TAX COURT OPINION

Case: Yen N. Luu, Petitioner, and Felix Luu, Intervenor
Docket Number: 3437-15
Judge: Holmes
Opinion Type: bench
Filed: 08/02/2016
Pages: 16

Suk ffolmes UNITED STATES TAX COURT WASHINGTON, DC 20217 Docket No. 3437-15. YEN N. LUU, and Felix Luu, Petitioner Intervenor v. ) ) ) ) ) ) ) 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 pages the transcript of the trial intervenor and to respondent a copy of to petitioner, of Mark V. Holmes at San Francisco, California, containing his oral findings of which the case was heard. in the above case before Judge fact and opinion rendered at the trial session at In accordance with the oral findings of fact and opinion, a decision will be entered for Petàtioner. 9% (Signed) Mark V. Holmes Judge Dated: Washington, D.C. August 2,2016 SERVED AUG - 8 2016 Capital Reporting Company Bench Opinion by Judge Mark V. Holmes June 13, 2016 Yen N. Luu, Petitioner, and Felix Luu, Intervenor, v. 3 Commissioner Docket No. 3437-15 THE COURT: In the case of Yen N. Luu, 1 2 3 4 5 6 7 Petitioner, and Felix Luu, Intervenor v. 8 9 10 11 12 13 14 15 16 Commissioner, Docket No. 3437-15, the Court has decided to render öral findings of fact and opinion, and the following is the Court's oral findings of fact and opinion. 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's Rules of Practice & Procedure. Both Luus were California residents when 17 Mrs. Luu filed her petition. The parties reached a 18 19 20 21 stipulation which, together with the testimony and exhibits, constitutes the record in this case. The case arose when the Commissioner issued a notice of deficiency determining extra income for 22 Mr. Luu in 2006 and 2007. This had, for those years, 23 24 25 three different sources. One was oneOseventh of the 1 net unreported income from A&A Markets, an S corporation Mr. Luu owned with his siblings of 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 $41,467 in 2006 and $44,791 in 2007; and similarly, one9seventh of the net unreported income from New Stockton Poultry -- another S .corporation Mr. Luu owned with his siblings -- or $57,956'in 2006 and $19,811 in 2007. In addition, for both those years, the Commissioner determined that Mr. Luu had not reported wages of $24,000 in.each year. This gave rise to a deficiency asserted against Mr. and Mrs. Luu of $39,000 in 2006 and $27,000 in 2007. The Government also asserted a fraud penalty under Section 6663 of 75 percent of those amounts. Those are the stakes, in other words, in this case. Now, the Luus had filed joint returns for both those years, and when she received the notice of deficiency, Mrs. Luu, by that time divorced, filed a petition in our Court. She did not contest the deficiency, but she raised the innocent spouse defense to it. The defendant -- Respondent, rather, agreed that Mrs. Luu is entitled to innocent spouse relief, but Mr. Luu intervened to oppose relief. We held the trial in San Francisco. Let me begin with some background on the Luu family. In 1980, Mr. Luu and his six siblings 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 immigrated to the United States from Vietnam. They were very successful businessmen, and by 2006, the Luus owned three businesses: Luu's Brothers Corp., doing business as A&A Market; the Luu' s Family Corporation, doing business as New Stockton 6 Poultry; and Palmer Farms, Incorporated. All three 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of these are subchapter S corporations, and the seven siblings were equal shareholders in the three S corporations. No one else outside the family owned any of the stock. Mr. Luu and his sibling Mr. Duc Luu devised a plan in about January 2006, apparently, to skim cash from the businesses and to distribute the unreported cash to the siblings during meetings at A&A Market. The siblings agreed to accumulate cash and distribute it equally among all of them, and they allegedly carried out the skimming operation during 2007 and 2008. There is in the record an actual signed receipt from the siblings in 2008 showing they had each received $10,000 in cash. They referred to this in some of the depositions that I've been reading as dividends, which might be a true characterization, except it wasn't reported to the government, which thus makes it a skimming operation. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company I 6 1 2 3 4 5 6 7 8 Something then happened in early 2008. One of Mr. Luu's siblings apparently assaulted Mrs. Luu in the A&A store. In addition, Mr. Luu came to believe that his brother Duc was stealing from the siblings, sort of skimming on the skimming, and the upshot was that, in May of that year, Mr. Luu was fired by his siblings from the family businesses. This then led to a great deal of litigation with 9 Mr. Luu filing a series of lawsuits against his 10 11 siblings for accounting injunctions, etc. Now, these didn't end entirely well for 12 Mr. Luu. But by 2013, the family had tired of 13 litigation and resolved to end everything by paying 14 Mr. and Mrs. Luu $500,000 each in exchange for 15 Mr. Luu's shares in the S corporations and Mrs. Luu's 16 17 18 19 20 21 22 23 24 25 community property interest in those shares. Now, what is one to make of the innocent spouse defense that Mrs. Luu made when the government came with its notice of deficiency? As a general rule, spouses who file joint tax returns are jointly and severally liable for the tax owed. See Section 6013(d)(3). Section 6015 provides three ways out of this joint liability. See Section 6015(b), -(c), -(f). These subsections address the same general 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 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 problem but differ in important ways. Relief under subsection (f) is available for a spouse who shows that, taking into account all the facts and circumstances, it is inequitable to hold her liable for any unpaid tax or any deficiency or any portion of either. Relief under subsections (b) and (c), when used as an affirmative