                         T.C. Memo. 1995-576



                       UNITED STATES TAX COURT



             PHILIP H. AND ANNA FRIEDMAN, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent1



     Docket No. 7359-90.          Filed December 4, 1995.



     Jay J. Freireich, Harvey R. Poe, and Gerald S. Rotunda, for

petitioners.

     Susan G. Lewis, Albert G. Kobylarz, and Guy G. Lavignera,

for respondent.


         SUPPLEMENTAL MEMORANDUM FINDINGS OF FACT AND OPINION


     GERBER, Judge:    This case has been the subject of three

prior opinions of this Court,2 the last of which held that Anna


     1
       This opinion supplements a previously released opinion:
Friedman v. Commissioner, T.C. Memo. 1993-549.
     2
         Friedman v. Commissioner, 97 T.C. 606 (1991), concerning
                                                     (continued...)
                               - 2 -

Friedman (petitioner) was not an innocent spouse within the

meaning of section 6013(e).3   The decision entered following the

third opinion was affirmed in part and reversed in part, and the

case was remanded to this Court for further proceedings.

Friedman v. Commissioner, T.C. Memo. 1993-549, affd. in part and

revd. in part 53 F.3d 523 (2d Cir. 1995).

     To qualify for innocent spouse relief, a taxpayer must meet

all four of the requirements of section 6013(e).   We found that

petitioner had shown that she filed a joint return and that a

certain tax shelter investment constituted a "grossly erroneous

item" within the meaning of section 6013(e).   However, we found

that petitioner did not qualify for relief because she failed to

meet the third requirement; i.e., the requirement that she did

not know and did not have reason to know that the deduction would

give rise to a substantial understatement.   Having reached that

conclusion, we did not consider whether petitioner met the fourth




     2
      (...continued)
whether "grossly erroneous items" could have been contained on a
refund claim, Form 1045, rather than on the Form 1040, within the
meaning of sec. 6013(e)(1)(B); Friedman v. Commissioner, T.C.
Memo. 1992-89, concerning whether the testimony of an expert
witness could be offered to show whether one of petitioners was a
truthful witness; and Friedman v. Commissioner, T.C. Memo. 1993-
549, which concerned whether Anna Friedman was an innocent spouse
within the meaning of sec. 6013(e).
     3
       All section references are to the Internal Revenue Code
in effect for the taxable period under consideration, and all
Rule references are to this Court's Rules of Practice and
Procedure, unless otherwise indicated.
                                - 3 -

test; i.e., whether, under the circumstances, it would be

inequitable to hold her jointly liable for the deficiencies.

     The U.S. Court of Appeals for the Second Circuit reversed

our holding that petitioner failed the third, or knowledge, test

as to the tax shelter item only, and remanded the matter to this

Court to find additional facts, if necessary, and to decide

whether petitioner has shown that, under the circumstances, it

would be inequitable to hold her jointly liable for the

deficiencies.

                          FINDINGS OF FACT4

     Petitioner met Philip Friedman in 1976 when she was hired as

his secretary.    They were married in 1979, the year that Philip

obtained a divorce from his prior wife.       In the course of that

divorce, Philip gave almost everything he owned to his first

wife.    Petitioner was a young widow with two small children and

depleted savings at the time of her first husband's death.

Petitioner had only a few assets when she married Philip,

including a cooperative residence and an automobile.

     When petitioners were first married, they lived in a rented

apartment in New York, New York, with petitioner's two daughters,


     4
       By this reference, the facts found in Friedman v.
Commissioner, T.C. Memo. 1993-549, are incorporated to the extent
that they are in accord with the opinion of the U.S. Court of
Appeals for the Second Circuit, which affirmed in part and
reversed in part our decision. We repeat some of these findings
here, as relevant to the issue now before us. The parties have
agreed that we may proceed to find facts and decide this matter
on remand based on the existing record and the briefs that have
been filed in this Court by the parties.
                                - 4 -

who were 13 and 17 years old.   At that time, petitioner and

Philip were splitting their time between the New York apartment

and an apartment in North Miami Beach, Florida.    The New York

apartment was in a building with a doorman and a beautiful lobby.

The Florida apartment was a two-bedroom unit.

