How one man used the ‘innocent spouse’ rule to win some relief in Tax Court
From the Wall Street Journal
Rick Jacobsen’s wife embezzled nearly $500,000.
After her conviction, the Internal Revenue Service asked him to pay more than $100,000 of taxes due on her theft. Yes, embezzled funds are taxable, and Mr. Jacobsen and his wife had filed joint tax returns.
But Mr. Jacobsen fought back, arguing his own case before a Tax Court judge. He said he didn’t know about the embezzlement and shouldn’t be forced to pay because he was an “innocent spouse.” In an opinion released last month, he won relief from about $150,000 of tax, interest and penalties.
“I’m no angel, but I pay my taxes. I spoke from the heart, and the judge believed me,” says Mr. Jacobsen, who is 54 and currently works at a cheese-processing plant in Plymouth, Wis.
Mr. Jacobsen’s odyssey through the tax system shows the perils of signing a joint return with a tax cheat. It also shows that innocent spouses can sometimes escape dire tax consequences with a lot of time and effort, even if they can’t afford a lawyer.
His issues began in June 2011, when his then-wife was arrested on charges of embezzling from a blood bank where she worked as an accountant. That November she was convicted of stealing about $486,000 from her employer and soon after was sentenced to prison, according to the Tax Court opinion in Jacobsen v. Commissioner.
As a result of these events, Mr. Jacobsen learned that embezzled funds are taxable, and that when spouses sign a joint return, each can be 100% responsible for errors or additional taxes.
The joint-liability provision has been in the tax code since 1938, despite the opposition of many experts, says Carlton Smith, an attorney affiliated with the federal tax clinic at Harvard Law School. In recent years about 50 million couples have filed joint income-tax returns annually, more than one-third of the total submitted.
The IRS asserted that Mr. Jacobsen owed about $110,000 in taxes and penalties for 2010 in connection with his wife’s embezzlement, and an additional $18,000 for funds she embezzled in 2011.
So he filed a handwritten request on Form 8857 for relief under the “innocent spouse” rules. Congress first passed this provision in 1971 to sever joint liability if one spouse isn’t complicit in the other’s bad tax behavior.
The IRS was inclined to offer Mr. Jacobsen relief. But then his wife, whom he was divorcing, said he had known about her embezzlement, and the agency denied his request.
Although his case was rejected by legal aid groups and he couldn’t afford a lawyer, Mr. Jacobsen didn’t give up. He filed a handwritten petition to the Tax Court appealing the IRS decision. The Court, which allows individuals to represent themselves, waived his $60 filing fee.
Judge Elizabeth Paris heard his case in March 2017. In her opinion released in late July of this year, she ruled that Mr. Jacobsen doesn’t owe the amount due for the 2010 embezzlement, which Mr. Smith estimates at $150,000 due to interest and penalties.
She also ruled that he owed the $18,000 for the funds embezzled in 2011, because by the time the return was filed he knew about the theft. Mr. Smith believes Mr. Jacobsen has good grounds to appeal this ruling because the judge failed to weigh the evidence properly.
What swung the decision in Mr. Jacobsen’s favor? Judge Paris cited his testimony on several factors, and the opinion offers a window into this complex provision that’s a lifeline for some.
*Lack of financial sophistication. Mr. Jacobsen, a factory worker, had an associate’s degree and no financial education. He said he trusted his wife to handle their financial affairs.
According to the opinion, his wife embezzled amounts that largely mirrored his payments for his free-lance work as a home inspector, helping to conceal the theft.
*No benefit from lavish expenditures. Mr. Jacobsen and his wife didn’t pay down their mortgage or buy items such as a new car. At one point their utilities were disconnected for nonpayment.
They did gamble at nearby casinos. For 2010, their tax return reported $161,951 of gambling losses and $162,951 of other income, their gambling winnings.
Mr. Jacobsen explained that he would gamble $100 on a slot machine and sometimes play for hours. Although the casino statement might show thousands of dollars of wins and losses that cancelled each other out, he only put in $100 of his own money. Judge Paris called his testimony “credible.”
*Spousal testimony. Mr. Jacobsen’s former wife said he knew of her theft, but she offered no evidence. The judge gave little weight to her assertions.
*Marital status. The law favors relief when the innocent spouse has been abandoned by the other, or when the spouses are no longer married. Mr. Jacobsen was divorced from his wife at the time of his trial.
*Health. Mr. Jacobsen is a disabled veteran due to a physical injury he sustained while in the U.S. Army. He was also being treated at a Veterans Affairs hospital for post-traumatic stress disorder due to the embezzlement.
*Tax compliance. At the time of the trial, Mr. Jacobsen was current with his income taxes.
Even with taxes, never estimate the legal power of the human story.
If you or a client need help fighting off the IRS, call Jeffrey R. Siegel, your Kansas City tax attorney. We help with IRS liens, wage garnishments, levies, offers in compromise, innocent spouse relief and installment agreements. Bring back some stability to your life, and call (913) 735-4829.