defense, doesn't even require a determination by the Commissioner denying relief before this Court can grant it. Butl.er v. Commissioner, 114 TC 276, 288 (2000). A requesting spouse, under these two subsections, generally has the burden of proof. Section 1.6015-3(d)(3) But needs only to persuade us by a preponderance of the evidence. See McClelland v. Commissioner, TC Memo 2005-121. Under subsection (b), we will relieve a spouse from liability if she persuades us that she was justifiably ignorant of the understatement and that she meets the subsection's other requirements. For relief under subsection (c), a requesting spouse must persuade us that she meets that subsection's requirements, and we will deny relief if she doesn't or if the Commissioner 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 persuades us that any one of the three exceptions for 2 which he bears the burden of proof applies. See 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Section 6015(c) (3) (A)(ii), (C), (d)(3) (C) (sic). Mrs. Luu was seeking relief under subsection (c) of Section 6015. In routine subsection (c) cases where the requesting spouse challenges the Commissioner's denial of relief, the allocation of the burden of proof sensibly places it on parties who are adverse to each other. But a problem arises in a case like this where the Commissioner also favors relief and the nonrequesting spouse intervenes to oppose it. See Section 6015(e) (4); Rule 325; see also King v. Commissioner, 115 TC 118 (2000); Corson v. Commissioner, 114 TC 354, 363 (nonrequesting spouse's right to intervene the same in both stand-alone and affirmative defense cases). In these cases, the Commissioner isn't adverse to the petitioning spouse any longer, so if 20 Mr. Luu intervened to oppose relief, relying on any 21 22 23 24 25 of the three exceptions listed above, there's a good chance that we would place the burden of proof on him to convince us that Mrs. Luu is not entitled to relief. We don't need to decide that today, because both parties introduced evidence, so we can just 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 decide the issues on who persuaded us by a preponderance of the evidence. The first question under 6015(c) is a threshold question. There have to be three things that Mrs. Luu can prove.. One is that she made a joint return for both years with her husband. The second is that, at the time she asked for innocent spouse relief, she was legally separated or divorced from her husband. And the third is that the election for relief was made after a deficiency was asserted but no later than two years after the Commissioner began collection activities. She has met these threshold requirements. And the parties stipulated that they filed joint returns in 2006 and 2007. They also stipulated that they were divorced at the time that Mrs. Luu raised the request for innocent spouse relief. And it was made within two years of the beginning of collection 19 activity. 20 21 22 23 24 25 Actually, collection activity has not technically begun in this case, but under the regulations, this is not considered a premature request for relief. A premature claim is "a claim for relief that is filed for a tax year prior to the receipt of a notification of an audit or a letter or 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 1 2 3 4 5 6 7 8 9 10 11 12 notice from the IRS indicating that there may be an outstanding liability with regard to that year." 26 CFR Section 1.6015-6 -- I'm sorry, -5(b)(5). Moreover, the regulations make clear that "an election or request for relief may be made before collection activity has commenced." See 26 CFR Section 1.6015-5(b)(3). That's the situation here. This isn't a race; this is an affirmative defense to a deficiency case, so she meets the threshold requirements. That means that I have to turn next to allocation. Section 6015(c)(1) says, "If an 13. individual who has made a joint return for any 14 15 16 17 18 19 20 21 22 23 24 25 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) . " Turning to subsection 6015(d), one reads, "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 . . . 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 11 bears to the net amount of all items taken into account in computing the deficiency." There are regulations as well that tell me how to allocate the deficiency between two spouses. This is an omission-of-income case and the relevant regulation is 26 CFR Section 1.6015-3(d)(2)(iii). "Erroneous items of income are allocated to the spouse who was the source of the income. Wage income is allocated to the spouse who performed the services producing such wages. Items of business or investment income are allocated to the spouse who owned the business or investment." Now, remember what I said about the notice of deficiency. It said that the missing income came from Mr. Luu's ownership of one seventh of the shares in the family corporations and from unreported wage income that he earned. So all the missing -- all the deficiency here is allocable to Mr. Luu, which he doesn't really contest. The key problem here is another obstacle to relief. Section 6015(c)(3)(C), which says, "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, 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 which is not allocable to such individual under subsection (d), such election shall not apply to such deficiency, or portion." So I have to determine whether Mrs. Luu had actual knowledge when she signed the 2006 and 2007 joint returns of the three items that gave rise to the deficiency in this case. To guide me, I look first at the regulations that define what actual knowledge is. There is such a regulation at 26 CFR Section 1.6015-3(c) (2) (i). "If, under Section 6015(c)(3)(C), the Secretary demonstrates that, at the time the return was signed, the requesting spouse had actual knowledge of an erroneous item that is allocable to the nonrequesting spouse, the election to allocate the deficiency attributable to that item is invalid." And goes on to say that in the case of omitted income -- "In the case of omitted income, knowledge of the item includes knowledge of the receipt of the income." Knowledge, it's -- the regulation goes on in 26 CFR Section 1.6015- 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 3(c)(2)(iii) that "Knowledge of the source of an 24 25 erroneous item is not sufficient to establish actual knowledge." 