Innocent Spouse Relief Granted to Taxpayer Who Was Not Involved in Husband's Business

(Parker Tax Publishing August 2024)

The Tax Court held that a taxpayer was entitled to innocent spouse relief under Code Sec. 6015(f) from deficiencies and penalties resulting from disallowed deductions relating to a condominium that her husband purchased and rented out to his wholly owned S corporation. The court found that there was no evidence linking her to the business's decision making and that she rarely used the condominium and thus did not derive a significant benefit from it. Schnackel v. Comm'r, T.C. Memo. 2024-76.

Background

Gregory Schnackel and Laura Schnackel (the Schnackels) were married in 1985 and filed joint tax returns. Their marriage was dissolved by decree of a district court in 2018.

Since 2000, Gregory has been the sole owner of SEI, an S corporation. SEI provides engineering and design services for commercial and residential construction projects. SEI is headquartered in Omaha, Nebraska, and has offices in various locations throughout the United States. Laura performed bookkeeping duties for SEI. Her responsibilities were limited to handling payroll and payroll taxes as well as invoices and accounts receivable. All other duties relating to finance and accounting were managed by an outside accountant.

In the early 2000s SEI began engaging the New York, New York, market. Starting around 2004 Gregory made several trips to New York to market SEI's services and build a network for project referrals. Initially, SEI shared office space with an architecture firm. Around 2005 the architecture firm no longer wanted to share space with SEI. During this timeframe Gregory stayed in hotels when in New York.

Around 2005 and 2006 SEI had only small projects in New York, but Gregory was spending at least a third of his time there. In December 2006, Gregory purchased a penthouse condominium in New York for $3,250,000. Only Gregory was listed as a purchaser of the condominium. Laura toured the condominium before purchase but played no other part in the decision to purchase it. The condominium was 2,900 square feet with an outdoor terrace featuring a view of Manhattan. As part of the purchase agreement, Gregory agreed that he would occupy the condominium as his second home and that he would not rent out the property. In 2007, Gregory executed a lease agreement by which he, in his personal capacity, leased the condominium to SEI, for which he signed in his role as president of SEI. The lease agreement permitted SEI to designate use of the condominium to any one employee.

SEI agreed to pay $28,000 per month in rent to Gregory for the condominium. The rent was calculated to cover Gregory's cost of ownership of the condominium. Neither Gregory nor Laura consulted a real estate expert to determine the fair market rent. After the condominium was acquired, Gregory through SEI purchased various furnishings and made renovations to it. The Schnackels used the SEI credit card to purchase furniture for the condominium. These purchases occurred over several years and totaled $326,190. For example, SEI claimed depreciation deductions in various amounts for each year at issue relating to a Steinway & Sons baby grand piano, nonoffice artwork, luxury sheets and table linens, furniture, rugs, and other miscellaneous home items.

The Schnackels did not use the New York condominium strictly for business purposes. They and their immediate family stayed at the condominium when visiting New York on Thanksgiving weekends and occasionally took personal trips to the city during the summer. The Schnackels' daughter lived in the condominium for a semester while attending New York University in 2013. Neither the Schnackels nor their accountant tracked the personal and/or business use of the condominium.

In 2011, SEI purchased a 2012 Range Rover at Gregory's request for $94,334. Gregory prepared a mileage log sometime in 2012 to document his use of the vehicle. The information on the mileage log was recalled from his memory of where he was on certain dates. Laura did not prepare documents related to the Range Rover, including a mileage log. SEI's accountant did not have the mileage log at the time he prepared SEI's 2011 tax return. SEI failed to report any use of the vehicle, business or otherwise, on its 2011 Form 4562, Depreciation and Amortization. SEI reported a special depreciation allowance of $94,334 for the purchase price of the Range Rover on its 2011 tax return. At the end of 2011 SEI still owned another vehicle that Gregory claimed to use for business purposes.

In 2010 Gregory met a woman with whom he had an affair while in New York. He met regularly with her for meals in 2010 to 2013. During this time Gregory stayed in hotels because he did not want to have her in the New York condominium. To further conceal the affair Gregory opened a JPMorgan credit card to hide spending related to the affair.

After an examination, the IRS disallowed the deductions claimed by SEI for renting the New York condominium from Gregory. The IRS also disallowed depreciation deductions with respect to the numerous home furnishings placed in the New York condominium, as well as for the Range Rover. Gregory and Laura filed a petition with the Tax Court seeking redetermination of the deficiencies. Laura filed a separate amended petition, opposed by Gregory, in which she raised innocent spouse relief under Code Sec. 6015 as an affirmative defense. The IRS conceded that Laura was eligible for innocent spouse relief, but Gregory continued his objection.

Analysis

The Tax Court held that SEI was not entitled to deduct rental expenses relating to the New Your condominium as a business expense and could not take depreciation deductions either for furnishings placed in the condominium or for the Range Rover. The court also held that Laura was entitled to innocent spouse relief under Code Sec. 6015(f).

The court found that the Schnackels failed to adequately substantiate the business purpose and the amounts of the New York condominium rental expenses. In the court's view, the calendars and credit card statements offered by the Schnackels showed when Gregory used the condominium but did not provide the reason for the expense or explain why he was in New York at the time. The court also took note of the Schnackels' personal use of the condominium, including family trips for Thanksgiving holidays and their daughter's use of the condominium while attending college. The court further observed that Gregory had personal motivations to be in New York as a result of his affair and reasoned that his agreement at closing to occupy the condominium as a second home indicated his intent to make personal use of the property. The depreciation deductions for the condominium furnishings were properly disallowed by the IRS, the court found, because they were not used in a trade or business. In addition, the court said that the Schnackels failed to substantiate the trade or business purpose of the Range Rover.

The court concluded that Laura was eligible for innocent spouse relief under Code Sec. 6015(f) after applying the factors set forth in Rev. Proc. 2013-34. Under that procedure, a requesting spouse may be eligible for equitable relief under Code Sec. 6015(f) if, considering all the facts and circumstances, it would be inequitable to hold the requesting spouse liable for the unpaid deficiency. Rev. Proc. 2013-34 lists the following nonexclusive factors: (1) marital status; (2) economic hardship; (3) knowledge, or reason to know, of the item giving rise to the deficiency; (4) legal obligation; (5) significant benefit; (6) compliance with tax laws; and (7) mental or physical health. The court found that most of these factors were neutral but two of them favored relief. According to the court, Laura did not know or have reason to know of the items giving rise to the deficiencies, and she did not derive significant benefit from the understatements.

Although Laura worked at SEI during the years at issue, the court noted that she was not responsible for any accounting function other than signing checks. The court found no evidence linking Laura to SEI's business decision making. Nor was she aware, the court found, of Gregory's lease with SEI regarding the condominium. In the court's view, Laura had on reason to question that her husband was staying in the condominium because of his business in New York. The court also observed that Gregory was deceitful in his relationship with his wife. He hid his affair and opened a secret credit card to hid spending associated with it. He funded the affair, the court found, by diverting marital assets unbeknownst to Laura. In addition, the court found that Laura derived no benefit at all from the Range Rover and rarely stayed in the New York condominium. In the court's view, Laura received only a minimal benefit from the condominium, and she would likely have received the same benefit when visiting Gregory in New York if he had continued staying in hotels. The court also found no evidence that Laura made large expenditures or received lavish benefits. Taking into consideration these two factors, the court concluded that Laura was eligible for innocent spouse relief under Code Sec. 6015(f).

For a discussion of substantiating deductions on a return, see Parker Tax ¶250,163. For a discussion of innocent spouse relief, see Parker Tax ¶260,560.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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