Wisconsin Tax Appeals Commission Docket No. 98-I-67

STATE OF WISCONSIN

TAX APPEALS COMMISSION

JEFFREY E. DAVIS

1137 Madison Street

Waukesha, WI 53188

Petitioner,

vs.

WISCONSIN DEPARTMENT OF REVENUE

P.O. Box 8933

Madison, WI 53708

Respondent.

DOCKET NO. 98-I-67

DECISION AND ORDER

MARK E. MUSOLF, CHAIRPERSON:

This matter was heard at Waukesha on July 29, 1998. Both parties filed post-hearing briefs. The petitioner represents himself. Attorney Lili Best Crane represented the respondent.

Having considered the entire record, the Commission hereby finds, concludes, and orders as follows:

FINDINGS OF FACT

1. Under date of December 4, 1995, respondent sent to petitioner, Jeffrey E. Davis, a Notice of Amount Due in the amount of $7,092.89, including tax, interest, penalty, and late fee, with respect to calendar years 1992 and 1993, which is the period under review.⁽¹⁾ The respondent's Office Audit Worksheet stated, among other things, that "The allocation of Schedule C net profit from taxpayer to spouse as reported will not be allowed."

2. By letter dated February 2, 1995, petitioner petitioned respondent for redetermination of the assessment, which was denied in a Notice of Action letter dated January 26, 1998 and received by petitioner on January 28, 1998.

3. On March 25, 1998, petitioner timely filed a petition for review with this commission.

4. Petitioner and Deborah Zydowicz ("Deborah") were married and resided together during 1992 and 1993. They were divorced November 1, 1994. Deborah was a homemaker and did not work outside their home in 1992. During 1993, she earned adjusted gross income of $2,534.17.

5. During 1992 and 1993, petitioner's principal business was furniture refinishing/woodwork repair. This business was a sole proprietor-ship in petitioner's name. Deborah assisted petitioner in maintaining the books and records of his business. She had no formal accounting experience or training, but she prepared monthly records of income and expenses during the period under review, except for December 1993. Her records included cumulative monthly receipt totals through August 1993 and an annual receipt total for 1992, which included a $12,122 pension distribution received from Armin Koch Furniture.

6. Deborah made bank deposits and wrote checks to pay business expenses, including sales taxes. She also wrote checks to herself from the business account, presumably for personal and household expenses. She paid all the household bills. Using figures compiled by Deborah, petitioner prepared their tax returns for the years prior to the period under review and his separate returns for 1992 and 1993.

7. In 1992, the net profit from petitioner's business was $31,904; in 1993, it was $51,579.

8. All of the income petitioner and Deborah received in 1992 and 1993 was marital property income. They did not timely file Wisconsin income tax returns for those years because they didn't have the money to pay the taxes due.

9. The parties separated in January 1994 when petitioner moved out of the marital residence, where most of the business records for 1992 and 1993 were located. Deborah remained there until April 1994, when petitioner returned and she moved out, taking some of the parties' financial records with her. These records, which included Deborah's Forms W-2 for 1993, were not returned to petitioner until May 1995, after which he used them to prepare his 1992 and 1993 separate income tax returns.

10. Petitioner did not file extensions for filing his 1992 and 1993 income tax returns, either with the Internal Revenue Service or the respondent. The unextended due date for petitioner's 1992 Wisconsin income tax return was April 15, 1993, and the unextended due date for his 1993 Wisconsin income tax return was April 15, 1994.

11. After petitioner and Deborah separated in 1994, they were unable to agree on filing a joint income tax return for either 1992 or 1993.

12. By letter dated September 15, 1995, petitioner notified Deborah that he had filed his income tax returns for 1992 and 1993 with the Internal Revenue Service. In the letter he advised her she would need to file her own tax returns for those years, and he enclosed copies of his returns and Deborah's 1993 Forms W-2.

