Tax Court Holds that IRS Must Prove Return Fraud After a Convicted Spouse is Convicted for Tax Evasion (5/30/26)

In Li v. Commissioner, T.C. Memo. 2026-42 (T.C. Case 12133-23 at #35, here, at #35, and GS here [to come], the Court addressed proof issues for applying the unlimited statute of limitations for a joint return spouse (“unconvicted spouse”) after the other spouse was convicted of tax evasion (“the convicted spouse”). Of course, as to the convicted spouse, collateral estoppel will apply to establish fraud for the unlimited statute of limitations (§ 6501(c)(1)) and the civil fraud penalty (§ 6663). Li addresses the issue of the effect of the convicted spouse’s conviction on the unconvicted spouse’s statute of limitations (§ 6501(c)(1)),

The background is the Allen issue. In Allen v. Commissioner, 128 T.C. 37 (2007), the Court held that fraud on a return by a return preparer without the taxpayer’s personal fraud invoked the unlimited statute of limitations in § 6501(c)(1). The issues Allen raises are discussed in several blog entries over the years, but I think they are presented in my most recent blogs: Update on Murrin Petition for Cert re Unlimited Civil Statute of Limitations for Non-Taxpayer Fraud Reported on Tax Return (Federal Tax Procedure Blog 5/19/26), here; and Further on Murrin and Allen and the Unlimited Statute of Limitations for Fraud on the Return (Federal Tax Procedure Blog 4/30/26), here.

Stripped down to basics, the current status of the Allen issue is as follows:

• for courts applying the Allen holding (that the preparer’s fraud alone will suffice to the unlimited statute of limitations; the taxpayer’s fraud is not required). This includes all courts addressing the issue except the Federal Circuit.
• the Federal Circuit held that the taxpayer’s fraud is required, at least in a context where the fraud on the return was not the preparer’s fraud (although the Federal Circuit did not intimate that preparer fraud would suffice).

Li dealt with the unlimited statute of limitations for the unconvicted spouse after the convicted spouse’s tax evasion conviction. The holding was that, as to the unconvicted spouse, the IRS must prove fraud on the return by clear and convincing evidence of fraud on the return (which need not necessarily be the unconvicted spouse’s personal fraud). In the Li facts, that means that the unconvicted spouse is not subject to collateral estoppel for the convicted spouse's conviction. Li does not address the issue I discuss in the first blog above as to whether fraud on the return committed by others than the tax return preparer (e.g., tax shelter promoters) will suffice.

I have synthesized the Li Opinion in my working draft for the Federal Tax Procedure Editions for 2026 (to be published in early August). I offer that synthesis here in the paragraph after discussing the Allen issue (note that the footnotes are presented after the text; the numbering on the footnotes will not be the same in the working draft or the final 2026 Practitioner Edition):

          One context in which these holdings might possibly apply is a joint return filing where one spouse is convicted of tax evasion with respect to the joint return (“the convicted spouse”) but the other spouse is not (“the unconvicted spouse”). The convicted spouse’s evasion conviction means that, for civil purposes (the civil fraud penalty and the unlimited statute of limitations), the convicted spouse is collaterally estopped on civil fraud, but the unconvicted spouse is not collaterally estopped on civil fraud. That means that, as to the unconvicted spouse, the IRS must prove by clear and convincing evidence of fraud:

           • Unlimited Statute of Limitations: in courts applying Allen, the return was fraudulent without collateral estoppel from the convicted spouse’s conviction (the unconvicted spouse’s personal fraud is not required under Allen; fraud on the return, e.g., by the convicted spouse or by the preparer, will suffice if proved); n1 in courts not applying Allen, the unconvicted spouse’s personal fraud must be proved; and

          • Civil Fraud Penalty: the unconvicted spouse committed fraud. n2

In Allen and another case, the taxpayer conceded the return fraud by the return preparer, thereby not requiring the IRS to meet the clear and convincing burden of proof. n3

 n1 Li v. Commissioner, T.C. Memo. 2026-42, *12 & *20 (holding that the unconvicted spouse is not collaterally estopped based on the convicted spouse’s evasion conviction, citing inter alia Stone v. Commissioner, 56 T.C. 213, 223, 226–28 (1971) and, after discussing cases, saying “We read this long line of cases to hold that the unconvicted spouse who was not a party to the convicted spouse’s section 7201 criminal proceedings is allowed her “day” in Court for purposes of litigating the application of the fraud exception to the general three-year period of limitations regardless of whether she herself is subject to a fraud penalty.” On that basis, the Court rejected the IRS position that “if a joint return is filed, proof of fraud as to one spouse lifts the bar of the period of limitations as to both spouses.”)

n2 § 6663(c) (requiring the personal fraud of the joint return filer, here the unconvicted spouse, for the civil fraud penalty).

n3 Li v. Commissioner, T.C. Memo. 2026-42, *19 n. 10.