Cheshire v. C.I.R., No. 00-60855.

• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)
• Writing for the Court: King
• Citation: 282 F.3d 326
• Parties: Kathryn CHESHIRE, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Docket Number: No. 00-60855.
• Decision Date: 08 February 2002

282 F.3d 326 Kathryn CHESHIRE, Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. No. 00-60855. United States Court of Appeals, Fifth Circuit. February 8, 2002.

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John Edward Leeper (argued), Law Office of Joseph Abraham, Jr., El Paso, TX, for Petitioner-Appellant.

Joan I. Oppenheimer (argued), David English Carmack, U.S. Dept. of Justice, Tax Div., Charles Casazza, Clerk, U.S. Tax Court, Richard W. Skillman, Chief Counsel, Eileen J. O'Connor, Asst. Atty. Gen., U.S. Dept. of Justice, Washington, DC, for Respondent-Appellee.

Appeal from the Decision of the United States Tax Court.

Before KING, Chief Judge, DAVIS, Circuit Judge, and VANCE, District Judge.^*

KING, Chief Judge:

The Commissioner of Internal Revenue assessed a tax deficiency and associated penalties against Petitioner — Appellant Kathryn Cheshire. In the United States Tax Court, Cheshire asserted claims for innocent spouse relief from the tax deficiency and penalties under § 6015(b), (c), and (f) of the Internal Revenue Code. 26 U.S.C. § 6015 (Supp.2001). The Tax Court denied Cheshire's request for innocent spouse relief, and Cheshire appeals that denial. For the following reasons, we AFFIRM the judgment of the Tax Court.

I. Factual History

The facts in this case are undisputed. Kathryn Cheshire ("Appellant") married David Cheshire in 1970. More than twenty years later, Mr. Cheshire retired from Southwestern Bell Telephone Company effective January 1, 1992, and received the following retirement distributions in 1992:

Lump sum distribution $199,771
                LESOP for salaried
                employees 5,919
                Savings plan for salaried
                employees 23,263
                ESOP 971
                 --------
                TOTAL $229,924
                

Of the $229,924 total distribution, $42,183 was rolled over into a qualified account and is not subject to federal income tax. Mr. Cheshire deposited $184,377 of the retirement distributions into the Cheshires' joint checking account, which earned $1168 in interest for 1992.¹ Appellant knew of Mr. Cheshire's receipt of $229,924 in retirement distributions and of the $1168 in interest earned on the distributions.

The Cheshires made several large disbursements from the retirement distributions in their joint checking account. They withdrew $99,425 from this account to pay off the mortgage on their marital residence, and they withdrew an additional $20,189 to purchase a new family car, a 1992 Ford Explorer. Mr. Cheshire also used the retirement proceeds to provide start-up capital for his new business, to satisfy loans taken out to acquire a family truck and an automobile for the Cheshires' daughter, to pay family expenses, and to establish a college fund for the Cheshires' daughter. Appellant knew of all these expenditures.

Appellant and Mr. Cheshire filed a joint federal income tax return, prepared by Mr. Cheshire, for 1992. On line 17a of this

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return, they reported the $199,771.05 in retirement distributions² but claimed only $56,150.12 of this amount as taxable. Before signing the return, Appellant questioned Mr. Cheshire about the tax consequences of the retirement distributions. Mr. Cheshire replied that John Daniel Mican, a certified public accountant, advised Mr. Cheshire that retirement proceeds used to pay off a mortgage are nontaxable. Appellant accepted this answer and made no further inquiries prior to signing the return on March 14, 1993. In fact, Mr. Cheshire had not consulted Mican, and all retirement proceeds that are not rolled over into a qualified account are taxable. Because of Mr. Cheshire's persistent problems with alcohol, the Cheshires permanently separated on July 13, 1993, and they divorced seventeen months later. The divorce decree awarded Appellant unencumbered title to the marital residence and to the Ford Explorer.

The Commissioner of Internal Revenue (the "Commissioner") audited the Cheshires' 1992 return and determined that Mr. Cheshire had received taxable retirement distributions of $187,741 — the difference between the total distributions ($229,924) and the rollover ($42,183). Thus, the Cheshires had understated the amount of their taxable distributions by $131,591. The Commissioner also determined that the Cheshires had underreported the interest income earned on the retirement distributions by $717. Because of these inaccuracies, the Commissioner imposed a penalty under § 6662(a) of the Internal Revenue Code.³

II. Procedural History

Appellant commenced this action in the Tax Court. She conceded that $131,591 of the retirement distributions and the corresponding earned interest were improperly excluded from taxable income. She claimed, however, that she was entitled to relief as an innocent spouse under § 6015(b),⁴ § 6015(c),⁵ or § 6015(f)⁶ of the

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Internal Revenue Code. 26 U.S.C. § 6015. Prior to trial, the Commissioner conceded that Appellant qualified for innocent spouse relief with respect to the LESOP distribution ($5919), the savings plan distribution ($23,262), and the ESOP distribution ($971). Consequently, the taxable income from the retirement distributions and the corresponding earned interest remaining in dispute totaled $101,438 and $691, respectively. These amounts roughly correspond to the improperly deducted amounts that the Cheshires used to pay off their mortgage.

