TAX CASE

ongress enacted the innocent spouse provisions to expand the relief available to certain taxpayers. The technical requirements for this relief, however, have resulted in numerous lawsuits. The Ninth Circuit Court of Appeals recently reversed the Tax Court, thus denying relief in certain situations.

Gwendolyn Ewing and Richard Wiwi married in 1995 and filed a joint tax return for the year. Because Richard had failed to pay estimated taxes on his income, a tax was due on the return; the couple included only part of this amount with the return. In 1999 Gwendolyn filed form 8857 requesting relief under the innocent spouse provisions for the remaining tax due. The IRS denied her request. She filed with the Tax Court, which ruled in her favor. The IRS appealed.

Result . For the IRS. IRC section 6015 grants innocent spouse relief in three instances. Subsection (b) grants relief if the requesting spouse was unaware of the erroneous item. Subsection (c) grants relief if the couple is divorced or separated. Subsection (f) grants relief if the taxpayer does not qualify under the other two sections and it would be inequitable not to grant relief. Gwendolyn requested relief under this third rule.

Section 6015(e) provides that the Tax Court can review a denial of relief in cases of tax deficiencies if the taxpayer claimed relief under subsection (b) or (c). Referring to the Congressional Record, the Tax Court determined its review was not limited to deficiency cases. The Ninth Circuit disagreed, saying the statutory language was clear and unambiguous. Thus, the Tax Court could not rely on the intent of Congress and had to enforce the words contained in the statute. This provision clearly states that a tax deficiency must exist in order for the Tax Court to review an IRS denial. Because there was an underpayment, not a deficiency, the court lacked the jurisdiction to overrule the IRS. The taxpayer had to pay the tax due.

The IRS did not raise one important issue: Subsection (e) says that the Tax Court can review only cases in which the taxpayer requests relief under subsections (b) and (c). Several prior courts have ruled that even if a deficiency exists, the courts cannot review relief requested under subsection (f). Since this issue was not before the court, the Ninth Circuit did not rule on this point. The fact that the circuit court referred to the prior rulings may indicate that it would follow them.

Innocent spouse relief is a very technical area. It is important to follow all procedures and rules exactly. Failure to do so usually results in a denial of relief.

Commissioner v. Gwendolyn Ewing, 439 F3d 1009 (CA-3).

Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.

TAX CASE

s an employer responsible for fully funding its retirees’ lifetime health benefits? The Sixth Circuit Court of Appeals recently affirmed a district court’s decision that, indeed, an employer does have such a responsibility.

The plaintiffs were retirees or surviving spouses of retirees of J.I. Case Co., which was a wholly owned subsidiary of Tenneco until 1994 when it was spun off and renamed Case Equipment. It is now CNH America. In 1996 Tenneco merged with El Paso National Gas to form El Paso Tennessee Pipeline.

The United Auto Workers (UAW) had negotiated collective bargaining agreements with Case that required the agreed-upon group insurance and pension plan to run concurrently. In 1995 the UAW and Case signed a letter of agreement that seemed to cap Case’s liability. During the years 1998–2003, El Paso increased the retiree portion of health insurance premiums from $0 to $561 per month.

The plaintiffs sought an injunction in district court alleging that El Paso had breached its labor agreements under the Labor-Management Relations Act and the Employee Retirement Income Security Act. The district court granted their request. El Paso appealed the decision.

Result . For the plaintiffs. The Sixth Circuit held that while employee medical benefits don’t normally come with the same vesting rights as pensions, parties can agree that these benefits should vest. Relying on UAW v. Yard-Man, Inc., the court looked to the letter of agreement for (1) the explicit language, (2) the words and phrases used and (3) the overall context of the agreement. The plaintiffs provided booklets, notices and memoranda to document their contention that the employer intended to vest the plans. The court concluded that, because the agreement used similar language to refer to both the group insurance and the pension plan, the parties intended both plans to vest. In addition, the court held that the original intent of the UAW/Case letter of agreement was to limit the impact of funding on the financial statements, not to limit the company’s funding responsibility.

The increasing numbers of retirees, rising health care costs and the growing trend of cost-shifting medical insurance premiums from employers to retirees ensure that other courts will address this issue. To support potential future claims, both currently employed and retired taxpayers should maintain all necessary documentation pertaining to their benefit packages.

Yolton v. El Paso Tennessee Pipeline, 435 F2d 571 (CA-6).

Prepared by Michael H. Brown, CPA, PhD, assistant professor of accounting, Tabor School of Business, Millikin University, Decatur, Ill.

TAX CASE

f a taxpayer successfully challenges the IRS, can that taxpayer recover reasonable litigation costs? Recently, the Tax Court applied the substantial justification standard when it reviewed Images and Allemeier , two cases involving litigation costs.

In Images , Denise Lopez owned and operated a dance studio. The IRS challenged her classification of dance instructors as independent contractors. After interviewing Lopez and the instructors and reviewing the employee manual, the IRS examining agent concluded an employer-employee relationship existed between Lopez and her staff. On administrative appeal, however, the appeals officer decided Lopez would likely win at trial. Lopez then sought to recover reasonable costs of litigating the matter.

In Allemeier the taxpayer claimed as business expenses the cost of an MBA and other expenses related to his work. The IRS argued the MBA was a minimum educational requirement that qualified the taxpayer for a new trade or business. The Tax Court held for Allemeier , who then sought to recover the reasonable litigation costs.

Result . In Images , for Lopez; in Allemeier , for the IRS. Under IRC section 7430(c)(4), a taxpayer who is the prevailing party can recover reasonable litigation costs. To be considered as such, the taxpayer must substantially prevail with respect to the amount at issue or the most significant issue presented and meet net worth requirements. In addition the IRS’s position must not be reasonably justified. Lopez was considered the prevailing party while Allemeier was not, even though he won his case.

In Images the court held the IRS did not substantially justify its position. The employee manuals were guidelines rather than requirements. Further, the dance instructors bought their own music and costumes and determined their fee structures. Therefore, it was not substantially justified for the IRS to reclassify these independent contractors as employees. In Allemeier , even though the taxpayer prevailed, the court held the IRS had justified its arguments.

Images in Motion of El Paso, Inc. v. Commissioner, TC Memo 2006-19; Allemeier v. Commissioner, TC Memo 2006-28.

Prepared by Michael H. Brown, CPA, PhD, assistant professor of accounting, Tabor School of Business, Millikin University, Decatur, Ill.