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Tax Court grants innocent spouse relief to gambler's ex-husband

I love it when real life taxes coincide with my tax scribblings.

Take the latest Weekly Tax Tip. It dealt with innocent spouse issues.

And what just happens to pop up on the tax radar a few days later? A U.S. Tax Court ruling granting a husband innocent spouse status because he didn't know the full extent of his wife's gambling winnings.

Leonard Harbin filed a petition with the Tax Court seeking relief from joint and several liability for his and his now ex-wife's taxes. The Internal Revenue Service disagreed, saying that Harbin didn't qualify for innocent spouse relief because he was involved in and participated in a prior hearing on the couple's joint tax filing.

True, acknowledged Harbin. Also true that he prepared and filed joint returns for himself and Bernice Nalls, his former wife, based on discussions with and records kept by Nalls.

But, said Harbin, he did not know or have reason to know that this information was incorrect.

First piece of advice to Harbin: Yes, even though you love your spouse, you need to apply Ronald Reagan's advice to joint tax returns: Trust but verify.

More to the point of the Tax Court case, Harbin said he did not participate meaningfully in the prior tax proceeding because the same attorney represented him and Nalls.

This conflict of interest was exacerbated, said Harbin, because he and Nalls were in the midst of their divorce at the time and the same attorney also was representing them both in the divorce. Harbin said he relied on his wife to provide their attorney with all of the necessary information regarding the gambling activities since she was the one with the personal knowledge and the records.

Second piece of advice to Harbin: Now I'm no attorney, either in the tax or divorce areas, but I do know that even in the most amicable separation situations, it's wise to have your own representation. The same holds true when it comes to tax advisers.

But despite his filing and legal counsel oversights, Harbin got lucky.

When he and Nalls were married, they reported all of her $45,540 in gambling winnings for 1999 and $113,445.50 for 2000. They also zeroed out her 1999 winnings with corresponding gambling losses of $45,540. In 2000, they claimed $108,945.50 in gambling losses.

Harbin reviewed the gambling records Nalls kept and he also discussed with Nalls what he thought were all of gambling winnings and losses when preparing the 1999 and 2000 returns. He didn't know or have reason to know at the time he prepared the couple's joint returns that Nalls' gambling losses were incorrect.

When Harbin subsequently filed a separate tax return, the IRS applied an overpayment credit against unpaid liabilities related to his ex-wife's gambling activities. He then submitted a request for innocent spouse relief, which the IRS denied, saying Harbin knew or had reason to know of his former wife's gambling income.

Ex-spouse gambles on innocent status and wins: Tax Court Judge Diane L. Kroupa disagreed with the IRS. Instead, she found that Harbin had not meaningfully participated in the prior proceedings because Nalls effectively exercised exclusive control in regard to the due taxes since they related to her gambling activities.

Kroupa also noted that the IRS didn't raise the issue of res judicata, i.e., a claim preclusion because, as the Latin says, it is "a matter [already] judged," until two years after Harbin requested relief.

And because Harbin and Nalls shared the same attorney, the conflict meant Harbin wasn't advised at the time of the possibility of seeking innocent spouse relief.

Therefore, ruled  Kroupa, Harbin is not barred from requesting innocent spouse relief. And citing stipulations by Harbin and the IRS, the Tax Court held that he was entitled to the requested tax relief.

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