Educated Spouse Denied Relief
The Tax Court upheld the IRS position that an educated spouse was unreasonable in believing her ex-husband would pay a tax deficiency, and denied her innocent spouse relief.
Elizabeth B. Kelly, who had received a degree in social science, married Sean Kelly in 1981. Sean Kelly worked at Portfolio Analytics, a brokerage and investment services company, as a marketing consultant. In 1987 Elizabeth Kelly also began working at Portfolio Analytics. Although as office administrator her position was less prominent than her husband’s, she had an ownership interest in the company. Sean Kelly’s father operated a retirement plan consulting company he had founded. In 1997 Sean Kelly and his parents formed EPC Consulting, to provide services to early retirement plans of teachers on the West Coast.
Sean and Elizabeth Kelly’s lifestyle featured several cars, private school tuition for their children, ownership of a horse, and a $900,000 home. Elizabeth Kelly managed the household and paid all the bills. She also worked with their accountant when having their joint income tax returns prepared.
Sean Kelly developed alcohol and drug addiction problems and ran up extravagant expenses charged to EPC Consulting. As a result, his parents bought out his share of the business as part of a severance agreement. The Kellys ultimately had difficulty paying their bills and developed bad credit as a result of reduced income and their continued high lifestyle. In 2009 they were divorced.
In 2004 and 2005, the Kellys reported total income of about $446,000 and $505,000, respectively. Those amounts included about $357,000 and $321,000, respectively, from severance payments from EPC Consulting to Sean Kelly. For the years in question there was little tax withholding or estimated taxes paid, and none of the severance money was used to pay the taxes. The unpaid tax liabilities were nearly $100,000 for 2004 and $115,000 for 2005. Elizabeth Kelly signed the tax returns each year, subsequently contending to the IRS that she did so because her husband had agreed to pay the balances due.
In 2006 the IRS began collection activities, and neither of the Kellys requested a collection due process hearing. In 2008 Elizabeth Kelly filed Form 8857 requesting innocent spouse relief under IRC § 6015, which the IRS denied, since she had missed the two-year deadline for filing as required in sections 6015(b) and (c). She then petitioned the Tax Court seeking equitable relief under section 6015(f). Although the statute does not specify a two-year deadline for filing under subsection (f), the IRS has imposed one in Treas. Reg. § 1.6015-5(b)(1). The Tax Court has held the regulation invalid but has been reversed by the Seventh and Third circuits (see “Innocent Spouse Relief: Alternatives After the Lantz Case,” JofA, Dec. 2010, page 46, and “Line Items: Another Circuit Upholds Two-Year Limit for Innocent Spouse Claims,” below). However, the Tax Court did not address the timeliness issue in the instant case, deciding it on other grounds.
The Tax Court considered the safe harbor provisions of Revenue Procedure 2003-61. A spouse requesting relief must have no knowledge or reason to know that the other spouse would not pay the tax. The court found that Kelly should have known that her husband would not pay the tax. The court noted that she had taken responsibility for paying the household’s other bills, her husband had a drug and alcohol addiction, he exhibited erratic behavior, and his severance pay had not been set aside or used to pay the tax at the time of filing. She knew of the family’s financial problems, and she was “an educated person” with more than 20 years of experience in the financial industry. The court was not sympathetic on the issue of economic hardship after considering conflicting information supplied to the IRS and seeing monthly expenses that included more than $300 for satellite television, more than $250 for cell phones, and more than $150 for maintenance of a horse.
In considering equitable factors under section 4.03 of the revenue procedure, the court still found no reason to grant innocent spouse relief. Although the tax liability was substantially her husband’s, and he had agreed to pay it under the terms of the divorce agreement, she should have known he could not pay. The court said Elizabeth Kelly received a significant benefit from the unpaid tax liability, specifically, her high lifestyle. Because of Elizabeth Kelly’s level of education and her involvement with the accountant preparing the tax returns, the court rejected her claim that she did not know she could file separately.
By Donald L. Rosenberg, Esq., CPA, professor of accounting, Towson University, Towson, Md.
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