                          T.C. Memo. 1996-352



                        UNITED STATES TAX COURT



   ESTATE OF ROBERT E. SYMPSON, DECEASED, ELIZABETH C. SYMPSON
PERSONAL REPRESENTATIVE AND ELIZABETH C. SYMPSON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket No. 971-92.                           Filed July 31, 1996.



     Bruce Hallmark, for petitioners.

     Steven B. Bass, for respondent.



                    SUPPLEMENTAL MEMORANDUM OPINION

     PARR, Judge:    This case is before the Court on remand from

the Court of Appeals for the Tenth Circuit.       Estate of Sympson v.

Commissioner, 54 F.3d 787, 75 AFTR 2d 95-2255, 95-1 USTC par.

50,276 (10th Cir. 1995), affg. in part and revg. in part without


     * This opinion supplements our opinion in Estate of Sympson
v. Commissioner, T.C. Memo. 1994-2.
                                 - 2 -


published opinion T.C. Memo. 1994-2.     We held therein that

petitioner Elizabeth C. Sympson was not eligible for relief under

section 6013(e)1 as an "innocent spouse".    The Court of Appeals

held that we erred in finding that it would not be inequitable to

hold Mrs. Sympson liable for the tax deficiency and remanded the

case for further proceedings.

     To qualify for innocent spouse relief, a taxpayer must meet

all four of the requirements of section 6013(e).     It is

undisputed that Mrs. Sympson had shown that she filed a joint

return and that there was a substantial understatement of tax

attributable to grossly erroneous items of her spouse (i.e.,

unreported embezzlement income).    Since we found that Mrs.

Sympson did not qualify for relief because she failed to meet the

fourth requirement, we did not consider whether she met the third

test; i.e., whether she had proven that she did not know and did

not have reason to know that there was a substantial

understatement on the returns.    Sec. 6013(e)(1)(C).   The Court of

Appeals therefore remanded the case for further findings of fact

on this issue.

     The tax years in issue are 1982 through 1987.      Beginning in

1982, and continuing to July 1987, Mrs. Sympson's husband

embezzled $898,642 from an elderly widow named Olga Roderick and


     1
        All section references are to the Internal Revenue Code
in effect for the taxable period under consideration.
                                 - 3 -


failed to report it in income.    The factors we analyzed included

the following:   During the years in issue Mr. and Mrs. Sympson

purchased a 25-acre ranch and home valued in 1986 at $500,000,

thereby doubling their home investment and tripling their

mortgage payments; they purchased two new Jaguars; they built a

$50,000 to $75,000 polo field on their ranch; and they employed a

maid.   Mr. Sympson gave Mrs. Sympson an $8,000 diamond and a

$3,000 fur coat.

     The Court of Appeals held that even assuming Mrs. Sympson

had benefited substantially, that was not a dispositive factor,

considering that she and her husband were later forced into

bankruptcy and some of their properties (not including the

$500,000 ranch) were turned over to the embezzlement victim.      The

Court of Appeals said:    "Because a determination of equity is

based on all the facts and circumstances, we hold that under

these circumstances it would be inequitable as well as

unconscionable to hold Mrs. Sympson liable for these

deficiencies."     Estate of Sympson v. Commissioner, 75 AFTR 2d at

95-2257, 95-1 USTC par. 50,276, at 88,021.

     The parties stipulated that of the amounts received by Mr.

Sympson from Olga B. Roderick's accounts, $145,000, $107,640,

$109,444, $250,233, $105,350, and $181,005 for the 1982, 1983,

1984, 1985, 1986, and 1987 taxable years, respectively, were not

reported on petitioners' income tax returns.
                                - 4 -


     We now turn, as instructed, to the question of whether Mrs.

Sympson has established that she neither knew nor had reason to

know that the returns she signed contained a substantial

understatement of tax.    Id.; sec. 6013(e)(1)(C).

     Respondent agrees, and we so find, that Mrs. Sympson had no

actual knowledge of the embezzlement before her husband was

caught.   Thus, the question is whether she had reason to know of

the understatements on the returns for tax years 1982 through

1986, and whether she had actual knowledge or reason to know for

tax year 1987.

     In deciding whether Mrs. Sympson "had reason to know" of the

substantial understatements when she signed the returns, we take

into account:    (1) her level of education; (2) her involvement in

the family's business and financial affairs; (3) the presence of

expenditures that appear lavish or unusual when compared with the

family's past levels of income, standard of living, and spending

pattern; and (4) the culpable spouse's evasiveness and deceit

concerning their finances.    Friedman v. Commissioner, 53 F.3d

523, 531-532 (2d Cir. 1995) (citing Hayman v. Commissioner, 992

F.2d 1256, 1261 (2d Cir. 1993), affg. T.C. Memo. 1992-228), affg.

in part and revg. in part T.C. Memo. 1993-549.   The foregoing

factors are considered "because, ordinarily, they predict what a

prudent person would realize regardless of the other spouse's
                               - 5 -


evasiveness or deceit."   Bliss v. Commissioner, 59 F.3d 374, 379

(2d Cir. 1995), affg. T.C. Memo. 1993-390.

