In Matter of Iris Egan, DTA No. 825114 (N.Y.S. Div. of Tax App., Sept. 11, 2014), a New York State Administrative Law Judge concluded that a married taxpayer was not entitled to innocent spouse relief from deficiency assessments based on disallowances of Qualified Empire Zone Enterprise tax credits (“QEZE credits”) that purportedly arose out of the operations of her spouse’s businesses, even though her spouse had recently been convicted of bank fraud and sentenced to time in federal prison.

Background. Ms. Egan, a college graduate with managerial experience, married Mr. Egan in 1981. Mr. Egan owned various businesses, and Ms. Egan performed many duties for those businesses. Ms. Egan testified that she and her husband “built a very big business together very successfully.” (Emphasis added.)

The Egans filed joint New York income tax returns for 2005 through 2007, and then filed amended returns for 2005 and 2006 increasing the amount of refund sought based on certain claimed QEZE credits. Ms. Egan did not participate in the filing of the returns, but she signed both the original and amended returns. The refund claims for 2005 through 2007 departed from the Egans’ filing history for previous years with regard to the QEZE credits.

Those QEZE credits were passed through to the Egans from S corporations owned by Mr. Egan. The Department notified the Egans that it could not process their 2005 amended return, due to missing forms and information relating, in part, to the QEZE credits, and no further information was supplied by the Egans. However, refund checks were issued by the Department for 2006 and 2007 (the “years in issue”), and Ms. Egan admitted endorsing the check for 2006 but denied endorsing the 2007 refund check. Eventually, due to the failure to provide the Department with substantiating information, the QEZE credits were disallowed, and in 2010 Notices of Determination were issued for 2006 and 2007 to recoup the refunds that had been issued.

In the same year, Mr. Egan was charged with and pled guilty to bank fraud, and in 2011 he was sentenced to 11 years in federal prison and had a judgment of over $85 million entered against him.

Thereafter, Ms. Egan formally requested innocent spouse relief from the asserted deficiencies for the years in issue. Ms. Egan maintained that the QEZE credits were properly claimed, but asserted that the records substantiating the QEZE credits were initially unavailable to her because the corporations were placed under the control of a courtappointed receiver as a result of the federal proceedings against Mr. Egan, and later could not be located. She also appeared to claim that Mr. Egan did not respond to the Department’s requests because he was distracted by the federal charges against him. She further maintained that the businesses were owned and operated by Mr. Egan without her direct involvement, and that she is facing financial hardship and now living on retirement and social security income. The Department rejected Ms. Egan’s request for innocent spouse relief, and Ms. Egan petitioned the Division of Tax Appeals.

The law. New York law on innocent spouse relief is modeled on the federal tax code, which provides that a spouse may receive relief from joint and several liability if, among other things: (a) on a joint return there is an understatement of tax attributable to erroneous items of one of the individuals filing the joint return; (b) the innocent spouse establishes that in signing the return he or she did not know or have reason to know of the understatement; and (c) the facts and circumstances establish that it would be inequitable to hold the innocent spouse liable for the deficiency resulting from the understatement. Tax Law § 654(a) (citing I.R.C. § 6015(b)(1)). Under New York case law, the petitioning spouse has the burden of showing he or she satisfies the elements of the innocent spouse relief rule. Matter of Revere v. Comm’r of Taxation & Fin., 75 A.D.3d 860 (N.Y. App. Div. 3rd Dep’t 2010).

The decision. Finding that Ms. Egan failed to show that “she did not know or have reason to know of the understatements” in the returns filed, the ALJ rejected Ms. Egan’s petition for innocent spouse relief. The ALJ focused on the activities of Ms. Egan leading up to her signing the returns for the years in issue, rather than the actions after the Department inquired about the claimed QEZE credits. The ALJ stated that Ms. Egan had “at least a minimum duty or obligation to make some inquiry” regarding the accuracy of the returns and found no evidence that she made any investigation or raised any questions regarding the refunds claimed on the returns. The ALJ rejected Ms. Egan’s attempts to separate herself from her spouse’s business, stating that Ms. Egan was educated and “was, by her own admission, involved in building the Egans’ businesses and in fact worked in such businesses over a significant period of time” and continued to work for the businesses on an as-needed basis during the years in issue. The ALJ also determined that Mr. Egan’s federal criminal charges were not related to the QEZE credits claimed in the years in issue and, while acknowledging that Mr. Egan’s attention may well have been diverted by his other legal issues from responding to the Department’s requests for substantiation of the claimed QEZE credits, that was found insufficient to entitle Ms. Egan to innocent spouse relief.

Additional Insights

The ALJ’s decision is consistent with previous New York State cases rejecting petitions for innocent spouse relief when the petitioner failed to show that he or she did not know or have reason to know of the understatements claimed on a joint return at the time of signing the return. To satisfy this requirement, a petitioning spouse lacking actual knowledge of an understatement on a joint return typically must show that he or she made meaningful attempts to verify the accuracy of the return prior to signing it. This decision serves as a warning to taxpayers that New York’s innocent spouse provision may provide no relief to taxpayers who solely rely on their spouses to complete their joint tax returns or respond to audit inquiries.