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CPA’s Guide to Tax Crimes and Divorce

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Table of Contents

    CALIFORNIA SOCIETY OF CPA’S

    HOLLYWOOD / BEVERLY BILLS DISCUSSION GROUP

    Ernest F. Howard, Chairman

    Ani Oalyan. Co-Chair

     

     

    The CPA’s Guide to Tax Crimes and Divorce

     

     

     

     

     

    David W. Klasing Esq. CPA M.S.-Tax has earned dual California licenses that enable him to simultaneously practice as an Attorney and as a Certified Public Accountant in the practice areas of Taxation, Estate Planning and Business Law.  He provides businesses and individuals with comprehensive Tax Representation, Planning & Compliance Services and Criminal Tax Representation. He has more than 20 years of professional tax, accounting and business consulting experience, coupled with extensive knowledge about federal and state tax codes, regulations and case law.

    As a former auditor, Mr. Klasing uses his past experience in public accounting to help his clients avoid tax problems before they develop where possible. As a Combo Tax Attorney CPA he aggressively protects his clients’ interests during audits, criminal investigations or in Tax Litigation. Mr. Klasing has assisted thousands of businesses and individuals through the audit / litigation and appeal process, and Mr. Klasing has a proven and sustained record of achieving favorable results for the clients he serves.

    Mr. Klasing is admitted to practice before all California State Courts, the United States District Court for the Central District of California and the United States Tax Court.

    Mr. Klasing’s education includes a bachelor’s degree in business administration, with an emphasis in accounting, from California State University Los Angeles, a master’s degree in taxation from Golden Gate University and a Juris Doctor from Western State University College of Law.

    Having earned a master’s degree in taxation with an emphasis in the estate and gift tax arena, along with having taken classes in Law School on Estate’s, Trusts and California Community Property, Mr. Klasing practices in the estate, trust and accounting areas.

     

    Mr. Klasing’s professional involvement includes serving as the (2014/2015) chair of the American Academy of Attorney – Certified Public Accountant Education Committee, the (2012/2013) chair of the California State Bar Association, Tax Procedure and Litigation Committee, the 2013 chair of the Orange County Bar Association Taxation Section. He is also a member of the American Bar Association Tax Section; the Orange County Bar Association, Tax, Business and Corporate Law, Trust & Estate Sections, the California Society of Certified Public Accountants State Committee on Taxation and the American Association of Attorney Certified Public Accountants. His firm is an “A+” rated current member of the Better Business Bureau.  He has a 10.0 AVVO rating (Superb) 

    IRS Tax Rules Pertaining to Divorce

    A divorce often represents a substantial change in the wealth and income of both parties involved in the action. Therefore, the federal government has a number of provisions that dictate how this shift in wealth should be treated for tax purposes.

    Alimony and Child Support Payments

    Divorce settlements or orders will often include provisions for support payments made by one spouse for the benefit of the other (alimony) or the children that the spouses share (child support).

    Alimony and child support payments are currently not deductible under any circumstances. Fortunately, child and alimony support payments are also not subject to tax. You do not need to report them as taxable income on your federal tax return.

    Dependency and Child Tax Credit

    If the divorcing spouses had a child and filed jointly prior to the divorce, they previously enjoyed a deduction for their child as a dependent. Once the divorce happens, only one of the parents may claim the child as a dependent on their tax returns.

    Generally, the custodial parent, or the parent that the child lives with for the majority of the year, enjoys the benefit of the dependency on their filing. The custodial parent is also typically the one who receives any child support payments. The non-custodial parent may claim the child as a dependent only if the custodial parent signs a written waiver saying that they will not claim the child as a dependent.

    Even if you are the non-custodial parent, you can include your child’s medical bills in your medical expense deduction if you were responsible for paying those bills and you deduct only the portion that was not fully covered by insurance. The custodial parent can still claim the child as a dependent in these situations but cannot claim the medical bills under their medical expense deduction if paid by the non-custodial parent.

    If you are the parent who claims the child as the dependent, you are the parent who is eligible for the child tax credit and the American Opportunity higher education credit. Custodial parents may also claim the childcare credit for expenses related to caring for a child under the age of 13.

