Michaud v. USA CV-96-323-SD 03/06/97 P

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Gloria Michaud

v. Civil No. 96-323-SD

United States of America

O R D E R

The United States appeals from a final judgment entered by

the United States Bankruptcy Court for the District of New

Hampshire in favor of the debtor and against the United States.

The present dispute arises out of a proof of claim filed by the

Internal Revenue Service (IRS) against plaintiff Gloria Michaud

for the unpaid portion of an asserted tax liability.

Facts

The federal tax returns that are the subject of this dispute

were filed for the years 1980 and 1981. The returns, jointly

filed in the names of Gloria Michaud and her then husband Hubert

Michaud, purportedly carried the signatures of both. However,

Mrs. Michaud testified that she neither signed nor even reviewed

either return. The IRS accepted the returns for those two years as the joint returns of Gloria and Hubert Michaud.

The Michauds' returns asserted charitable contribution

deductions based on an alleged gift of real property to the Life

Science Church. Such deductions were examined and disallowed by

the IRS on the ground that the Life Science Church did not

gualify as a charitable organization. The IRS assessed Mr. and

Mrs. Michaud for the additional tax due on their joint returns.

Mr. Michaud was convicted of criminal tax evasion as a

result of the fraudulent charitable deduction. The IRS then

filed a proof of claim against Gloria Michaud (hereinafter

"Michaud") in the amount of $491,383.17, which includes

approximately $104,000 for taxes owed and $387,000 for interest

and penalties. In response, she filed adversary proceedings in

the Bankruptcy Court for the District of New Hampshire.

The bankruptcy court held that Michaud was not liable for

the taxes attributable to the erroneous charitable deductions

included in the Michauds' tax returns. The court held that

Michaud was entitled to "innocent spouse" relief from otherwise

applicable joint and several liability for understatements in

jointly filed tax returns. The bankruptcy court ordered that the

claimed tax liability be set to zero, and further ordered the IRS

to refund to Michaud the money she already paid to the IRS

pursuant to the asserted liability.

2 Discussion

The United States contends that the bankruptcy court lacked

jurisdiction to order a tax refund in favor of Michaud because

she had not previously filed a request for refund from the IRS.

Title

(a)(1) grants jurisdiction to the bankruptcy

court as follows:

Except as provided in paragraph (2) of this subsection, the court may determine the amount or legality of any tax, any fine or penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.

Excepted from this grant of jurisdiction is the authority to

determine

any right of the estate to a tax refund, before the earlier of-- (i) 120 days after the trustee properly requests such refund from the governmental unit from which such refund is claimed; or (ii) a determination by such governmental unit of such request.

(a)(2)(B).

It is undisputed that Michaud did not request a refund from

the IRS prior to adjudication by the bankruptcy court; therefore,

she has not exhausted her administrative remedies as required by

section 505(a) (2) (B) .

Nonetheless, this court holds that the bankruptcy court was

acting within its jurisdiction under section 505 of the

3 Bankruptcy Code when it ordered a refund in favor of Michaud,

even though Michaud had failed to exhaust her administrative

remedies. The court in In re Dunhill Medical, Inc.,

, at *5 (Bankr. D.N.J. March 27, 1996), found an exception

to the exhaustion requirement "where refunds are sought as an

offset or counterclaim to a claim or request for payment by the

IRS, or other tax authority, [and stated that] no refund claim

need first be made with the tax authority." Here, the government

filed a proof of claim against Michaud in the bankruptcy court

for tax liabilities allegedly accrued in 1980 and 1981. Michaud

responded by asserting the "innocent spouse" shield to that

liability and prayed the bankruptcy court to set the asserted

liability to zero and order a refund of monies she had already

paid pursuant to that liability. Under In re Dunhill's exception

to the exhaustion requirement, the bankruptcy court had

jurisdiction to award both the prospective relief of setting the

asserted liability to zero and the retrospective relief of

refund.

