Tax Return Is Key Information Source For Divorce Attorney

Lauren Crane is one of the founders of Bender & Crane, a five woman law firm that focuses on divorce.  She made it a point to let me know that even though the team is all women, they represent both women and men.  We were discussing tax returns and divorce and some of the ways accountants interact with divorce attorneys.  Ms. Crane focuses on high income/net worth clients. Her clients live in the State of New York portion of the metro New York City area, mostly in Manhattan. Speaking with her I learned some things that I would never learn from reading Tax Court decisions.

The First Thing To Look At

Working out child custody issues is the first priority, but it is possible that the financial issues can be worked on before they are fully settled.  With me being a CPA and all I did not get into discussing custody issues with Ms. Crane. Maybe I need to watch Kramer Versus Kramer again.

That leaves the financial issues.  And the first thing that Ms. Crane wants to see is the tax return.  And it’s not so much page one and two where you learn what the totals of various sorts of income are and total gross income and what the total tax is.  Ms. Crane is much more interested in the details.

“They think that all we want to look at is how much they earn, what’s on your 1040? The 1040 is one of the least interesting parts of a tax return to me.”

Schedule B will have a list of all accounts that yield interest and dividends.  There are also those neat questions about whether you have any foreign accounts and what countries you have them in. Schedule C gives details of expenses some of which will be adjusted in child support computations.  Schedule D, even when it shows losses, indicates gross proceeds from asset sales and those gross proceeds had to go somewhere.  And then there is Schedule E.

“Some people don’t understand that when their spouse works at a large bank, they’re getting private equity interests.  I can find them on the tax returns.”

If those interests are partnerships there will be K-1s and they leave a trail on Schedule E.  She also wants to read any explanatory notes the preparer attaches to the return.  Personally, I am not a big fan of attaching anything to a return that is not absolutely required, but maybe that is just me.

Forensic Accountants

When there are numerous accounts with complex flows, Ms Crane will call in forensic accountants.  They are also required to work on valuation of business interests. When each of the couple hire their own forensic accountant they can sometimes help reconcile the differences in value.  Ms. Crane enjoys working with the forensic accountants.  She finds that she always learning new things from them.  The forensic accountants work for various firms and which firm they work for keeps changing as practices get gobbled up.

The Adjustments

The talk about the adjustments got me curious, so I did a little digging which brought me to the language of the Child Support Standards Act.  The income used for determining child support starts with gross income as should have been reported on the most recent federal income tax return. Them the adjustments commence.  To the extent not included in federal gross income, you add investment income net of applicable expenses, workers compensation, disability benefits, veteran benefits, pension and retirement benefits, fellowships and stipends and annuity payments.

At the discretion of the court there can be imputed income from non-income producing assets and for things like deducted meals, lodging, memberships and automobiles, etc. that directly or indirectly confer personal economic benefits. Income can also be imputed from money or other things from relative or friends and former resources or income, if the court determines that a parent has reduced resources or income in order to reduce the child support obligation. Deductions taken against business income can be added back including depreciation greater than straight-line and entertainment and travel allowances to the extent that they reduce personal expenditures.

Going the other way there are deductions for alimony and child support, local income tax, FICA, unreimbursed business expenses among others and a “self-support reserve” of 135% of poverty income as determined by the federal department of health and human services.

Joint Returns – Tax Indemnity Agreement

One of the issues that I get a little passionate about is the assumption that filing joint returns is always the right answer without considering the implication of joint and several liability. I have been raising alarms about that for many years.   I was surprised that Ms. Crane did not view that as more of an issue, but that I realized it has to do with the high end client base.  I reached my conclusion from reading Tax Court opinions.  It happens that the Tax Court is one of the more accessible courts.  It costs sixty bucks to file a petition and there are often volunteer attorneys to help people out. Tax Court judges are used to dealing with pro se taxpayers.

So there are quite a few “innocent spouse” cases where spouses are trying to get out from under joint and several liability.  The IRS is chasing which ever half of the couple can pay.  Establishing innocent spouse status can be challenging.  As I am reading the opinions, my Monday morning quarterbacking of the return preparer is often that a joint return should not have been filed.  Here is one of the more egregious stories about a dutiful spouse going to great lengths to file jointly with their imprisoned embezzler spouse.  The return omitted the embezzled income.

The way Ms. Crane addresses these issues for her clients is through a tax indemnity agreement which outlines who is responsible for the balance due and different sorts of subsequent adjustments.  The weakness with this sort of agreement is that it is not binding on the IRS. For the overwhelming majority of Ms. Crane’s client this is not a problem.  If the IRS insists on collecting from the “wrong spouse”, enforcement of the tax indemnity agreement fixes the problem.  Most importantly, with her sort of client base, the “right spouse” will be able to pay.

I am writing this on April 2 when she tells me there is a bit of a rush on tax indemnity agreements.  If you need one you should insist on extending the return. Then get it taken care of no later than July or August, as there is another rush in September as the extended due date draws near.

Advice From Our President

This project got me thinking about a couple of the books that our President is credited with even though he may have had help writing them.  This comes from Think Big: Make It Happen in Business and Life by Donald J Trump and Bill Zanker:

“You should have a prenup. I know it sounds terrible, and there is nothing romantic about it. It is a hard subject to talk about with someone you love. Where a lot of money and assets are concerned, it is vital. You never know about love, but you do know that when the love is gone there will be a knock-down, drag-out fight over the assets.

It always happens, unless you have a prenup. In your business, you always determine ahead of time what will happen if the business relationship comes to an end. It is the responsible thing to do. Why not do the same thing with your personal relationship? Sure, it is not pleasant, but it makes a lot of sense to define how things will be divided if the two of you call it quits. A prenup can spare you most of the messiest, most unpleasant aspects of a divorce.”

I close with some divorce advice from someone I know well.  It doesn’t apply to the top 1%, but maybe the rest of the top 10% or 15%.  If you are reasonably certain that both you and your ex are not going to die broke and you are both leaving money to the same kids don’t worry so much about the financial split.  That attitude will really lessen the stress.

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Originally published on Forbes.com.