Appeal from the United States Tax Court
No. 18606-88--Lawrence T. Wright, Judge.
Before BAUER, EASTERBROOK and RIPPLE, Circuit Judges.
Appellant Melinda B. Resser and her husband Alan M. Resser filed a joint federal income tax return for taxable year 1982. The United States Tax Court decided that Mr. and Mrs. Resser were liable for income tax deficiencies due to a substantial understatement of tax on their 1982 tax return. After conducting a separate trial on the reserved issue of Mrs. Resser's qualification for "innocent spouse" relief, the Tax Court decided that Mrs. Resser did not meet the statutory requirements of 26 U.S.C. sec. 6013(e) and therefore was not entitled to that relief from the joint tax liability. Mrs. Resser now appeals the denial of "innocent spouse" status. For the reasons that follow, we reverse the judg ment of the Tax Court and remand for further proceedings.
In 1963, Alan Resser earned a bachelor of science degree in finance, married Melinda (the appellant), and began working for a brokerage house. After taking positions as a computer programmer for the Midwest Stock Exchange and as a stockbroker, in 1970 Mr. Resser turned to selling futures on securities for Merrill Lynch and Company. In 1973, with borrowed money, Mr. Resser bought a seat on the Chicago Board Options Exchange (CBOE), a newly registered national securities exchange. *fn1 From then through 1982, the taxable year at issue, he held market maker status in appointed stock options that he traded at the CBOE. In 1974 the Ressers purchased a home in Highland Park, Illinois, in which they and their two children resided during taxable year 1982.
They lived a comfortable, perhaps affluent, lifestyle, with cleaning help, frequent nice vacations, season tickets to the opera, and summer camps for the children. In addition, Mr. Resser owned several expensive automobiles.
Mrs. Resser earned a bachelor of science degree in English and a master's degree in medical communications. She worked as a medical writer until 1969. Although she stopped working at that time to raise the couple's two children, she did work at home as a market researcher in the early 1970s. In 1978, Mrs. Resser volunteered at Highland Park Hospital; the next year she received a position there as a part-time consultant, and in 1980 she began to work full-time there. At the end of 1983, she took a position as a marketing director for a health care company.
However, the marriage was not harmonious. One element adding strain to their marriage was Mr. Resser's manic-depressive illness, known as bipolar depression, which manifested itself around 1970 and continued, episodically, throughout their marriage. In early 1980, when the illness returned, Mr. Resser exhibited erratic behavior. He first left his wife and started divorce proceedings, and then withdrew the divorce papers and returned home. The partners in Mr. Resser's trading business asked him to stop trading. They notified Mrs. Resser that her husband's performance at work was inadequate and that they were forced to terminate their partnership with him. At that time, Mrs. Resser began to work full-time at the hospital. During 1982, she earned $14,655. In 1982 the Ressers also borrowed $250,000 for use in Mr. Resser's continued trading activity; they used their home as collateral. In October 1988, during another period of manic depression, Mr. Resser left Mrs. Resser once again and withdrew all of the cash from their savings account. At the time of the tax trials, Mr. and Mrs. Resser maintained separate residences; *fn2 Mr. Resser was unemployed, due to health complications, *fn3 and was receiving monthly disability insurance.
Mrs. Resser did not participate in the management of day-to-day operations of Mr. Resser's business. She paid the household expenses until 1980; however, at that time, apparently at the suggestion of his psychiatrist, Mr. Resser took over control of the family finances when he recovered from his depression. Mrs. Resser had signature authority on some of their bank accounts, but knew nothing of his trading accounts. The tax returns were prepared each year by an accountant. Mrs. Resser's involvement with the preparation of the joint returns consisted of gathering income reporting forms and any other relevant tax information delivered to the house and presenting it to the accountant. When the return was completed, Mrs. Resser signed it without reviewing it.
B. Procedural History *fn4
During the 1982 tax year, Mr. Resser, as a member of the CBOE, made stock option trades in two accounts, AMR and QRF. Only account QRF transactions were at issue in Resser I, the previous decision on the Ressers' tax liability. *fn5 In April 1988, the Commissioner of Internal Revenue sent the Ressers a notice of deficiency claiming a $391,113 deficiency in their joint federal income tax liability for 1982, plus a $97,778 addition to tax for the substantial understatement of tax liability, and an increased rate of interest on the underpayment. In Resser I, the Tax Court found that the stock option spread losses used in the QRF transactions were not deductible under section 165 of the Tax Code because Mr. Resser "failed to prove that he entered into the transactions at issue primarily for profit." Resser I, 62 T.C.M. (CCH) 617, 627. It decided that the Ressers were jointly liable for the deficient taxes and interest charged by the Commissioner. *fn6 Id. at 628-29.
Then the Tax Court conducted a second trial to determine whether Mrs. Resser qualified for relief from that liability because she was an innocent spouse. The court attributed the existence of the substantial understatement *fn7 to Mr. Resser and found that Mrs. Resser did not know of the transactions producing the understatement.