The government responds that In re Dunhill was wrongly

decided. The court in In re Dunhill found support for an

exception to section 505(a)(2)(B)'s exhaustion requirement in the

legislative history. The government argues that this legislative

history is inconsistent with the statutory language, which on its

4 face appears to mandate a request for refund in every case and

does not permit exceptions. According to the government, the

statute's plain meaning must control interpretation to the

exclusion of inconsistent legislative history. As support, the

government relies on Hubbard v. United States, ___ U.S. , _____

115 S. C t . 1754, 1761 (1995), indicating "[c]ourts should not

rely on inconclusive statutory history as a basis for refusing to

give effect to the plain language of an Act of Congress."

However, the plain meaning rule is "rather an axiom of

experience than a rule of law, and does not preclude

consideration of persuasive evidence if it exists." Boston Sand

& Gravel Co. v. United States,

(1928) . As the

Court stated in Church of the Holy Trinity v. United States,

(1892):

It is a familiar rule, that a thing may be within the letter of the statute and yet not within the statute, because not within its spirit, nor within the intention of its makers. . . . This is not the substitution of the will of the judge for that of the legislator, for frequently words of general meaning are used in a statute, words broad enough to include an act in question, and yet a consideration of the whole legislation, or ofthe circumstances surrounding its enactment, or of the absurd results which follow from giving such broad meaning to the words, makes it unreasonable to believe that the legislator intended to include the particular act.

Where the literal reading of a statutory term would "compel an

odd result," Green v. Bock Laundry Machine Co.,

, 509

5 (1989), courts must search for other evidence of congressional

intent to lend the statutory terms their proper scope. The

results of applying the plain meaning rule need not rise to an

absurdity before the strictures of the plain meaning rule are

relaxed. Public Citizen v. United States Department of Justice,

, 454 n.9(1989) ("this Court has never adopted so

strict a standard [as the absurdity test] for reviewing committee

reports, floor debates, and other non-statutory indications of

congressional intent, and we explicitly reject that standard

today"). Rather, "[l]ooking beyond the naked text for guidance

is perfectly proper when the result it apparently decrees is

difficult to fathom or where it seems inconsistent with Congress'

intention."

(emphasis added).

It would be an "odd result" if section 505(a)(2)(B)'s

exhaustion reguirement were bereft of an exception for cases such

as this, where the refund reguested by the taxpayer and the proof

of claim filed by the IRS pertain to the same year's tax

liability. The rule that the taxpayer must first reguest a

refund from the IRS before the bankruptcy court has jurisdiction

to order a refund is aimed at efficiency and preservation of

resources. A refund reguest affords the IRS an opportunity to

consider the merits of a taxpayer's claim of refund before the

government's litigation resources and judicial resources are

6 expended on the matter. See McNeil v. United States,

(1993) ("Congress intended to require complete exhaustion of

Executive remedies before invocation of the judicial process.

Every premature filing of an action under the [Federal Tort

Claims Act] imposes some burden on the judicial system and on the

Department of Justice which must assume defense of such

actions.") However, when the IRS files a proof of claim against

a taxpayer for a given tax year's liability, it would be futile

for the taxpayer to request a refund of monies paid pursuant to

that very same year's tax liability. The filing of the proof of

claim implies the belief of the IRS that the taxpayer has

underpaid taxes for that given year, and the IRS is unlikely to

radically change positions by honoring the taxpayer's request for

refund. Once the IRS files a proof of claim, the United States

has committed itself to expending resources resolving the

taxpayer's liability for the year in question, and no additional

burden is levied by arming the bankruptcy court with jurisdiction

to order a refund should those liability issues be resolved in

favor of the taxpayer.

