Sanders v. U.S.

Decision Date07 March 1975
Docket NumberNo. 74--1862,74--1862
Citation509 F.2d 162
Parties, 75-1 USTC P 9297 Bettye A. SANDERS, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant
CourtU.S. Court of Appeals — Fifth Circuit

Scott P. Crampton, Asst. Atty. Gen., Tax Div., Dept. of Justice, Washington, D.C., Wayman G. Sherrer, U.S. Atty., Charles D. Stewart, Asst. U.S. Atty., Birmingham, Ala., Benton Burroughs, Jr., Meyer Rothwacks, Chief, Appellate Sec., Ernest J. Brown, Elmer J. Kelsey, Liberto Marinelli, Jr., Michael L. Paup, Tax Div., Dept. of Justice, Washington, D.C., for defendant-appellant.

Richard J. Cohn, Robert B. Eubank, Birmingham, Ala., for plaintiff-appellee.

Appeal from the United States District Court for the Northern District of Alabama.

Before THORNBERRY, COLEMAN and ROSENN, * Circuit Judges.

THORNBERRY, Circuit Judge:

This is a refund suit for taxes paid by appellee, Mrs. Bettye Sanders, with respect to calendar years 1968 and 1969. Bettye and her husband Charles, who died of a heart attack on November 2, 1970, filed joint income tax returns for these two years. All gross income for the period in question, except $2,058.75, was earned by Charles. In midsummer 1971 the IRS assessed deficiencies amounting to just over $30,000.00 against appellee and Charles's estate because of the Commissioner's discovery, using the so-called bank deposits plus expenditures accounting method, of substantial unreported income received by Charles during the tax years here in issue. 1 Since the estate was insolvent, Mrs. Sanders paid the entire assessment. She then brought this suit to recover the sums paid, claiming that she was an 'innocent spouse' protected by 26 U.S.C. § 6013(e) (1971). After a nonjury trial the district court entered judgment in appellee's favor and filed an opinion. 2 We affirm.

Married taxpayers who choose to accept the benefits of filing a joint tax return are in turn jointly and severally liable for the tax due on their combined incomes. 26 U.S.C. § 6013 (1967). Because this joint and several liability often produced hardship on an 'innocent spouse' whose marriage partner received substantial unreported income and then disappeared, leaving the spouse to pay a large deficiency, 3 Congress in 1971 enacted § 6013(e):

(1) In General.--Under regulations prescribed by the Secretary or his delegate, if--

(A) a joint return has been made under this section for a taxable year and on such return there was omitted from gross income an amount properly includable therein which is attributable to one spouse and which is in excess of 25 percent of the amount of gross income stated in the return,

(B) the other spouse establishes that in signing the return he or she did not know of, and had no reason to know of, such omission, and

(C) taking into account whether or not the other spouse significantly benefited directly or indirectly from the items omitted from gross income and taking into account all other facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for such taxable year attributable to such omission, then the other spouse shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent that such liability is attributable to such omission from gross income.

The government does not now dispute the district court's finding that appellee meets the requirements of (e)(1)(A), but it does vigorously contest the conclusion that appellee qualifies under (e)(1)(B) and (e)(1)(C). In the interests of clarity we will discuss separately the district court's findings and conclusions concerning the contested subsections.

