- 15 -
disallowed deduction or an item of omitted income. Price v.
Commissioner, 887 F.2d at 963. For disallowed deductions, the
taxpayer must establish that "she [or he] did not know and did
not have reason to know that the deduction would give rise to a
substantial understatement." Id.
In cases involving the omission of income, a slightly higher
hurdle for the taxpayer exists: the relief-seeking spouse must
show that she did not know, and should not have known, of an
income-producing transaction that her spouse failed to report on
their joint return, thus giving rise to the substantial
understatement. Hayman v. Commissioner, 992 F.2d at 1261; see
Langberg v. Commissioner, T.C. Memo. 1994-223. The Court of
Appeals for the Second Circuit in Friedman succinctly stated the
rationale for the differing standards: "[A]pplying the omission
of income test to cases involving the disallowance of deductions
would eviscerate the innocent spouse defense, since merely
looking at the tax return informs the spouse of the transaction *
* * that gave rise to the deduction." Friedman v. Commissioner,
53 F.3d at 530.
With respect to a taxpayer's "reason to know", courts tend
to use a test possessing both subjective and objective
components: whether a "'reasonably prudent taxpayer in * * *
[taxpayer's] position at the time she signed the return could be
expected to know that the return contained the substantial
understatement.'" Hayman v. Commissioner, 992 F.2d at 1261
Page: Previous 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 NextLast modified: May 25, 2011