Wilson v. Comm'r of Internal Revenue

• Decision Date: 15 January 2013
• Docket Number: No. 10–72754.,10–72754.
• Parties: Karen Marie WILSON, Petitioner–Appellee, v. COMMISSIONER of INTERNAL REVENUE, Respondent–Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

705 F.3d 980

Karen Marie WILSON, Petitioner–Appellee,

v.COMMISSIONER of INTERNAL REVENUE, Respondent–Appellant.

No. 10–72754.

United States Court of Appeals,Ninth Circuit.

Argued and Submitted Nov. 15, 2011.

Filed Jan. 15, 2013.

Philip A. O'Connell, Jr., SNR Denton US LLP, Boston, MA; Katherine J. Evans and Khoa Ngo, SNR Denton US LLP, San Francisco, CA, for Petitioner.

John A. DiCicco, Acting Assistant Attorney General; Teresa E. McLaughlin and Bethany B. Hauser, Attorneys, Tax Division, Department of Justice, Washington, D.C., for Respondent.

Appeal from a Decision of the United States Tax Court, Tax Ct. No. 23882–04.

Before: SIDNEY R. THOMAS, RONALD M. GOULD, and JAY S. BYBEE, Circuit Judges.

Opinion by Judge THOMAS; Dissent by Judge BYBEE.

OPINION

THOMAS, Circuit Judge:

In this case, we consider how the Tax Court should review appeals for equitable innocent spouse relief from joint and several liability for unpaid taxes under 26 U.S.C. § 6015(f). We join the Eleventh Circuit and hold that the Tax Court properly considered new evidence outside the administrative record. We also conclude that the Tax Court correctly applied a de novo standard of review in determining the taxpayer's eligibility for equitable relief. We affirm the judgment of the Tax Court.

I

Thousands of citizens each year discover to their surprise that they are liable for their former spouse's tax debt.¹ Most of them are recently divorced, separated, or widowed women.² Many are victims of domestic abuse, whose ability to review or correct a joint return before it is filed is impaired.³ A substantial number are low-income, single parents. ⁴

Congress has not turned a blind eye to this situation, and the legislative history of its response is important to our understanding of the Tax Court's role.

Before 1918, each spouse was required to file a separate return. In 1918, Congress first permitted married couples to file a joint return,⁵ and in 1921 clarified that the tax on a joint return was to be computed on aggregate income.⁶ Shortly thereafter, the Internal Revenue Service (“IRS”) took the position that each spouse was individually responsible for the entire tax debt.⁷ However, we rejected that joint and several liability interpretation in 1935 and held that the IRS should apportion tax liability on the basis of each spouse's respective income. Cole v. Comm'r, 81 F.2d 485, 489 (9th Cir.1935). Congress legislatively overruled Cole in 1938, adopting the IRS theory of joint and several marital tax liability, ⁸ and in 1948 created a separate tax schedule for joint returns. ⁹

The “marriage bonus” awarded when filing jointly reduced tax liability for many married couples who resided in certain states. However, joint returns also imposed a heavy burden on some spouses who discovered they were liable for extraordinary tax debts created by a former spouse's fraudulent activities. During the first five decades of the income tax, the only way a spouse could avoid joint and several liability for taxes owed was to prove that he or she signed a joint tax return under duress. Reg. § 1.6013–4(d).¹⁰ An individual who discovered a tax debt on illicit income concealed by her spouse had no reprieve.

The Tax Court commented on the unfairness of the rule, noting in one case that “[a]lthough we have much sympathy for petitioner's unhappy situation and are appalled at the harshness of this result in the instant case, the inflexible statute leaves no room for amelioration.” Scudder v. Comm'r, 48 T.C. 36, 41 (1967). The court concluded that “only remedial legislation can soften the impact of the rule of strict individual liability for income taxes on the many married women who are unknowingly subjected to its provisions by filing joint returns.” Id.

In 1971, Congress passed the Innocent Spouse Act to provide relief from joint and several liability for innocent spouses in limited circumstances. Act of Jan. 12, 1971, Pub.L. No. 91–679, 83 Stat. 675 (1971). Under this legislation, taxpayers were eligible for relief only in cases involving unreported income and only if they could fulfill certain strict requirements. The scope of this hardship relief was expanded in 1984, but still required a spouse seeking relief to demonstrate (1) that a joint return was made for the taxable year; (2) that the joint return contained a substantial understatement of tax attributable to grossly erroneous items of the other spouse; (3) that the taxpayer did not know, and had no reason to know, of the substantial understatement when he or she signed the joint return; and (4) that it would be inequitable to hold the taxpayer liable for the deficiency in income tax attributable to the substantial understatement. Deficit Reduction Act of 1984, Pub.L. 98–369, § 424, 98 Stat. 494, 801.

