Federal Case Shows California Taxpayers Who Under-Report Their Income May be Subject to Foreclosure in a Tax Collection Action
In United States v. Peters, a married woman owned and managed a rental property company in Missouri. Her husband performed maintenance and other management duties for her business. Following a purchase agreement dispute, the woman sold one of her rental properties pursuant to a court order. The proceeds of the sale were later deposited with the woman’s company and were not reinvested in a replacement property. The couple jointly filed a 2002 federal income tax return but failed to pay taxes on or report the gains realized from the sale of the rental property. According to the couple, the gain realized was not taxable because the sale of the property was involuntary.
After reviewing the couple’s tax return, the Internal Revenue Service stated the involuntary conversion rules set forth in 26 U.S.C. § 1033 did not apply to their situation. Following an audit, the IRS issued a Notice of Deficiency to the couple over the unreported capital gain realized on the sale of the rental property. The Agency found that the couple understated their income by more than $155,000 and were subject to a non-discretionary penalty as a result. The IRS then filed a Notice of Federal Tax Lien against the couple.
A few months after the tax lien was filed, the man sought innocent spouse relief from the IRS. In general, married taxpayers who file a joint federal income tax return are equally responsible for any tax, interest, or penalties that may arise from the return. This is the case even if the couple later chooses to divorce. Innocent spouse relief normally releases a taxpayer from his or her obligation to pay any additional tax that may be owed if a spouse or former spouse improperly reported or failed to report income or claimed inappropriate tax deductions or credits. After the IRS denied the man’s request for relief, an Agency employee erroneously indicated the man was entitled to innocent spouse relief in the IRS computer system. About one year later, the error was discovered and rectified.
Between 2006 and 2011, the couple paid nothing related to the additional tax penalties assessed by the IRS for the 2002 tax year. In 2011, the IRS again made an error related to the couple’s tax liability when the Agency released its federal tax lien on the woman. A few months later, the IRS revoked this release and filed another Notice of Federal Tax Lien against her. In 2012, the agency filed a tax collection action in federal court seeking to enforce its lien through the sale of the couple’s home.
Although both members of the couple admitted to owing the delinquent tax, they contested the amount assessed. Following discovery, both the couple and the United States government filed a motion for summary judgment. When such a motion is filed, a party to a lawsuit is asking the court to rule in its favor because no material facts are in dispute, and that party is entitled to judgment as a matter of law.
Initially, the court stated that a taxpayer who disagrees with an IRS tax assessment bears the burden of proving the Agency was incorrect. Next, the court examined the relevant statutes and the validity of the tax assessment. According to the court, the couple’s admission to owing the tax established their indebtedness to the IRS. Although the woman claimed the assessment was made in error, the federal court said she admitted otherwise at the pleading stage. The court also found that the couple failed to meet their burden of establishing that the sale of the rental property was not subject to capital gains tax. Finally, the federal court held the government was not required to show that the couple’s other assets were insufficient to satisfy the tax lien prior to foreclosing on their residence. In the end, the federal court denied the couple’s motion for summary judgment, granted the government’s motion, and ruled in favor of the U.S.
Certified tax law specialist William Hartsock has decades of experience helping clients in San Diego with their federal and other income tax issues. To speak with a seasoned tax lawyer about your situation, do not hesitate to call Mr. Hartsock today at (858) 481-4844 or contact him through his website.
United States v. Peters, Dist. Court, ED Missouri 2014