13. Petitioner filed his 1992 and 1993 Wisconsin income tax returns with respondent on or about November 6, 1995, checking the box "married filing separate return." On those returns, he subtracted one-half of their marital property income as allocable to Deborah, including half of his Schedule C net profit and half of the $12,122 pension distribution from Armin Koch Furniture. However, he reported 100% of the allowable self-employment tax and claimed 100% of the allowable self-employed health insurance deduction and 100% of the marital itemized deductions.

14. Deborah did not file her 1992 and 1993 income tax returns with respondent until November of 1996. She reported no income for 1992, referring to herself as an "innocent spouse," and citing to the terms of her divorce from petitioner. For 1993, the only income she reported was the $2,534.17 of wages that had been reported to her on Forms W-2, even though she knew petitioner had reported half of those wages on his separate 1993 return as his share of marital property income.

15. Petitioner's final divorce decree, dated November 1, 1994, which incorporated his and Deborah's Marital Settlement Agreement and amendments made at their divorce trial, provides in relevant part as follows:

Each party shall be solely responsible for his or her own individual tax liabilities. Any tax refund received by the parties for the 1993 tax year shall be divided equally between the parties.⁽²⁾

The respondent [Jeffrey Davis] is awarded his business known as the Furniture Doctor including all assets and liabilities with regard to this business and the petitioner [Deborah Zydowicz] is divested of any interest thereon.⁽³⁾

The parties shall equally share any tax liability for 1993.⁽⁴⁾

16. A Revision of Divorce Judgment, approved by court order dated December 13, 1995, provided in relevant part as follows:

The respondent [Jeffrey Davis] shall continue to remain liable to accurately report income earned while the partners were married and shall continue to be liable for the payment of all taxes, interest and penalties due to the State of Wisconsin and the Internal Revenue Service and shall hold the petitioner [Deborah Zydowicz] harmless of any such debts.

17. A subsequent court order in the divorce case, dated December 2, 1996, provides in relevant part as follows:

The Revision of Divorce Judgment ... does not alter the responsibility of petitioner [Deborah Zydowicz] and respondent [Jeffrey Davis], as between the parties, to pay their respective share of the 1992 and 1993 Federal and State income tax liability. [T]he obligation of petitioner [Deborah Zydowicz] and respondent [Jeffrey Davis] to pay their respective share is set forth in the Judgment of Divorce entered herein.

APPLICABLE LAW

Wisconsin Statutes

71.10 General provisions.

* * *

(6m) RETURNS OF FORMERLY MARRIED AND REMARRIED PERSONS.

(a) A formerly married or remarried person filing a return for a period during which the person was married may be relieved of liability for the tax, interest, penalties, fees, additions to tax and additional assessments under this chapter for unreported marital property income from that period as if the person were a spouse under section 66(c) of the internal revenue code. The department may not apply ch. 766 in assessing the former spouse of the person with respect to marital property income that the former spouse did not report if that former spouse failed to notify the taxpayer's spouse about the amount and nature of the income before the due date, including extensions, for filing the return for the taxable year during which the income was derived. The department shall include all of that marital property income in the gross income of the former spouse and exclude all of that marital property income from the gross income of the person.

Internal Revenue Code

Sec. 66 [1986 Code].

* * *

(1) an individual does not file a joint return for any taxable year,

(2) such individual does not include in gross income for such taxable year an item of community income properly includible therein which, in accordance with the rules contained in section 879(a), would be treated as the income of the other spouse,

(3) the individual establishes that he or she did not know of, and had no reason to know of, such item of community income, and

(4) taking into account all facts and circumstances, it is inequitable to include such item of community income in such individual's gross income, then, for purposes of this title, such item of community income shall be included in the gross income of the other spouse (and not in the gross income of the individual)....