     We feel somewhat constrained in our findings, because, in

addition to stating that it would be unconscionable to hold Mrs.

Sympson liable, the Court of Appeals commented on some of the

evidence which would bear on our analysis.   For instance, we

would ordinarily have given weight to the Sympsons' increasing

wealth and expenditures during the years in issue in contrast to

the amounts reported on the income tax returns.   From 1982

through 1987, the Sympsons reported taxable income as follows:

                  Year            Amount
                  1982          ($22,561)
                  1983            32,266
                  1984            25,111
                  1985              -0-
                  1986              -0-
                  1987              -0-


Ordinarily, such a disparity would be a factor putting one on

notice and would support a finding that a spouse had reason to

know of an understatement.

     We feel instructed, however, by the court's finding that

"there is substantial evidence that the lifestyle of the Sympsons

during this period did not change."    Estate of Sympson v.

Commissioner, 75 AFTR 2d at 95-2257, 95-1 USTC par. 50,276, at

88,021.   The Court of Appeals also said:

          In contrast to this evidence [i.e. of increasing
     expenditures], Mrs. Sympson testified that, while the
     family lifestyle gradually improved each year
                               - 6 -


     throughout the marriage, including the years of
     defalcation, there was no dramatic change. * * *
     Importantly, there was evidence that the Sympsons had
     sufficient cash flow from sources other than the
     unreported income to more than cover their family
     expenditures during this period. [Id. at 95-2257, 95-1
     USTC par. 50,276, at 88,020-88,021.]

So instructed, we conclude that the Court of Appeals would find

that the increasing expenditures would not have given Mrs.

Sympson reason to know.   Therefore, we find that, for tax years

1982, 1983, 1984, 1985, and 1986, Mrs. Sympson did not have

reason to know of the substantial understatement.

     For 1987, however, another factor is present.   Mr. Sympson's

thefts were discovered in July of that year.   Mrs. Sympson became

aware of the problem soon after, when her father told her that

all the furniture was gone out of Mr. Sympson's office, and she

learned that he had been fired.   In August or September 1987,

Robert asked her to sign deeds on various properties, telling her

that there was a problem with Mrs. Roderick's funds.   In early

1988, Mrs. Sympson was served with a copy of a State court suit

for more than $14 million.   She read the complaint, which accused

her husband of stealing from Mrs. Roderick.

     In the spring of 1988, Mrs. Sympson was told by attorneys

that there could be a tax problem with the misappropriated funds.

When her husband told her he would treat the withdrawals from

Mrs. Roderick's accounts as loans on their income tax return,

Mrs. Sympson accepted that without further question, even though
                                 - 7 -


there were no loan documents and the supposed "lender" had

another view of the transfers.    Mrs. Sympson signed the 1987

return on October 17, 1988.   By that time she knew that her

husband had been accused of theft and fired, and that he and she

were being sued for millions of dollars.    Moreover, a lawyer had

explicitly warned her of potential tax problems.    The joint

income tax return she signed showed only $49,000 received from

Olga Roderick in 1987.

     Generally, the question of whether a spouse knew or had

reason to know of a substantial understatement is governed by

whether a "reasonably prudent taxpayer under the circumstances of

the spouse at the time of signing the return could be expected to

know that the tax liability stated was erroneous or that further

investigation was warranted."     Stevens v. Commissioner, 872 F.2d

1499, 1505 (11th Cir. 1989), affg. T.C. Memo. 1988-63; see Griner

v. Commissioner, 951 F.2d 360 (9th Cir. 1991), affg. without

published opinion T.C. Memo. 1990-301; Bokum v. Commissioner, 94

T.C. 126, 148 (1990), affd. 992 F.2d 1132 (11th Cir. 1993).

     Mrs. Sympson is a college graduate who had owned and

operated an art gallery.   She was not afraid of her husband or

mistreated by him.   Trust does not eliminate a spouse's duty to

inquire when circumstances indicate further inquiry is necessary.

Hayman v. Commissioner, supra at 1262.     We believe a reasonably

prudent person in Mrs. Sympson's circumstances would have
                              - 8 -


inquired further and/or refused to sign the return.   Mrs. Sympson

has not carried her burden of showing that she neither knew nor

had reason to know of the substantial understatement on the 1987

return when she signed it.

     In light of the above, we hold that Mrs. Sympson is entitled

to be relieved of liability as an innocent spouse for tax years

1982 through 1986, and that she is not so entitled for 1987.



                                         An appropriate order and

                                      decision will be entered.
