Forensic Review of Tax Returns a Must in Marital Dissolution Matters

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The phrase “trust but verify” has many universal applications, but it becomes very personal when dealing with the breakup of a marriage.

In many marriages, one spouse handles most of the financial matters and thus is the most familiar with the true value and nature of the relationship’s assets. However, when a relationship sours, the spouse who was less involved with finances can be left in the dark, particularly when it comes to equitable division of marital assets.

Marital Dissolution Reviews

As part of the process, both spouses are required to disclose their current income, expenses, assets and liabilities by preparing financial affidavits. Financial affidavits provide information to the parties which can be used for settlement purposes. However, considering that many divorces become hostile, how can the spouse who has not been fully involved in the couple’s finances determine that everything has been fully disclosed?

Experienced forensic accountants usually start the hunt for undisclosed assets with an in-depth review of tax returns. The first two pages of a typical federal individual income tax return summarize income and deductions, but for a more complete picture it often is necessary to dig deeper. A good place to start is with Schedule A: Itemized Deductions.

When preparing tax returns, accountants are usually provided with the information and documentation necessary to fully support deductions and credits taken on a client’s tax return. Thus, it is unlikely that a taxpayer would exclude deductions and credits which would potentially reduce tax liability, especially in years prior to filing or planning for divorce. By reviewing Schedule A, it is possible to discover assets that may not have been disclosed on the financial affidavit.

Schedule A – Taxes Paid

The section of Schedule A titled “Taxes You Paid” contains lists of real estate taxes, personal property taxes and other taxes paid during the year. The supporting schedules may indicate additional properties, vehicles, and even assets such as boats.  A review of this section may point towards assets that were not disclosed on the financial affidavit or may bring up questions as to the disposition of proceeds from assets that were sold in previous years.

The next section of Schedule A is titled “Interest You Paid.”  A review of this section may provide information on mortgage interest paid on undisclosed property. In addition, if there is a deduction for investment interest expense, it may be an indication that there are interest-generating brokerage accounts that may not have been disclosed. It may also indicate the existence of a margin account.  A margin account is offered by brokerage firms to allow investors to borrow money to buy securities and use those securities as collateral.  The deduction of margin account interest may point to the need for further analysis to determine if all brokerage accounts have been disclosed.

Schedule A also includes a section for deduction of charitable contributions. It is important to review and possibly investigate the organizations that purportedly received donations as well as the amounts of the donations. This should be done in order to make sure that the organizations actually exist and that the donations were actually made and not simply siphoned off into an undisclosed account.

The last area to review is the “Miscellaneous Deductions” section of Schedule A. This section can indicate deductions such as fees paid for estate planning or safe deposit boxes. Estate planning documents may disclose the establishment of undisclosed trusts or the gifting or transfer of assets. Safe deposit boxes are often held to store valuable documents, cash and other assets which may not have been disclosed.

When attempting to determine the assets accumulated during a marriage, a financial affidavit is a great starting point, but it is just that, a starting place. The affidavits do not always show the entire picture, and therefore it is important to conduct a much deeper investigation.

Part two in this article series will discuss researching additional schedules within the tax return.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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