Thursday, January 23, 2003

Make No Bones About It

I generally do not share the sentiments of those who rage incessantly about unethical lawyers bringing baseless cases and making frivolous arguments. It is the job of an attorney, after all, to push the envelope of justification for his or her client's position. Indeed, the most often cited cases of purported spurious arguments such as the McDonald's coffee scalding case or the purported cigar/fire insurance case can be shown to present either meritorious claims or an urban legend. (I even feel that there is some validity to the plaintiffs' arguments in the recent "Big Macs made me fat" case. But these claims will more likely be won by consumers voting their wallets.)

However, not all arguments deserve to be made. To paraphrase Dorothy Parker, there are arguments that should not be tossed aside lightly. They should be thrown with great force. Such is the case of the argument of Mrs. Barranco that she was an innocent spouse who should not have to pay the tax liabilities associated with the fraudulent income tax returns she filed jointly with her husband.

Mrs. Barranco's husband is an orthopedic surgeon. From 1983 through 1992, they filed joint income tax returns and reported a total of $732,632 in adjusted gross income. However, as reconstructed by the IRS, it appears that they omitted to report a trifling $5,878,813 in income over this period. In one year, they reported only a little over $5,000 in taxable income, omitting over $805,000 of actual income. In May, 1995, Dr. Barranco pled guilty to conspiracy to commit tax fraud and tax evasion. He was sentence to 27 months in jail.

Now orthopedic surgeons and their families usually live the good life and the Barrancos were no exception. Their four children got nice cars and nice college educations. The three Barranco daughters got nice weddings. There were ski trips to France, Switzerland, and Colorado. There was a trip to Scandinavia and a bus tour of Italy. Mrs. Barranco got furs and jewels. Of course, there was the obligatory boat.

They built their primary residence on a 29 acre parcel of land. Just to protect their privacy, they purchased, in Mrs. Barranco's name, 100.7 acres adjoining that parcel. And, just to get away from it all, they had two parcels of vacation property, on one of which they first built and they remodeled, a vacation home. Ultimately, all of these properties were titled in Mrs. Barranco's name.

Finally, in 1996, after Dr. Barranco had pled guilty, Mrs. Barranco transferred the real property to an LLC owned by her four children in exchange for a promissory note bearing only 3% per annum interest. About a year after that, the residence together with six acres of land was re-conveyed to Mrs. Barranco without consideration.

The "innocent spouse" doctrine is codified as IRC Section 6015. There are a variety of types of innocent spouse applications available there. In this case the primary basis asserted was under Section 6015(b). In order to qualify for relief under that section, a spouse must establish that she did not know and had no reason to know that on the joint returns there were understatements of income. The purported innocent spouse is charged with the knowledge of what is actually contained on the returns. In deciding whether a spouse had reason to know of an understatement, a key factor is the extent to which family expenditures, of which the spouse had knowledge, exceeded reported income. Other relevant factors include the spouse's education level; her involvement in the family's business and financial affairs; the presence of lavish or unusual expenditures as compared to the family's past income levels, income standards, and spending patterns; and the culpable spouse's evasiveness and deceit concerning the couple's finances.

The Court's conclusion is best summarized in the following passage: "On brief, [Mrs. Barranco] contends that the Barrancos' lifestyle was not lavish or unusual, but it was simply the 'lifestyle of a hard-working orthopedic surgeon's family.' In support of this contention, petitioner states on brief that 'orthopedic surgeons generally do have very good incomes.' Therein lies the rub. Although the Barrancos were enjoying the lifestyle of a 'hardworking orthopedic surgeon’s family' during the years at issue, Dr. Barranco and [his wife] were reporting much less than the 'very good incomes' that orthopedic surgeons might generally be expected to earn to support such a lifestyle. On the basis of all the evidence, we believe that [Mrs. Barranco] should have been aware of this discrepancy."

I've recently had a successful result in an innocent spouse case. However, in that case the income shown on the joint income tax return was consonant with the modest lifestyle the family lead. In the Barrancos' case, the lifestyle was lavish, the returns were modest. Mrs. Barranco should have made no bones about the assessment.

The Barranco case is Barranco v. Commissioner, T.C. Memo 2003-18.

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