Sarah S. O’Nan, T. C. Memo. 2023-117, filed 9/18/23, was denied a refund of the $123K net proceeds from the non-short sale of the house she and deceased spouse held in a OH “survivorship tenancy.” For non-dirt lawyers, that means survivor takes all. But there was a NFTL for the $123K in unpaid taxes. Sarah filed innocent spousery, got Section 6015(f) equitable partial relief for Year One and total relief for Year Two, but IRS held on to the $123K that came out of the sale (obviously to release the lien).

I want to start with a Taishoff “Good Job, First Class,” to Sarah’s trusty attorney, whom I’ll call Louie.

Sarah was widowed when spouse died suddenly at age 43, leaving her broke and owing taxes. There were two (count ’em, two) mortgages on their home, on which Sarah stopped paying. Sarah signed both mortgage deeds (OH is apparently a conveyance state), but deceased spouse only signed the senior mortgage note; unclear whether Sarah signed the junior mortgage note. While the senior mortgagee was foreclosing, Sarah sold, paid off both mortgages, and the tax lien.

When the dust cleared, Sarah owed IRS $3340 for Year One, and zero for Year Two. IRS would not give back the $123K, claiming Sarah flunks the Section 6015(g)(1) payment-from-own-funds test. While there can be a refund for an innocent spouse to the extent the relieved liability arises from nonrequestor, the innocent spouse must have paid the tax from which s/he is now relieved.

Review in this case is de novo. Before every reader yells “Section 6015(e)(7),” Sarah petitioned before the Taxpayer First Act came into effect, so she gets a real trial, but with BoP attached. She’s already innocent, which nobody denies.

State law determines whether the NFTL attaches to the interest she automatically inherited at her late spouse’s death; and there’s caselaw that says it does.

Comes Section 6015(f) to the rescue. Judge Elizabeth A. (“Tax”) Copeland judge-‘splains.

“…when a requesting spouse is granted section 6015(f) relief, we recalculate her federal tax liability as if she and her spouse (or deceased spouse) had filed married-filing-separately returns for the relevant years. If Mr. and Mrs. O’Nan had filed married-filing-separately returns for the years in issue, then for [Year One] Mrs. O’Nan would have had a liability of $3,340 (the amount for which she was denied section 6015(f) relief) and for [Year Two] she would have had no liability (as she was granted full relief for that year). We therefore hold that although the IRS retained a lien on the family home in the full amount of the liabilities for the years in issue, that lien did not encumber Mrs. O’Nan’s original one-half interest except to the extent of $3,340 plus interest.” T. C. Memo. 2023-117, at p. 8.

Judge Tex Copeland whacks up the sales proceeds from deceased spouse’s half first. Closing costs come out off the top; most of that is State and local tax, she assumes without deciding (as those total only $14K, it probably doesn’t matter). Only deceased spouse signed the first mortgage note; Sarah signing the mortgage is at best a surety, and since deceased spouse’s share of the proceeds is more than enough to pay off the first mortgage, Sarah’s share is untouched; likewise, the first mortgage was perfected before the NFTL, so it has Section 6323  priority.

As for the junior mortgage, the record doesn’t show who signed the mortgage note, but deceased spouse was primary breadwinner and junior mortgage was made only about a year after the first. Howbeit, that mortgage was senior to the NFTL also. And whatever was left of deceased spouse’s half of the proceeds went to pay the junior mortgage.

So as IRS is low totem on the pole, and as Sarah is adjudicated innocent except for the $3340, and there’s nothing left of deceased spouse’s half, whatever paid off the lien must have come from Sarah’s half, hence her money.

IRS argues deceased spouse’s death has nothing to do with the lien. True, but Sarah was given innocent spousery for all but $3340. Sarah wants back the whole $123K, but IRS gets to keep the $3340.

Going for innocent spousery first with a young, broke, sympathetic widow was a good move. Not putting in the second mortgage note was brilliant; well done, Louie. I’m surprised the lenders didn’t insist on both parties signing both note and mortgage; I always did when I represented lenders. The Little League catchers’ rule: Tag ’em all, baserunner, batter, umpire and yourself.

Takeaway: Post Section 6015(e)(7), when you have a stand-alone innocent spousery, Appeals is your trial. Put everything in the administrative record. You won’t get a second chance. And tell ’em Louie sent ya.