Innocent Spouse Relief Denied to Tax Lawyer’s Wife Who is Also an Attorney

Rogers v. Comm., (CA7 11/19/2018) 122 AFTR 2d ¶2018-5435

The United States Court of Appeals for the Seventh Circuit covers Illinois, Indiana, and Wisconsin.

The Court of Appeals for the Seventh Circuit, affirming the Tax Court, has held that Code Sec. 6015(g)(2) — which provides an exception to res judicata where a spouse seeks innocent spouse relief with respect to a joint tax return if the requesting spouse didn’t “participate meaningfully” in a previous court case involving that tax return — didn’t apply to a wife because, as a result of her sophistication and involvement with the couple’s finances, she was considered to have participated meaningfully in the couple’s previous case. The Court also found that the Tax Court did not error in considering IRS’s argument (that she was barred from seeking innocent spouse relief) because IRS failed to notify her before trial of her right to request innocent spouse relief.

Tax Code Background:

Although married persons who file a joint Federal income tax return are, as a general rule, each jointly and severally liable for the tax shown on the return and any deficiency arising from that return (Code Sec. 6013(d)(3)), Code Sec. 6015 provides for three types of relief from joint and several liability that are contained in Code Sec. 6015(b), Code Sec. 6015(c), and Code Sec. 6015(f).

Code Sec. 6015(f) allows for equitable relief under procedures prescribed by IRS if:

1. Taking into account all the facts and circumstances, it is inequitable to hold the individual liable for any unpaid tax or any deficiency and
2. Relief is not available to the requesting spouse under Code Sec. 6015(b) or Code Sec. 6015(c).

The requesting spouse has the burden of proving that he/she is entitled to relief. (Alt, (2002) 119 TC 306)

In general, res judicata requires that when a court of competent jurisdiction enters a final judgment on the merits of a cause of action, the parties to the action are bound by that decision as to all matters that were or could have been litigated and decided in the proceeding. (Comm. v. Sunnen, (S Ct 1948) 36 AFTR 611)

However, Code Sec. 6015(g)(2) provides an exception to this general rule. Under Code Sec. 6015(g)(2), res judicata does not bar a taxpayer from requesting relief under Code Sec. 6015(b), Code Sec. 6015(c), or Code Sec. 6015(f) if:

1. Relief from joint and several liability under Code Sec. 6015 was not an issue in the prior proceeding; and
2. The taxpayer did not participate meaningfully in the prior proceeding.

“Meaningful participation” is not defined in Code Sec. 6015(g)(2) or the accompanying regs.

Facts of the Case:

The taxpayer was Frances Rogers who filed a joint 2004 return with her husband.

Ms. Rogers was highly educated, holding a master’s degree in biochemistry, a doctorate in educational administration, and a law degree. She was a member of the Illinois bar. In 2011 and 2012, she completed multiple classes in tax and accounting, including income tax accounting, advance tax accounting, and principles of financial accounting.

She inherited several large plots of property which she transferred to a corporation in which she was the only shareholder. She and her husband were involved in building houses on these plots.

Ms. Rogers’ husband was a tax attorney with over 40 years of experience. As part of his practice, he was involved in putting together tax shelter deals for his clients and for his own investment.

Since Ms. Rogers and her husband first married, he had always prepared their jointly filed Forms 1040, including the joint return filed for 2004. They had a routine they followed each year in preparing their joint return. After Ms. Rogers’ husband obtained the necessary documents and prepared the joint return, he and Ms. Rogers went through the return together, and she would ask questions. She was aware that they usually paid little or no tax and thought this was so because of her husband’s being a good lawyer. Ms. Rogers had access to the documents that her husband used to prepare their joint returns, but she did not review them.

The 2004 return showed her salary income as a school principal, his salary income from his law firm, her Schedule C income from her work as a realtor, and a large loss on Schedule E having to do with the husband’s tax shelters.

In 2009, Ms. Rogers’ husband became acutely ill and was hospitalized for an extended period. Around this time, Ms. Rogers took over the role of office manager for Rogers & Associates, a law office that her husband had opened in 2008. She became more involved in his business affairs. Ms. Rogers paid the rent, payroll, and other bills and made deposits on behalf of Rogers & Associates. In some instances, she accessed her own accounts to pay these expenses.