    Asset Transfers

    In the course of a divorce, assets and property often shift from the control of one spouse to the other. This shift is not typically a taxable event. In other words, you won’t have to pay taxes on property that you acquire through a divorce. However, you should bear in mind that because the transfer is not a taxable event, the property’s tax basis retains the same value. In other words, if you later sell the asset, you will have to pay taxes on the appreciation to the property that occurred prior to the divorce as well as after the divorce.

    To illustrate the difference, let’s use an example. Let’s say that, in your divorce settlement, you received stock worth $50,000 and a bank account containing $50,000. When the stock was purchased two years prior to the divorce, it had a value of $25,000. You won’t be taxed on the bank account or the stock when you receive it under the terms of the divorce. However, when you sell the stock later and realize the gain, you will be taxed on the $25,000 worth of appreciation of the stocks in addition to any appreciation that occurred after the divorce.

    Real Property

    Some of the most sizeable property that gets moved around in a divorce is the family home. Often, many couples will choose to sell their home as a way of making the post-divorce distribution cleaner and more equitable. Tax law allows certain exemptions to tax on any capital gains from the sale of the family house.

    The law allows for married couples filing jointly to exclude up to $500,000 of the gain from the sale of their primary residence from capital gains income. These exemptions still apply to a sale that occurs as a result of a divorce and may benefit both spouses. To meet the criteria for the exemption, the taxpayers must have lived in the home for at least two of the last five years. At least one of the spouses must have owned the home, and the couple must have used the property as a primary residence during this time.

    If the sale occurs upon a divorce, both spouses may exclude $250,000 each on their individual returns. Even if the criteria for the exemption aren’t fully met, the spouses may still enjoy reduced benefits from the tax law. For instance, if you only lived in the house for one year, you may still each exclude $125,000 from your taxable capital gains.

    If the sale occurs years after a divorce and the sale of the property was not a part of the divorce settlement, the ex-spouse who owns the property can still exclude up to $250,000 in capital gains from the sale, provided they meet the criteria listed above. The spouse who no longer owns the property will not be able to use the exemption once the property is transferred in the divorce.

    Who Pays Back Taxes After a Divorce?

    Even after a divorce, both spouses are responsible for the tax returns that they filed jointly while married. This means that the IRS can come after either spouse for any outstanding balance of tax debt, interest assessed on that balance, or penalties for noncompliance. They may do this even if your divorce agreement specifically accounted for payment of delinquent taxes or the penalties that might stem from them.

    Fortunately, there are three avenues for protecting yourself from your ex-spouse’s tax noncompliance issues. You can apply for Innocent Spouse Relief, Separation of Liability Relief, or Equitable Relief.

    Innocent Spouse Relief

    The IRS may provide Innocent Spouse Relief to a taxpayer whose previous joint return had an understatement of tax which was the fault of the other filing party. The government will only grant Innocent Spouse Relief if the petitioning party had no knowledge (and no reason that they should have had knowledge) of the misstatement and if it would be unfair to hold you liable for the consequences. You only have two years from the first time that the IRS attempted to collect on the unpaid taxes to apply for Innocent Spouse Relief.

    Separation of Liability Relief

    While you might not escape tax liability entirely like you would with Innocent Spouse Relief, you might be able to obtain a more equitable allocation of tax debt through Separation of Liability Relief. To qualify, you still must not have been aware of the issue that caused the underreporting when you filed the joint return. You must be divorced from the spouse with whom you jointly filed to get Separation of Liability Relief. The same two-year deadline for Innocent Spouse Relief applies for Separation of Liability Relief.

    Equitable Relief

    Equitable Relief is what is left if the taxpayer does not qualify for Innocent Spouse or Separation of Liability Relief. If the misstatement contained on a previous jointly filed tax return is generally attributable to the other spouse, you can obtain some reworking of the tax debt to achieve equity. Equitable Relief may also be available in situations where the tax return was filed accurately and timely but the tax debt was not paid.

    The IRS considers each case individually to determine whether Equitable Relief is appropriate. Below is a list of just some of the factors that the government may consider when evaluating a request for Equitable Relief.