ISSUES AND CONCLUSIONS OF LAW

1. Did the petitioner fail to notify his then-spouse about the amount and nature of marital property income the petitioner did not report to respondent, so that the respondent may not apply Chapter 766 in assessing petitioner on such income for 1992 and 1993? The Commission concludes that notification by the statutory deadline in Wis. Stat. § 71.10(6m) was not required for 1992. For 1993, we conclude that petitioner failed to notify his former spouse Deborah of his Schedule C business net income within the meaning of Wis. Stat. § 71.10(6m), and that the income-splitting provisions of Chapter 766 may not be applied by respondent in assessing petitioner for 1993 with respect to that income and related interest and penalties.

2. What is petitioner's liability to respondent for 1992 and 1993 Wisconsin income taxes under the terms of his divorce from his former wife Deborah? The Commission concludes that, although under petitioner's divorce decree as amended, he is liable for one-half of his and Deborah's tax liabilities for 1992 and 1993, the respondent is bound by § 71.10(6m), not the divorce decree, in assessing the petitioner.

OPINION

Applicability of § 71.10(6m)⁽⁵⁾

Wisconsin Statute § 71.10(6m) contains two provisions. The first provides that a former spouse filing a separate return may be relieved of liability with regard to unreported marital property income in the manner specified for spouses in § 66(c) of the Internal Revenue Code. Section 66(c)(3) specifies that a taxpayer must establish that he or she did not know of and had no reason to know of such item of community income⁽⁶⁾ in order to be relieved of reporting it. This provision was designed to relieve an innocent spouse who was unaware of the community income that he or she did not report. Petitioner is obviously not eligible for relief under this provision because he was fully aware of all of his and Deborah's marital property income.

The second provision of § 71.10(6m) prohibits respondent from applying the income-splitting provisions of the marital property law in assessing a former spouse (petitioner) where he didn't notify his former spouse (Deborah) of the income before the due date of the return for the year it was reportable.

Respondent maintains that it properly assessed petitioner for all of the marital property income for both 1992 and 1993, including Deborah's share, because he did not notify her of the amount of that income until September 1995, well beyond the due dates for those returns. Petitioner insists that Deborah knew the amount and nature of the income because she helped keep the books for the business that produced it and knew the amount of income.

Notice of 1992 Income

The due date of the 1992 tax return was April 15, 1993, when petitioner and Deborah were married and living together. They were financial partners at that time and had been for all of 1992. The business was petitioner's, but Deborah did extensive bookkeeping, made bank deposits, and paid business expenses. She wrote checks to herself from the business account, presumably for her personal and household use. She paid all the household bills and kept the household records. Both Deborah and petitioner were equally responsible for timely filing the 1992 tax return and paying the taxes but, as petitioner testified, "we didn't have the money to pay 'em and just blew it off."

Although petitioner didn't formally notify Deborah of her share of their marital income by April 15, 1993, there was no reason for him to do so. They were married at the time and knew of the income, but they still decided not to timely file a return. Knowledge of their marital income was not an issue until after they separated in 1994 and were at odds over taxes during their divorce proceedings. Even after they separated, Deborah had all of the 1992 records in her possession while she remained in the parties' home from January through early April of 1994. Had she cared to file at that time, all of the records were available to her and she could have done so. Neither she nor petitioner was an innocent spouse with respect to the requisite knowledge for filing a timely1992 income tax return.

Under these circumstances, we conclude that the statutory notice deadline in § 71.10(6m) does not apply, and that petitioner gave proper notice to Deborah in September 1995 of his separate filing, including the amounts he reported as income (and deductions). This conclusion is reinforced by the Legislative Council Committee Supplemental Notes Relating to 1985 Acts 29 and 37, which included § 71.10(6)(b):

If one spouse, particularly a spouse with sole management and control powers, fails to notify the other spouse in a timely fashion of the amount and nature of any income associated with marital property or survivorship marital property, the special committee concluded that it is unfair to hold the uninformed spouse liable for the taxes associated with the income and that the spouse who has knowledge should be held liable.

(Emphasis supplied.) We agree. Here, both Deborah and petitioner shared the management and control of their marital finances until they separated in 1994. Neither was "uninformed" on April 15, 1994.