When an IRS proof of claim and a taxpayer's request for

refund regard the same tax liabilities, it would be without

purpose and irrational to deny the bankruptcy court jurisdiction

to order a refund until the taxpayer makes a formal request for a

7 refund from the IRS. For this reason, this court rejects a

strict construction of section 505(a)(2)(B)'s language, which

permits no exceptions to the exhaustion reguirement. Instead,

this court interprets the statute in light of the statement in

the legislative history indicating an exception when "the refund

results from an offset or counterclaim to a claim or reguest for

payment by the Internal Revenue Service." Collier on Bankruptcy §

505.LH [2] [a] .

The exception is clearly applicable on these facts, and thus

the bankruptcy court had jurisdiction to order a refund in favor

of Michaud, despite the failure of a prior refund reguest to the

IRS.

The United State urges this court to reverse the bankruptcy

court's holding that Michaud was entitled to "innocent spouse"

relief from tax liability for the deficiencies on the 1980 and

1981 tax returns jointly filed with her husband. Spouses who

file joint returns generally are jointly and severally liable for

the full amount of tax on their combined income, and any

deficiencies on the joint return are chargeable to either spouse.

(d) (3) . However, section 6013(e) (1) provides an

exception to joint and several liability for an "innocent spouse"

who was unaware that the other spouse either intentionally or

negligently created an understatement on their joint tax returns. The bankruptcy court held that Michaud was an "innocent spouse,"

relieved of joint and several tax liability for the

understatements intentionally caused by her husband.

According to the United States, the bankruptcy court erred

as a matter of law in extending "innocent spouse" relief to

Michaud. One seeking to gualify for "innocent spouse" status

must prove, among other things, that "in signing the return he or

she did not know, and had no reason to know, that there was such

substantial understatement."

(e)(1). It is well

settled that an "innocent spouse" must discharge a duty of

inguiry, and failure of this duty precludes the reguisite finding

that the spouse had no reason to know of the understatement. The

innocent spouse exception "is designed to protect theinnocent,

not the intentionally ignorant." Erdahl v. Commissioner of

Internal Revenue,

(8th Cir. 1991) . The

bankruptcy court found adeguate proof that Michaud was "innocent"

and had no reason to know of the understatements, even though she

neither read nor reviewed the 1980 and 1981 joint returns. The

United States objects to this finding on the ground that the

broader umbrella duty of inguiry should at least include the more

specific duty to review the returns. According to the

government, a spouse who fails to review a jointly filed return

has not met her duty of inguiry and is precluded, as a matter of law, from claiming status as an "innocent spouse." Since Michaud

neither reviewed her joint returns nor made any effort to do so,

the United States urges that the bankruptcy court erred as a

matter of law in conferring "innocent spouse" status on Michaud.

However, whether a spouse has satisfied a duty of inguiry or

instead has remained "intentionally ignorant" is a fact-specific

analysis. The scope of the duty of inguiry and the boundaries

between the "innocent" and the "intentionally ignorant" depend on

the circumstances of each case. The standard is whether "a

reasonably prudent taxpayer in his or her position could be

expected to know that the stated tax liability was erroneous or

that further investigation was warranted." House v. Commissioner

of Internal Revenue,

, at *80 (U.S. Tax C t . Mar. 6,

1995) (citing Kistner v. Commissioner,

(11th

Cir. 1994)). While this appears an objective standard, courts

typically consider subjective factors in determining what is

reasonable in each case. For instance, courts consider: "(1) the

putative innocent spouse's level of education, (2) his or her

involvement in the family's business and financial affairs, (3)

the putative guilty spouse's evasiveness and deceit about the

family's finances, and (4) the presence of lavish or unusual

expenditures or any large unexplained increase in the family's

standard of living." Silverman v. Commissioner of Internal

10 Revenue,

, at *11 (U.S. Tax C t . Feb. 20, 1996);

Price v. Commissioner of Internal Revenue,

(9th

Cir. 1989). Under the case law, the duty of inquiry is

predominantly a subjective, factual standard rather than an

inflexible objective rule.

Likewise, the United States Tax Court has employed a

subjective standard to resolve whether a spouse's failure to

review a return was reasonable under the circumstances.

