Pietromonaco v. C.I.R., No. 92-70101

• Decision Date: 02 September 1993
• Docket Number: No. 92-70101
• Citation: 3 F.3d 1342
• Parties: -5817, 93-2 USTC P 50,509 Emilia R. PIETROMONACO, Petitioner-Appellant, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1342

3 F.3d 1342

72 A.F.T.R.2d 93-5817, 93-2 USTC P 50,509

Emilia R. PIETROMONACO, Petitioner-Appellant, v. COMMISSIONER INTERNAL REVENUE SERVICE, Respondent-Appellee.

No. 92-70101.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Aug. 6, 1993.

Decided Sept. 2, 1993.

Bruce I. Hochman and Dennis L. Perez, Hochman, Salkin & Deroy, Beverly Hills, CA, for petitioner-appellant.

Reginia S. Moriarty and Gary R. Allen, U.S. Dept. of Justice, Tax Div., Washington, DC, for respondent-appellee.

Appeal from the United States Tax Court.

Before: NOONAN, FERNANDEZ, and KLEINFELD, Circuit Judges.

FERNANDEZ, Circuit Judge:

Emilia Pietromonaco ("Emilia") appeals from the Tax Court's decision that she was ineligible for relief from tax liability under the "innocent spouse" provision, 26 U.S.C. Sec. 6013(e) (1990). ¹ Emilia contends that she was "innocent" within the meaning of the provision and that she should have been shielded from liability arising out of a tax deficiency. That deficiency was the result of income omissions in her and her spouse's joint income tax returns for the years 1980, 1981 and 1982. Emilia also argues that the negligence penalty assessed under 26 U.S.C. Sec. 6653(a) was improper. We reverse.

STATEMENT OF FACTS

Emilia married Erminio Pietromonaco ("Erminio") in 1940 at the age of 18. Emilia's formal education extended only through high school. The couple remained married for over fifty years until Erminio's death in 1992. During the marriage, Erminio handled all of the family's finances, while Emilia cared for their two daughters and maintained the household. Emilia was responsible for the household expenses, for which she wrote checks from a joint account at Security Pacific Bank. The expenses included groceries, utilities and the mortgage. Erminio was responsible for depositing funds into the Security Pacific account. Those were the funds known and available to her. He controlled the rest. Except for a three week stint in a shoe store, Emilia did not work outside the home and relied completely on Erminio's earning capacity.

Throughout Erminio's life, Emilia performed the responsibilities that had been hers for over 40 years, namely paying the household expenses and maintaining the house. As her daughter testified, Erminio

"wanted to be in charge of everything and he really didn't want my mother involved financially or with the business, and I guess she was typical in being a housewife. She enjoyed that and was content doing that."

In 1974, Erminio went into a partnership with his brother and opened Le Monaco's Hair Styling Shop ("Le Monaco's") in Westminster, California. Emilia (then at age 52), did not participate in the operation of Le Monaco's and rarely even visited the shop, which was 40 miles from their house. Erminio never discussed the shop with Emilia and she did not know how much her husband was making. In 1977, Erminio bought his brother's share in the shop and later sold a twenty-five percent interest to David Berru. Erminio operated the shop until 1986.

During the tax years spanning 1980 to 1982, Erminio and Emilia filed joint income tax returns which were prepared by Edward Wildrick, a bookkeeper for International Bookkeeping. Emilia's only participation in the execution of those returns was to provide Wildrick with a list of her household expenses. She and Erminio would visit Wildrick and Emilia would socialize with Wildrick's spouse while the men prepared the tax returns. Emilia signed the tax returns without question. She relied on the belief that "it was done by a bookkeeper and that should be sufficient."

On February 14, 1989, the Internal Revenue Service ("IRS") issued a joint notice of deficiency to Erminio and Emilia for the years 1980, 1981 and 1982. The IRS determined that taxable income from the operation of Le Monaco's had not been reported in each of those years. ² As a result, Erminio and Emilia owed an additional $13,394 for 1980, $18,099 for 1981, and $13,915 for 1982. Later these amounts were adjusted so that the deficiencies were $10,814 (1980), $11,721 (1981), and $11,429 (1982). In addition, the IRS assessed negligence penalties under 26 U.S.C. Sec. 6653(a). In sum, Erminio and Emilia owe the IRS $35,661.50. ³

At trial, the only issue was whether Emilia was an innocent spouse as to all or part of the adjustments, including additions to tax. The Tax Court concluded that Emilia should have known that the amount of income reported on the tax returns was financially deficient. Moreover, the Tax Court found that it would not be inequitable to hold Emilia liable for the tax. Emilia timely appealed.

