On September 9, 2021, the Tax Court issued a Memorandum Opinion in the case of Sutherland v. Commissioner (T.C. Memo. 2021-110). The primary issue presented in Sutherland v. Commissioner was whether the petitioner was eligible for relief from joint and several liability under IRC § 6015(f).
Background to Sutherland v. Commissioner
Donna Sutherland Scott Sutherland operated Sutherland Installation and Services (SIS), a business that installed and maintained draft beer systems at restaurants, sports complexes, and other large venues. Scott’s wife Donna, the petitioner in the present case, was at times a “dispatcher,” but her primary responsibility with SIS was as its bookkeeper.
Donna reviewed receipts, billed customers, and deposited customers’ checks into the business bank account. She wrote checks for business expenses, including payroll checks, on the SIS bank account. During the Tax Court trial, she would vehemently deny that she ever issued Forms W-2, but Judge Lauber was not convinced.
The IRS Examination and Criminal Investigation
In December 2005 the IRS selected the Sutherlands’ 2003 and 2004 joint Federal income tax returns for examination. The revenue agent (RA) assigned to the case reviewed their returns and began investigating SIS.
During an interview with the RA, Scott represented that Donna handled most of SIS’ bookkeeping because he “didn’t use the computer much.” He stated that Donna was responsible for inputting business and payroll data into the computer using an accounting software platform.
During the examination the RA discovered that SIS had not filed employment tax returns for 2003 or 2004. The RA referred the case to an employment tax specialist, who found that Scott had withheld payroll taxes from his employees’ paychecks but had not paid those taxes over to the IRS. In June 2008 this issue was referred to the IRS Criminal Investigation Division.
A special was assigned, and he determined that the withheld taxes had been deposited into SIS’ business bank account, and that Donna and Scott had used this money for various personal expenditures, including vacations, mortgage payments, and private school tuition for their daughter.
Donna begrudgingly acknowledged at trial that she knew the “business account was used” technically for these personal expenditures “sometimes.” The SA recommended that both Scott and Donna be prosecuted.
In September 2010 Scott was indicted in the U.S. District Court for the District of Massachusetts for willfully failing to deposit his employees’ payroll taxes. He pleaded guilty, and as part of his plea agreement he was required to submit delinquent income tax returns for several years, including 2005 and 2006. His defense attorney hired an accountant to prepare joint Federal income tax returns for the relevant periods.
The 2005 and 2006 returns showed tax liabilities of $19,204 and $21,354, respectively. Donna signed those returns in the courthouse cafeteria less than an hour before Scott’s sentencing on June 29, 2011. She testified as to her belief that signing the returns might help Scott avoid prison time. The Tax Court notes that Donna “did not review the returns with any care before signing them.”
Scott did avoid the hoosegow, was sentenced to six months home confinement, and was ordered to pay $250,000 in restitution. At the time Donna signed the 2005 and 2006 income tax returns, she understood that the payroll taxes would be paid back “through his restitution.”
At trial Donna testified as to her belief that the payment of restitution was Scott’s responsibility because “it was his business.” She also testified as to her belief that their 2005 and 2006 joint income tax liabilities, though unrelated to the criminal case, would be defrayed out of the restitution.
The Request for Innocent Spouse Relief
In September 2016, Donna filed a Form 8857 (Request for Innocent Spouse Relief) on which she stated that she had signed the 2005 and 2006 returns during a “confusing and emotional” period, that the returns had been prepared by her husband’s accountant with no input from her, and that she simply signed the returns as instructed. She further represented on the Form 8857 that “[Scott] kept the finances to himself,” that she “had no personal knowledge of our circumstances,” and that she “at all times was a homemaker.”
This was, in a word, popp
ycock.
On November 15, 2017, the IRS issued Donna a determination letter denying her request for innocent spouse relief. She timely petitioned the Tax Court in February 2018.
Joint Liability and Innocent Spouse Relief
Married taxpayers may elect to file a joint Federal income tax return. IRC § 6013(a). After making this election, each spouse is jointly and severally liable for the entire tax due for that year. IRC § 6013(d)(3); Butler v. Commissioner, 114 T.C. 276, 282 (2000). In certain circumstances, however, a spouse who has filed a joint return may seek relief from joint and several liability under the provisions of IRC § 6015.