    • Current marital status
    • Current financial hardship status
    • Cause of the liability
    • Mental or physical condition of the petitioning spouse when they signed the return
    • Mental or physical condition of the petitioning spouse at the time they filed for Equitable Relief
    • General level of compliance in taxable years subsequent to the filing in question
    • Petitioning spouse’s reasonable belief that the filing was accurate
    • Petitioning spouse’s reasonable belief that the tax debt had been paid
    • Any domestic abuse during the marriage

    The term for Equitable Relief requests runs for three years after the date the return is filed if you are seeking a tax refund. If you filed in a community property state, such as California, and did not jointly file as married, you may have to look to the state’s community property law for relief.

    1. Risk of Public Disclosure of Tax Fraud During Divorce Proceedings
      1. Gross Income Reported on Returns Presumptively Correct for Divorce Purposes but Rebuttable with Evidence to the Contrary.
        1. Gross income earned during the marriage central to alimony, distribution of marital assets and spousal support determinations made by family law court.
        2. Tax return can (and often will) be proven to be unreliable if evidence is available that indicates a party may have earned more income than reported on his or her tax return.
      2. Competing interests
        1. Disharmony of consequences between zealous divorce representation and a criminal tax defense.
          1. Need to limit the disclosure or potentially incriminating evidence of tax crimes.
          2. Need accurate income and martial assets disclosure for divorce purposes
        2. Get the Best Settlement Possible
          1. Threatening to Expose a Spouse for Tax Fraud as a Sword
            1. Ethical Violation (discussed later)
            2. Unintended Consequences
              1. To a jaded and angry divorcing informant spouse sending her soon to be ex tax cheating spouse to jail by sparking a criminal tax investigation can sound initially very attractive.
              2. Potential informant spouse needs to be counseled that if she is successful in sparking an investigation / tax crime prosecution, this will result in:
                1. Huge (potentially total) depletion of the marital assets
                2. Decreasing or complete cessation of the continuing income stream of the accused spouse during any investigation / incarceration and potentially long afterward if accompanied by loss of professional license.
                3. The informant spouse may not qualify for Innocent Spouse relief if he or she had knowledge of the transactions leading to the investigation and can face prosecution / civil liability of tax penalties (including restitution) and interest themselves.
              3. Defenses to Threats of Criminal Prosecution in Divorce
                1. Common tax crimes accusations in divorce scenarios involve claims of unreported income, false deduction of personal expenses, false statements to taxing authorities, and unreported foreign bank accounts and associated income.
                2. Common tax crimes charged in divorce include:
                  1. Tax evasion.
                  2. Submitting false documents.
                  3. Conspiracy (Between H and W or with Preparer)
                  4. Willful failure to collect or pay tax.
                  5. Filing False returns.
                  6. Money laundering.
    • Identify Exposure Early
      1. If risk of tax fraud has merit:
        1. Divorce should not proceed until criminal tax exposure is mitigated to mitigate against the following.
          1. One spouse turning government informant because of revenge seeking behavior.
          2. Deposed tax cheat spouse likely to attempt to cover up past indiscretions by making false statements under oath (Perjury) which may shed additional light on false statements made in prior fraudulent returns.
    • Mandatory public disclosure as a result of the divorce discovery process will result in loss of 5th Amendment protection for documents produced.
    1. IRS known to monitor public court documents looking for accusations / indications of tax fraud.
    2. Forensic accountants or other witnesses may become into possession of incriminating documents or information and be forced to testify on behalf of the taxing authorities.
    3. Damage to credibility of tax cheating spouse with the divorce court.
    • Actions by accusatory spouse may cause corrective actions of tax cheat spouse to be viewed as non-voluntary and thus kill the availability of a potential pass on criminal prosecution.
    • Evidence of tax crimes exists forever in the public divorce court records and no SOL on tax crimes.
    1. Judge or his or her staff or third party reports perceived tax fraud to taxing authority.

