Innocent Spouse Provisions

One of the most important changes Congress introduced recently to make the tax laws more equitable was a revision of the innocent spouse rules. Since their enactment, the courts have been busy determining which taxpayers qualify for relief.

Ellen Hinckley was married for more than 30 years and, for most of that time, she was a homemaker. She had an undergraduate degree in nutrition and a master’s degree in art history. Her husband had a law degree and an LLM in taxation. Starting in 1994 her husband, who prepared the couple’s joint tax returns, omitted his pension from their taxable income. The IRS objected to the omission. In 1995 Hinkley’s husband sent the agency a letter explaining why he omitted the income. He had his wife sign the letter. She divorced him in 1999. The IRS attempted to collect the tax due on the omitted income from Hinkley. She objected, arguing she was entitled to innocent spouse relief.

Result. For the taxpayer. Hinkley argued she was entitled to relief because she did not know there was an understatement of tax—which is provided for in IRC section 6015(b). (The IRS conceded she met the other requirements of that section.) Alternatively, she argued that, even had she known of the understatement, she had signed the return under duress and was entitled to relief under section 6015(c) (3)(C). The court rejected her primary argument, concluding she, in fact, did know of the omission (as she had signed the 1995 letter). Under the applicable subsection, it is sufficient for a taxpayer to have known the income existed. He or she does not have to have understood the proper tax treatment.

A taxpayer is deemed to have knowledge of an omission if a reasonably prudent person could be expected to know of it. This is determined based on a taxpayer’s education, his or her involvement in the business, the presence of lavish expenditures in relation to prior expenditures and whether or not the taxpayer’s spouse hid the family’s finances from him or her. Using these criteria, Hinkley would appear to qualify for relief based on an absence of knowledge. However the fact that she signed a separate letter addressing the omitted item sufficiently outweighs the general factors. In other words, any action a taxpayer takes that could support the existence of actual knowledge will nullify all factors in his or her favor.

Although Hinkley had knowledge of the omitted item, she was entitled to relief because she signed the returns under duress. Duress exists based on either physical abuse or continued mental intimidation. However, duress requires both abuse and a signature obtained because of fear of abuse. The court cited Stanley as an example. In that case the taxpayer had been physically abused for many years. The fact that by signing the returns she avoided additional abuse did not qualify as duress because she did not know of an error on the return that would cause her to fear signing it. There was no reason for her not to sign the return. Hinkley’s case was different. She knew of the omission and signed the return in spite of it because she feared what would happen if she did not. Thus, she signed under duress.

If the courts follow this decision in future cases, a taxpayer will be entitled to innocent spouse relief if he or she

Did not know or have reason to know of the omission.

Knew of the omission but signed the return anyway out of fear of the consequences of refusing.

In re Ellen A. Hinckley, 86 AFTR2d 2000-5614, Bankruptcy Ct, Florida.

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