Sample v. Commissioner

The $600,000 Split: When an IRS Visit Changes the Clock

More than $500,000 in combined tax liabilities hung in the balance as Judge Holmes dissected Jodell Sample’s plea for innocent spouse relief. Sample, married to a Minnesota dentist, sought relief under Section 6015, which provides mechanisms for a taxpayer to be relieved of joint liability from a tax return. While Judge Holmes granted equitable relief for tax years 2011 through 2013, he drew a line in the sand, denying relief for 2014, 2017, and 2018. The pivotal moment? A 2015 visit from an IRS revenue officer. This case underscores a crucial lesson for taxpayers: "innocence," in the eyes of the Tax Court, has a shelf life, particularly after the IRS starts asking questions.

The Dentist, The Manager, and The 'Temporary' Problem

As the Tax Court often observes, the path to tax liability can be paved with good intentions, or at least, assurances. Schara and Sample married in 1995. Schara owned a dental practice, and Sample became his office manager. The business was their primary income source. Sample, whose formal education ended with high school, relied on Schara for financial matters, signing joint tax returns without scrutiny. Schara managed their finances, reassuring her that he would resolve any issues. Though she worked alongside him, Sample showed little interest in the business finances.

Their tax troubles began well before the years in question. The couple failed to pay the tax due with their 2004 return, and it took them almost a decade to resolve that debt. They also had unreported income for 2008 and 2010. Then, starting in 2011, the couple stopped reporting all of their income to the IRS. Sample was aware of unpaid taxes before 2015, but Schara consistently assured her that these debts were "just temporary" and that he would take care of them.

In 2015, an IRS revenue officer visited the couple. The exact details of this visit become critical later in Judge Holmes's analysis.

In late March 2019, Sample and Schara legally separated after Sample discovered the full extent of their financial problems. The terms of the separation agreement were notably favorable to Sample. Schara agreed to be solely responsible for their federal and state tax debts. Sample received one of their shared cars, their main residence in Minnesota, a second home in Montana, and Schara's entire Section 401(k) account. Despite the legal separation, they continued to live together in their marital home, at least into 2021, a fact the court found significant.

Jurisdictional Mechanics: No Right to Endless Hearings

Despite the favorable terms of her separation agreement, which assigned sole responsibility for tax debts to her husband and awarded her significant assets, Jodell Sample found herself facing a procedural hurdle in Tax Court. She argued that the IRS, specifically the Cincinnati Centralized Innocent Spouse Operation (CCISO), denied her a fair hearing by failing to provide her with an opportunity to present new evidence and rebut the government's fact-finding.

Judge Holmes rejected this argument, pointing out that Sample had ample opportunity to present additional evidence at various stages of the administrative process but failed to do so. She chose not to submit supplemental material after filing her Form 8857, "Request for Innocent Spouse Relief." Moreover, she did not offer any "newly discovered or previously unavailable evidence" even when the case reached the Tax Court.

The court also addressed a key jurisdictional issue regarding the Collection Due Process (CDP) hearing for 2017. When the IRS seeks to collect taxes by seizing a taxpayer's property, Section 6330 requires the issuance of a notice of intent to levy, which informs the taxpayer of their right to a CDP hearing. Sample had requested innocent-spouse relief during her CDP hearing. The court emphasized that raising an innocent spouse defense in a CDP hearing effectively transforms the proceeding into a determination under Section 6015, which governs innocent spouse relief. Specifically, Section 6015(e)(7) dictates that the Tax Court review such determinations de novo, meaning "anew," and bases its decision on the administrative record and any newly discovered or previously unavailable evidence.

This is consequential because it establishes the Tax Court's power to review all years in question de novo, regardless of whether the innocent spouse claim was initially raised in a stand-alone petition or during a CDP hearing. This power to review all years anew also impacts the remedy the Court can provide. De novo decisions in Section 6015 cases prevent the Tax Court from sending the case back to the IRS for further consideration.

2014: The Year of Missing Wages

The Tax Court then turned to the question of relief for tax year 2014 under Section 6015(b). This section of the tax code provides relief from joint and several liability on a joint return if several conditions are met. These conditions are: a joint return was filed; there is an understatement of tax attributable to an erroneous item of the non-requesting spouse; the requesting spouse did not know and had no reason to know of the understatement at the time of signing the return; it would be inequitable to hold the requesting spouse liable for the deficiency; and the claim for relief is timely.

The court emphasized that all these conditions must be met for relief to be granted. Sample sought relief only for her 2014 tax year, but her request hinged on the third requirement: whether she knew or had reason to know about the understatement when she signed the 2014 return. The court clarified that it wasn't looking for knowledge of the specific amount of the understatement, but rather whether Sample was "aware of the circumstances that gave rise to the understatement of income," a concept referred to as the "knowledge-of-the-transaction" test.

