New York Law Journal: Planning Ahead for Tax Liabilities

By Jeffrey A. Galant

A man who does not plan long ahead will find trouble at his door – Confucius

It is generally a good idea for married folks having substantial property to consider how best to preserve their assets. Broadly speaking, it makes sense to explore implementing those various estate planning and asset protection techniques best suited to their needs.  As part of such planning, it is not unusual for couples to divide the ownership of their property between them for reasons such as taking advantage of progressive tax rates and available gift, estate, and generation-skipping transfer tax exemptions as well as decreasing exposure of their assets to claims of future creditors.

A noteworthy aspect of such planning, and the focus of this article, is the benefit, if any, of planning in advance for the relief from certain federal income tax liabilities potentially available to a married couple who reside together. Section 6015 of the Internal Revenue Code provides the criteria for obtaining such relief. Or to be more specific, the relief for a purported “innocent” spouse from joint and several tax liability related to the earnings or income of his or her spouse is provided by section 6015(b) or (f). We will describe the necessary factors that need to be satisfied but note that at its very heart section 6015 is grounded in equity, meaning that the person seeking such relief must come with clean hands.

Section 6015(b) requires the spouse requesting relief to establish that: (1) a joint return was filed for the taxable year; (2) there was an understatement of tax attributable to the other spouse; (3) when signing the return, the requesting spouse was unaware, and had no reason to know, that there was an understatement; (4) considering all of the facts and circumstances, it would be inequitable to hold the requesting spouse liable for the tax deficiency; and (5) a timely election was made under section 6015(b).

If not all five of the foregoing factors can be established, Section 6015(f) may still provide relief if considering all the facts and circumstances, it would be inequitable to hold the requesting spouse liable for any unpaid tax or any deficiency.

Strom v. Commissioner

The availability of innocent spouse relief has recently been explored by the U. S. Tax Court in Strom v. Commissioner, T.C. Memo 2024-58.

In Strom,taxpayers Mark and Bernee, married in 1967 and living together since including during the tax years in issue, were concerned with the realization of a potentially very large amount of taxable income. Obviously, a very talented couple. Mark was a physician and had also served as an executive and a consultant in the health-care industry. Meanwhile, Bernee had been engaged as the leading or other high executive of various companies in a variety of innovative entrepreneurial endeavors, including as president and chief operating officer of, Inc. (InfoSpace).

In 2000, Bernee exercised various InfoSpace employee non-qualified stock options and based on the stock’s value in that year, she realized approximately one hundred million dollars of gain upon such exercises. Being related to her employment, the gain was considered ordinary income for federal income tax purposes. As the world turned, however, by 2001 the stock had substantially declined in value. Had Bernee exercised the options in 2001 instead of 2000, the potential income tax liability would have been substantially less.

Digressing a moment, it seems noteworthy to recognize the dramatic effects under the current economic environment of grants of equity-based compensation to top executives, particularly in the private equity and tech industries. See, e.g., For Chief Executives, the Sky is the Limit for Pay, New York Times Sunday Business Section, page 3, June 9, 2024.

The Plan

Although not expressly articulated as such, Mark and Bernee adopted a two-pronged approach to dealing with their potential tax liability for taxable year 2000. Initially they sought to obtain deferral to 2001 of the taxation of the gain realized on the exercise of the options and, failing that, they pursued innocent spouse relief.


Mark and Bernee met with various tax lawyers and other consultants to develop arguments promoting deferral of the year in which the gain is realized upon the exercise of the various options from 2000 to 2001, when, as previously mentioned, the gain would have been much lower due to the substantial decline in value of the InfoSpace stock. The deferral, according to their argument, was required because during 2000 the stock was subject to a “substantial risk of forfeiture” within the meaning of Section 83 of the Internal Revenue Code of 1986, as amended, and the Treasury Regulations promulgated thereunder. Section 83 requires the deferral of taxation of property received in connection with the performance of services until such time as the property is no longer subject to a substantial risk of forfeiture.

Why was there a substantial risk of forfeiture of the InfoSpace stock received upon exercises of the options?  Resisting a deep dive into the Treasury Regulations, suffice it to say that the regulations treat certain limitations imposed on the sale of stock by the federal securities law and by certain accounting principles as being subject to a substantial risk of forfeiture.

More specifically, the limitation imposed on stock sales and purchases provided under Section 16(b) of the Securities Exchange Act of 1934, during the 6-month period during which such limitation applies.  Violation of the limitation requires the offending shareholder to pay any profit eared on the transaction to the issuer corporation. (The limitation is popularly known as the “short-swing profit rule”.) See, Treasury Regulation 1.83-3(j).

Perhaps more esoteric was the limitation imposed by the so-called “pooling-of-interest” financial accounting rules which during the taxable years in issue barred sales of stock during the period a merger was taking place pursuant to Accounting Principles Board Opinion No. 16. See, Treasury Regulation 1.83-3(k).