Mr. Resser testified that he discussed his trading practices and methods of deferring taxes with petitioner and therefore petitioner was aware of the transactions which resulted in the losses at issue in Resser I. The record indicates, however, that petitioner did not participate in the management or day-to-day operations of Mr. Resser's business. Based on this record, we conclude that petitioner did not know of the transactions producing the understatement. Resser II, 67 T.C.M. (CCH) 3025, 3025-3.
Nevertheless, the Tax Court believed that she had reason to know of the understatement because the figures reported on the 1982 joint return--wage income and income interest of approximately $300,000, but taxable income of only $3,526, for which no tax was owed--should have alerted Mrs. Resser to the fact that there was an understatement of tax. The court pointed out that Mrs.
Resser was responsible for gathering the income statements and other tax forms, and thus she should have been aware of the amounts reported on them and should have known that the reported taxable income would not support their lifestyle. The court also noted that Mrs. Resser was an intelligent, mature, well-educated woman who had written the family checks and was cognizant of the amount of income necessary to support the household. The Tax Court concluded that "a reasonably prudent person, with petitioner's knowledge of the family finances, would have reason to know of the understatement." 67 T.C.M. at 3026.
The court further found that Mrs. Resser failed to inquire about the understatement once she had reason to know of it. It noted Mrs. Resser's testimony that she preferred not to know what Mr. Resser did on a daily basis because his business was so volatile, and that she did not review the returns because they did not mean anything to her. It was significant to the court that she chose not to review the tax returns and did not claim that they were concealed from her. When she signed the return each year, the court commented, she should have realized her responsibility for reviewing it. Because "Section 6013(e) is designed to protect the innocent, not the intentionally ignorant," id., the court concluded that Mrs. Resser's failure to inquire was not reasonable.
It also determined that it would not be inequitable to hold Mrs. Resser liable for the deficiency attributable to the substantial understatement. 67 T.C.M. at 3027. After noting the Ressers' expensive lifestyle and Mr. Resser's estimate that their living expenses were $21,000 each month in 1982, the court decided that Mrs. Resser significantly benefited from the understatement and had not met her burden of proving otherwise by providing specific facts regarding their lifestyle expenditures. It also pointed out that, even though Mr. Resser was responsible for the trading that created the understated income, "the loss was claimed on their joint return and the decreased tax liability allowed more funds to be available for the household." 67 T.C.M. at 3026. Because she benefited from those funds, the court concluded that it was not inequitable to hold Mrs. Resser liable for the deficiency. The Tax Court then decided that Mrs. Resser was not entitled to relief as an innocent spouse.
The Internal Revenue Code provides that a husband and wife who file a joint tax return are liable, jointly and severally, for the taxes due on their combined incomes. 26 U.S.C. sec. 6013(d)(3). "This is so 'regardless of the source of the income or of the fact that one spouse may be far less informed about the contents of the return than the other.' " Bliss v. Comm'r, 59 F.3d 374, 377 (2d Cir. 1995) (quoting Sonnenborn v. Comm'r, 57 T.C. 373, 381, 1971 WL 2600 (1971)). However, the "innocent spouse" provision was enacted to remedy "grave injustice." Bliss, 59 F.3d at 378 (quoting Hayman v. Comm'r, 992 F.2d 1256, 1259 (2d Cir. 1993)). It is therefore construed and applied liberally in favor of the person claiming its benefits. Friedman v. Comm'r, 53 F.3d 523, 528-29 (2d Cir. 1995). An "innocent spouse" may be relieved of liability if he or she proves all four requirements of the defense embodied in section 6013(e)(1):
sec. 6013(e) Spouse relieved of liability in certain cases.--
(1) In general.--Under regulations prescribed by the Secretary, if--
(A) a joint return has been made under this section for a taxable year,
(B) on such return there is a substantial understatement of tax attributable to grossly erroneous items of one spouse,
(C) the other spouse establishes that in signing the return he or she did not know, and had no reason to know, that there was such substantial understatement, and
(D) taking into account all the facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for such taxable year attributable to such substantial understatement, then the other spouse shall be relieved of liability for tax (including interest, penalties, and other amounts) for such taxable year to the extent such liability is attributable to such substantial understatement. 26 U.S.C. sec. 6013(e). *fn8
We review the Tax Court's decision in the same manner and to the same extent as we review district court decisions from the bench in civil actions. Applegate v. Comm'r, 980 F.2d 1125, 1128 (7th Cir. 1992).
The Tax Court's conclusions of law are subject to de novo review, and its findings of fact are overturned only if there is clear error. Id.; see Williams v. Comm'r, 1 F.3d 502, 505 (7th Cir. 1993) (stating that Tax Court decisions on questions of fact and mixed questions of fact and law are reviewed under the clear error standard). In this case, there is no dispute that a joint return was filed with a significant tax understatement attributable to Mr. Resser's activities. See 26 U.S.C. secs. 6013(e)(1)(A), (B). Nevertheless the Tax Court ...