IRC § 6015(b) specifies procedures for relief from liability for all joint filers, and IRC § 6015(c) specifies procedures to limit liability for taxpayers who are no longer married or are living separately. Petitioner concedes that she is not entitled to relief under IRC § 6015(b) or IRC § 6015(c). Instead, Donna contended that she was entitled to relief under IRC § 6015(f).
A Note on the Scope of Review
The IRS denied her request for relief, and the Tax Court’s review of that determination was de novo. However, this standard is no longer used for cases filed before Congress enacted IRC § 6015(e)(7) (July 1, 2019). This recent change to the Code generally limits the Tax Court’s review to the administrative record.
The Equitable Remedies of IRC § 6015(f)
IRC § 6015(f) provides that “equitable relief” may be afforded to a taxpayer if “relief is not available to such individual under subsection IRC § 6015(b) or IRC § 6015(c).” Equitable relief may be available if, “taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency (or any portion of either).” IRC § 6015(f)(1); see also Treas. Reg. § 1.6015-4(a). The procedures governing equitable relief are found in Rev. Proc. 2013-34, § 4.01.
A requesting spouse who does not qualify for a “streamlined determination”[1] may still be granted equitable relief under Rev. Proc. 2013-34, § 4.03, which lists seven factors for consideration in determining whether relief should be granted. These factors are simply guides; they are not intended to comprise an exclusive list. Id., § 4.03(2).
The listed factors are as follows:[2]
- Marital status;
- Economic hardship;
- Significant benefit;
- Subsequent compliance with Federal tax laws;
- Legal obligation to pay the outstanding tax liability;
- Knowledge or reason to know that the tax liability would not be paid; and
- Mental or physical health.
Marital Status
This factor is neutral because Donna is, and was at all pertinent times, married to Scott.
Economic Hardship
“[E]conomic hardship exists if satisfaction of the tax liability in whole or in part will cause the requesting spouse to be unable to pay reasonable basic living expenses.” Id., § 4.03(2)(b). The petitioner received a $400,000 inheritance from her mother’s estate. Thus, she could have easily paid the $40,000 liability if she wanted to, which she absolutely, positively did not want to do.
Significant Benefit
“A significant benefit is any benefit in excess of normal support.” Id., § 4.03(2)(e). If the requesting spouse “enjoyed the benefits of a lavish lifestyle,” the significant benefit factor will weigh against relief. Id. By contrast, if the requesting spouse “had little or no benefit” from the underpayment of tax, this factor will weigh in favor of relief. Id.
There is no evidence that Donna enjoyed a “lavish lifestyle,” and the parties agree that she and Scott shared the benefits of not paying their 2005 and 2006 tax liabilities. Consequently, this factor is neutral.
Subsequent Compliance
If the requesting spouse remains married to the nonrequesting spouse and continues to file joint returns with the nonrequesting spouse after requesting relief, then this factor will be neutral if the joint returns are compliant with the tax laws.” Id., § 4.03(2)(f)(ii). The parties agreed that Donna and Scott’s subsequent returns were compliant. Therefore, this factor is neutral.
Legal Obligation
This factor favors relief if the nonrequesting spouse has the legal obligation to pay an outstanding Federal tax liability. “[A] legal obligation is an obligation arising from a divorce decree or other legally binding agreement.” Id., § 4.03(2)(d). This factor is neutral if there is no binding agreement or if “the spouses are not separated or divorced.” Id. Donna and Scott remained married, so this factor is neutral.
Knowledge or Reason to Know—Donna’s Undoing
Judge Lauber observes that in a case such as this, involving underpayment rather than underreporting of tax, relief is favored if the requesting spouse “reasonably expected the nonrequesting spouse to pay the tax liability reported on the return.” See Rev. Proc. 2013-34, § 403(2)(c)(ii). By contrast, this factor weighs against relief if, “based on the facts and circumstances of the case, it was not reasonable for the requesting spouse to believe that the nonrequesting spouse would or could pay the tax liability.” Id.