    (Whistleblower reward)

    1. A forensic accountant should not be hired until any criminal tax issues are resolved.
      1. The Forensic accountant has no ACP because the privilege under I.R.C. section 7525 does not apply to criminal tax matters.
      2. Forensic accountants do not have ACP where employed to provide expert testimony in a divorce.
    • Documents created by the forensic accountant will not constitute privileged attorney work-product because they are prepared in support of the expert’s trial testimony and are therefore discoverable.
    1. Documents provided by the client to the expert will lose Fifth Amendment Production Protection.
    1. Experienced Criminal Tax Defense Counsel should be hired to advise the client and supervise the conduct of a tax investigation utilizing Kovel Accountants to assess risk of tax crimes having been committed and to mitigate the client’s exposure.
      1. Kovel accountant hired specifically to assist counsel in rendering legal services to the client.
      2. Kovel accountant should not prepare tax returns because tax returns are public disclosures and therefore information going into the tax return is not attorney-client privileged.
    2. A single Criminal Tax Defense Lawyer should ordinarily not represent both spouses in mitigating any criminal tax issues.
      1. A joint defense agreement may preserve communication and work product privileges
      2. Conflicts-of-interest are inherent in the parties’ divorce case,
    • Divorcing spouses ordinarily have differing level of knowledge and perceived culpability concerning past tax crimes.
    1. Even if spouses hold out to be equally culpable, any available evidence may not be equally incriminating and either spouse can change their mind later.
    1. If risk of tax fraud lacks immediately apparent merit:
      1. Divorce can proceed.
      2. Forensic accountant should be instructed to report to divorce lawyer any evidence of tax improprieties and instructed not to discuss any such matters with anyone, including the client. If concrete evidence of tax crimes discovered, consult an experienced Criminal Tax Defense Attorney.
    2. Voluntary Disclosure
      1. Loud Disclosure
        1. A properly filed and legally sufficient Voluntary Disclosures made to the IRS can provide a taxpayer with a level of protection against criminal charges relating to his or her disclosed potentially criminal non-compliance.
        2. If terms of program met, taxpayer will not be recommended for criminal prosecution.
        3. In the interests of the efficient administration of the tax system, the IRS has long held that taxpayers who come forward voluntarily, make a full and complete disclosure, and agree to pay a penalty can avoid criminal penalties including prison.
        4. The IRS has held a policy passing on criminal prosecution where individuals voluntarily come forward, fully disclose their past acts or omissions of non-compliance, file accurate returns for the affected years still open to criminal statute (generally 5 years), and whom make full payment or enters into an approved payment plan.
        5. Provided that the disclosure is voluntary, complete, accurate, and legally sufficient the IRS has a policy of refraining from recommending these taxpayers for criminal prosecution.
        6. For a Voluntary Disclosure to be effective it must be timely. If the taxpayers are reasonably aware of an investigation or facts and circumstances suggesting that the government has already discovered the non-compliance that is the subject of the disclosure is not timely.
        7. Voluntary disclosures are timely when they are made:
        8. Prior to the start of an IRS examination or prior to IRS notification to the taxpayer of an impending audit or examination.

     

