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Lessons from the Tax Court: Taxpayer is proven innocent

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in Small Business Tax

When a married couple files a joint return, they can be held jointly or severally liable for an underpayment of tax. However, if one party is duped, he or she may apply for “innocent spouse relief.” Usually, the Tax Court is not generous in applying this rule, but it showed mercy to a taxpayer in a new decision. (Bishop, TC Summary Opinion 2018-1, 1/4/18)

Key facts: A husband and wife who married in 2007, were temporarily separated twice in 2014, separated for good in June 2015 and finally divorced in 2016. From 2014 through the time of the permanent separation in 2015, they maintained a joint checking account and used it for payroll check deposits and other transactions. Both the husband and wife had debit cards to access the account.

In 2014, the wife received a distribution of more than $15,000 from an Edward Jones retirement account. Edward Jones withheld about $2,700 for taxes from the distribution and reported both of those amounts to the IRS. Later in the year, $6,000 was deposited into the joint checking account that the couple maintained. As they had done in prior years, they together provided information to their tax return preparer for 2014, but they didn’t report the Edward Jones distribution. On audit, IRS determined a $3,545 deficiency in the husband’s 2014 income tax return.

Although the husband admitted that he knew about the retirement account and about withdrawals made in other years for various family expenditures, he denied actual knowledge of the distribution. He argued that his wife deliberately deceived him and that he relied on her silence while not identifying any specific misrepresentations by her. He also acknowledged that he was at fault for not checking the joint bank account records.

But the wife disputed the husband’s credibility. She argued that he had actual knowledge of the 2014 distribution because it was deposited in their joint bank account about seven months before the return was prepared. He continued to write checks from the account and access funds by debit card.

Tax outcome: The Tax Court concluded that the husband should have known about the transaction, but it said that the lack of actual knowledge controlled in this case. Thus, it granted innocent spouse relief to the husband.

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