Certified Public Accountants in Lewisville

An unfortunate aspect of life in our society is a divorce rate in excess of 50 percent. The tax issues that are frequently a by-product of our clients' marital discord send them into crisis mode, fleeing to us for damage control. We need to be prepared to help them during this difficult time.

Find a Silver Lining
Within our firm, we view every crisis as an opportunity to help our clients; divorce engagements are no exception. Aside from the obvious complexities of divorce-year tax returns, we have developed many other facets of our divorce consultation services that prove beneficial to our clients and lucrative for our firm. We have cultivated an excellent professional relationship with family law attorneys in our area who provide a steady stream of referrals for our services throughout the year.

Attorneys typically focus on maximizing property settlements. However, what appears to be a reasonable distribution of property between spouses often produces an inequitable tax burden. Our primary role in divorce consultations is to minimize the tax burden produced by property settlements.

Determine the Tax Burden
A case in point was that of our client, a displaced homemaker, who required a supplemental income stream while she trained to re-enter the job market. Under consideration were alimony, division of the husband's 401K, a significant stock portfolio, and substantial equity in the family residence.

The initial settlement proposal was for one-half of the 401K account, alimony for a specified number of years, and one-half of the stock portfolio plus an additional amount of stock with a fair market value (FMV) equivalent to one-half of the equity in the residence. This sounds reasonable doesn't it? Well, only if you were representing the other party! Remember that our client needed cash flow to cover her basic living expenses, relocate to a smaller home, and pay her educational costs. Alimony and 401K distributions would be taxed at her ordinary income tax rate, as would the sale of short-term stock. The sale of long-term stock would at least receive the advantage of the lower capital gain rate. However, our client was in the unusual position of receiving low-basis stock that even in today's market would generate a substantial capital gain.

Our counterproposal, ultimately accepted by both parties, still involved one-half of the 401K. However, we recommended a more modest alimony figure with cash settlement in lieu of stock, representing one-half of the FMV of the portfolio plus one-half of the home equity. The settlement was in the form of an initial lump-sum payment with the balance paid over five years with interest. In this manner, the only taxable items for our client were the alimony payments and interest income from the note. The cash settlement provided enough supplemental income to meet our client's financial needs until she could re-enter the workforce, plus it avoided taxable distributions from the 401K. Her former spouse, although forced to take out loans to satisfy the lump sum settlement, was able to deduct alimony payments, kept assets intact, and had a manageable payout plan with the five-year note.

Are There Prior-Year Tax Obligations?
Another significant aspect of divorce settlements is the issue of responsibility for prior-years tax liabilities stemming from periods when the parties were filing joint tax returns. Individuals in the throes of divorce frequently come to us for assistance when confronted with the harsh reality that the IRS now holds them accountable for payment of back-tax liabilities related to the financial transactions of their former spouse.

Our firm has secured relief for many taxpayers facing these circumstances by filing Form 8857, Request for Innocent Spouse Relief and Relief by Separation of Liability and Equitable Relief. Tax practitioners who are unfamiliar with issues of innocent spouse relief should reference IRS Publication 971 (Rev. March 2004) for a detailed analysis of options currently available. The key to a successful outcome lies in selecting the correct category of relief, then presenting as many facts and circumstances as possible supporting the claim. We also recommend that divorce decrees address responsibility for payment of prior-years tax liabilities. Although this is not binding upon the IRS with respect to joint tax liabilities, it is an item favorable to the spouse seeking some form of innocent spouse relief.

Community Property Law
Residing in Texas, our divorce consultations are frequently complicated by matters of community property law. The conventional approach is to allocate all items of income and expense equally between the two parties. However, there are exceptions to this rule that significantly impact the preparation of tax returns for individuals in the midst of divorce litigation. Frequently, our clients discover that they must file delinquent tax returns before a court can finalize any divorce settlements.

The typical scenario involves a client whose spouse was either self-employed, an LLC member, or S corporation shareholder. During the course of the marriage, our client had no knowledge of her spouse's business affairs and the spouse was responsible for the preparation of tax returns. The parties are now in an adversarial position; the spouse is not forthcoming with business records. How can we proceed with the preparation of our clients' tax returns when we cannot verify income and there is also reason to believe the spouse's business practices may expose our client to significant tax penalties?

The solution lies within the provisions of §66 that presents several exceptions to the community property allocation. If applicable, we prepare our divorce clients' returns as married filing separately, attaching a Form 8275, Regulation Disclosure Statement, describing the circumstances and citing the appropriate sub-paragraph of §66 as our authority. In this manner, we bring our clients into compliance and establish a basis for a separation of liability determination.

And yes, there is life after divorce. Our position as trusted advisors during this stressful season of life opens the door to many other service opportunities. In addition to tax return preparation, clients rebuilding their lives in the aftermath of a divorce seek our ongoing guidance with respect to budgeting, investments, estate planning, and other services offered by our firm. Successful divorce consultations yield mutually beneficial business relationships for years to come.

NATP member, Linda Burney Fuhr, EA, has been a tax practitioner in the Lewisville, Texas area since 1985. She is currently a tax partner with the firm of Owen Lyon & Associates, PC. Linda has a broad range of experience in compliance and IRS representation. Family law attorneys frequently consult with her concerning the tax implications of divorce settlements, innocent spouse relief, and for resolution of IRS collection issues. Linda is a member of the Dallas Center for Nonprofit Management, a graduate of the Chamber of Commerce Leadership Lewisville Class of 2000, and serves on the Board of Directors of PediPlace, a nonprofit children's health care clinic.