In 1995, the American Bar Association (“ABA”) examined the innocent spouse defense and, after concluding that the defense did little to help “a reasonably knowledgeable spouse to protect herself (or, in rare cases, himself) against an unknown and unexpected tax liability,” proposed replacing the joint and several tax liability standard with a proportional liability standard. ABA Section of Taxation Domestic Relations Committee, Comments on Liability of Divorced Spouses for Tax Deficiencies on Previously Filed Joint Returns, 50 Tax Law. 395, 402 (1997).

In response, Congress directed the GAO and the Department of the Treasury to study the innocent spouse relief provisions and to evaluate the ABA proposal. ¹¹ After evaluating the responses, Congress engaged in innocent spouse taxpayer reform by repealing the prior provisions altogether and enacting the current innocent spouse laws, codified at 26 U.S.C. § 6015, IRS Restructuring and Reform Act of 1998, Pub.L. No. 105–206, § 3201(b), 112 Stat. 685, 734–40. Under § 6015, the IRS may grant taxpayers relief from joint liabilityin three contexts. Sections 6015(b) and (c) apply when taxpayers have demonstrated an “understatement” or “deficiency” on joint returns filed with the IRS.¹² In non-deficiency cases, “where a spouse asks for relief on her own initiative, and not in response to a deficiency action or moves by the IRS to collect a tax debt,” relief is available through § 6015(f), which provides for equitable relief where there is an underpayment of tax on a correct return.¹³

As originally enacted, § 6015(e)(1) allowed taxpayers denied relief by the IRS under subsections (b) or (c) to petition the Tax Court for relief. In Ewing v. Commissioner, 118 T.C. 494 (2002), the Tax Court concluded that § 6015(e)(1) granted it jurisdiction over non-deficiency cases brought under § 6015(f) as well. We reversed the Tax Court's assertion of jurisdiction over § 6015(f) petitions in Ewing v. Commissioner, 439 F.3d 1009 (9th Cir.2006), after finding that the plain language of the statute precluded this interpretation. Congress thereafter amended § 6015(e)¹⁴ to expressly grant the Tax Court jurisdiction to review petitions for equitable relief under § 6015(f) that have been denied by the IRS, like the petition at issue here. Tax Relief and Health Care Act of 2006, Pub.L. No. 109–432, div. C, § 408, 120 Stat. 2920, 3061–62.

In implementing the innocent spouse tax relief enacted by Congress, the Departmentof the Treasury promulgated a regulation establishing the factors to be utilized in analyzing requests for equitable relief. The IRS established a single processing site in Cincinnati, Ohio to handle the claims, known as “The Commissioner's Cincinnati Centralized Innocent Spouse Operation” (“CCCISO”). CCCISO staff screen innocent spouse tax relief requests to determine whether they meet basic eligibility requirements. Applications that do not meet the requirements are closed at screening, and the taxpayer is informed of the decision. If a claim meets basic eligibility requirements, the file is transferred to an examiner to further review the claim and decide whether relief should be granted. When a decision is made, the taxpayer is informed and given thirty days to appeal to the IRS's Office of Appeals. After the administrative appeal is decided, the IRS sends a final determination letter. The taxpayer then has the right to appeal the IRS decision to federal court. The taxpayer has the option of either petitioning the U.S. Tax Court for review, or paying the deficiency and filing a refund claim in federal district court or the Court of Federal Claims.

II

Petitioner Karen Marie Wilson is a fairly typical applicant for innocent spouse relief. For the first fourteen years of their marriage, her husband Lloyd worked as a self-employed insurance salesman. In 1997, Lloyd started a venture capital business that dramatically increased his income: he went from earning approximately $30,000 a year as a salesman to netting $20,000 a month. The new business, however, was a Ponzi scheme. In May of 1999, the Securities and Exchange Commission issued a cease-and-desist order that abruptly ended Lloyd's enterprise. Significant tax liabilities were levied. Claiming ignorance of his fraudulent actions, Karen applied for innocent spouse relief.

Wilson contends that she “did not understand the nature of her husband's business—she believed it was legitimate and had no knowledge about its operations or fraudulent nature.” Although Wilson had prepared the couple's joint personal tax returns in previous years, she did not prepare the 1997, 1998, or 1999 returns at issue in this appeal, because Lloyd's new business made the necessary accounting much more complicated than it had been previously. Instead, the couple hired an accountant who prepared the Wilsons' 1997 and 1998 joint returns without reporting the substantial income Lloyd was sending to offshore accounts. In 1999, a new accountant advised the Wilsons to amend their returns for 1997 and 1998 and file a return for 1999 to report the offshore income; the total tax liability reported on these returns was $540,000. Wilson signed these...