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Knowledge of the Understatement
Petitioners contend that Ms. Walters had no actual or
constructive knowledge of the embezzlement income before or
during the applicable years. Respondent does not agree.
To establish lack of knowledge of the understatement, Ms.
Walters must show that she was unaware of the circumstances
giving rise to the omission of income. See Park v. Commissioner,
25 F.3d 1289, 1294 (5th Cir. 1994) ("Courts have generally agreed
that in innocent spouse cases involving the omission of income,
relevant inquiry is whether the spouse claiming innocent spouse
relief knew or should have known of an income-producing
transaction that the other spouse failed to report in their joint
return."), affg. T.C. Memo. 1993-252; Purcell v. Commissioner, 86
T.C. at 238. She must show that she lacked both actual knowledge
and constructive knowledge of the omission such that a reasonably
prudent person under the circumstances at the time that the
return was filed could not be expected to know that the tax
liability stated was erroneous or that further inquiry was
necessary. See Stevens v. Commissioner, 872 F.2d 1499, 1504-1505
(11th Cir. 1989), affg. T.C. Memo. 1988-63; Sanders v. United
States, 509 F.2d 162, 167 (5th Cir. 1975). Whether the spouse
seeking relief had reason to know of the substantial
understatement is a question of fact to be determined after
reviewing the entire record. Guth v. Commissioner, 897 F.2d 441
(9th Cir. 1990), affg. T.C. Memo. 1987-522.
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