I. Section 6013(e)(1)(B)

The lower court found that Mrs. Sanders 'did not know, or have reason to know, of the omissions of gross income attributable to Charles from their 1968 and 1969 joint income tax returns.' 369 F.Supp. at 163. As to actual knowledge the judge simply credited Mrs. Sanders's testimony that she knew nothing of the omitted items of income. This finding of fact, turning as it does entirely on a credibility determination by the trial judge, comes to us with a strong presumption of correctness. It is not clearly erroneous. Fed.R.Civ.P.52(a). Accordingly we must turn our attention to the government's primary contention relating to this subsection: Did the district judge apply an erroneous legal standard in determining that Bettye Sanders had no reason to know of the unreported income? 4 The lower court cited a number of factors that led it to conclude that appellee met the 'no reason to know' test: (1) Charles's financial affairs were complex and took even the IRS a good deal of time to unravel; (2) appellee was a high school educated housewife who during this period was having severe emotional problems heightened by heavy alcoholic consumption; (3) Charles rarely confided in appellee concerning his business affairs; (4) appellee placed great trust and reliance on their accountant, whom she had recommended to her husband; (5) although appellee typed letters for her husband concerning the transactions that resulted in the unreported income, she is an experienced typist who types without comprehension of her material; and (6) although appellee balanced checkbooks for her husband that showed large deposits in excess of reported income, this was insufficient to convey knowledge because it took the IRS over 100 manhours to deduce the omissions from the same checkbooks. Finally, to explain in part why a new home with interior and exterior improvements, new expensive automobiles each year, gambling trips to Las Vegas, and a new condominium in the Bahamas did not put appellee on notice of omissions from gross income, the court noted 'that the cost of the house was relatively modest; that it was mortgaged heavily; that the condominium likewise represented only an equity investment, and was bought with borrowed money . . ..' 369 F.Supp. at 165. As we understand its position, the government makes no real challenge to these individual factfindings but instead questions whether, in light of the circumstances of this case, the district court has not read the 'no reason to know' requirement too liberally in the taxpayer's favor.

The government suggests that subparagraph (B) puts the burden on the taxpayer to prove that she was 'completely without fault and could not possibly have discovered the omission before executing the returns.' (Appellant's Brief at 17.) The taxpayer, on the other hand, suggests that the highest permissible standard of care would be what a reasonable person in the taxpayer's subjective position would have discovered. (Appellee's Brief at 18--19.) The district court seems to have adopted appellee's standard, for the opinion states that 'plaintiff has proven to the Court's satisfaction that, as a reasonably prudent taxpayer, she had no reason to know of the omissions.' 5 369 F.Supp. at 166 (emphasis added).

We agree with Mrs. Sanders that the government's proposed test is too stringent and thus inconsistent with the remedial purpose of § 6013(e). Admittedly the statute was passed as an exception to the normal rule of joint and several liability. Jerome J. Sonnenborn, 57 T.C. 373, 380 (1971). But Congress intended the exception to remedy a perceived injustice, and we should not hinder that praiseworthy intent by giving the exception an unduly narrow or restrictive reading. 6 Moreover, the test suggested by the taxpayer and apparently adopted by the district court is in line with the usual legal understanding of the phrase 'reason to know':

A person has reason to know of a fact if he had information from which a person of ordinary intelligence which such person may have, or of the superior intelligence which such person may have, would infer that the fact in question exists or that there is such a substantial chance of its existence that, if exercising reasonable care with reference to the matter in question, his action would be predicated upon the assumption of its possible existence.

Restatement (Second) of Agency § 9, comment d (1958). Finally, we do not read the opinions by other courts who have been called upon to construe this language in (e)(1)(B) as inconsistent with the standard that we today approve. Although the Tax Court has cited a number of factors that it believes can be decisive in making the 'reason to know' determination--factors that we will examine shortly when deciding whether the district judge clearly erred here--its opinions offer scant support for the strict reading suggested by the government. 7

It remains only for us to determine, then, whether the district court clearly erred in concluding that Bettye Sanders had no reason to know of the omissions from gross income on the joint returns. 8 The question is close, even under the lower court's less restrictive reading of (e)(1)(B). Examination of the cases suggests at least three factors that courts have thought significant in deciding whether a spouse had reason to know of omissions from gross income: (1) unusual or lavish expenditures; 9 (2) participation in business affairs or bookkeeping; 10 and (3) the 'guilty' spouse's refusal to be forthright about the couple's income. 11 The district court here added at least three more: the claimant spouse's emotional condition during the period in question, the complexity of the financial transactions that produced the funds, and the complexity of the method used by the IRS for deducing the omissions.

In Patricia E. Mysse, 57 T.C. 680 (1972), a wife whose husband had embezzled large sums of money from the bank where he worked and neglected to report these amounts as gross income was held to satisfy (e)(1)(B), but the court warned that spouses would not be allowed to 'close . . . (their) eyes to unusual or lavish expenditures.' 57 T.C. at 699. As noted, the district judge in this case apparently accepted appellee's explanation of why...

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