Opinion ID: 2978878
Heading Depth: 4
Heading Rank: 1

Heading: Applicable Legal Test

Text: As an initial matter, this case presents us the opportunity to decide what test should be used in determining whether a taxpayer had a reason to know of an understatement, or to suspect a possible understatement, resulting from disallowed deductions or credits. The Tax Court previously has stated that in all tax-deficiency cases—that is, in both omitted-income and erroneous-deduction cases—it will find that a taxpayer had reason to know of an understatement if he or she had knowledge of the transaction giving rise to the claimed tax benefits. See Bokum v. Comm’r, 94 T.C. 126, 146 (1990), aff’d on other grounds, 992 F.2d 1132 (11th Cir. 1993). We have followed this knowledge-of-the-transaction test in omitted-income cases. See Kosinski v. Comm’r, 541 F.3d 671, 681 (6th Cir. 2008) (holding that taxpayer was not entitled to innocentspouse relief when she knew of and played an active role in fraudulent transactions that allowed couple to under-report income); Richardson, 509 F.3d at 746 (same, when taxpayer knew of trust-scheme transactions that shielded couple’s income from taxation); Purcell v. Comm’r, 826 F.2d 470, 473-74 (6th Cir. 1987) (denying relief from No. 09-1420 Greer v. Comm’r Page 10 liability for omitted income when taxpayer knew of transaction giving rise to that income, and denying relief from liability for impermissible deductions when taxpayer could not prove that the deductions that her spouse had taken had no basis in law or fact, as required by an older version of the innocent-spouse provision). We have not applied the knowledge-of-the-transaction test to erroneous-deduction cases. In Price v. Commissioner, the Ninth Circuit pointed out that the knowledge-ofthe-transaction test is appropriate in omitted-income cases, but not in erroneousdeduction cases: We decline to follow the tax court’s literal superimposition of the legal standard developed in omission cases onto deduction cases in part because to do so would for the most part wipe out innocent spouse protection in the latter category. Such a standard may be workable in omission cases simply because the understatement is caused by includable income being left off a return. Therefore, it is considerably easier for a spouse to show that she was unaware of the transaction giving rise to the omission, and thus to qualify for relief. But because deductions are necessarily recorded, any spouse who at least reads the joint return will be put on notice that some transaction allegedly has occurred to give rise to the deduction. As a result, if knowledge of the transaction, operating of itself, were to bar relief, a spouse would be extremely hard-pressed ever to be able to satisfy the lack of actual and constructive knowledge element of section [6015(b)(1)] in a deduction case. Thus, adoption of such an interpretation would do violence to the intent Congress clearly expressed when it expanded coverage of the provision to include relief for spouses from deficiencies caused by deductions for which there is no basis in fact or law. It would also hinder Congress’s broader purpose in enacting section [6015(b)]—that of seeking to remedy an injustice—by giving the section an unduly narrow and restrictive reading. Price, 887 F.2d at 963 n.9 (citations omitted). The court went on to hold that in erroneous-deduction cases, “[a] spouse has ‘reason to know’ of the substantial understatement if a reasonably prudent taxpayer in her position at the time she signed the return could be expected to know that the return contained the substantial understatement.” Id. at 965. It identified four factors to be considered in making that inquiry: (1) the spouse’s education, (2) the spouse’s involvement in the family’s No. 09-1420 Greer v. Comm’r Page 11 financial affairs, (3) the presence of unusual or lavish expenditures beyond the family’s norm, and (4) the other spouse’s evasiveness or deceitfulness concerning the family’s finances. Id. All circuits to have ruled on the Price approach have adopted its test for erroneous-deduction cases. See Hayman v. Comm’r, 992 F.2d 1256, 1261 (2d Cir. 1993); Reser v. Comm’r, 112 F.3d 1258, 1267 (5th Cir. 1997); Resser v. Comm’r, 74 F.3d 1528, 1536 (7th Cir. 1996); Erdahl v. Comm’r, 930 F.2d 585, 589 (8th Cir. 1991); Kistner v. Comm’r, 18 F.3d 1521, 