Friday, November 26, 2010

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.


  1. I agree that tax advisors should not give out tax advise hastily. The wife should have been advised that she would have been liable jointly and severally for the taxes owed once the unfiled joint returns were signed.

    Undoubtedly she would have thought twice before consenting on the joint returns. The IRS stance that innocent spouse could not be claimed on unfiled returns is correct. The former Mrs Pugsley may have recourse against her former accountant for not advising her that her husbands taxes would also be her problem.

    Once filing jointly you cannot amend after the due date of the return to file separately but you can the other way around another reason not to hastily file joint returns which can be amended later to claim a refund.

    When innocent spouse is not an option some practioners have successfully filed "Doubt as to Liability" or "collectibility" compromises under code section 7122.

    Practioners need to be careful when advising both spouses especially when one spouse owes the lions share large tax liability. Unfiled returns with tax liabilities are subject to to the twin killing penalties of failing to pay tax and file a return on time (code section 6651) these two penalties plus interest can easily make a $25,000 tax liability $40,000 on unfiled delinquent returns.

    There is also relief from these penalties under the "Reasonable Cause" standard if one can be established. Actually in the Doctors case alcoholism has been argued successfully in abating the penalities as "Reasonable Cause". It is a health issue that caused his untimely filing and payment.

    Mark Stanhope

  2. I wish I had either one of you as accountants!!This is my case, so I thought I would comment...

    Talk about being between a rock and a hard place. According the IRS, I had to first sign the tax returns, acknowledging they were my debt, before I could request Innocent Spouse. How can I be responsible and innocent at the same time?? None of that income was accruable to me! I was in graduate school, and was a TA so for a couple of those years I made $9000, and taxes were taken out.

    You know, it's funny what is written about you in a situation like this, e.g. I did not declare my spousal support in 2009. Both my accountant in Ohio and my accountant here in Illinois where I eventually had to move to find a job, said that I did not need to declare it, because it had not been court ordered yet. Dan, my ex, declared it as income in 2009. So, why should both spouses declare the same income? In 2010 when it was court ordered, I declared it, and Dan took it as a deduction. Also, I was going to contribute to an IRA, but at the last minute, I ended up buying a small condo, so my accountant amended my return. I did that weeks before the trial, the amended return was not submitted to the trial, because I had no idea it would come up, and I didn't even inform my lawyer until we were on our way to the trial. The amended return was submitted right after the trial.

    The fact that the IRS said I received substantial benefit from being married to Dan was comical. I left with nothing. We lost our home in foreclosure, my kids all went to school on a combination of loans and scholarships along with every cent I inherited from my parents to get them through. I hadn't had a new winter coat in 10 years. Our membership at that tony club ended years before.My car was worthless. It's a miracle that I have a roof over my head.

    In my opinion, the Innocent Spouse statute needs to be revised. I thought I was in the clear, because even my ex-husband came and testified that he lied and kept me in the dark about all the financial information. As you can read in my case, I had my hands full with graduate school, 4 children, and ailing parents. But even his testimony did not sway them. Imagine all the women out there whose husbands have no interest in admitting in a court that they perpetrated lies and demonstrated deceitful behavior. Dan was sober at the time, and needed to make amends. Not all ex's feel the same, I am sure. There needs to be some serious examination of that statute. But in the current economic climate, when the government is looking for money under every crack and crevice, I don't imagine it will happen any time soon.

    Eileen Pugsley

  3. Thanks for weighing in

    It was classy of your ex to testify for you. Often the spouse is in the case as an "intervenor". I hope you do well enough that Mark and I will be competing for your business. He's a much better looking guy than I am, but I think I'm more clever. LOL