The Tax Court majority, consisting of twelve judges, denied Appellant relief under § 6015(b), (c), and (f). Cheshire v. Comm'r, 115 T.C. 183, 2000 WL 1227132 (2000). The Tax Court found that Appellant failed to establish that she "did not know, and had no reason to know" of the tax understatement as required for relief under § 6015(b)(1)(C). Id. at 193. The Tax Court also found that Appellant was not entitled to relief under § 6015(c) because she had "actual knowledge... of any item giving rise to a deficiency" within the meaning of § 6015(c)(3)(C).⁷ Id. at 197. Finally, the Tax Court held that the Commissioner did not abuse his discretion in denying Appellant equitable relief under § 6015(f) with respect to the retirement distributions and the interest income, as well as the § 6662(a) penalty associated with the interest income.⁸ Id. at 198.

III. The Statutory Scheme

Generally, spouses who choose to file a joint return are subject to joint and several liability for tax deficiencies under the Internal Revenue Code. 26 U.S.C. § 6013(d)(3) (Supp.2001). Recognizing that joint and several liability may be unjust in certain circumstances, Congress authorized relief from such liability under the "innocent spouse" provision, 26 U.S.C. § 6015. Section 6015 provides three distinct types of relief for taxpayers who file joint returns.⁹ First, § 6015(b) provides

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relief for all joint filers who satisfy the five requirements listed in that section.¹⁰ Second, § 6015(c) allows a spouse who filed a joint tax return to elect to limit her income tax liability for that year to her separate liability amount.¹¹ Section 6015(c) applies only to taxpayers who are no longer married, are legally separated, or do not reside together over a twelve-month period. 26 U.S.C. § 6015(c)(3)(A)(i). Furthermore, a spouse who had actual knowledge of an item giving rise to a deficiency at the time that spouse signed the return may not seek relief under § 6015(c). 26 U.S.C. § 6015(c)(3)(C).¹²

Finally, a taxpayer may seek relief as an "innocent spouse" under § 6015(f), which authorizes the Secretary of the Treasury (the "Secretary") or his delegate to grant equitable relief from joint and several liability when relief is unavailable under § 6015(b) and (c).¹³ Except for the knowledge requirement of § 6015(c)(3)(C) (the provision disallowing election of separate liability to a spouse with actual knowledge of the item giving rise to the deficiency), the taxpayer bears the burden of proving that she has met all the prerequisites for innocent spouse relief. See Reser v. Comm'r, 112 F.3d 1258, 1262-63 (5th Cir.1997). Section 6015(c)(3)(C) explicitly places the burden of proof on the Secretary.

IV Standard of Review

This court reviews decisions of the Tax Court "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." 26 U.S.C. § 7482(a)(1) (1989 & Supp.2001). Thus, we review issues of law de novo and findings of fact for clear error. Park v. Comm'r, 25 F.3d 1289, 1291 (5th Cir.1994). The Tax Court's determination that a spouse is not entitled to innocent spouse relief is a finding of fact that this court reviews for clear error. Reser, 112 F.3d at 1262.

V Section 6015(b) Relief

Section 6015(b)(1) provides innocent spouse relief if the taxpayer satisfies all of the five requirements listed in that section.¹⁴ In this case, the parties concede that Appellant satisfied the requirements of subsections (A), (B), and (E) of § 6015(b)(1). Thus, the § 6015(b) issue presented by this case is whether Appellant satisfied the requirements of subsections (C) and (D). We conclude that Appellant has not satisfied the requirement of subsection (C) and thus is not entitled to relief under § 6015(b).

Subsection (C) allows for innocent spouse relief only if the spouse "establishes that in signing the return he or she did not know, and had no reason to know, that there was such understatement."¹⁵ 26 U.S.C. § 6015(b)(1)(C). Originally, the innocent spouse provision (formerly codified at § 6013(e)(1)) granted relief only in cases involving omitted income, i.e., cases

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in which the tax return failed to report taxable income. Since the enactment of the original provision, courts have agreed that in omitted income cases, the spouse's actual knowledge of the underlying transaction that produced the income is sufficient to preclude innocent spouse relief (the "knowledge-of-the-transaction test"). Reser, 112 F.3d at 1265.¹⁶ In 1984, the innocent spouse provision was expanded to include relief in erroneous deduction cases,...