1527 (11th Cir. 1994). One circuit has declined to decide the issue. See Doyle v. Comm’r, 94 F. App’x 949, 951-52 (3d Cir. 2004) (unpublished opinion) (holding that the petitioner could not prevail under either the knowledge-of-the-transaction test or the Price test). In an unpublished order, a panel of this court applied the Price factors in an erroneous-deduction situation, but it did not cite Price. See Streck v. Comm’r, No. 98-1064, 1999 WL 427381, at -3 (6th Cir. June 16, 1999) (unpublished order); see also Alt, 101 F. App’x at 41 (citing Streck and applying the factors in an omitted-income case). In the instant case, the Tax Court applied Price, and the Commissioner has briefed the test’s four factors. Based on the persuasive logic of the Ninth Circuit and on our own case law, we now join our sister circuits in formally adopting the Price test for erroneous-deduction cases. The knowledge-of-the-transaction test leaves room for a taxpayer to claim innocent-spouse relief in omitted-income claims, because the understatement arises in such cases from information being left off a return, and the spouse otherwise may not have known or had reason to know that information. In erroneous-deduction cases, the understatement arises from information being included on the return, so a spouse who signs a tax return necessarily learns of the transaction.4 The knowledge-of-thetransaction test writes the innocent-spouse provision out of the law in such cases. A 4 A taxpayer who signs a tax return will not be heard to claim innocence for not having actually read the return, as he or she is charged with constructive knowledge of its contents. Park v. Comm’r, 25 F.3d 1289, 1299 (5th Cir. 1994) (citing Hayman, 992 F.2d at 1262); see also Schneller v. Comm’r, No. 961910, 1997 WL 720388, at  (6th Cir. Nov. 10, 1997) (unpublished opinion) (rejecting taxpayers’ argument that penalty for understatement of tax attributable to negligence was improper because they relied on their accountant to prepare their return and did not read it before signing). No. 09-1420 Greer v. Comm’r Page 12 more nuanced approach is thus required, especially given that an understatement arising from a deduction usually is not obvious from the face of a tax return. A taxpayer who knows how much money the family earned will know that tax has been understated if income is omitted from the return, as it is common knowledge that income is taxable. See Price, 887 F.2d at 963 n.9. By contrast, a taxpayer who is aware of an investment may or may not know that tax benefits claimed on its basis are impermissible, depending on that taxpayer’s level of sophistication and how much he or she knows about the investment. See Reser, 112 F.3d at 1267 (“[I]n the 1980’s, it was common knowledge that investors could legally obtain large tax benefits through clever investment strategies.”). The Price test takes account of this difference. The Price test also is consistent with our own binding case law. In Shea v. Commissioner, 780 F.2d 561 (6th Cir. 1986), we applied a context-specific test under which a taxpayer’s reason to know of an understatement depends on “(1) the circumstances which face the [taxpayer]; and (2) whether a reasonable person in the same position would infer that omissions or erroneous deductions had been made.” Id. at 565-66. In establishing this test, we relied on Sanders v. United States, 509 F.2d 162, 167 (5th Cir. 1975), which set out three of the four factors later adopted by the Ninth Circuit in Price. Shea, 780 F.2d at 565. The Price test provides a helpful way of guiding the totality-of-the-circumstances inquiry that we established for innocent-spouse cases years ago in Shea. While the Price factors are used to determine whether a spouse had reason to know of an understatement, they may also be employed to determine whether a spouse had a duty of inquiry. Park, 25 F.3d at 1293; Kistner, 18 F.3d at 1525; Erdahl, 930 F.2d at 590-91. In duty-of-inquiry cases, courts have also considered whether the tax returns set forth deductions or credits large enough, relative to the size of the underlying investment or of reported income, to prod a reasonable taxpayer into further investigation. See Reser, 112 F.3d at 1267-68, 1269; Friedman v. Comm’r, 53 F.3d 523, 531 (2d Cir. 1995); Park, 25 F.3d at 1298; Price, 887 F.2d at 961. No. 09-1420 Greer v. Comm’r Page 13