An IRS agent was found to be qualified for innocent spouse relief in the case of Merlo v. Commissioner, TC Summary Opinion 2018-47. That was true even though the IRS agent had prepared the tax return in question as the couple was in the midst of divorcing.
This all began with a notice that the agent received related to the 2011 joint return. As the Tax Court notes:
Respondent mailed a notice of deficiency to petitioner and intervenor (Merlos) determining that for 2011 they had failed to report $4,628 in taxable wages that intervenor had received from Prudential Insurance Co. of America (Prudential), as had been reported to respondent on a Form W-2, Wage and Tax Statement, filed by Prudential. Petitioner timely petitioned for redetermination, averring that he had no knowledge of, and had not received, the Form W-2 or the income referenced in the notice of deficiency. He further averred that the Form W-2 “references a different taxpayer and social security number”.
Respondent later learned that the “different taxpayer” was petitioner's former spouse (now the intervenor) with whom petitioner had filed a joint return for 2011.
The IRS took the agent’s response as a request for innocent spouse relief under IRC §6015(c), which provides a limited form of innocent spouse relief for a taxpayer that had filed a joint return but now is no longer married to the individual in question. When it applies, the taxpayer is relieved of liability for items not allocable to that spouse.
IRC §6015(c)(3)(C) limits this relief in certain cases, as it provides:
If the Secretary demonstrates that an individual making an election under this subsection had actual knowledge, at the time such individual signed the return, of any item giving rise to a deficiency (or portion thereof) which is not allocable to such individual under subsection (d), such election shall not apply to such deficiency (or portion). This subparagraph shall not apply where the individual with actual knowledge establishes that such individual signed the return under duress.
In this case, the missing income arose from a W-2 that was issued in the name of the taxpayer’s former spouse. As well, there was no contention that the requesting spouse had signed the return under duress. So the only real question was whether the agent had knowledge of this income when he prepared the tax return.
The actual W-2 income for the year was detailed in the Court’s opinion:
For 2011 the Merlos received wage income totaling $112,674 consisting of: (1) $106,863 in wages paid to Mr. Merlo by the Department of the Treasury for his work as a revenue agent for the Internal Revenue Service (IRS), (2) $1,182 in wages paid to Ms. Nelson by Ethan Allen, Inc. (Ethan Allen), and (3) $4,629 in disability income paid to Ms. Nelson by Prudential, which Prudential reported as wage income on a Form W-2.
The Prudential disability income was the item that ultimately was not reflected on the tax return in question.
The taxpayers ended up racing to meet the October 15 filing deadline due to the couple separating following the end of 2011 but before their tax returns were filed. As the Court notes:
Sometime before April 15, 2012, the Merlos timely filed a Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, extending the due date of their 2011 Federal income tax return to October 15, 2012. Shortly thereafter, in May 2012, Ms. Nelson moved out of the marital residence and filed for divorce. Between the divorce filing and early October 2012 the Merlos seldom spoke, lived in separate households, and communicated primarily through their divorce counsel.
On October 12, 2012, three days before the return due date as extended, Mr. Merlo sent an email to his counsel for forwarding to Ms. Nelson. In the email he inquired whether Ms. Nelson wished to file a joint return with him for 2011. The email also stated: “I believe the information for * * * [Ms. Nelson] is correct. A paper return does require the Form W-2 for * * * [Ms. Nelson] be attached which I do not have.” Attached to the email was a draft of the Merlos’ 2011 Federal income tax return (draft Federal return) prepared by Mr. Merlo, which reported $112,674 as the Merlos’ total wage income. Mr. Merlo also attached to the draft Federal return a worksheet he had prepared that listed Ms. Nelson’s wages from Ethan Allen and his wages from the Department of the Treasury as the only sources of the Merlos’ total wage income of $112,674. On his worksheet Mr. Merlo treated Ms. Nelson’s wages from Ethan Allen as $5,811 in reaching the total wages figure of $112,674 because Ms. Nelson had at some point advised him that she had total wages for 2011 in that amount.
The soon-to-be former spouse (Ms. Nelson) replied on October 14, 2012, leading to three email exchanges. She agreed to file a joint return and indicated certain changes should be made to the draft federal return, which Mr. Merlo made.
However, Ms. Nelson noted an issue when she reviewed the proposed state income tax return. As the Court noted:
Mr. Merlo also prepared a draft of the Merlos’ 2011 Michigan income tax return (draft Michigan return). The Schedule W, 2011 Michigan Withholding Tax Schedule, attached to the draft Michigan return listed the components of the Merlos’ total wage income of $112,674 as coming from two sources: wages of $106,863 from the Department of the Treasury attributable to Mr. Merlo and wages of $5,811 from Ethan Allen attributable to Ms. Nelson.