The critical question is whether, at the time the returns were filed, Donna knew that Scott “would not or could not pay the tax liability at that time or within a reasonable period of time after the filing of the return[s].” Id. The Tax Court may consider (among other things) whether Donna knew of “financial difficulties” that might prevent timely payment. Id.
Scott faced a number of “financial difficulties” when Donna signed the 2005 and 2006 returns—not the least of which was to be locked up in the clink for an extended period. Further, the Tax Court found that the obligation to pay restitution of $1,250 per month was a financial difficulty.
Donna was aware, when she signed the returns, that the payroll taxes “would need to be paid back to the Government” and that repayment would be made “through [Scott’s] restitution.” The amount of restitution was calculated as $254,351.
Donna was intimately involved in Scott’s business and intimately familiar with its finances. If she believed the beer tap business would generate sufficient cash to defray the restitution obligation and the 2005 and 2006 income tax liabilities within a reasonable period of time, she could have testified to that effect. She did not.
In a last ditch effort, Donna argued that she “could not possess actual knowledge that the liability would go unpaid since she did not have actual knowledge of the liability.” The Tax Court was not persuaded, because Donna signed the 2005 and 2006 returns and is thus charged with constructive knowledge of their contents. See Porter v. Commissioner, 132 T.C. 203, 211 (2009).
IRC § 6015 does not protect a spouse who turns a blind eye to facts readily available to her. Id. at 212. This is not a case where Donna’s knowledge is “negated” because of spousal abuse or lack of access to household finances. See Rev. Proc. 2013-34, § 4.03(2)(c)(ii); cf. Robinson v. Commissioner, T.C. Memo. 2020-134 (concluding that the spouse’s knowledge was negated because her husband “prevented [her] from questioning the payment of tax reported as due”). For all of these reasons, the Tax Court concluded that the “reason to know” factor weighs against relief.
Mental or Physical Health
This factor may favor relief if the requesting spouse “was in poor physical or mental health” when the tax returns were filed or when the request for relief was made. See Rev. Proc. 2013-34, § 4.03(2)(g); see also Pullins v. Commissioner, 136 T.C. 432, 454 (2011). Relevant considerations include “the nature, extent, and duration of the condition, including the ongoing economic impact of the illness.” See Rev. Proc. 2013-34, § 4.03(2)(g). If the requesting spouse was not in poor mental or physical health, this factor is neutral. See id.
Being a “[hot] mess,” “on the edge,” “extremely stressed out,” and a generally unstable person at the time she signed the returns did not tip the scale of equity in Donna’s favor. Indeed, the Tax Court found that these facts were insufficient to establish “poor physical or mental health” within the meaning of the revenue procedure. Donna testified only about the stress she felt; she did not testify as to whether or how that stress affected her health.
In any event, Donna failed to show that an alleged health condition affected her ability to comply with the tax laws. This ultimately scuttled her innocent spouse argument because “the question is not whether the requesting spouse was ill but whether an illness impacted the spouse’s ability to meet her Federal tax obligations.” See Banderas v. Commissioner, T.C. Memo. 2007-129 (internal quotations omitted).
Tallying the Negative Factors
Six of the seven factors were neutral, but the actual knowledge factor weighed heavily against Donna. Bookkeepers are not “solely homemakers” as Donna claimed at trial. Donna had her fingers on the pulse of the finances, and the only way she wouldn’t have known about the personal expenditures was if she dug her head into the sand and became willfully ignorant of what was going on.
A Word to the Wise: Tax attorneys, CPAs, and even bookkeepers do not generally (read: ever) make good Tax Court petitioners in any context. The attorneys are to smart to get caught, the CPAs are too clever for the IRS to notice the cut corners, and bookkeepers deal with the businesses finances and should be knowledgeable about any tax malfeasance.
Unfortunately for Donna, September 16, 2021, was not a good day for her to be a bookkeeper.
(T.C. Memo. 2021-110) Sutherland v. Commissioner
Footnotes
[1] Donna failed the streamlined tests, because she remained married to Scott. See Rev. Proc. 2013-34, § 4.02.
[2] Id.
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