Think Before Filing Joint Returns

Eileen L. Pugsley v. Commissioner, TC Memo 2010-255

I've written before on not reflexively filing joint returns.  This case may be a particularly good illustration of the point.  It is also one of those stories that illustrates the point that tax problems are frequently the tip of the iceberg of more serious problems.  Eileen Pugsley put up with a lot before she divorced her dentist husband, Daniel.  She was asking the tax court if she has to put up with being saddled with 6 years worth of unpaid tax liabilities.  The tax court indicated that she will.

Doctor Pugsley had been on a long slide due to alcoholism.  In 2005, he lost his dental license, because of failure to fulfill his CPE requirement.  He continued to practice without a license until 2007 when his practice was shut down by the Ohio State Dental Board.   He continued dressing for work and leaving the house each day, but spent the day drinking. 

Finally he entered a rehabilitation program.  While he was there Mrs. Pugsley found unfiled joint tax returns for the years 1999 to 2003 in a dresser drawer.  She called the family accountant who advised her to file them right away.  Prior to filing the returns she applied for innocent spouse relief.  The IRS turned her down because the returns hadn't been filed.  Several months later the returns were filed.  She applied again for innocent spouse relief and was denied again.  The factors considered were as follow:

(1) is separated or divorced from the nonrequesting spouse,
(2) had knowledge or reason to know that the nonrequesting spouse would not pay the income tax liability,
 (3) would suffer economic hardship if relief were denied,
(4) complied with income tax laws in years after the year at issue,
(5) received significant economic benefit from the unpaid income tax liability,
 (6) was abused by the nonrequesting spouse,
(7) was in poor health when signing the return or requesting relief,
(8) whether the nonrequesting spouse had a legal obligation to pay the outstanding

The first factor that she was divorced when filing with the tax court was the only factor in her favor.  The second factor weighed against her since she should have known that her husband was not capable of paying the tax.  The third factor weighed against her :

Petitioner receives $58,000 per year in salary, $1,500 in monthly spousal support, $484.17 in monthly marital asset payments and $240 per month for health insurance payments for her children. Petitioner testified that her monthly expenses are minimal. Petitioner has no dependents though she provides some financial support to her youngest child. Respondent determined that, based on petitioner's spousal support and salary, petitioner had monthly disposable income of $461 that could be applied to the tax liabilities.

The fourth factor also weighed against her :

Respondent's Appeals Office determined that petitioner was compliant with tax laws as of 2008. Petitioner failed, however, to report spousal alimony as taxable income after her separation agreement was executed in September 2009. She also claimed a $5,000 deduction for contributing to an IRA but failed to make the requisite contribution. She alleges to have filed an amended return only after the issue was brought to her attorney's attention, though no amended return was submitted into evidence.

She also lost on the fifth factor, although I have a little trouble understanding this one:

Petitioner spent $300 a month to belong to a tony athletic club and purchased a home for over $500,000. Petitioner also sent her children to expensive private colleges. The facts and circumstances presented strongly suggest that petitioner received a significant benefit from the failure to pay the tax liabilities. This factor also weighs against relief.

I mean what is so great about having Tony in your health club ?

The remaining factors were neutral.  She tried to argue that Dr. Pugsley's financial irresponsibility constituted abuse, but that isn't the type of abuse they mean.  The Court found his agreement under the divorce decree to pay the taxes of no account since he clearly couldn't pay them in full.  He was paying the IRS $1,000 per month.

The final score was 1 favorable factor, 4 unfavorable and 3 neutral.  So Mrs. Pugsley has to keep paying the IRS monthly on the debt her husband is responsible for according to the divorce decree.

I don't have all the facts, but I am going to go out on a limb here.  I believe it is likely that the decision to file joint returns was a mistake.  If I had gotten the panicked call from Mrs. Pugsley, I would certainly not have told her to just go ahead and file the returns.  There is a good chance that I would have concluded that she should have sent in Married Filing Separate returns even if they were not required.  (This is because a non-signing spouse can be deemed to have consented to a joint return, an issue I previously discussed.)

The problem is that there are really two fairly distinct areas of tax practice.  The one that is most familiar and where I spend most of my time involves determining the correct tax and planning the legitimate ways of minimizing it.  Included in this is elections such as the election to file a joint return.  The other area is collection.  In collection matters, the correct amount of the tax is often only of academic interest, if that.  What is important in this area is how much they think they can get from you and whether you are acting like a good doobie.  Presumably if Dr. Pugsley had filed separately his correct tax would be even higher.  However, the benefit of joint filing reduced the tax to an amount that was still higher than what he could conceivably pay.  There is a sense in which all tax amounts that can never be fully paid are equal.  The joint filing created another source that IRS could collect from namely Mrs. Pugsley's post divorce salary.

It may be that I am being unfair to Mrs. Pugsley's advisers.  They may have duly considered separate filing and rejected it for some reason that does not appear in the record of the case.  I have practiced enough in this area to know, however, that the decision to file jointly is often made reflexively or is just viewed in terms of tax minimizing.  Requesting innocent spouse relief on unfiled returns indicates that there was a fundamental misunderstanding of the two different systems.