Early on the morning of October 15, 2012, the due date for filing the 2011 return, Mr. Merlo emailed Ms. Nelson the draft Federal return and draft Michigan return for her to review for accuracy. Ms. Nelson responded by text, informing Mr. Merlo that he had misstated her wages from Ethan Allen on the draft returns as equal to $5,811 rather than $1,182, the correct figure. Mr. Merlo, now believing the draft returns to be incorrect, revised them by reducing Ms. Nelson’s wage income from $5,811 to $1,182, a $4,629 difference. Mr. Merlo thereafter emailed Ms. Nelson a revised draft Form 1040 worksheet for her to review at 7:20 a.m. The worksheet listed the Merlos’ wage income as $108,045, consisting of $106,863 in wages from the Department of the Treasury and $1,182 in wages from Ethan Allen.
This introduced the error--while it was true that Ms. Nelson’s Ethan Allen wages were only $1,182, her total wages had been correct on the original worksheet. The return omitting the amount paid from Prudential was eventually filed as noted by the Court:
Mr. Merlo agreed to leave copies of the revised Federal and Michigan returns for Ms. Nelson to sign at the residence they had previously occupied together. Ms. Nelson confirmed with Mr. Merlo that she needed to attach her Form W-2 for the Ethan Allen wages to the returns, and he clarified that the Form W-2 needed to be attached only to the Federal return. The Merlos’ Federal return was timely filed on October 15, 2012, reporting total wage income as $108,045.
The IRS concluded that Mr. Merlo was entitled to innocent spouse relief. Not surprisingly Ms. Nelson, who now would be the sole party the IRS would look to collect the deficiency from, objected. The question was simple: was Mr. Merlo aware of the $4,629 of disability income from Prudential when he filed the return?
The Tax Court agreed with the IRS in this case, noting:
We conclude that it has not been established by a preponderance of the evidence that Mr. Merlo had actual knowledge of the omitted Prudential income. Mr. Merlo testified that he believed Ms. Nelson’s only source of wage income for 2011 was Ethan Allen and that he was unaware that she had received any disability income from Prudential during that year. He further testified that Ms. Nelson had orally advised him at some point that her total wage income for that year was $5,811. Thus, Mr. Merlo contends, when he sent Ms. Nelson the draft Federal return with a worksheet indicating that her Ethan Allen wages were $5,811 and she responded by asserting that the correct figure was $1,182, he believed his initial figure was erroneous and adjusted it to $1,182. In so doing he reduced reported income by $4,629 — the amount of the omitted Prudential income.
The opinion noted that there was evidence that backed up the agent’s assertion that he was not aware of the Prudential income, including evidence that Ms. Nelson’s responses had reasonably led the agent to conclude the original draft return had overstated Ms. Nelson’s wages:
Mr. Merlo’s testimony is corroborated by contemporaneous documentation. The worksheet attached to the draft Federal return and the Schedule W attached to the draft Michigan return, both prepared by Mr. Merlo, listed $5,811 as Ms. Nelson’s wages from Ethan Allen. That figure actually represented the total of Ms. Nelson’s Ethan Allen wages of $1,182 and her Prudential income of $4,629, but Mr. Merlo’s having listed the total as all coming from Ethan Allen confirms that he believed Ethan Allen was the source of all of Ms. Nelson’s wage income at the time he prepared the 2011 return. Moreover, in his email of October 12, 2012, he advised the couple’s respective divorce counsel that he did not have any Form W-2 from her. At the time that was not a self-serving statement.
Mr. Merlo’s lack of knowledge of the Prudential income is supported circumstantially as well. Ms. Nelson maintained a separate bank account during 2011. It can be readily inferred that she deposited her checks from Prudential there, which removes a means by which Mr. Merlo could have obtained actual knowledge of the income. Moreover, in contrast to her having worked at Ethan Allen, she could have applied for and obtained disability benefits without Mr. Merlo’s having become aware of these actions.
We are persuaded that Mr. Merlo’s lack of knowledge of Ms. Nelson’s Prudential income and his good-faith belief that the only source of her wage income was Ethan Allen are what caused him to adjust her total wage income downward from $5,811 to $1,182 when she advised him that the latter figure was the correct amount of her wage income from Ethan Allen.