Tax Court Rules for IRS on $40M Innocent Spouse Claim Relief

Tax Court Rules for IRS on $40 Million Innocent Spouse Claim

In the recent case of Strom, the petitioner is the spouse of a high-income earner who petitioned the U.S. Tax Court for innocent spouse relief of more than $39 million in deficient taxes due to unreported income claimed by his wife. More specifically, the petitioner claims under Internal Revenue Code section 6015 that he should not be subject to liability for the deficiency that resulted from the income that was not reported because he was an innocent spouse. It should be noted, that there is no claim as to whether the notice of deficiency amount is accurate because both taxpayers agreed with the IRS affirming the unreported income adjustment and the deficiency that was determined by the IRS. Therefore, the only issue that currently remained was whether or not the husband’s spouse was able to claim an innocent spouse under the above reference code section. Not surprisingly, the U.S. Tax Court rejected the petitioner’s claim and affirmed that the spouse was subject to joint and several liabilities as a result of the fact that they filed a joint tax return in that year and that the taxpayer did not show facts sufficient to establish innocent spouse under section 6015. Let’s walk through the ruling to get an understanding of why the Tax Court rejected his claim.

Petitioner was aware of the Options

• • • First, Dr. Strom was not only aware of Mrs. Strom’s InfoSpace option exercises in 2000; he was involved in them. He has conceded that he knew Mrs. Strom was exercising InfoSpace options in 2000 and that he did not object because he trusted her judgment that the stock was a good investment. Dr. Strom has also conceded that he had opportunities to speak with Mrs. Strom about the InfoSpace option exercises but deferred to her judgment because he “felt that . . . [she] had the information base and the sophistication to be capable of making the right decision.”

    • Moreover, he signed the “Consent of Spouse” form attached to each of the three InfoSpace stock option agreements and has conceded that he read at least one of those agreements before providing his consent. Relatedly, Dr. Strom was involved in obtaining the $10 million BoA Loan that was used to fund Mrs. Strom’s InfoSpace option exercises in 2000. He signed the BoA Loan Agreement, and the proceeds of the loan were deposited into a bank account held by the Stroms jointly.

Petitioner in the Option Exercise Analysis

• • • Second, Dr. Strom participated alongside Mrs. Strom in the nearly nine-month process of engaging with the team of lawyers and tax consultants they jointly retained to gather the facts involving Mrs. Strom’s InfoSpace option exercises in 2000 and to develop taxfavorable positions on the 2000 return with respect to the income attributable to those exercises. Among other things, the process of gathering the facts and developing the reporting positions on the 2000 return included at least three in-person meetings between the Stroms and their lawyers and tax consultants. Dr. Strom has conceded that he was present for these meetings.

• • • He testified: “I made it my business to go to those meetings so that I could . . . fully understand, as best it was possible for me to understand, what was going on, what the significance of it was, and so that I could do my own due diligence to understand . . . what was happening” with respect to the reporting positions being taken on the return. He further testified that the meetings were held with the Stroms’ lawyers and tax consultants because he and Mrs. Strom “were seeking a sophisticated legal opinion regarding the timing of when to report those stock options on our tax returns” and that he attended the meetings “to be sure that things were being discussed and ultimately resolved by consensus to [his] satisfaction to make sure things were being properly done within [his] level of expertise.” Moreover, Dr. Strom has conceded that, during the meetings, “the facts, circumstances, and legal issues” relating to the exercise of InfoSpace stock options were discussed.

Petitioner Approved the Reporting Positions

• • • Third, Dr. Strom approved the reporting positions on the 2000 return with respect to the income attributable to Mrs. Strom’s InfoSpace option exercises. Dr. Strom has conceded that at the time the 2000 return was filed, he was aware that there was a discrepancy between the amount of income reported by the Stroms with respect to Mrs. Strom’s InfoSpace option exercises in 2000 and the amount of income reported by InfoSpace on the Forms W–2 issued to her for that year.

    • Moreover, Dr. Strom has conceded that he reviewed the Stroms’ 2000 return, including the Form W–2 information attached thereto, before signing it,57 that the Stroms were given a choice of how to report the income attributable to Mrs. Strom’s InfoSpace option exercises, and that “Bernee and . . . [he] decided to follow the advice of the consultants that were called.” Dr. Strom testified that when he and Mrs. Strom made the choices on the 2000 return with respect to reporting positions, they did so together as a team. Ms. Swartz confirmed this fact, testifying that the Stroms, after consulting with their legal counsel, ultimately chose the reporting positions on the 2000 return with respect to the income attributable to Mrs. Strom’s InfoSpace option exercises in that year.

    • Strom has also conceded that, before the filing of the Stroms’ 2000 return, he read and approved the Form 8275 and the Disclosure Statement attached thereto.

The Petitioner Knew of The Risks

• • • Additionally, Dr. Strom has conceded that he received a letter from Ms. Swartz of KPMG regarding the risks associated with the reporting positions with respect to the income attributable to Mrs. Strom’s InfoSpace option exercises.59 By letter dated October 12, 2001, and addressed to Mr. Cowan, Dr. Strom, and Mrs. Strom, Ms. Swartz of KPMG not only summarized the facts, circumstances, and legal issues pertaining to the reporting positions, but also warned of the risks associated with adopting them.

    • The letter advised that, while KPMG had concluded that there was a “reasonable basis” for the positions, this standard did not reflect an expectation of success if the positions were challenged by the IRS. Moreover, the letter warned that, because of the “magnitude of the income and tax involved,” and the fact that the reporting positions were inconsistent with the reporting of InfoSpace on the Forms W–2 issued to Mrs. Strom, KPMG expected the Stroms’ 2000 return to be audited and the positions to be challenged.

Court’s Conclusion

• • • In view of the foregoing, and on the basis of the entire record, we find, and so hold, that Dr. Strom had actual knowledge of Mrs. Strom’s InfoSpace stock option exercises in 2000. Accordingly, he does not satisfy section 6015(b)(1)(C) and is not entitled to relief under section 6015(b). See Cheshire, 115 T.C. at 192–93; Mitchell, T.C. Memo. 2000- 332, slip op. at 8–10.

    • On the basis of the entire record, we also find, and so hold, that Dr. Strom knew “virtually all of the facts pertaining to the transaction[s] which underlie[] the . . . understatement, [such that his] defense . . . is premised solely on ignorance of law.” See Price v. Commissioner, 887 F.2d at 964. Accordingly, Dr. Strom also had “reason to know” of the understatement as a matter of law and is not entitled to relief under section 6015(b). See Mitchell v. Commissioner, 292 F.3d at 803–04; Cheshire v. Commissioner, 282 F.3d at 334–35; Price v. Commissioner, 887 F.2d at 964.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs Prior Year Non-Compliance

Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.