Cathy Miller Hardy v. Commissioner of Internal Revenue

Citations: 181 F.3d 1002; 99 Daily Journal DAR 6825; 99 Cal. Daily Op. Serv. 5320; 84 A.F.T.R.2d (RIA) 5015; 1999 U.S. App. LEXIS 14882; 1999 WL 446530Docket: 97-71097

Court: Court of Appeals for the Ninth Circuit; July 2, 1999; Federal Appellate Court

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Cathy Miller Hardy appealed a decision from the United States Tax Court affirming the IRS's tax deficiency assessment against her for the years 1981 to 1986. Hardy contested the Tax Court's burden of proof allocation and the application of innocent spouse provisions of the Internal Revenue Code. The IRS had issued a notice of deficiency based on her earnings and half of her husband Ray Hardy's earnings, considering them community property. 

During the proceedings, the IRS conceded that Hardy owed no taxes for 1981, 1982, or 1986 and based the trial on her community property share of Mr. Hardy's income for 1983, 1984, and 1985. The Tax Court found Hardy's claim of an oral agreement to keep their properties separate uncredible. It upheld the IRS's assessments for the years in question: $5,257 for 1983, $1,331 for 1984, and $2,059 for 1985, along with associated penalties.

The Ninth Circuit confirmed jurisdiction under 26 U.S.C. § 7482, reviewing the Tax Court's factual findings for clear error and legal conclusions de novo. It found the Tax Court correctly placed the burden of proof on the IRS for 1983 and on Hardy for 1984 and 1985, with the Commissioner not contesting the burden allocation for 1983. The appeal was ultimately affirmed.

A presumption of correctness applies to notices of deficiency in the Tax Court, as established in case law. For this presumption to hold, the Commissioner must provide substantive evidence of unreported income. If the Commissioner does so, the burden then shifts to the taxpayer to demonstrate that the deficiency is arbitrary or erroneous. Should the taxpayer succeed, the burden shifts back to the Commissioner to prove the assessment's correctness. In this case, the Commissioner presented worksheets calculating tax owed based on income statements from Mr. Hardy's employer and bank, along with stipulations from Hardy acknowledging the IRS had received these income statements and that she was married to Mr. Hardy during the relevant years. Given that Nevada is a community property state, the tax deficiency notice for 1984 and 1985 is presumptively correct, undermining Hardy's claims of insufficient linkage to the unreported income.

Hardy contends that the presumption should not apply because the case involves unreported income, referencing several cases. However, it is noted that one case involved illegal income, and extending this precedent requires the Commissioner to lack any evidentiary foundation for the deficiency notice. In this instance, the Commissioner's reliance on reported income satisfies the necessary foundational requirements.

Hardy argues that the Commissioner should lose the presumption of correctness for tax assessments in 1983, 1984, and 1985 due to prior stipulations admitting errors in 1981, 1982, and 1986. However, legal precedents establish that concessions regarding certain years do not bind the Commissioner for other disputed years, as it would unfairly shift the burden of proof. At trial, Hardy claimed the tax deficiency was incorrect because it included income attributed to her husband, which she did not receive, asserting that they managed finances separately. This argument is invalid in Nevada, a community property state, where spouses are liable for taxes on half of the income earned by either during marriage, as affirmed by the Supreme Court in United States v. Mitchell. Under Nevada law, property acquired during marriage is presumed community property and can only be rebutted by clear and convincing evidence. The Hardys were married in Nevada, and Mr. Hardy's income during that time subjects Hardy to tax liability unless she can prove one of four exceptions to community property. Hardy only presented evidence of an oral agreement to keep finances separate, which does not meet legal requirements. Consequently, Hardy failed to demonstrate that the 1984 and 1985 tax deficiency notices were erroneous, leading to the affirmation of the Tax Court's decisions on those deficiencies.

The Tax Court's findings regarding Mr. Hardy's 1983 tax deficiencies were upheld, confirming that the IRS met its burden of proof through evidence from Mr. Hardy's employer and bank, alongside Hardy's acknowledgment of the IRS's receipt of his income statements. Hardy's sole evidence, an oral agreement, was insufficient to counter the IRS's assessment. Hardy was found ineligible for 'innocent spouse provisions' under 26 U.S.C. § 66, which protects spouses in community property states from liability for the other spouse's income. Specifically, Hardy did not qualify under § 66(b), as it applies only to tax years after December 31, 1984, and does not provide relief but rather discretion to the Secretary of the Treasury. Additionally, § 66(c) requires specific conditions for tax relief, which Hardy could not meet, as she had knowledge or reason to know of her husband's income. The Tax Court's allocation of the burden of proof and its conclusions regarding the applicability of community property laws and innocent spouse protection were affirmed.

The Honorable Barry T. Moskowitz, a United States District Judge, is presiding over this case. Recent statutory changes, specifically 26 U.S.C. § 6201(d) and 26 U.S.C. § 7491, regarding the presumption of correctness for tax deficiency notices, are not pertinent to this appeal. Hardy contends that the Commissioner bears the burden of proof under Tax Court Rule 142(d), which requires the Commissioner to demonstrate a petitioner's liability as a transferee of property. This rule is inapplicable here due to Nevada's community property laws, which grant each spouse a vested one-half interest in the other's income upon receipt, meaning Mr. Hardy did not 'transfer' his income to Hardy as she owned it upon its receipt.

Under Nevada law, spousal agreements regarding property must be recorded to be effective against third-party creditors, and Hardy failed to provide clear and convincing evidence of an oral agreement. The Tax Court determined that Hardy and her witnesses lacked credibility, presented contradictory evidence, and could not substantiate the existence of such an agreement. The court highlighted Mr. Hardy's deposition testimony denying any separate property agreement, Hardy's acknowledgment of Mr. Hardy's income during the relevant years, and their joint use of his income for household expenses. Furthermore, 26 U.S.C. § 66(a) applies only when spouses live apart, and the record lacks evidence of the Hardys living separately, rendering this section inapplicable.