The recent Tax Court decision in the case of Allison O’Neil is one of the better ones. Well better is perhaps not quite right way to put it. Perhaps “more instructive”is what I have in mind. Most taxpayers and even most practitioners, including many divorce attorneys who should know better, fail to recognize the downside of signing a joint return. It creates joint and several liability. The IRS can extract the full amount of the tax from either one of the couple. What the divorce agreement or even the state courts say about who is responsible for the tax does not matter. The local probate court might say that the husband is responsible for the entire tax liability, but they can’t keep the IRS from going after the wife, if hubby does not pay up. For that you need the Tax Court.
The O’Neil case raises two practice points. One I constantly harp on. If the full amount of the joint tax is not going in with the joint return, the lower income spouse should probably not sign. Filing jointly is an election. An irrevocable election. If a separate return goes in with a higher tax due, it can be later amended. The joint and several liability cannot be undone, except through an innocent spouse proceeding, which we know from this and many other cases is anything but a piece of cake for the taxpayer. The second practice point concerns partnership income, which I will explain when we get to it. There is also a policy issue. One of the factors that is considered in innocent spouse cases is the existence of abuse. What constitutes abuse ? Here are some of the highlights of the case.
Michael and his partners sold a large Colorado project to Pulte Homes in 2005. He received a net gain of $268,000 from the deal, and used the money to pay his own expenses and provide for Allison and the children. What he didn’t do was set aside enough for the IRS—in 2005 and 2006, the O’Neils made only three estimated tax payments toward their 2005 tax liability, and the payments added up to less than $7,000.
When it came time to file their 2005 income tax return, the O’Neils got an extension until October 2006, though they did not include payment of the $13,000 they estimated they would owe. Michael gathered much of the information the couple used to prepare their return, but Allison collected at least some, such as the mortgage interest they paid and charitable contributions that they made and certain investment income that they received. She sent what she got to Michael’s accountant in Colorado. Michael sent two draft 2005 income tax returns back home, and Allison reviewed them. The couple also discussed their taxes and finances, even if not at great length.
The O’Neils’ Colorado gold soon turned to straw. One of Michael’s partners sued him over the allocation of the partnership’s profits, and in August 2006 a state court entered a $1.5 million judgment against him.
This pressed down on the O’Neils. In early October 2006, Michael gave Allison a draft return that differed substantially from the others—it reported the substantial additional income from the partnership’s 2005 sale to Pulte Homes and showed about $70,000 in unpaid tax liability. Allison reviewed the return, and challenged Michael about where this unexpected income came from. Her attorney reviewed the return, and she and her attorney both questioned Michael’s accountant, who did his best to explain why the tax was due.
Neither O’Neil could pay that large a tax bill at once, and they had no specific plan for how to pay this liability later on. Michael, for his part, told Allison that the additional income was an error and that he would get a different Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., that would negate the large tax liability. In October Allison signed the return and mailed it to the IRS. No payment accompanied it, and the IRS assessed the unpaid tax liability that it showed in November 2006.
Right there are the two practice points. What did the couple gain by filing a joint return ? Presumably the balance due would have been higher if Mr. O’Neil had filed a separate return. For talking purposes let’s say it would have been $90,000. It really does not matter. Mr. O’Neil appeared to be heading for bankruptcy. IRS will probably not be able to get $70,000 from him, so whether he owes $70,000 or $90,000 is, as a practical matter, not that important. By making it a joint return they can chase Mrs. O’Neil for the entire $70,000. In the event that within the next couple of years things got better and Mr. O’Neil was actually able to pay the $70,000, they could have amended to a joint return. They cannot, however, amend out of a joint return. The election is irrevocable.
The other practice point may have been something that was considered and rejected, but I think it is worth mentioning. Generally, a partner is stuck with whatever the K-1 of a partnership says. Changes need to be made at the partnership level. There is, however, a way of registering disagreement. You can attach Form 8082 – Notice of Inconsistent Treatment to your return. This is the type of situation where that might be considered. Perhaps, it was considered and rejected, but it is a procedure that many people are not aware is available.
What About Abuse And Financial Control ?
In Notice 2012-8 The IRS has made motions to be kinder and gentler in innocent spouse cases where there is abuse or financial control by the non-requesting spouse reasoning that the requesting spouse might have not been a free agent in signing the joint return. Mrs. O’Neil did not have any luck with either the IRS or the Tax Court in her request for relief on those grounds, though.
While both parties agree that abuse may weigh in favor of finding relief, they look at the facts here quite differently. Allison suggests that Michael was abusive within the meaning of Rev. Proc. 2003-61 because he lied to her repeatedly, “emotionally and psychologically bullied” her, and threatened her with “trouble” if she didn’t sign the return.
The Commissioner disputes this characterization of the O’Neils’ relationship. He notes that there is no documented evidence of abuse. He notes that the “threat” Michael allegedly lobbed at Allison was based upon the couple’s legal obligation to file and pay taxes, which Allison already knew. He observes that Michael was already separated from Allison by the time she signed the return—legally, and by substantial distance—and that she signed the return only after consulting with legal counsel, Michael, and his accountant.
We agree with the Commissioner. Allison appears not to have had a happy marriage with Michael. But we have no basis to find “bullying” or intimidation here—much less more substantial abuse.
This conclusion doesn’t change if we adjust the scope and standard of our review. Apart from alleging that she was “psychologically and emotionally bullied,” Allison introduced no evidence of abuse: The doctors’ reports she provided noted only that she was prescribed antidepressants, and that Michael was “secretive,” leading to great marital stress. She introduced no police reports, and no witness statements. We cannot say that the Commissioner erred when he concluded under the facts available to him at the time he made his final determination that Allison wasn’t abused. This factor is neutral for Allison no matter which standard and scope of review we use.
I asked activist lawyer Cathy Brennan to take a look at the decision. She thinks the Tax Court took too narrow a view.
This decision ignores the dynamics of an abusive relationship. In such a relationship, the abuser dominates all aspects of his partner’s life and uses all tactics available to him to control her. A woman in an abusive relationship seeks court redress not as a first resort, but as a last. That this decision fails to look deeper fails women struggling to escape abusive relationships.
I see the Tax Court’s point in that they were already separated and she did have legal advice. What I am scratching my head about is why she was advised to sign the return.
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Originally published on Forbes.com Dec 18th, 2012