Innocent Spouse Relief

Contreras v. Comm’r , T.C. Memo. 201912, 2019 WL 980695 (2019)

(a) Facts: Husband and wife had two children. The husband ran a construction business, while the wife was a homemaker. The parties were divorced in 2011.

The husband brought into the marriage a piece of real property called Lot 13, and during the marriage the parties acquired an adjoining parcel, Lot 12. In 2005, the husband conveyed to the wife half of Lot 13, and he built a home upon it.

During the marriage, the wife was regularly subjected to physical abuse. The police were called to the home repeatedly, and the parties’ daughter witnessed the abuse. The abuse was so severe that the wife at times took the children and stayed with her grandmother. In 2010, the wife obtained a temporary restraining order against the husband on the ground of domestic violence.

The final divorce decree included provisions to protect the wife and children from further abuse. It awarded the wife half of Lot 12 and half of Lot 13, securing the entire property division award (including a monetary award to divide other assets) with a lien. The husband failed to pay the award, and in 2012, the husband transferred both Lot 12 and Lot 13 to the wife to satisfy the judgment.

It is difficult to understand why the IRS took the position that the wife’s foreclosure on Lots 12 and 13 was fraudulent, when she was clearly responding to the husband’s failure to comply with the divorce decree.

The husband had substantial tax liability from 2008, and to satisfy that liability, the IRS sought to foreclose upon Lots 12 and 13. In IRS proceedings arising from the 2008 deficiency, the husband and the wife had the same counsel, paid by the husband, even though they had been divorced for over a year. The IRS declined to respond to the wife’s questions and referred her to the husband’s counsel.

The wife filed a petition for discretionary innocent spouse relief, claiming expressly that she signed the returns at issue under duress. The IRS denied relief, and the wife sought review in the Tax Court.

(b) Issue: Was the wife entitled to discretionary innocent spouse relief?

(c) Answer to Issue: Yes.

(d) Summary of Rationale: The fourth threshold condition for discretionary innocent spouse relief provides that relief is not available if assets were fraudulently transferred between the spouses. The IRS claimed that the transfers of Lots 12 and 13 were fraudulent. To the contrary, the transfers were made, with the guidance of wife’s divorce attorney, as payment for obligations placed upon the husband by the divorce decree. The transfers were recorded publicly and were not hidden from the IRS. They were not fraudulent transfers.

The first safe harbor condition, which requires that the parties be divorced, was clearly met. The second condition requires proof of economic hardship. The wife had income of $3,371.66 per month and expenses of $4,600 per month. She relied on child support and government assistance to make ends meet. Her income was below 250% of the federal poverty guidelines and would fall under that amount even if income were imputed to her. The IRS argued that the wife could sell her real property, but that would leave her homeless. The court held that economic hardship was present.

The third safe harbor condition requires proof that the requesting spouse did not have reason to know that the tax would not be paid. The wife did not know the husband’s income during the marriage, and she had no involvement with his business, Thus, she had no way to know he would not pay taxes.

The wife did know before signing some of the returns that the husband had not complied with his financial obligations under the divorce decree. Therefore, she had some reason to suspect that he would not pay the overdue taxes either. But the husband’s long-term abusive conduct limited the effect of the wife’s knowledge. The wife even attempted to ask questions about the overdue taxes, but the IRS only referred her to counsel –who was paid by the husband. The wife “was not a willing participant in filing the joint returns, but rather a victim still being controlled by her exhusband’s actions.” 2019 WL 980695, at *22.

Because all of the safe harbor conditions were met, the court granted discretionary innocent spouse relief.

Observations:

1. Contreras is another example of the type of case at which the recent innocent spouse reforms were aimed. It is difficult to understand why the IRS took the position that the wife’s foreclosure on Lots 12 and 13 was fraudulent when she was clearly responding to the husband’s failure to comply with the divorce decree. It is appalling that the IRS apparently suspected some sort of collusive behavior between the husband and wife despite a long history of physical abuse documented by repeated police visits and by the findings in the divorce decree. The IRS’s lack of sensitivity to the wife’s difficult economic situation is also hard to explain.

2. The fact that the IRS did not contest Hiramanek is some evidence that the IRS is becoming more sensitive to abuse issues. The fact that the IRS did contest Contreras is strong evidence that more progress is necessary.

Question: Did valid joint returns exist at all in Contreras? The wife would seem to have an argument that she signed the returns under duress. See Hiramanek. But she did not expressly argue that the joint returns were invalid.