     In 1982, petitioners bought a condominium (condo) in

Bayside, Queens, New York, because they thought it would be a

better environment in which to raise children.    The condo was a

three-bedroom, two-bathroom, nicely furnished unit.    One of the

bedrooms was converted into an office for Philip.    The condo was

purchased jointly, without a mortgage, for $171,000.    The condo

was worth $295,000 and had unpaid liens of $290,000 against it at

the time of trial.   During 1984 and 1985, the condo had a similar

value and outstanding liens of $175,000.   Petitioners hired an

interior decorator to decorate the condo in 1982 and again in

1985, spending a total of over $50,000.

     Petitioners also owned a home on Fire Island, New York.

Philip purchased the land in 1978 and built a three-bedroom house

in 1979, all without a mortgage on the property.    That home cost

in the range of $74,000 to $79,000 and had a value of

approximately $200,000 at the time of trial.    Philip transferred

the Fire Island property to petitioner, as sole owner, in 1980.

An equity loan and $150,000 mortgage were taken on the Fire

Island house by petitioner in January 1991, and Philip was
                                - 5 -

jointly liable for the mortgage and responsible for making the

payments on that obligation.

     Petitioners went on an annual, week-long vacation to Puerto

Rico and, occasionally, petitioner's daughters would go with

them.   Petitioner and Philip went on numerous gambling trips

together.    On some of those trips, petitioners' room, food,

beverage, entertainment, and sometimes transportation (i.e.,

airfare) were paid for by the casino.    Although petitioner did

not gamble much, she did obtain the benefit of the amenities

provided by the resort or casino.    Philip gave petitioner a

diamond wedding band, but petitioner did not receive much

additional jewelry during their marriage.    During April 1986,

Philip purchased an automobile for petitioner at a cost of almost

$14,000.    Petitioner had a VISA credit card and other credit

cards for major New York City area department stores, including

Saks Fifth Avenue, Bloomingdale's, Fortunoff, A&S, and Macy's.

During the years in issue, petitioner obtained a black mink coat.

She also enjoyed the theater and attended many shows.

     Petitioner's daughters' tuition and some expenses for

private school education, tutoring, and college were paid for by

Philip.    Philip paid for food, clothing, and other expenses for

petitioner's daughters, including the acquisition of an

automobile for one of the daughters.    During 1983, petitioner

transferred stocks and bonds with a $20,000 value from her and

Philip's joint account with Merrill Lynch to the account of one
                                - 6 -

of her daughters.   Petitioner paid her daughters' and mother's

income tax out of her joint bank account with Philip.    Philip

paid a total of approximately $15,000 for petitioner's daughter's

wedding expenses.

     Petitioners had a joint bank account from which to pay

household expenses.    Philip would deposit either cash or checks

into the account for petitioner to use to pay various expenses.

Petitioners also paid a variety of their expenses in cash.

Philip would give petitioner the cash to pay for groceries, dry

cleaning, domestic help, etc.    The cash Philip gave petitioner

was in addition to the money he deposited in their joint account.

Philip also had several individual bank accounts.

     Petitioners' recreation was combined with gambling.    They

went to Las Vegas, Nevada, on their honeymoon and took other

vacations where gambling was a focal point, such as their annual

trip to Puerto Rico.   Philip would go on day trips to Atlantic

City, New Jersey, or take weekend trips to Las Vegas, Nevada.

Petitioner would occasionally accompany Philip on the weekend

trips, or they would both go with their good friends Adrienne and

Elwood Lerman (Lerman).    Lerman was also petitioners' accountant

and financial adviser.    Some of these gambling trips would be

"comped"; i.e., the casino would pay for travel, meals, and hotel

room.

     While on these trips, Philip would spend most of his time

gambling in the casinos.    He usually played at the craps table
                                  - 7 -

and preferred the tables with a large minimum bet.      While Philip

gambled, petitioner would either play at a different table or go

shopping.    Petitioner was aware of the amount of time Philip

spent gambling, and they would often argue about it.

     Philip gambled with large amounts of money.       He often signed

markers to the casinos to get more cash with which to gamble.

Philip tried to pay off the markers before they could be noticed

by petitioner.    When petitioner was with him, Philip tried to

hide the size of his bets and his winnings or losings from her.

     Petitioners would often go together or with the Lermans for

an evening at the racetrack.      Petitioner would make small bets

during the evening, while Philip made larger, more substantial

bets.    He tried to keep the tickets hidden, or show petitioner

tickets with smaller bets, so that she would not know how much

money he was risking.    Petitioners even invested in racehorses.

