Tax Brake with Robert G. Nath, Esq.

Mr. Cheshire retired from a Baby Bell in 1992. The telephone company paid him over $200,000 in various items. With that money the couple paid down their mortgage, bought a car, and started a new business. They reported the retirement pay, but the husband excluded most of it from income because he thought (based on what turned out to be a non-existent accountant) that if you put the money into a home, it was not taxable. Mrs. Cheshire did not know this, but she did know about the paydown.

Of course, the IRS tagged the return with additional income. The couple divorced, and Mrs. Filed for relief under the innocent spouse provisions. The whole case gave the United States Tax Court (and the court of appeals) a great deal of difficulty. The main problem was interpreting what was meant by “actual knowledge” of “any item giving rise to a [tax] deficiency,” the words of the new innocent spouse law. If you had such actual knowledge, you don't qualify for relief.

The IRS said this means you're out if you knew of the transaction, even if you did not know its tax implications. Mrs. Cheshire said the opposite, claiming you are OK if you did not know that the way it was reported was wrong.

The Court of Appeals held for the IRS. This means that to obtain relief, you must have no actual knowledge of the item the IRS says was incorrectly reported. In this case, if Mrs. Cheshire had proved she did not know the money was used to pay down the mortgage, she would have had a better case. Since she actually knew, her lack of knowledge that the amount was taxable was irrelevant.

This case narrows the class of people who will otherwise qualify for relief under the innocent spouse provisions. When making your case, therefore, consider this standard. While it applies, technically, only in the states covered by the Fifth Circuit (in the South), it will be looked to by other courts for guidance.

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