JURISDICTION AND STANDARD OF REVIEW

We have jurisdiction pursuant to 26 U.S.C. Sec. 7482. "We review Tax Court decisions 'in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury.' ... We will review a Tax Court's determination of relief under section 6013(e) for clear error." Guth v Commissioner, 897 F.2d 441, 443 (9th Cir.1990); Clevenger v. Commissioner, 826 F.2d 1379, 1382 (4th Cir.1987).

DISCUSSION

A. Innocent Spouse Relief Under Section 6013(e)

"An innocent spouse is relieved from liability for the tax on any understatement of a joint return, as well as any interest, penalties or other amount attributable to an omission from gross income for the taxable year...." Mertens, Law of Federal Income Tax Sec. 55.181 (1991); see 26 U.S.C. Sec. 6013(e)(1). The spouse must show that:

(1) [the couple] filed a joint return, 26 U.S.C. Sec. 6013(e)(1)(A); (2) the return contained a "substantial understatement of tax" attributable to errors the other spouse committed, 26 U.S.C. Sec. 6013(e)(1)(B); (3) in signing the return [the innocent spouse] did not know or have reason to know of the substantial understatement, 26 U.S.C. Sec. 6013(e)(1)(C); and (4) it would be inequitable to hold her liable for the deficiency in question, 26 U.S.C. Sec. 6013(e)(1)(D). The person seeking relief from liability carries the burden of proving each element of section 6013(e)(1).

Price v. Commissioner, 887 F.2d 959, 961-62 (9th Cir.1989) (footnotes omitted). Both parties concede that the first two factors were satisfied. Only the third and fourth factors are at issue.

1. Lack of Knowledge, 26 U.S.C. Sec. 6013(e)(1)(C)

"A spouse has 'reason to know' of the substantial understatement if a reasonably prudent taxpayer in her position at the time she signed the return could be expected to know that the return contained the substantial understatement." Price, 887 F.2d at 965 (emphasis added); Sanders v. United States, 509 F.2d 162, 166-67 (5th Cir.1975) (remedial purpose of statute calls for reasonable person standard). The standard is objective because we look at the reasonably prudent taxpayer, but this objective standard is not an abstraction. It is the reasonably prudent taxpayer in the particular circumstances in which the taxpayer before us was placed. We have held that several factors should be considered in determining whether a spouse has "reason to know" including: "(1) the spouse's level of education; (2) the spouse's involvement in the family's business and financial affairs; (3) the presence of expenditures that appear lavish or unusual when compared to the family's past levels of income, standard of living, and spending patterns; and (4) the culpable spouse's evasiveness and deceit concerning the couple's finances." Price, 887 F.2d at 965; Stevens v. Commissioner, 872 F.2d 1499, 1505 (11th Cir.1989).

The Tax Court has said that, "[a] key factor in deciding whether a spouse should have known of substantial understatements of tax is the extent that family expenses, about which the spouse had knowledge or awareness, exceed reported income." Hammond v. Commissioner, 58 T.C.M. (CCH) 1196, 1199, 1990 WL 1107 (1990) (emphasis added) (citing Jackson v. Commissioner, 72 T.C. 356, 361, 1979 WL 3737 (1979)), aff'd 938 F.2d 185 (8th Cir.1991); see Mertens, Law of Federal Income Taxation Sec. 55.188 at 330 (1991). "[W]here the spouse makes unusual or lavish expenditures, a taxpayer is on notice" that an income omission is probable. Jackson, 72 T.C. at 361; see Clevenger, 826 F.2d at 1382 (expenses to improve property were extreme and given taxpayer's occupational background, he should have known of erroneous deductions).

The Tax Court concluded that Emilia did not know of the understatement of income because she did not review the tax returns. Thus, the question was whether Emilia had "reason to know" of the omission. The Tax Court found that Emilia's highest education level was high school and that she was completely dependent on Erminio for financial support. Emilia's only involvement in the family's finances was limited to paying household expenses and she had nothing to do with Erminio's business and financial affairs. See Botsaris v. Commissioner, 56 T.C.M. (CCH) 168, 169-71, 1988 WL 93993 (1988) (spouse's full time responsibility was raising children and maintaining house). Those facts were supported by the record and weigh in favor of granting relief to Emilia, but standing alone, they do not entitle her to innocent spouse status. Stevens, 872 F.2d at 1505-06. The Tax Court found that Emilia's lifestyle was modest and did not improve during the years at issue. See Sanders, 509 F.2d at 168 (even if standard of living generally improved, spouse not necessarily put on notice that income omitted). Finally, the Tax Court concluded that Erminio maintained total control over his business affairs. He was evasive with regard to his gambling winnings and losses. Those findings are supported by the record and also weigh in favor of Emilia's innocence. See id.; Botsaris, 56 T.C.M. (CCH) at 171; Hinds v. Commissioner, 56 T.C.M. (CCH) 104, 106, 1988 WL 92148 (1988) (fact that husband exerted total control over finances and standard of living remained constant supports innocent spouse finding).

Nevertheless,...