July 2007 #1. Civil and Criminal Tax Considerations in a Marital Dissolution.

• Author: by Charles P. Rettig

Hawaii Bar Journal

2007.

July 2007 #1.

Civil and Criminal Tax Considerations in a Marital Dissolution

Hawaii State Bar JournalJuly 2007Civil and Criminal Tax Considerations in a Marital Dissolutionby Charles P. RettigHaving just been retained in a family dissolution proceeding by the soon to be ex-spouse of an extremely wealthy physician, the family law practitioner has finally discovered Nirvana. During the initial consultation, counsel was advised that the couple's federal and Hawaii returns significantly underreported gross receipts from the medical practice and cash receipts from various rental properties. Counsel knows that the financial vulnerability of the physician should translate into a significant award of spousal and child support under threat of exposing the unreported receipts to the Internal Revenue Service or the Hawaii Department of Taxation. A favorable resolution result is on the horizon.

To determine the appropriate amount of spousal support, counsel would typically engage the services of a forensic accountant to delve into the couple's financial affairs and transactions. The forensic accountant will thoroughly examine many different aspects of the couple's business activities and will review various financial and business books and records, bank accounts, retirement accounts, and the expenditure of business funds for personal items. Various expenditures will be traced to search for potentially hidden assets. During this process, substantial amounts of unreported income are often discovered even if one of the spouses happens to be completely unaware of such additional income. The discovery of the unreported income or hidden assets is often used as a sword to attempt to compel the other spouse to be forthcoming with additional financial support. However, it is not uncommon for the sword to become a financial guillotine.

In the dissolution proceeding, information the forensic accountant discovered may be filed with the court in a declaration as the basis for an award of spousal and child support and a realistic division of the jointly held assets. If the physician failed to acknowledge the actual amounts of income, various witnesses, including the physician and forensic accountants for both spouses, could be required to testify in order to assist the court in formulating an appropriate level of support and a realistic division of the joint assets. How would counsel be rewarded as a result of the court awarding substantial support payments and a division of the joint assets based upon the actual, rather than reported, income and assets? Perhaps, counsel's reward may be a legal malpractice action at a later date.

Is Someone Going To Locate The Cemetery? The IRS has long proven itself extremely capable of investigating both civil tax fraud and criminal tax fraud. The investigation of tax fraud is one of the most important phases in the administration and enforcement of the federal tax laws. Certainly, the viability of every self-assessment, voluntary compliant system requires an effective enforcement mechanism as a strong deterrent to potential unlawful behavior. Various declarations are often filed in marital dissolution proceedings setting forth the financial status of the marital estate, without regard to the potential impact the declarations may have in a subsequent tax-related proceeding. It is not uncommon and should be anticipated that various court personnel, including judges and court reporters, may feel compelled to refer matters to the taxing authorities based upon information generated during the marital dissolution proceedings on the theory that "I file my returns and pay my taxes and expect others to do the same!" It should be anticipated that all information provided during the course of a marital dissolution proceeding will be obtained and thoroughly reviewed by a government agent in a subsequent tax audit.

"Tax Gap" Enforcement. The taxing authorities have significantly increased their enforcement activities in an effort to reduce the "Tax Gap." The Senate Finance Committee recently held hearings entitled "A Closer Look at the Size and Sources of the Tax Gap." Because the "Tax Gap" represents unpaid taxes, any estimate is, at best, a WAG (wild-guess) although most believe the current federal net Tax Gap...