Knowing But Innocent

The Tax Court held that the IRS abused its discretion in denying a stay-at-home mom’s request for innocent spouse relief because it did not consider all of the relevant factors. Chrystina Nihiser filed for relief after her husband stopped paying their taxes due to financial problems with his business. Although she had known the couple would most likely fail to pay the taxes shown on the returns she signed, the Tax Court found other factors weighed in her favor, resulting in relief from a tax liability for tax years 1996–2001 of close to $250,000.

Nihiser married Kevin Connelly in 1980 and stopped working as a schoolteacher when she gave birth to their daughter in 1988. They lived in California. Connolly supported the family with his law practice and controlled all of the finances, keeping his income and expenses hidden from Nihiser. In 1993, Connolly began filing their joint returns, which he had Nihiser sign on the due date, without paying the taxes due. In 1999, Connelly presented Nihiser with divorce papers but never filed them. Although the couple began living in separate rooms of the same apartment, they continued to file joint returns for the next two years. Ultimately, Connelly was imprisoned for stealing from his clients, and Nihiser returned to full-time teaching.

Although the IRS did not begin any actions against the couple, Nihiser initiated innocent spouse proceedings. Because the tax liability was neither an understatement nor a deficiency, Nihiser was limited to filing under section 6015(f), which calls for relief if, taking into account all the facts and circumstances, it would be inequitable to hold her liable. The court looked to the balancing test of Revenue Procedure 2000-15 (since superseded by Rev. Proc. 2003- 61) to examine whether the IRS abused its discretion by denying Nihiser relief and, if so, to determine the appropriate relief.

Four of the eight factors were in contest, each raising new questions for the court:

(1) The requesting spouse is divorced, legally separated or living apart from the nonrequesting spouse. The court held that the couple’s living apart, albeit within the same household, weighed in favor of relief.

(2) The requesting spouse would suffer economic hardship if forced to pay the tax liability. It was unclear whether this determination should be based on when relief was requested (when Nihiser was working only part time), during appeals (when she was working full time) or at trial (when her wages were being garnisheed to pay a state tax debt). Because remand is not an option in innocent spouse cases, the Tax Court based the determination on the trial record rather than just the administrative record. In so ruling, the court cited a line of prior decisions including Ewing (118 TC 494, rev’d on other grounds, 97 AFTR2d 2006-1224 (9th Cir. 2006); see also “Tax Matters: Innocent Spouse Relief Reversed,” JofA, Aug. 06, page 74); Robinette (123 TC 85); and the more recent Porter (130 TC no. 10).

(3) The requesting spouse was abused by the nonrequesting spouse. Such abuse need not rise to the level of duress to favor relief. Describing this as an “underdeveloped area,” the court referred to factors of psychological abuse cited in domesticrelations law, such as drug use, threats of suicide, possessive behavior and degrading language, all of which were substantiated by Nihiser’s administrative record.

(4) Whether the requesting spouse knew or had reason to know of the liability. This factor weighed against relief.

Other factors conceded by the government as favoring Nihiser were (1) that the tax liability was attributable to the other spouse and (2) she received no significant benefit from the underpayment. Thus, the court said, five factors favored relief and one weighed against it. The remaining two factors were considered neutral or irrelevant: (1) the requesting spouse subsequently complied in good faith with federal tax laws and (2) the nonrequesting spouse was not under a legal obligation pursuant to a divorce decree or agreement to pay the outstanding liability.

Knowledge of the liability generally is an “extremely strong” factor but can be outweighed by other considerations in “limited situations,” the court said, quoting the revenue procedure. Since Nihiser’s ability to act on her knowledge was restricted by abuse that included her husband’s hiding the broader state of the family’s finances, this, the court said, was such a situation.

Nihiser v. Commissioner, TC Memo 2008-135

By Laura Lee Mannino, CPA, LL.M., assistant professor of accounting and taxation, St. John’s University, Jamaica, N.Y.