They had an interest in several racehorses during the years in

issue.

     For the years in question, Philip reconstructed the amounts

expended on gambling as follows:

           Cash         Marker       Personal Checks
Year      Philip        Checks          to Casino          Total
                                                              1
1981        ---           ---               ---
1982      $72,800         -0-               -0-           $72,800
1983      137,400       $36,000           $8,300          181,700
1984       76,800       119,500           31,500          227,800
1985       63,500       112,500              500          176,500
  Total                                                   658,800
     1
       Petitioner did not provide any evidence of gambling
expenditures for 1981.
                               - 8 -

The reconstruction is, to some extent, overstated because some of

the source documents were shown not to reflect gambling

expenditures.   In addition, it has not been established that the

amounts reflected were expended solely for gambling.   The

expenditures do not reflect the source of the funds expended.

Some of the funds may represent winnings, and some may represent

Philip's and petitioner's cash-flow from other income, tax

savings, or other sources.

     Petitioner was aware that Philip was an avid gambler both

when she married him and during their marriage.   During the years

in issue, petitioner was not aware of the full extent of Philip's

gambling expenditures.   Philip wrote checks and depleted both his

and the couple's checking accounts to the point where checks on

the account used by petitioner for household matters were

returned because of insufficient funds.   By 1990, petitioner and

Philip argued, and their relationship deteriorated due to

Philip's gambling and the overdrawn accounts.

     Petitioner's and Philip's joint income tax returns for the

taxable years 1981 through 1985 reported income in the amounts of

$297,982, $595,375, $216,932, $660,892, and $1,264,674.   The

income tax deficiencies determined by respondent for the taxable

years 1981 through 1985 are as follows:
                                 - 9 -

                Year             Income Tax Deficiency
                1981                   $41,221.00
                1982                   129,944.00
                1983                   119,644.76
                1984                   183,985.50
                1985                   501,303.00
                  Total                976,098.26

Of the total of $976,098.26 for the 5 years, approximately 72

percent, or $702,791, is attributable to respondent's

disallowance of the tax shelter deductions and carryback losses

which represent the "grossly erroneous item".

     On February 4, 1991, Philip and petitioner entered into a

separation agreement.     Pursuant to the agreement, Philip assigned

a partnership interest to petitioner.    At the time of trial,

income distributions from the partnership amounted to $4,371 per

month.   The separation agreement provided that, upon petitioner's

vacating the condo, Philip would be entitled to live there and

would be required to pay all expenses, taxes, utilities, etc.

connected therewith.    By allowing Philip to reside in the condo,

petitioner did not waive her ownership rights in the property.

In the event of Philip's death, petitioner would receive full

ownership of the condo.    Petitioner was given the other

residential real property and certain specific personalty which

was then located in the condo.    Petitioner also received a 1986

automobile under the separation agreement.

     The separation agreement contained Federal income tax

provisions as follows:

     Any refund payable with respect to any joint tax
     return, now or hereafter filed, shall be paid to the
                              - 10 -

     Husband, and the Wife shall endorse refund checks such
     [sic] payment. If there is any deficiency or tax
     liability assessed on any jointly filed tax return,
     such deficiency or tax liability, with any interest or
     penalties thereon, shall be paid solely by the Husband,
     and the said Husband does hereby forever save, hold
     harmless, indemnify and defend the Wife of, from and
     against any and all claim or claims that may be made
     against them or her for the payment, collection or
     satisfaction of any such tax, interest or penalty due
     or alleged to be or become due as a result of the
     filing and/or failure to file any such joint tax
     return. * * * The cost, if any[,] incurred or to be
     incurred by either of the parties in connection with
     the examination and/or audit of any such joint return
     shall be borne solely and exclusively by the Husband.

     On April 9, 1992, petitioner, with Philip's consent, filed

for a divorce.   Petitioner asserts that she and Philip were

divorced during 1992.   As of the time of trial (April 6, 7, and

8, 1992), the separation agreement was still in effect; however,

petitioner and Philip continued to live together at the same

location.