The short-swing profit and pooling of interest issues were the subject of a separate litigation with IRS for the tax years 1999 and 2000. Mark and Bernee had sued in federal district court in the Western District of Washington and, after the district court’s decision they and the IRS cross-appealed to the Ninth Circuit Court of Appeals. The litigation was based upon refund claims that Mark and Bernee filed with IRS, and upon which IRS did not act, for income taxes and Medicare taxes withheld from Bernee by InfoSpace. InfoSpace withheld income taxes and Medicare taxes in 1999 due to Bernee’s exercise of stock options in that year, and for Medicare taxes withheld in 2000 for the exercises by Bernee in that year. InfoSpace did not withhold income taxes in 2000 in connection with Bernee’s exercises in that year, thus creating the deficiency which ultimately led to the separate litigation in the Tax Court.

The Ninth Circuit determined that the 16(b)-restriction lapsed in 2000, so it could not be relied upon to defer taxation of the gain to 2001.  See, Strom v. U.S., 641 F.3d 1051 (9th Cir. 2011).  Additionally, the issue of the applicability of the “pooling-of-interest” merger restriction with respect to premerger sales was remanded to the district court for further fact finding, but apparently the district court had no further action.

Although Mark and Bernee obtained legal opinions supporting the deferral to 2001 of the gain realized upon the exercise of the options in 2000, KPMG, the taxpayers’ accountant, warned them in writing that although the proposed tax positions were not frivolous, they would likely be challenged on audit especially since InfoSpace had issued to Bernee a W-2 reporting the gain as being taxable in 2000.

Mark and Bernee filed their 2000 joint federal income tax return without including in their taxable income the gain realized on the  exercise of the options. They did, however, disclose the gain on the option exercises on the return and on the IRS Disclosure Statement (Form 8275) which was attached to their income tax return.  As expected, there was an audit with the IRS insisting that the gain realized on the exercise of the InfoSpace options was taxable in 2000 and not 2001. As the matter wound its way to the Tax Court, Mark and Bernee ultimately conceded the substantive tax issues concerning the proper year of inclusion in income and accepted that the gains were taxable in 2000.

Innocent Spouse

Regarding their planning for innocent spouse relief, Mark and Bernee decided to divide their property between them so that Mark’s share of the assets would be beyond IRS reach to satisfy the liability caused by Bernee’s exercise of the stock options, of course assuming that Mark was entitled to innocent spouse relief. In other words, Mark would claim that as an innocent spouse he was not liable for any part of the liability resulting from the failure to report in 2000 the gain realized upon Bernee’s exercise of the stock options, and, therefore, his assets were not available to satisfy the liability.

In furtherance of such end, Mark and Bernee hired new lawyers (a separate lawyer for each of them) to prepare a so-called “Property Separation Agreement.” Among their various assets, they owned a valuable condominium apartment in Seattle, Washington. However, the agreement did not fare well with the Tax Court since the property division under the circumstances was not reasonable in its view, including the important fact that it was not supported with appropriate appraisals. For example, apparently valuable real estate and other tangible property was put in Mark’s name whereas Bernee was credited with speculative interests in property, e.g., ownership of equity in corporate enterprises, that she may or may not receive in connection with her entrepreneurial endeavors.

Mark and Bernee also consulted a separate tax lawyer in connection with asset protection matters and based on advice they ultimately transferred some of their assets to offshore entities. Of course, the whole idea being to make it harder for creditors to reach such property. Clearly, as it turned out, not a good fact for section 6015 innocent spouse equitable relief.

After the concessions by Mark and Bernee, the Tax Court litigation concerned solely the issue of innocent spouse relief under sec. 6015. Basically, the issue was whether Mark was entitled to equitable relief. As explained below, the court concluded that Mark was not entitled to equitable relief.

Too little surprise, the court found that Mark was aware of the understatement on Bernee and his 2000 joint federal income tax return.  Mark clearly knew of Bernee’s exercise of the stock options in 2000, and, in fact, helped her implement the exercises by arranging the necessary bank financing. Furthermore, as the evidence showed, Mark actively participated in the planning to defer the year in which the realization of the gain occurred upon the exercise of the options from 2000 to 2001.

When deciding whether equitable relief was available to Mark under section 6015, the court had to determine, based on its precedents, whether Mark had received a significant benefit from the understatement, and whether Bernee had committed any wrongdoing in connection with the understatement. Although no wrongdoing was found with respect to Bernee, the court did find that Mark had significantly benefitted from the understatement. As a result, Mark was not entitled to equitable relief.

In a rather lengthy analysis, the court found that such benefit, based on the fact that Mark could utilize the improper tax refund, i.e., a refund of approximately $15 million received from IRS based on the faulty 2000 joint return, to his (and Bernee’s) advantage. For example, Mark favorably settled the outstanding loan from the option exercise financing with part of the refund money, and Mark and Bernee kept the rest of the refund money apparently improving their financial condition, at least for the moment.


Planning for innocent spouse relief if it is done at all should be part of the bigger picture. That is, it should be considered as an available tool in the tool box of overall estate planning, income tax planning and asset protection.

Reprinted with permission from the New York Law Journal, An ALM Publication

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