Tax Court denies innocent spouse relief to wife of "compulsive spender"

The Tax Court recently denied a taxpayer equitable spouse relief, agreeing with the IRS that she did not satisfy the requirements for relief under Code Sec. 6015(f)'s safe harbor provision. The taxpayer had knowledge that her husband would not pay the tax liability at issue and she would not suffer any economic hardship if relief was denied.

Living large

The taxpayer and her husband enjoyed a very extravagant lifestyle while they were married. However, the husband was a compulsive shopper, a problem that the taxpayer was fully aware of. Thus, more often than not, the couple's expenses exceeded their income. They eventually sold their $2.2 million Beverly Hills home in 1990, relocating to a $900,000 home to reduce costs. The couple used a $220,000 distribution from the husband's individual retirement account (IRA) in 1993 to pay the expenses that were necessary to maintain the comfortable lifestyle to which they were accustomed. Plagued by continuing financial problems, they filed for bankruptcy in 1994.

The taxpayer and her husband filed a joint income tax return for the 1993 tax year, which showed an underpayment of $81,000. In 1995, the couple divorced. In addition to paying the taxpayer monthly spousal and child support, the divorce settlement required the taxpayer's ex-husband to pay the 1993 underpayment of tax. In 2004, the taxpayer filed a request for equitable spouse relief for $55,000 of the underpayment.

Knowledge that husband would not pay

The Tax Court found that the IRS had rightly denied the taxpayer's request for equitable innocent spouse relief. First, the court determined that it was not reasonable for the taxpayer to believe that, at the time she signed the 1993 joint return, her ex-husband would pay the underpayment in light of their recent bankruptcy filing. Additionally, the taxpayer had knowledge of their financial problems during the marriage because she paid the bills. The court found this fact further deprived her of making the claim that she believed her ex-husband would pay the liability. Moreover, although the couple's divorce agreement obligated the ex-husband to pay the liability, the taxpayer knew at the time she entered into that agreement he was unlikely to do so.

No economic hardship

The court next determined that the taxpayer would not suffer any economic hardship if relief was denied. A denial of equitable innocent spouse relief will generally be found to impose economic hardship if the requesting spouse cannot pay basic reasonable living expenses. However, the court reinforced, reasonable living expenses do not include amounts needed to maintain a luxurious lifestyle, such as the taxpayer was currently living. The taxpayer, for example, was making monthly lease payments of $600 on a BMW.

Moreover, the court determined that the taxpayer had sufficient disposable income to apply to the tax liability. Not only did she earn $1,000 a month from her salary, but she was also receiving $4,500 a month in spousal support at the time she filed the request for relief. Moreover, she had assets available to satisfy the tax liability, including a $500,000 townhouse with $80,000 of equity and an interest in her ex-husband's pension. The court found it irrelevant that the ex-husband had a higher income and not as many expenses as the taxpayer, and could therefore more satisfy the liability more easily.

(Stolkin, TC Memo 2008-211)