Silverman, supra,

at *12. The court recognized

that "ordinarily, we would conclude that [the guilty spouse's]

failure to present the [tax returns] to [the innocent spouse] for

signing should . . . have alerted [the innocent spouse] that

something was wrong."

However, the court went on to hold

that the taxpayer had explained the failure to review the return

by offering evidence that dispelled the notion that she chose to

remain willfully blind. The court held that, on those facts, she

met her duty of reasonable inquiry, even though she never

reviewed the return.

The United States' contention that a spouse who does not

review tax returns can never qualify for "innocent spouse" status

has some support in the case law. Havman v. Commissioner of

Internal Revenue,

(2d Cir. 1993) ("Although

Hayman claims to have signed the returns without reading them.

11 she nevertheless is charged with constructive knowledge of their

contents."); House, supra,

, at *81 ("Mrs. House had

a duty to review her completed income tax returns, and she is not

relieved of that obligation because of her reliance on others to

complete the return properly."). However, such a rule does not

fit smoothly with the prevailing subjective approach to defining

the duty of inguiry, because it does not permit a consideration

of the relevant circumstances in assessing whether the failure to

review was reasonable. Rather, that rule dictates that failure

to review is always and without exception unreasonable. By

closing off the "innocent spouse" exception to spouses who fail

to review the tax return, the exception loses the flexibility

necessary to effectuate its eguitable purposes. As the Tax Court

has recognized, "The legislative history of section 6013 makes it

plain that the statute was designed to bring government tax

collection practices into accord with basic principles of eguity

and fairness." LaBelle v. Commissioner of Internal Revenue,

,

, at *9 (U.S. Tax C t . Feb. 13,

1984) .

This court refuses to adopt a per se rule that "innocent

spouse" status is unavailable to spouses who fail to review their

tax returns. Often, the "innocent spouse's" failure to review

may be attributable to a division of labor in the marriage and

12 reasonable reliance on the spouse responsible for financial

matters. This court agrees with the tax court in Silverman that

whether the failure to review was reasonable is a question of

fact. Here, the bankruptcy court found that Michaud's failure to

review her tax returns was excusable and did not breach her duty

of reasonable inquiry under the circumstances. Bankruptcy Rule

8013 provides that the bankruptcy court's "[f]indings of fact

. . . shall not be set aside unless clearly erroneous." Aside

from the previous argument on the law, the United States has

presented no evidence on the record to indicate that the

bankruptcy court was clearly erroneous and its holding in need of

second-guessing.

Next, the United States contends that the bankruptcy court

erred as a matter of law in finding that it would be inequitable

to hold Michaud liable for the tax deficiencies attributable to

the understatements on the 1980 and 1981 tax returns. A spouse

seeking to qualify for "innocent spouse" relief must prove that

it would be inequitable to hold her liable for the deficiency.

The spouse bears the burden of proving all the elements of a

claim for "innocent spouse" relief. Friedman v. United States,

(2d Cir. 1995). According to the United States,

the bankruptcy court placed the burden of proof on the government

with respect to the equity of holding Michaud liable for the

13 understatements, and this constituted error as a matter of law.

This court disagrees that the bankruptcy court erred in its

legal conclusions. The bankruptcy court considered whether

Michaud financially benefited from the deficiency on the 1980 and

1981 returns as a factor bearing on the eguity of holding her

liable. In assessing this factor, the bankruptcy court held

"that there is insufficient evidence in the record to support

such a finding . . . that [Michaud's] restaurant was the fruit of

the improper deductions." Order of Bankruptcy Court dated April

26, 1996, at 14. According to the United States, this evidences

the bankruptcy court's erroneous legal conclusion that the United

States carried the burden of proof on this issue. The relevant

inguiry, according to the United States, was whether there was

sufficient evidence to support a finding that the restaurant was

not the fruit of the improper deductions.

However, the government's contention overstates Michaud's

burden of proof. Granted, Michaud had the burden of proving that

it would be ineguitable to hold her liable for the deficiencies.

