NJ Family Legal Blog : New Jersey Divorce and Family Lawyer & Attorney : Fox Rothschild Law Firm : Domestic Violence, Prenuptial Agreements, Child Custody

Mark Ashton, a partner in our Exton (Chester County), Pennsylvania office and the editor of our Pennsylvania Family Law Blog, wrote an interesting post entitled "The Owner Know Thy Business" on that blog.

To read the complete post, click here.
 

EDITORS NOTE:  Mark's post leads to a discussion of several interesting issues that are frequently encountered in matrimonial cases.  It is not unusual in cases where one or both parties are self employed that there is either unreported income and/or personal expenses being paid through he business.  In those cases, the tax returns are obviously unreliable for support purposes and you have to get the business books and records, credit card records and other documents to determine the business owner's actual income/cash flow.  I say cash flow because that person is not paying taxes on the expenses being paid through he business and the expenses are not added to that person's income.  In some cases, though there are some personal expenses that are paid through the business, that is neither unusual nor problematic from an income tax perspective.  A perfect example is the deduction of automobile expenses.  While this is acceptable, within limits, per the IRS, those expenses have to be added back to income per the Child Support Guidelines.  In fact, all personal expenses are supposed to be added back.  I have been involved in other cases where the husband was declaring just enough income to pay the mortgage, taxes and utilities on the parties' $2 million dollar house and there was no other declared income apparent to pay their other expenses which amounted to a few hundred thousand per year.  In that case, we had to use a forensic accountant to reconstruct the income through the parties' budget because, there were, surprise, sparse records. 

An interesting question, and unanswered question,  is how these non-taxed expenses should be treated for support purposes.  If some declares $100,000 in taxable income and has another $100,000 in non-taxable perks, what is the income number for support purposes.  $200,000 doesn't seem right because only half is taxed.  A normal, taxpaying citizen may have to earn $240,000 or more to have the same net after tax spending power.

A bigger issue to address which deserves its own separate blog entry is what to do when the case has these issues because of a NJ case called Sheridan v. Sheridan.  The rule as per Sheridan is that when a judge hears evidence of unreported income, they are duty bound to refer the matter to the IRS.  As Mark suggests, filing amended tax returns makes the most sense when confronted with this issue - as long as it doesn't happen too late - as was the case in the example in Mark's post.                        -Eric Solotoff

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The process for seeking Innocent Spouse Relief, a provision for individuals concerned about the accuracy of tax returns filed by their current or former spouses, has become a potential minefield.

In June 2007, the IRS published a revised Form 8857 - Request for Innocent Spouse Relief. Prior to that time, the form was short and simple. This one-page form asked the name and address of each taxpayer, whether the relief seeker had been a victim of domestic abuse and feared that filing a claim would result in retaliation, if the IRS had determined an underpayment of tax, and whether the understatement was due to erroneous entries by the spouse. (see note 1) The new form, however, is four pages long and the questions are far more in-depth. Given the possibility for self-incrimination, the form must now be completed with great care.

Often, when preparing a party's financial statement or budget for a divorce action the conversation turns to tax returns. When the parties involved lack substantial debt - consumer or otherwise - and yet still cannot explain how spending exceeded the level of income and asset draw downs, the accuracy of tax returns is brought into question. Often, and particularly in divorce cases, one spouse was not aware that the tax returns were inaccurate when filed. In such cases, that party may be entitled to Innocent Spouse Relief from the IRS.

So how does it happen? How can a spouse not know that the tax return was inaccurate when it was filed? Didn't the spouse sign the return under penalty of perjury? Some common answers clients may give include: 'It was April 15 (or August 15, October 15 if on extension) and my spouse shoved the tax returns in front of me and told me to sign them because we had to get them in the mail that day,' 'I trusted my spouse that the returns were right and just signed them,' 'My spouse told me they were correct, and I signed them,' 'I have no idea of the finances, my spouse handles everything,' and so on. On occasion, 'My spouse forged my name' also has been used.

During divorce actions, it is not uncommon for parties to still file joint tax returns. Hopefully, this is done after the non- or lesser-earning spouse has had his or her attorney and accountant review the returns. Also, it is common that Indemnification Agreements are signed to protect one spouse from the inaccurate income reporting and/or improper deductions taken by the other spouse. However, the agreements are only binding between the parties, not with the IRS or state taxing authorities.

What should a spouse or former spouse do when the IRS comes calling and he or she really did not know that the tax return was inaccurate? It goes without saying that the individual should immediately contact his or her attorney and tax professional - especially now that the new form asks for more and deeper personal information.

The new form asks for more and deeper information than the original, much of which appears as if it could trigger the trap door precluding Innocent Spouse Relief. Worse yet, the responses to many of the questions could possibly be self-incriminating, which is why representation is essential.

Some of the new questions seek the following information:

-your highest level of education
-whether you were a victim of spousal abuse during the years that you are seeking relief (and further asks for a description and documentation such as police reports, restraining orders, doctor's notes, etc.)
-whether you signed the returns, and if so, whether you were forced to sign under duress, threat of harm, etc., or if your signature was forged
-whether you had mental or physical problems both at the time the returns were signed and at the time you are filing the form (and documentation is requested)
-how involved you were in preparing the returns and whether you reviewed them before they were signed
-whether you were concerned that the returns were incorrect or incomplete when they were signed, and, if so, whether you just said nothing or made inquiry
-what you knew about your spouse's income when the return was signed; and further, if your spouse was self-employed, whether you helped with the books
-when the returns were signed, whether you knew that tax was due, and if so, how you thought the tax was going to be paid
-whether you were having financial problems when the returns were signed
-your involvement in the household finances during the years you seek relief, including whether you had access to information and decision-making power regarding finances
whether your spouse ever transferred any assets to you
-a listing of your monthly income and expenses

Since the form has to be signed under penalty of perjury, a wrong answer not only could preclude granting of Innocent Spouse Relief, but also could be used to assert - if not prove - tax fraud given a person's knowledge and involvement when the returns were filed.

The bottom line is that great care should be taken when completing this form.  A person seeking to do so should consult with an attorney and tax advisor, in advance, so as to not incriminate themself. 

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