Innocent Spouse Relief

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IRC 6015

The Tax Court in Keri A. deGuzman and Brian deGuzman v. Comm’r of Internal Revenue, at Docket No. 13230-20, issued an opinion after trial on May 2, 2023 finding that it was appropriate to grant Innocent Spouse Relief under IRC section 6015 (c). In this case, Brian deGuzman was a cardiothoracic surgeon. He met his wife, Keri, at a hospital where she was a nurse.  They married in 2004.  They ultimately adopted four children and Ms. deGuzman ceased working.   Dr. DeGuzman was not only a surgeon, but also the co-founder of two medical device related companies and the chief medical officer of one of the companies.  The DeGuzman’s lived a “lavish,” lifestyle per the Court. Ms. DeGuzman enjoyed as much of the lavish lifestyle as her husband. During the 2013 to 2018 time period, the taxpayers either failed to timely file their income tax returns, or failed to properly pay their taxes.  They ultimately owed hundreds of thousands of dollars to the IRS. Interestingly, it was also Ms. DeGuzman who regularly communicated with the CPA regarding preparation of the family tax returns…including at least some information about Dr. DeGuzman’s businesses. She also participated in meetings with the CPA about the tax issues.  While the 2016 and 2017 returns were filed late, 2018 was timely filed.  All were examined by the IRS and ultimately adjusted.  Ms. DeGuzman requested relief from the exam assessments under the Innocent Spouse statutory sections and the IRS allowed it. Ultimately, Dr. DeGuzman disagreed and the matter ended up before the Tax Court.   All of the above is mentioned because it normally negates the success of a taxpayer seeking innocent spouse relief.  However, in this case, the IRS had granted the relief and the Appeals division sustained it.  In this case, the spouse has brought the matter before the Court.  The statute indicates that it is the requirement of the government to prove that the requesting spouse (Ms. DeGuzman) had actual knowledge of the items that gave rise to the deficiency.  Remember, it wasn’t the IRS arguing that Ms. DeGuzman should be held liable here, it was her husband.  As such, nothing before the Court reflected the IRS arguing that Ms. DeGuzman had actual knowledge of these items giving rise to the deficiency. Because of that issue, the Court could not conclude that Ms. DeGuzman had actual knowledge of the understatement items and therefore the relief granted under the Innocent Spouse provisions of Section 6015(c) stood.  Regardless of the reasons, this case is a bit of an outlier when it comes to relief for someone that seemingly benefited so much personally from non-payment of tax deficiencies. 

Frivolous Return Penalty

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IRC 6702(a)

The Tax Court ruled in Srbislav B. Stanojevich, 160 T.C. No. 7, filed April 10, 2023 that the Petitioner, in his capacity as trustee of a grantor-type trust, filed frivolous income tax returns for four tax periods.  As such, he was held liable for penalties because the law provides at IRC 6702(a) that a penalty is imposed on a “person [who] files what purports to be a return of the tax imposed by this title,” and Petitioner’s filing of the frivolous returns on behalf of the trust falls within the meaning of that provision.  The IRS assessed a $5,000 per return penalty in this case.  In January of 2013, Petitioner submitted a request to the IRS for an employer tax identification number for the Source Financial Trust (SFT) and represented that the trust was a grantor-type trust and that he was the trustee. Petitioner later filed a Form 1041, U.S. Income Tax Return for Estates and Trusts for each relevant year. The total taxable income on each return was from interest income. Each return also reported that SFT had federal income tax withheld in an amount equal to the amount of interest/total taxable income reported on the return.  The total tax on each return was then put at zero and an overpayment equal to the amount of tax withheld was claimed.  Forms 1099 were attached reflecting income paid to SFT. Some of the 1099s reflected tax withholdings.  The IRS determined the 1099s were false. The IRS deemed the returns to be frivolous and assessed the Petitioner with the penalty referenced above.  The Petitioner argued that he should not be assessed the penalty because these were not his personal returns. This was the issue the Court decided – could a taxpayer be assessed a section 6702(a) penalty for filing a frivolous return that is not his personal return?  The Court indicated that it was appropriate for the IRS to make this assessment.  The Court saw nothing in the statute that prevented its application in this instance and cited IRC section 6102(b)(4) as further support because it has a mandate that the return of a trust “shall be made by the fiduciary thereof.”  So, its trustee. The Court explained that the fact that Congress placed on the trustee the duties and responsibilities associated with the filing of the trust’s income tax return supports its conclusion that Congress considered it appropriate to impose section 6702(a) liability on a trustee who files a frivolous income tax return on behalf of a trust. 

