John R. Bullis: IRS fails again: Tax relief granted to innocent spouse

Windy and Richard Harris filed their 2011 individual income tax return. In 2012 they separated and then were divorced. The tax return reported her sole owner business as a real estate agent and a second Schedule C with Windy and Richard as proprietors of “Harris Stables.” He bought about 20 acres to do the activity-first to raise horses and later to raise cattle.

The “Harris Stables” business showed gross income of $1,598 and expenses of $134,875. The main expense was depreciation expense of $123,681 of a 6,000-square-foot barn and related items.

In 2013 IRS audited the return and gave a notice of deficiency of $30,467. IRS denied Windy’s request for relief (relief meaning she doesn’t have to pay) from the joint and several liability as an “innocent spouse.”

Section 6015(b) of the internal revenue code provides full or part relief from the joint and several liability for an understatement of tax. The requesting spouse must establish he or she “did not know, and had no reason to know” of the understatement. The requesting spouse (the one asking to not be required to pay) signed the return. If a reasonably prudent person in her position when she signed could be expected to know the return was wrong, then she is liable and does not get relief.

Windy agreed she reviewed the return before she signed it. The court said she had reason to know of the understatement and Section 6015(b) means she is liable.

However, Section 6015(c) has an election to treat former spouses as if they had filed separate returns and each spouse has liability for the part of the deficiency (tax owed) that is properly allocable to the electing spouse (the one asking for relief from paying). The conditions required are a joint return was filed; the requesting spouse is no longer married to the other spouse; section 6015(c) is elected within two years after IRS begins collection activity; and the deficiency is unpaid.

IRS said she did not get relief and she had to pay. It is another case where IRS had the wrong idea.

The court found nearly the entire tax due for 2011 was allocable to Mr. Harris, not to Windy. Even though the indication for “Harris Stables” was showing both of them as owners, his cattle ranching activity was what was reported on that Schedule C. The court also determined that Windy was not involved in that activity. Also the court found the activity was not done with an intent of making a profit. Since IRS failed to prove she knew he did not have a profit intent, she is entitled to relief.

Did you hear? “Be wary of the man who urges an action in which he himself incurs no risk,” by Joaquin Setanti.

John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.