Notice of 1993 Income

The due date of the 1993 tax return was April 15, 1994. This was after petitioner and Deborah had separated but while she still had in her possession her own W-2 forms as well as some of the household financial records petitioner would have needed to prepare the return.

Just as they were for 1992, petitioner and Deborah were married financial partners during all but the final month of 1993, when petitioner did all of the business bookkeeping. However, Deborah had all of the 1993 business and household records in her possession in their home after petitioner moved out in early 1994 and until a few weeks before the 1993 tax filing deadline of April 15, 1994. She could have filed a timely separate return from the records in her possession, although she was likely preoccupied with the separation and impending divorce.

However, because the parties were separated for a period immediately prior to the filing deadline, Deborah was without complete information at that critical time as to petitioner's Schedule C business net income. We therefore conclude that § 71.10(6m) applies with respect to that income. Because petitioner did not notify Deborah before the deadline in § 71.10(6m), respondent properly assessed him for all of the 1993 Schedule C income.

Liability Under Petitioner's Divorce Judgment

The divorce judgment makes petitioner and Deborah each responsible for "his or her own individual tax liabilities." Although a 1995 "Revision" of the judgment suggests otherwise,⁽⁷⁾ the sharing language in the original judgment was reaffirmed in a court order in 1996.⁽⁸⁾

With respect to 1992, petitioner and Deborah had no "individual tax liabilities" as such because they were married and subject to Chapter 766. Under Chapter 766, tax liabilities -- like other obligations -- are shared equally because they were presumably incurred in the interest of the marriage and are payable from marital property, which includes all income and other assets. Wis. Stats. §§ 766.55(1)⁽⁹⁾ and (2)(b);⁽¹⁰⁾ and 766.31(4).⁽¹¹⁾ This did not change simply because they later filed separate returns for 1992.

With respect to liability for 1993 taxes, the divorce judgment is unambiguous: both petitioner and Deborah are to equally share "any" tax liability. Under this provision, petitioner would be responsible for one-half of his and Deborah's total combined tax liability to respondent. However, because respondent is prohibited by § 71.10(6m) from splitting petitioner's Schedule C net income in assessing him, the effect is that petitioner's statutory liability produces a result at odds with the equal sharing mandated in the divorce judgment. This dichotomy is not a matter to be resolved by the respondent or the Commission; it can only be addressed by the divorce court. Our only authority is to resolve the dispute between petitioner and respondent.

ORDER

The respondent's assessment against petitioner is modified in accordance with the Conclusions of Law and Opinion set forth above, and is affirmed as modified.

Dated at Madison, Wisconsin, this 30th day of April, 1999.

WISCONSIN TAX APPEALS COMMISSION

___________________________________________

Mark E. Musolf, Chairperson

___________________________________________

Don M. Millis, Commissioner

___________________________________________

Thomas M. Boykoff, Commissioner

ATTACHMENT: "NOTICE OF APPEAL INFORMATION"

¹ All facts pertain to the period under review unless otherwise stated.

² This language was incorporated by the Court from the Marital Settlement Agreement dated May 30, 1994.

³ This language was incorporated by the Court from "Ammendments to Marital Settlement Agreement" (sic) made at trial.

⁴ See Footnote 2.

⁵ § 71.10(6)(b), cited by respondent, applies to married taxpayers. Here, the parties were no longer married when the returns were filed and when petitioner was assessed.

⁶ Wisconsin's marital property is a form of community property. Wis. Stat. § 766.001(2).

⁷ Finding of Fact 16.

⁸ Finding of Fact 17.

⁹ "An obligation incurred by a spouse during marriage is presumed to be incurred in the interest of the marriage"

¹⁰ "An obligation incurred by a spouse in the interest of the marriage or family may be satisfied only from all marital property and all other property of the incurring spouse."

¹¹ " income earned or accrued by a spouse or attributable to property of a spouse during marriage is marital property."