Labels - My CFOmycfo-mycpa.com/...JoinRetrnsNeedWarningLabels.pdf · Labels Theresa Karam was denied innocent spouse status by the Tax Court and has lost on appeal to the Sixth Circuit

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TAXES | 11/24/2012 @ 9:19AM | 387 views

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Theresa Karam was denied innocent

spouse status by the Tax Court and

has lost on appeal to the Sixth

Circuit. There is a very interesting

twist to her case. Her failure to get

innocent spouse status was

cushioned by the lawsuit that she

won against her accountant. He did

not make it clear to his client that

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Page 1 of 8Joint Returns Need Warning Labels - Forbes

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filing a joint return is an election. A

joint return will generally result in a

lower tax than the total of two

married filing separate returns, but

there is a significant downside. It is called joint and several liability. The IRS

can collect the entire tax from either of the spouses. There can be relief from

this harsh result but, as Theresa Karam learned, it is not easy to get that relief.

The story is a little odd:

The Karams have used an accountant to file joint

federal income tax returns since they were

married. However, in 1997, following the death of

their long-time accountant, James Karam retained

Theodore C. Schumann, P.C., C.P.A., doing

business as Dental Business Services, Inc. (the

“Schumann firm”), to take over the family’s

accounting and taxes. Although James provided

the Schumann firm with tax documentation

necessary to timely prepare their tax returns, the

firm was delinquent in preparing the Karam’s tax

returns for the years 1998, 1999, 2000, and 2001.

The Karams later discovered that the accountant

assigned to their file was ill, and the firm never

had another accountant prepare their returns.

I don’t get how Dr. Karam went as long as he did

providing information to timely file his returns and

not think that there was some sort of problem when

they never got prepared. It took pressure from the

IRS to get him to look into it.

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In August 2002, IRS Officer Sharon Sloan

demanded that the Karams file their delinquent

income tax returns or face a financial records

subpoena. Thereafter, the Schumann firm finally

delivered joint income tax returns for the Karams

to sign. Attached to each return was a note saying

“please sign.” Theresa Karam alleges that she had

to sign the returns as presented and was unaware

that she could decline to file a joint return and

instead file as “married filing separately.” The

Schumann firm never advised her with respect to

the tax consequences of filing a joint return. She

nevertheless signed each of the four returns, and

the Schumann firm filed them with the IRS.

I don’t want to knock the accountants for the

mistake that they seem to have made, because it is

close to a universal mistake. There are two very

distinct areas of tax practice. In one area you are

determining the correct tax and coming up with

legitimate ways to make the correct tax as low as

possible given whatever constraints you might be

working with. Call that compliance/planning. The

other area is collections. When practicing in the

collections area, lowering the correct tax will often

be only of academic interest. Collections is all about

what you can pay. Filing a joint return is almost

always the right answer in compliance/planning

mode. If the balance due is being paid, making it as

small as possible is clearly the way to go.

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If the balance due is not going to be paid, filing a

joint return is quite likely the wrong answer. Ms.

Karam was an employee and presumably had

withholdings. It seems unlikely that she would not

have had a huge balance due had she filed

separately. Doctor Karam would likely have owed

even more on a separate return. So what ? He

didn’t pay the lower balance due for the joint return

and by making it a joint return the IRS ended up with two people they could

chase for it.

In August 2006, Theresa Karam sued the Schumann firm in Michigan state

court, alleging that the firm’s negligence and breach of contract resulted in

her joint and several liability for federal income taxes. The case was

ultimately settled, with a payment of $150,000 to petitioner. After paying

attorney’s fees and costs, Karam offered the IRS the remaining balance of

$99,186 to settle her outstanding tax liability. Pursuant to administrative

procedure, Karam was required to deposit twenty percent of her offer with

the IRS, which she did. However, the IRS ultimately rejected Karam’s

settlement offer and kept her $19,837 deposit.

Ms. Karam was denied innocent spouse relief for a couple of reasons. The

Court did not believe that she was unaware that her husband was not going to

pay the balance due on the delinquent returns. There was also a finding that

she had benefited from the unpaid taxes since they allowed her to devote her

own earnings towards the expenses of getting a PhD and sending her children

to private schools. Perhaps the unkindest cut of all:

Additionally, her admission that she is using the remaining $80,000 from

the settlement with the Schumann firm to finance this litigation further

undermines her claim for relief. Karam questionably asserts “economic

hardship” while possessing a large litigation fund that she could use to make

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partial payments on her tax debt. The equities of the situation are not in her

favor.

Robert Steinberg in his The Tax Wars Blog wrote about the original Tax Court

decision last year. He suggested that preparers add a paragraph, which he

provides, to engagement or transmittal letters warning about the implications

of filing a joint return. The idea has merit, but when I think about how long

some engagement letters already are, the value of adding another paragraph,

beyond CYA for the preparer, is limited. What is really important is for

preparers to be alert to the situations where separate filing might be the best

course. A pile of delinquent returns with large balances is such a situation.

Making the large balances a little less large might not be worth giving IRS

collections people another person to pursue. It is also important for the

preparer to recognize that the interests of the couple might not be aligned in

situations like that.

You can follow me on twitter @peterreillycpa.

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Labels - My CFOmycfo-mycpa.com/...JoinRetrnsNeedWarningLabels.pdf · Labels Theresa Karam was denied innocent spouse status by the Tax Court and has lost on appeal to the Sixth Circuit