866.488.DEPO www.Capita1ReportingCompany.com Capital Reporting Company 13 1 2 3 4 5 6 7 8 9 10 11 12 And, finally, the regulation in subparagraph (iv) tells me that I have to look at all the facts and circumstances of the case to determine whether the requesting spouse, in this case Mrs. Luu, had actual knowledge. We have some case law that interprets these rules as well. In Cheshire v. Commissioner, 115 TC 183 (2000), we held "The knowledge requirement of Section 6015(c)(3)(C) does not require the electing spouse to possess knowledge of the tax consequences arising from the item giving rise to the deficiency or that the item reported on the return is incorrect. 13 Rather, the statute mandates only a showing that the 14 15 16 17 18 19 20 21 22 23 24 25 electing spouse actually knew of the item on the return that gave rise to the deficiency." We look for "actual and clear awareness" as opposed to "reason to know" of the existence of an item which gives rise to the deficiency. Similarly, in Pounds v. Commissioner, 102 TCM 184 (2011), the Court looks to the surrounding facts and circumstances for an actual and clear awareness of the items giving rise to the deficiency. This case is very similar to the Pounds case; in that both Mr. and Mrs. Luu each testified and numerous documents were introduced into evidence 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 on Mr. Luu's behalf. It's clear that Mrs. Luu worked for a company which Mr. Luu ran, at least in part, for both of the tax years at issue. It's also clear that as in Pounds she didn't own any interest in the company and performed extremely limited tasks for it. I found that there was zero proof of any involvement in the finances of the Luu siblings' S corporations by Mrs. Luu, who was an in-law not one of the siblings, or that she had any reason to know of the underreported wages that Mr. Luu apparently received/ for both 2006 and 2007. She has a very limited education and participation in the family business. She ran register No. 2 at the A&A Market during the years in question, and she had extremely limited involvement in the preparation of the return, i.e., she simply signed the returns when they were given to her. Mr. Luu cited two facts in support of denying his wife innocent spouse relief under 6015(c). The first was that Mrs. Luu was paid in both cash and checks, and I'm prepared to believe that she was paid in both cash and checks during those years. But I don't find anything odd here. A&A Market was a closely held family business that had a lot of cash going in and coming out, and 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 there's no allegation at all that the cash that 2 Mrs. Luu received was not reflected on her W-2 at the 15 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 end of the year. The second fact that Mr. Luu points me to as an indication for why Mrs. Luu had actual knowledge in 2006 and 2007 was that she was switching registers at the A&A Market. This was a little bit of a complex procedure whereby Mrs. Luu had two physically different cash registers at her register station. And around noon or 1:00 o'clock during at least part of 2006 and 2007, she would switch from using one register to another, closing out and putting into the brown paper bags that were used to collect receip money in excess of two or three hundred dollars plus any checks, together with the register tape. She'd then put those in a paper bag and hand them to one of the Luu siblings who .would then take them to the back office. Unlike the other registers, she did this twice, and apparently put the number for register 2 on one bag and then in the afternoon or early evening would put 2, the circle with a slash through it, and do the same thing, hand off the bag to one of the Luu siblings. I do believe her that she was simply told to do this by Duc Luu and that this would make sense 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 16 1 2 3 for somebody who's had experience now for many years as a Tax Court judge looking into fraudulent schemes of small businesses to underreport their income, 4 well, might have made me suspicious, in other words, 5 but I don't find that it would make somebody in 6 Mrs. Luu's position suspicious. 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Again, this was just the way that she was told to work her register. She doesn't know how other businesses operate and she was just doing what she was told. There was certainly no way that she could be aware that maybe or maybe not t41Ñone of the two paper bags filled with receipts was somehow connected to the operation of the three S corps.7- including the two that during those two years, 2006 and 2007, were being used by the Luu siblings to pay themselves distributions that then went unreported to the IR much less any additional wages to Mr. Luu ir those two years. It is extremely unlikely that she had any actual knowledge or actually even any reason to know about these unrcpe-rÑsources of unreported income. So on this point, I find her to be a very credible witness, and I find that she had no actual knowledge of the sources of omitted income on the returns for 2006 and 2007. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 1 I thus agree with the IRS, and I agree with 2 Mrs. Luu and find in her favor in this case. 17 Decision will be entered for Petitioner. This concludes the Court's oral findings of fact and opinion in the case. We are adjourned. THE CLERK: All rise. (Whereupon, at 5:00 p.m., above- entitled matter was concluded.) 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com