Tax Liens

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IRC 6321

In the case of Julie Dinwiddie v. United States of America, Internal Revenue Service, the Ninth Circuit Court of Appeals illustrates the reach of the federal tax lien. This case is No. 21-35368 filed May 11, 2023. The action in this case was an allegation by Julie Dinwiddie that her personal bank account was wrongfully levied by the IRS.  In 2007 the IRS assessed Julie Dinwiddie’s husband, Jeffrey, with $3.7 million in tax liabilities.  And a tax lien attached in favor of the government to his property.  At that time, Jeffery was sole shareholder of Evergreen Nursery Incorporated (“ENI”). As the court explains, a tax lien broadly reaches every interest in property that a taxpayer might have.  As such, the lien attached to the stock and any monetary distribution associated with that stock.  At some point after the lien is filed, Jeffrey transferred his stock to Julie.  Julie then distributed funds from ENI’s bank account to her personal account as the new sole stockholder.  Because the lien attached to ENI and the money that flowed from it, the IRS properly levied her personal bank account. There are methods to transfer property to another free of the federal tax lien, but none of those situations existed in this matter. 

Passport Notice

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IRC 7345

The Tax Court ruled in Guy Alvarez Gayou v. Comm’r of Internal Revenue, T.C. Memo 2023-61, Filed May 16, 2023 that the IRS properly certified the taxpayer’s account as seriously delinquent under the law for action by the Secretary of State as it relates to the denial, revocation or limitation of a taxpayer’s passport.  This ruling is representative of the rather straightforward effect of the now 7-year-old law. As the Court explains, a taxpayer may be notified that they have a “seriously delinquent tax debt,” and that certification shall be transmitted to the Department of State so that the Secretary of State may act, as reflected above, relating to the taxpayer’s passport.  The assessment amount for this process must be higher than $50,000 – which has adjusted for inflation and currently stands at $59,000. The Court analyzed the exceptions to the definition of “seriously delinquent tax debt,” to support the taxpayer’s position.  Those exceptions are: 1) that the debt is being paid in a timely manner pursuant to an installment agreement under IRC section 6159, 2) that the debt is being paid properly under an Offer in Compromise, 3) that collections is suspended because the taxpayer asked for a Collection Due Process hearing, or 4) that collections is suspended while the IRS reviews an application for innocent spouse relief.  While the taxpayer previously had an installment agreement in place, he did not have one in place at this time. This is the most common way to decertify the seriously delinquent debt and put one’s passport in good standing.  

Offer in Compromise 

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IRC 7122

The Tax Court ruled in Duane Whittaker and Candace Whittaker v. Comm’r of Internal Revenue, T.C. Memo 2023-59, filed May 15, 2023 that an IRS Settlement Officer had abused her discretion when calculating the Reasonable Collection Potential (RCP) of the taxpayers while reviewing an Offer in Compromise as a collection alternative in the context of a Collection Due Process hearing. The Court remanded the matter to the Appeals Office to consider updated financials and other directives of the Court in resolution of the matter. Taxpayers owed approximately $50,000 at submission of the Offer in Compromise.  The issue before the Court was whether the IRS abused its discretion by failing to adequately consider: 1) the taxpayers’ reliance on their retirement account for income, 2) the special circumstances that they raised – specifically that they were near retirement and unable to borrow against their home, and 3) the change in their financial situation due to the pandemic.  In regards to the retirement income, the taxpayers argued that under the Internal Revenue Manual (IRM) and under Treasury Regulation section 301.7122-1(c)(3)(iii)(example 2), that the IRS may characterize retirement funds as income, rather than equity, when the taxpayer is within one year of retirement and they need the funds for necessary living expenses.  The Court indicated that even though the Settlement Officer made reference to this issue in the administrative record, the analysis did not make it into the determination notice from the Settlement Officer.  On the issue of home equity, the taxpayers indicated they would have problems borrowing because the assessed value was not reflective of the appraised value based on the condition of the home. They offered to obtain more information for the Settlement Officer,  but instead of asking for that information, the Settlement Officer merely indicated that she would not remove the equity in the home from the calculation of RCP. The Court concluded that the Settlement Officer’s conclusion that the taxpayers could tap the equity of the home was erroneous as their evidence was not, in fact, reviewed. And therefore, the Settlement Officer’s reliance on the equity to calculate the Reasonable Collection Potential was an abuse of discretion. Though the Court did not necessarily indicate that the taxpayers had sound positions on the issues they raised, this opinion should have a beneficial effect on how closely Settlement Officers address Reasonable Collection Potential in that it would be detrimental to the IRS to not inquire further about issues like these and document the provision, or lack of provision, of further evidence by the taxpayer.  