Later that year, IRS issued a notice of deficiency to the couple for 2004. It disallowed some Schedule C deductions and the loss on Schedule E.

In 2010, Ms. Rogers and her husband filed a joint petition in the Tax Court in response to the 2004 notice (2004 deficiency case). The trial took place in 2012 (2012 trial). Her husband acted as counsel for himself and Ms. Rogers at the 2012 trial. Ms. Rogers attended the 2012 trial, and during the trial she sat next to her husband at the table reserved for the plaintiff and the plaintiff’s counsel. She did not testify. She did not raise a claim for relief from joint and several liability under Code Sec. 6015 at any stage in the 2004 deficiency case.

On July 17, 2014, the Tax Court issued its opinion in the 2004 deficiency case. On Sept. 17, 2014, Ms. Rogers signed and submitted to IRS a Form 8857, Request for Innocent Spouse Relief, under Code Sec. 6015(f). On June 12, 2015, Ms. Rogers filed a petition seeking innocent spouse relief from the deficiency that was the subject of the 2004 deficiency case.

Tax Court decision:

The Tax Court held that Ms. Rogers failed to carry her burden of demonstrating she qualified for innocent spouse relief. It rejected as lacking credibility her contention that she did not have knowledge of business and financial matters, including complex tax matters, and otherwise did not understand what transpired during the 2012 trial. The Court reasoned that Code Sec. 6015(g)(2) does not afford innocent spouse relief to individuals who feign ignorance or choose to remain willfully blind to their own tax predicament. Nor, the Tax Court underscored, did Congress intend to afford such relief to someone like Ms. Rogers who had every opportunity to raise her claim during the 2012 trial. (See Rogers, TC Memo 2017-130)

On appeal, Ms. Rogers contended that a disclosure violation by IRS should have precluded the Tax Court from considering IRS’s argument that she was barred from seeking innocent spouse relief. She argued that IRS was bound under provisions in the Internal Revenue Manual (IRM) to notify her before the 2012 trial of her right to request innocent spouse relief. That it failed to do so, she contends, means that the Tax Court should not have permitted IRS to invoke the meaningful participation bar in Code Sec. 6015(g)(2).

7th Circuit Appellate decision:

The Seventh Circuit disagreed. Even assuming that Ms. Rogers could establish that she did not receive a particular disclosure, she failed to identify any authority that a disclosure shortcoming precluded IRS from taking the position that she was not entitled to innocent spouse relief. Citing Mater of Carlson, (CA7 1997) 80 AFTR 2d 97-6558, the Court noted that procedures in the IRM are intended to aid in the internal administration of IRS; they do not confer rights on taxpayers.

The Seventh Circuit found that Ms. Rogers’s position on the merits fared no better. In reviewing her petition for innocent spouse relief, the Tax Court found substantial portions of her testimony to defy reality and lack credibility.

Despite having an M.B.A. and a J.D. and having completed multiple courses in taxation, Ms. Rogers contended that she had “no understanding’ of items and transactions reported on their joint returns, which were the subject of the 2004 deficiency case”. On her Form 8857 and in her testimony Ms. Rogers portrayed herself as having a near complete lack of knowledge or sophistication with respect to business and financial matters. She stated that before 2009 she was not capable of understanding a checking account or credit card statement and that she still was unable to understand basic financial statements.

The Tax Court had stated that if, as she contended, she truly had no idea about the maters being considered, then she could and should have consulted with her attorney to clarify any misunderstanding. Instead, Ms. Rogers chose to do nothing.

The Seventh Circuit found that the Tax Court stood on solid ground when rejecting Ms. Rogers’ position. Credibility maters. This principle applies with particular force where, as here, the taxpayer’s testimony is self-serving and at odds with her education and experience.

The Seventh Circuit also noted that the Tax Court found that Ms. Rogers’s participation through her counsel, an experienced tax attorney, in the prior Tax Court proceedings indicated she participated meaningfully.

References: For the effect of earlier court determinations on innocent spouse requests, see FTC 2d/FIN ¶U-2151; United States Tax Reporter ¶60,154.03.