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Innocent Spouse Relief Granted Due to Lack of Knowledge or Control of Corporate Finances. (Parker Tax Publishing November 13, 2014)

Despite being listed as a director and incorporator, the taxpayer had no access to or control over corporate accounts, and had no knowledge of the distributions to her husband that gave rise to a tax deficiency; thus, the taxpayer was entitled to innocent spouse relief. Varela vs. Comm'r, T.C. Memo. 2014-222 (10/22/14).

Jose Lozano was the president and sole shareholder of JL Unique Homes (JL), a C corporation engaged in the business of building homes. His wife, Elizabeth Varela, was initially named a director and incorporator of the company, but was never employed by JL, never performed any services as a director, and never received dividends; her only contribution was to briefly help a new office manager organize paperwork.

Mr. Lozano paid his share of household and other expenses out of JL's corporate accounts. Ms. Varela did not have access to those accounts or to the corporation's books and records. She did not learn of Mr. Lozano's withdrawal of funds from the corporation until 2010. In addition, on their 2007 and 2008 returns, Ms. Varela and Mr. Lozano reported, among other items, wages, nonemployee compensation from JL, and a capital gain. Attached to each of the returns was a Schedule E, Supplemental Income and Loss, on which they reported losses in connection with several rental properties. Only Mr. Lozano and JL's employees, not Ms. Varela, had information relating to the income and expenses associated with the rental properties. The properties were managed by Mr. Lozano and JL's employees, and rents received went to an account to which Ms. Varela did not have access.

After examining the couple's joint returns for 2007 and 2008, the IRS determined that the withdrawals were constructive dividends, made adjustments to the rents and expenses reported in connection with the rental properties and assessed a deficiency. Ms. Varela did not contest the adjustments, but filed a petition for innocent spouse relief on the grounds that she had no knowledge of her husband's withdrawals from JL and no knowledge of the understatement with respect to the rental properties.

Generally, under Code Sec. 6013(d)(3), married taxpayers are jointly and severally liable for the tax reported or reportable on their returns. Code Sec. 6015, however, allows a spouse to obtain some relief from liability in certain circumstances. Code Sec. 6015 provides for three types of innocent spouse relief:

(1) full or apportioned relief under Code Sec. 6015(b),

(2) proportionate tax relief for divorced or separated taxpayers under Code Sec. 6015(c), and

(3) equitable relief under Code Sec. 6015(f) when relief is unavailable under the other sections.

In particular, Code Sec. 6015(b) provides relief to a joint filer if on the joint return there is an understatement of tax attributable to one of the filers, the other establishes that he or she neither knew nor had reason to know of the understatement when the return was signed, and it would be inequitable to hold that filer liable for the other's error. Under Alt v. Comm'r, 119 T.C. 306 (2002) factors to consider in determining if liability would be inequitable include (1) whether there has been a significant benefit to the spouse claiming relief and (2) whether the failure to report the correct tax liability on the joint return results from concealment, overreaching, or any other wrongdoing on the part of the other spouse.

Over the protests of Mr. Lozano, the Tax Court and the IRS agreed that Ms. Varela was entitled to full relief under Code Sec. 6015(b). The court noted that both the 2007 and 2008 returns contained understatements of tax attributable to constructive dividends from JL and erroneous deductions for rental property expenses, all of which were attributable to Mr. Lozano. Additionally, even though Ms. Varela was listed as a director and incorporator of JL, she could avoid liability, as she did not actually participate in the management of the company, was never issued formal stock certificates, and never received a formal dividend. Ms. Varela also had no hand in managing the rental properties, nor did she have access to information about the related expenses.

Finally, the court found that Ms. Varela neither knew nor had reason to know of the understatements of tax, as she had no access to either Mr. Lozano's or JL's bank accounts, and thus could not know that he was improperly withdrawing funds from the company. The court realized Mr. Lozano concealed the fact that the withdrawn funds were inappropriately taken from JL, and Ms. Varela did not learn of his withdrawal of the funds until 2010, during the couple's divorce proceedings. Moreover, while the funds were used to pay household expenses for the family, the court was convinced that Ms. Varela did not receive a benefit that is traceable to the funds beyond ordinary support. Thus, the Tax Court held that Ms. Varela had established that she was entitled to relief from joint and several liability under the innocent spouse relief provisions of Code Sec. 6015.

For more on innocent spouse relief, see Parker Tax ¶ 260,560. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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