Penalty Abatement—Preparer Reliance

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IRC 6662

The Tax Court held in Lucell Trammer, III & Sharonda M. Trammer v. Comm’r of Internal Revenue, Docket No. 6615-22, issued March 14, 2023 that the taxpayers had met the reasonable cause exception of IRC Section 6664(c)(1) that provides relief from the accuracy related penalties assessed against them under IRC Section 6662.  The taxpayers filed returns for 2019 and 2020 – taking their receipts to a return preparer who decided how and where to report items on their returns.  As it turned out, some personal expenses, like mortgage interest, were reported multiple times.  Some personal expenses were claimed as business expenses. Ultimately, the IRS issued a notice of deficiency assessing tax and accuracy related penalties under IRC 6662(a). The Court indicated that relief from an accuracy-related penalty only applies if the taxpayers’ reliance on the return preparer meets Treasury Regulation Section 1.6664-4(b), as follows: (1) the advisor was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the advisor, and (3) the taxpayer actually relied in good faith on the advisor’s judgment.  Though the taxpayer was held liable for the tax adjustment, the Court ruled that the accuracy related penalties would not apply to the years at issue. 

Passport: Seriously Delinquent Taxes

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IRC 7345

The Tax Court ruled in Ifeoma Ezekwo v. Comm’r of Internal Revenue, T.C. Memo 2022-54 filed May 31, 2022 that there was no error in the Commissioner’s certification to the Department of State that the taxpayer had a “seriously delinquent tax debt,” and that her passport could be revoked, limited, or an application for the same could be denied.  IRC Section 7345 provides that if the IRS certifies that a taxpayer has a “seriously delinquent tax debt,” that certification is transmitted to the Department of State for action relating to a taxpayer’s passport.  A “seriously delinquent tax debt” is one that is unpaid, legally enforceable, and in excess of the current threshold adjusted for inflation – currently, $55,000. It is important to note that if a taxpayer is on an installment agreement, or in currently not collectible status, they are not seriously delinquent for this purpose.  This case is a straightforward fact pattern with a taxpayer seemingly in denial that they still owed the government money after levy.  As such, the Court disposed of the matter quickly.  Of note, the Court stated that the only determination they are allowed to make under the statute is whether the Commissioner’s certification of a taxpayer as seriously delinquent was “erroneous.”  They made this point to illustrate the fact that they cannot review the underlying liabilities in a review of the certification.  The Court also pointed out a couple of exclusions for debts that could be certified.  One was relating to a pending Collection Due Process hearing. If timely filed, the debt associated with the periods that triggered the hearing rights would not be included in the total debt for certification purposes.  Also, the Court explained that a debt for which innocent spouse relief is requested will not be part of the certification.   Taxpayers who have disagreements with the government, and are close to the threshold, could pay down the liability below the current amount that triggers the certification and de-certify.  Additionally, this author would note that if a case is assigned to a field Revenue Officer, there are provisions that allow them to expedite a request for decertification if a taxpayer meets an exemption – such as the placement of an installment agreement. During the pandemic, the certification process was paused.  That has since restarted and taxpayers are being certified at this time. 

Offer in Compromise

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IRC 6320 Hearing

The United States Court of Appeals for the Seventh Circuit in Craig L. Galloway v. Comm’r of Internal Revenue, No. 21-2269 decided February 9, 2022 that because the issue at hand was outside of the authority of the Tax Court to decide, then the issue also fell outside of the authority of this Court to review.  