                              OPINION

      The U.S. Court of Appeals for the Second Circuit outlined

its mandate to this Court as follows:

          The resolution of this issue [whether it would be
     inequitable to hold petitioner jointly liable for the
     tax deficiencies] depends upon a fact-intensive inquiry
     into the surrounding facts and circumstances. I.R.C.
     §6013(e)(1)(D). Relevant factors include significant
     benefits received as a result of the understatements by
     the spouse claiming relief, any participation in
     wrongdoing on the part of the "innocent" spouse, and
     the effect of a subsequent divorce or separation. See
     S. Rep. No. 1537, 91st Cong., 2d Sess. (1970)
     (considering bill to amend the Internal Revenue Code of
     1954), reprinted in 1970 U.S.C.C.A.N. 6089, 6092.
     Normal support, measured by the circumstances of the
     parties, is not considered a significant benefit for
     purposes of this determination. Flynn, 93 T.C. at 367
                                   - 11 -

       * * *. The magnitude of Friedman's gambling losses,
       which allegedly exceed the total tax deficiencies owed,
       would be a factor weighing heavily in favor of a
       finding that taxpayer did not personally benefit from
       the tax shelter. See Pietromonaco, 3 F.3d at 1348.
       [Friedman v. Commissioner, 53 F.3d at 531.]

       The statute requires that petitioner show that "taking into

account all the facts and circumstances, it is inequitable to

hold       * * * [her] liable".   Sec. 6013(e)(1)(D).   Petitioner bears

the burden of proof as to whether it would be inequitable to hold

her liable for the tax shelter portion of the deficiency.         Rule

142(a); Russo v. Commissioner, 98 T.C. 28, 31-32 (1992).         In

deciding whether it was inequitable to hold a spouse liable,

courts have considered whether the purported innocent spouse

benefited5 beyond normal support, either directly or indirectly,

from the understatement of tax liability.        Hayman v.

Commissioner, 992 F.2d 1256, 1262 (2d Cir. 1993), affg. T.C.

Memo. 1992-228; Belk v. Commissioner, 93 T.C. 434, 440 (1989);

Purcell v. Commissioner, 86 T.C. 228, 242 (1986), affd. 826 F.2d

470 (6th Cir. 1987); H. Rept. 98-432 (Part 2), at 1501-1502

(1984); sec. 1.6013-5(b), Income Tax Regs.        Deduction items, to

the extent that they reduce taxpayers' tax burden, have the

potential to benefit the purported innocent spouse.          Bokum v.

Commissioner, 94 T.C. 126, 157 (1990), affd. 992 F.2d 1132 (11th

Cir. 1993).       Normal support is determined in the context of the


       5
       The statute once required a significant benefit, but the
wording of the statute for the years under consideration does not
specify a significant benefit. See Purificato v. Commissioner, 9
F.3d 290 (3d Cir. 1993), affg. T.C. Memo. 1992-580.
                              - 12 -

circumstances of taxpayers.   Sanders v. United States, 509 F.2d

162, 168 (5th Cir. 1975); Flynn v. Commissioner, 93 T.C. 355, 367

(1989).

     Evidence of direct or indirect benefits may consist of

property transfers, including transfers received several years

after the year in which the erroneous deductions were claimed.

See sec. 1.6013-5(b), Income Tax Regs.   This would include the

division of property in a subsequent divorce proceeding.

Pettinato v. Commissioner, T.C. Memo. 1995-85.   Finally, in

deciding whether it is equitable to hold a spouse liable for

deficiencies or "innocent" under section 6013(e), we are to

consider the probable future hardships that would be imposed on

the spouse seeking relief, if such relief was denied.     Sanders v.

United States, supra at 171 n.16; Dakil v. United States, 496

F.2d 431, 433 (10th Cir. 1974).

     Petitioner admits that her lifestyle may have been

considered lavish, but it was the standard she had enjoyed during

her marriage with Philip.   Respondent contends that petitioner

and Philip entered into the marriage on a relatively equal

financial footing and that any benefits to petitioner were earned

and consumed during the marriage and the years in issue.

Petitioner also contends that Philip gambled away the tax shelter

benefits.   The tax benefits in question stem from a 1983

transaction for which losses were claimed for 1983, 1984, and
                                - 13 -

1985.   In addition, net operating loss deductions were carried

back to 1981 and 1982.

     Although petitioner and Philip entered into their marriage

on a similar footing as to assets, Philip had a substantial

earning capacity and, from the beginning, was able to provide a

high standard of living for himself, petitioner, and petitioner's

daughters.   Throughout the period under consideration,

petitioners lived in high-quality residences.    However, the

important factor here is that their standard of living did not

increase, either during or after the years that the grossly

erroneous deductions drastically reduced their tax liability.

