Originally published on Forbes.com.
Filing a joint return usually produces a lower tax than filing two separate returns. There is a disadvantage though – joint and several liability. Regardless of which half of the couple generated the income (or spent it), the IRS can collect any balance due, including one from an audit, from either spouse.
Joint Filing Is Elective
Here is something very important that does not sink in very well. Filing a joint return is an election, an irrevocable election. You don’t have to do it. And there are times, when you should clearly not. A recent Seventh Circuit appeal of a Tax Court innocent spouse decision has me screaming – What were you thinking? – at the unsuccessful appellant.
Background
The real names of the couple are of course in the public record and you can find them in the decision, but not wanting to add to their fame, I will call them Joe and Mary.
Mary, an accountant, took care of all the couple’s finances. She worked for a blood bank where she processed payables and issued checks to vendors. Vague memories from the CPA exam make me think there might be a separation of duties problem there.
Joe worked as a machine operator 14 shifts of 12 hours per month. In his “spare time”, he inspected homes for financial institutions and insurance companies. The machine operator wages went into his own bank account. The other income went into the joint account Mary tended.
I don’t know if it was that separation of duties thing, I noted, but in June 2011, Mary was arrested and charged with stealing $450,000 from her employer.
An Innocent Spouse
The court found Joe’s claims that he knew nothing of the embezzlement quite credible.
“First, as discussed above, ————- was for the most part completely uninvolved with the couple’s finances. Specifically, he never reviewed bank or credit card statements, nor did he look over their personal or business finances, which ————- managed. Nor would have reviewing their finances necessarily have alerted him to —————- embezzlement given her practice of depositing the embezzled funds via check into the couple’s joint account. These checks would have been difficult to distinguish from the checks for the home inspection business, which were also made out to ————- and tended to be for similar amounts.”
That embezzlement income created a tax problem. There were deficiencies for 2009, 2010 and 2011 mostly but not entirely due to the embezzlement income. Joe claimed innocent spouse status for all three years.
2009 ended up being moot because by the time the Tax Court got to it in 2018, the liability had been discharged in bankruptcy. For 2010, Joe got off as he checked off the required boxes for relief under Code Section 6015(b).
Not 100%
Joe did not get relief for 2011, though. The reason is that when it came to doing that return in 2012, Mary being in prison and all, Joe handled organizing the information and bringing it to the preparer. And he did not tell the preparer about the embezzlement.
It is possible to get innocent spouse relief under Code Section 6015(f) based on it being inequitable to hold the taxpayer liable. The knowledge of the embezzlement and the involvement in the preparation of the 2011 return was too much to for Joe to overcome, though.
Joe had argued that he didn’t know exactly how much had been embezzled, but that did not get him anywhere.
“The Tax Court noted that by the time he filed the return in April, ———— was aware of ————— arrest in June of 2011, her conviction in November 2011 of embezzling $485,681, and her January 2012 sentence to incarceration and restitution. ————— cites no authority, nor are we aware of any, suggesting that a finding of actual knowledge would be precluded by the fact that a petitioning spouse may not, as a result of his own lack of investigation, be aware of the precise amount of embezzlement, particularly when he has not offered any explanation as to why he failed to access that information.”
Some Sympathy
The appeal ended up not getting Joe anything other than a goodly amount of sympathy.
“We are sympathetic to —————— situation, and recognize that the Tax Court could have easily decided on this record that ————- was entitled to equitable relief under
§ 6015(f). Indeed, were we deciding the case in the first instance as opposed to on deferential review, we may have decided the case differently. “
The fine points of the innocent spouse issue make this case worth studying, but that is not my main takeaway. I look back to April 2012, when Joe is arranging his tax filing. He was still married and the couple did not become estranged until later, so it made sense for him to help arrange Mary’s tax compliance.
Worst Joint Return Decision I Have Seen
But it is hard to see a compelling reason for him to file jointly with her. He knew she had been embezzling – just not exactly how much. I have been noting these cases for a long time, and Joe takes the cake for the most egregious example of somebody who should not have filed jointly.
Looking back over the last decade, I have seen that I have written about this too many times to mention, so I will just refer you to this one piece, which sums it up pretty well.
Other Coverage
Dylan Moroses covered the decision behind the Law360 paywall.
Bloomberg Tax has Taxpayer First Act Doesn’t Apply in $450,000 Embezzlement Case behind its paywall.
Laura Saunders had a really good story in the Wall Street Journal on the original Tax Court decision including an interview with “Joe”.
This case attracted the attention of the Federal Tax Clinic at Harvard Law School. Here is the appellate brief prepared by Professor T. Keith Fogg.
Carlton Smith who was also representing the taxpayer has this on Procedurally Taxing.
“Keith and I hoped a reversal of the Tax Court in the ———- case would have a salutary effect on Tax Court judges not to overweigh the actual knowledge factor. And, this would be the first appeals court to ever have to apply Rev. Proc. 2013-34 (surprisingly). Then, during briefing of the appeal, Congress enacted the Taxpayer First Act, which amended section 6015(e) to add paragraph (7) providing that the Tax Court should decide innocent spouse cases on a de novo standard and a supplemented administrative record. Because the amendment applied to pending cases, the —————- Seventh Circuit opinion would also be the first to consider the impact of subsection (e)(7) on appellate review.”