The Taxpayer in this case had an unpaid income tax liability of $64,315.43.  Taxpayer submitted an Offer in Compromise which was rejected by the IRS because they believed the taxpayer could pay the liability based on the reasonable collection potential.  Rather than appeal this decision, taxpayer filed another Offer in Compromise. It was rejected for the same reason.  He appealed, but the decision of the Offer unit was sustained.  After the appeal, the IRS issued a Notice of Federal Tax Lien Filing with rights to a Collection Due Process hearing under IRC 6320. Taxpayer requested a hearing and during that hearing the Officer advised that he could submit a new Offer directly to the Offer Unit, but that if it was the same Offer, it would be rejected.  No Offer was filed and the Tax Lien was sustained.  Taxpayer then appealed the decision to sustain the filing of the Notice of Federal Tax Lien to the Tax Court.  The IRS won in Tax Court by correctly arguing the taxpayer was prohibited from raising a challenge to the Offer in that setting – which he was trying to do.  Taxpayer then appealed to this Court.  This Court indicated that their review would be based on whether there was an abuse of discretion by the settlement officer in sustaining the federal tax lien – not a review of the underlying rejection of the Offer. This was because the taxpayer had participated meaningfully in his appeal of the Offer rejection.  Because the Tax Court was limited in reviewing the underlying debt, so too is this Court of Appeals.

Appeal Rights and Trust Fund Recovery Penalty

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Letter 1153

The United States Tax Court in Mohammad A. Kazmi v. Comm’r of Internal Revenue, T.C. Memo 2022-13 filed March 1, 2022, ruled in favor of the IRS that a properly served and received Letter 1153 constitutes a prior opportunity to challenge the underlying liability and therefore a failure to appeal it prohibits the same challenge at a Collection Due Process hearing (CDP hearing). The taxpayer was issued a Letter 1153, Proposed Trust Fund Recovery Penalty, after interview by a Revenue Officer in his capacity as part-time hourly bookkeeper for his employer who had failed to pay over employment taxes.  A taxpayer has 60 days to challenge a Letter 1153 by submitting a written appeal.  Taxpayer did not make any effort to appeal and as such the IRS assessed him with the penalty.  After issuance of a Notice of Federal Tax Lien, taxpayer filed a timely CDP request and attempted to argue that he should not be held liable for the trust fund recovery penalty.  The settlement officer determined the taxpayer was prohibited from challenging the underlying liability in the CDP hearing.  Taxpayer argued that a Letter 1153 does not constitute a prior opportunity to address the liability because there is no ability to seek judicial review before the Tax Court if appeals would deny the requested relief. The Court agreed that it is correct there is no opportunity to seek Tax Court relief in this instance, but under the law, the taxpayer could get judicial review by paying the tax and seeking review in the Federal District Court.  As such, this does constitute a prior opportunity to seek judicial review.  Lesson  – always seek Appeal review after issuance of Letter 1153 if there are arguments to be made for relief from assessment.

Trust Fund Recovery Penalty 

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IRC Section 6672

The United States Court of Appeals for the Fifth Circuit ruled in United States of America v. Charles I. Williams, DDS, as Executor of Mary C. Williams, at Case No. 20-10433 filed July 6, 2021 that Charles I. Williams, acted “willfully” within the meaning of the statute and that the district court’s ruling indicating the same was affirmed. As such, Mr. Williams was held personally liable for the trust fund recovery penalties under section 6672(a) of the Internal Revenue Code. Mr. Williams owned and operated several dentistry practices. After not paying employment taxes, the government pursued collections. The central issue in the case was whether Williams acted willfully to allow for personal liability under the statute. Personal liability against responsible persons can attach under the statute when the person is a responsible person who willfully fails to turn over the withheld taxes. Willfulness requires only a voluntary, conscious, and intentional act, not a bad motive or evil intent. The Court explained that evidence showed that the responsible person had knowledge of payments to other creditors after he was aware of the failure to pay withholding tax is sufficient to show willfulness. Mr. Williams had argued that he was in a mental fog and could not have willfully spurned his tax obligations. Further he argued that he had turned over his businesses’ tax duties to his bookkeeper and another individual. The Court ruled that he was in fact willful because he knew of the unpaid payroll taxes and yet decided to pay private creditors instead of the IRS.