Ultimately, in the separation agreement, petitioner received a

partnership interest that provided her with about $4,300 per

month, the right to the Fire Island property, a moderately priced

1986 automobile, and claim to her joint share of any equity in

the condo.   The $4,300 amount appears to approximate the monthly

living expenditures attributable to petitioner.    At the time of

the separation agreement, the condo was substantially mortgaged,

the Fire Island property had a relatively large mortgage, and the

automobile was about 4 years old.    The bulk of the assets

received in accordance with the separation agreement was

purchased for cash prior to the deduction of the "grossly

erroneous items" in question.    Other than a fur coat, petitioner

did not receive lavish assets or jewelry during the marriage.
                              - 14 -

     Petitioner did, however, enjoy the benefits of traveling to

resorts in connection with gambling activities, and some of that

travel was lavish.   The amount of travel was about the same,

before, during, and after the tax years for which the grossly

erroneous deductions were claimed.

     Philip's reported gross income, without considering

deductions or the grossly erroneous amounts, ranged from a low of

$297,982 to a high of $1,264,674 from 1981 through 1985.   The

record reflects that his reported income in other years was

similar in amount.   His income fluctuated due to the nature of

his business activity--mortgage broker.   That amount of income

would have provided petitioners with a high standard of living

without considering the tax savings generated by the tax shelter

in question.   A substantial portion of the tax savings was likely

consumed by Philip's gambling losses.   About $700,000 of tax

savings is attributable to the grossly erroneous deductions

generated by the subject tax shelter.   During the same period,

Philip's gambling activity consumed as much as $650,000.   In

subsequent years, Philip's gambling activity appears to have

increased, and his losses also likely increased, ultimately

ending in the conflict with petitioner that led to separation

and, allegedly, to divorce.   Our record does not reflect whether

petitioner and Philip were actually divorced, but references to

the divorce appear in the appellate briefs connected with this

case.   We are also unaware of the ultimate divorce settlement,
                                - 15 -

but accept the separation agreement as the model for the ultimate

division of property.

     Although petitioner continued to live with Philip after

entering into the separation agreement, petitioner testified that

she and Philip lived separately at the same location until she

was able to move.     The fact that petitioner and Philip continued

to live together, as opposed to living separately and/or being

divorced, militates against an inequity finding.    See sec.

1.6013-5(b), Income Tax Regs.    We also note that Philip, in the

separation agreement, agreed to pay any tax deficiencies and save

petitioner harmless from any expense connected with tax audits.

The effect of such a promise has been considered by this Court on

several occasions.6    The impact on the relative equities of

holding a spouse liable if the other spouse promises to pay joint

tax deficiencies is dependent on whether the promise is reliable

or speculative.    Although Philip's actions toward petitioner have

been amicable, his gambling habit, which was the root of

petitioners' marital problems, renders his promise to pay the tax

inconsequential.    At the time of the separation agreement,

petitioners' bank accounts were overdrawn, and significant pieces

of property, like the condo, were fully mortgaged.    Accordingly,




     6
       See, e.g., Stiteler v. Commissioner, T.C. Memo. 1995-279;
Foley v. Commissioner, T.C. Memo. 1995-16; Buchine v.
Commissioner, T.C. Memo. 1992-36, affd. 20 F.3d 173 (5th Cir.
1994); Henninger v. Commissioner, T.C. Memo. 1991-574; Knapp v.
Commissioner, T.C. Memo. 1988-109.
                              - 16 -

in this case, Philip's promise to pay is not considered reliable.

See Foley v. Commissioner, T.C. Memo. 1995-16.

     Based on the record, we find that petitioner has shown that

she did not benefit beyond the amount of her normal support,

either directly or indirectly, from the understatement of tax

attributable to the grossly erroneous deductions.    Accordingly,

we find that, if petitioner did not know and had no reason to

know, as the U.S. Court of Appeals for the Second Circuit found,

it would be inequitable to hold petitioner liable for the portion

of the deficiencies and additions to tax attributable to these

tax shelter items.   Based on our findings and in accordance with

the holding of the U.S. Court of Appeals for the Second Circuit,

we find that petitioner is an innocent spouse within the meaning

of section 6013(e) as to the deficiencies in income tax and

additions to tax attributable to the tax shelter items only.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
