knowledge of the facts that resulted in respondent's disallowance of deductions that [his wife] had claimed. " That is, McDaniel did involve substantiation problems, but they were substantiation problems of which the husband had no knowledge, and they were not the only problems. In the Pauls' very different circumstance, Ms. Paul was very much involved in the claiming of the deductions the disallowance of which gave rise to the deficiency. She had experience over the course of six years in seeing how Mr. Paul (in consultation with her) came up with his figures. She continues to insist that the deductions were bona fide. It was Ms. Paul who assembled their tax return information and took it to the return preparer--and who therefore Heritage Reporting Corporation (202) 628-4888 | | | 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 14 knew what records they had and did not have. Lack of substantiation is the circumstance giving rise to the deficiency, and Ms. Paul had actual knowledge of that circumstance. If the increase in the 2007 expenses over the amounts in prior years is grounds to suppose that some of the expenses may have been overstated, then that circumstance, too, is one that was well known to Ms. Paul, since every year she reported the expenses to the return preparer. Ms. Paul asserted.at trial that the divorce decree obliges Mr. Paul to pay "the joint debts". This could be a factor in determining equitable relief under section 6015(f), but Ms. Paul did not assert any claim under section 6015(f). Under section 6015(c), this term of the -divorce decree has no evident relevance. If, as between Mr. and Ms. Paul, he is obliged by State court order to pay the tax debt fully, then perhaps she will have a cause of action against him under State law for any money that the IRS does collect from her--an issue not before us. At issue here is the IRS's right to collect tax from her on a liability that, pursuant to Federal law, is joint and several--i.e., that is her liability. A State court does not have the power to decree that Ms. Paul is not liable to the IRS for her Federal tax debt. Heritage Reporting Corporation (202) 628-4888 | 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 15 In sum, we find that Ms. Paul is not entitled to relief under section 6015 (c) from joint liability for the Pauls' income tax and accuracy-related penalty liability for 2007. This concludes the Court's oral Findings of Fact and opinion in this case. (Whereupon, at 3:15 p.m., the bench opinion in the above-entitled matter was concluded.) // // // // // // // // // // // // // // // // // Heritage Reporting Corporation (202) 628-4888