The court acknowledged that Sample's level of financial sophistication was lower than her husband's. However, the court found that it did not take an accounting degree to realize the 2014 return was problematic. The return reported $0 business income, despite Sample working as the office manager in her husband's dental practice and being paid from the business's income. The court noted that prior joint returns from 2011-2013 had shown nearly $300,000 or more in annual business income.

The court then cited Treasury Regulation § 1.6015-2(c), which states that a failure to question items that a reasonable person would question at or before the time the return was signed creates an inference of knowledge. The court pointed out additional errors on the return, such as the failure to report Sample's own W-2 income, which should have prompted her to take a closer look.

The court concluded that, considering Sample's involvement in the business and the obvious errors on the return, it was more likely than not that she had reason to know of the understatement. It emphasized that Section 6015(b)(1)(C) is not intended to protect the "intentionally ignorant."

The court then shifted its analysis to Section 6015(c), which allows for the allocation of a deficiency between spouses who are divorced, legally separated, or not living together. To qualify for relief under 6015(c), a joint return must have been filed; the spouses must be divorced, legally separated, or not living in the same household for the 12 months preceding the relief request; the requesting spouse must seek relief within two years of the IRS's first collection activity; the spouses must not have transferred property to avoid tax; and the requesting spouse must not have had actual knowledge of the items giving rise to the deficiency at the time the return was signed.

The court noted that, unlike Section 6015(b), the IRS bears the burden of proving that the requesting spouse had actual knowledge of the item giving rise to the deficiency, not just what a reasonably prudent person would have known. Despite this higher burden, the court found that the IRS had demonstrated that Sample had actual knowledge that her husband's dental practice was earning income that should have been reported. While acknowledging Sample's lack of financial sophistication, the court emphasized that she worked at the business and knew it was the family's primary source of income. Therefore, the court concluded it was more likely than not that she actually knew the dental practice was earning income.

The Timeline of Equity: Ignorance Before, Knowledge After

The Tax Court, in its equitable relief analysis under Section 6015(f), divided Ms. Sample's claims into two distinct periods, hinging on the 2015 IRS visit to the dental office. Section 6015(f) provides a path for taxpayers to seek "equitable relief" from joint tax liability, available only if they don't qualify for relief under other subsections of Section 6015. This analysis is guided by Revenue Procedure 2013-34, which outlines threshold requirements, streamlined relief conditions, and a multifactor balancing test.

For the years 2011 through 2013, the court sided with Ms. Sample, finding that she reasonably believed her husband's assurances that the tax debts were temporary and would be paid. The court noted that at the time she signed the joint returns, she had little reason to suspect any issues with their accounts, further solidifying the court's conclusion that it was more likely than not Sample did not know or have reason to know that Schara would not be able to cure the underpayment.

However, the tide turned in 2015. For the 2014, 2017, and 2018 tax years, the court denied equitable relief, concluding that Ms. Sample had "reason to know" her husband was not fulfilling his tax obligations. Specifically, the court pointed to the IRS's visit to the dental office in 2015 as a pivotal moment. This event, the court reasoned, should have alerted Ms. Sample to the severity of their tax situation. Further solidifying this finding, the court emphasized the defensive legal separation initiated in 2019, shortly after the Department of Justice filed suit to foreclose on Sample’s residence to collect unpaid federal tax liabilities, as evidence that she knew her husband was not paying their taxes.

The court also addressed the possibility of "streamlined relief" under Section 4.02 of Revenue Procedure 2013-34, which requires, among other things, that the requesting spouse would suffer economic hardship if relief was not granted. The court found that Ms. Sample did not meet this requirement. Despite being legally separated, she still lived with her husband. Ms. Sample reported a significant monthly income of $12,000 (wages and alimony) and assets totaling $896,693. The court concluded that she could "make payments towards the tax liability" while still maintaining a reasonable standard of living, thereby disqualifying her from streamlined relief.

The Knowledge Horizon

The Tax Court, in its review of Ms. Sample's case spanning the 2011, 2012, 2013, 2014, 2017, and 2018 tax years, drew a firm line in 2015, the year Ms. Sample learned of the IRS's visit. Before this pivotal moment, the court acknowledged her reasonable ignorance regarding her husband's underpayments for 2011 through 2013. However, the court also concluded that she possessed knowledge of the substantial understatements, particularly starting with the 2014 return. The lesson is clear: innocent spouse relief under Section 6015 can shield a taxpayer from a partner's financial misdeeds, but the protection wanes once an external event, such as an IRS inquiry, unveils the deception. At that point, the 'innocent' spouse assumes a responsibility to extricate themselves from the financial entanglement. The court, therefore, granted Ms. Sample equitable relief under Section 6015(f) for the 2011 through 2013 tax years but denied relief for 2014, 2017, and 2018, holding her liable for the periods after she should have reasonably known of the tax issues.