This does not mean, as the United States' argument implies, that

Michaud had the burden of proving every disputed issue of fact in

her favor. Rather, this inguiry is factual and open-ended. "The

'facts and circumstances' that must be considered are those

having a rational bearing on whether a putatively 'innocent

14 spouse' should be held liable for taxes and additions due."

Purificato v. Commissioner,

(3d Cir. 1993), cert.

denied, ___ U.S. ,114 S. C t . 1398 (1994). She only had the

burden of proving enough relevant facts to show by a

preponderance of the evidence that the eguities weigh in her

favor. Stevens v. Commissioner of Internal Revenue,

(11th Cir. 1989). Once Michaud met her burden of

proof by a preponderance of the evidence, the United States had

the burden of proving facts alleged to defeat Michaud's claim for

"innocent spouse" relief. The bankruptcy court found that

Michaud met her burden of proof by coming forward with the

following evidence.

In this case, the Plaintiff testified that she received a weekly allowance to pay household expenses both before and after the filing of the 1980 and 1981 tax returns. Early in the marriage the amount was $250 per week, it increased to $300 per week in the late 1970s and eventually increased to $350 per week. The Plaintiff also testified that she had no joint accounts with her husband and accumulated little savings during the marriage. Her travel consisted of some cruises and trips to the Mediterranean, Bermuda, and Majorca. Upon her divorce from her husband in 1991, she received title to the family home in Dover, New Hampshire, which had been held solely in his name; today it is the Plaintiff's only asset. The IRS has taken the Plaintiff's IRA, her checking account, and the proceeds from a small house which was in her name. She does not own an automobile.

Order of Bankruptcy Court, supra, at 13. The United States

15 countered by arguing that Michaud benefitted from the

deficiencies by running the restaurant in issue. This fact could

not stand to defeat Michaud's showing that, by a preponderance of

the evidence, it is ineguitable to hold her liable unless the

fact were proven. The bankruptcy court committed no legal error

by placing the burden of proving this fact on the United States

because it does not imply that the United States carried the

burden of proof on this element of the "innocent spouse" claim.

The only implication was that, once Michaud met her burden of

proof on this issue, her claim for "innocent spouse" relief would

not be defeated by unproven facts.

Finally, the United States argues that the bankruptcy court

erred in granting "innocent spouse" relief to Michaud because

there was no direct evidence that her husband spent the realized

tax savings outside the household. The government relies on a

footnote in Bliss v. Commissioner of Internal Revenue,

, 380 n.3 (2d Cir. 1995), which defined "innocent spouse" as

one who is "innocent vis-a-vis a guilty spouse whose income is

concealed from the innocent and spent outside the family."

(Emphasis added.) However, it is not clear that the Bliss court

was implying that proof that the income was spent outside the

family is a necessary showing. Other courts have held that the

focus is on whether the putative "innocent spouse" benefitted

16 from the tax savings,

, and this

factor is not even determinative.

Evidence that the money

was spent outside the family is evidence that the "innocent

spouse" did not benefit from the tax savings. However, it would

be no more probative than evidence that the "innocent spouses"

realized no improved standard of living. The bankruptcy court

found that Michaud's standard of living did not improve, and this

is legally sufficient to support a finding that she did not

benefit from the tax savings, even in the absence of direct

evidence that the money was spent outside the family. The

bankruptcy court committed no legal error in finding that Michaud

did not benefit from the tax savings.

Conclusion

For the foregoing reasons, the order of the bankruptcy is

upheld in its entirety. The clerk shall enter judgment

accordingly.

SO ORDERED.

Shane Devine, Senior Judge United States District Court

March 6, 1997

17 cc: David L. Broderick, Esq. Carina J. Campobasso, Esq. Stephen C. Chute, Esq. Sarah Ruef Luck, Esq. Georqe Vannah, Clerk, US Bankr. C t .

18