    1. Prior to a third-party whistle-blower supplying information regarding fraud or other noncompliance with the IRS.
    2. Prior to the IRS’ acquisition of information regarding noncompliance through other sources.
    3. A voluntary disclosure is a noisy disclosure because the IRS criminal investigation division is contacted at the outset of the process.
    1. Quiet Disclosure
    1. A quiet disclosure would merely involve filing 5 years of amended returns with the client’s normal service center.
    2. The advantage of this method is that the taxpayer may escape the costs and stress of submitting to an audit that ordinarily follows a loud voluntary disclosure.
    3. The disadvantage is that a quiet disclosure could be viewed as an admission of guilt without the expected pass on criminal prosecution that follows a loud disclosure.
    4. The critical decision to go loud or quiet should not be made without engaging experienced criminal tax defense counsel.
      1. Private Judge
        1. It may be advisable where past tax fraud may be an issue to utilize a private judge in the divorce in order to prevent the creation of on record incriminating evidence or testimony.
      2. Fifth Amendment Right not to Self-Incriminate
        1. In civil divorce proceeding the court may draw an adverse inference against a party asserting the 5th.
      3. Hidden Assets and Tax Fraud
        1. Full Disclosure of Martial Assets and Income Sources
          1. Grounds for Setting Aside Marital Settlement Agreement
            1. Settlement agreement is viewed by most courts as a type of contract and many commonly contain a clause similar to the following:
              1. Moreover, the failure of either party to disclose property shall constitute a material breach of this agreement, which shall give rise to whatever remedies at law or in equity may be available to the other party.
            2. Commons Schemes and Red Flags
              1. H and or W live a lifestyle in excess of their reported income and purchases items such as cars, planes, boats, etc., which are above the standard of living that is reasonably possible based on their history of reported income.
            3. Discovery Methods
              1. Using Tax Returns to Uncover Hidden Assets / Income Sources in Divorce
                1. List of Income Sources that are Often Overlooked;
                  1. Social Security or pension income
                  2. Unemployment compensation
                  3. Rental income
                  4. Accrued vacation pay
                  5. Tuition refund plans
                  6. Barter arrangements
                  7. Canceled indebtedness income
                  8. Capital loss or N.O.L. carryforwards
                  9. Spousal or child support from someone not a party to the present case
                  10. Veterans’ or military benefits
                  11. Employee stock option plans
                  12. Tax-free dividends
                  13. Trust distributions
                  14. Severance pay
                  15. Commissions and bonuses
                  16. Worker’s compensation
                  17. Disability income
                  18. Savings matching programs
                  19. Deferred compensation
                  20. Expense account reimbursement
                  21. Contributions to retirement or pension plans
                  22. Earned income credit and other tax credits
                  23. Lottery winnings
                  24. Prizes and awards
                  25. Cash basis or under the table income
                2. Analysis of Schedule D – Capital Gains and Losses
                  1. Sales of investments and other property sales are reported as capital gains or losses on Schedule D of the Form 1040. The Schedule D gain or loss and other supporting schedules lists details regarding capital transactions, such as the date an asset was purchased, original cost, date sold, proceeds received etc. In order to search for hidden assets, it’s important to match these sales transactions to their supporting documents. It is possible to detect an unreported brokerage account or distributions from a fund that was not disclosed as income to the other spouse in this manner. It is also important to determine the source of funds used to purchase the investments and to trace the deposit of the sale proceeds.
                3. Analysis of Business Income
                  1. If there is a business within the marital estate, examine the compensation of the ex-spouse. Owner may pay himself a much higher salary, in order to reduce the amount of the company earnings and artificially reduce the valuation of the company as a marital asset. Look for the business owner spouse to attempt to increase other expenses of the business before and during the divorce further decrease business earnings in an attempt to minimize a divorce settlement. This same motivation can create a desire to fraudulently omit income and deduct personal expenses leading to tax fraud.
                4. Interrogatories
                  1. Where divorce counsel suspects hidden assets or income, but cannot immediately prove it, interrogatories should be served on the other party addressing; cash on hand and on deposit, cash transactions, asset transfers with or without consideration (sales vs gifts).
                  2. Require that answers be filed under oath and thus force the wrongdoer spouse to commit perjury in order to hide assets or income.
                  3. Unless counsel insist on the filing of answers signed under oath, they could be undermining the strength of the client’s detrimental reliance argument if fraudulent transfers or hidden income are subsequently discovered.
                5. Financial Fraud and Divorce
                  1. Common warning signs exists to indicate where H or W may have committed financial fraud against their spouse during the marriage or during the divorce; the larger the number of red flags identified, the higher the likelihood fraud may have occurred. Many attempt at fraud during a divorce are motivated by a desire to minimize a property settlement or support obligation.
                  2. Examples of Property Settlement to Support Fraud
                    1. Hiding undeclared assets during a divorce
                    2. Fraudulent undervaluation of property or assets
                    3. Fraudulently understating income levels
                    4. Fraud on the income and expense reporting provided to the divorce court
                    5. Providing fraudulent tax information in order to understate income levels (which may or may not have actually have been filed)
    • In addition to common dissipation / misappropriation of family assets (discussed below), other types of fraud can be discovered during divorce where family finances are investigated.
      1. forgeries and questionable documents,
      2. tax fraud,
      3. loan fraud, and
      4. insurance fraud.
    1. Common Warning Signs
      1. The greater the number of red flags, the more likely that there is something amiss concerning the family’s finances.
      2. The longer a spouse has access to perpetrating a fraud, the easier it is to get away with it;
        1. the more time that passes,
        2. the more difficult it can be to access certain records or trace funds.
      3. Drastic change in the level of communication and confidentiality between H and W.
      4. Mail being rerouted from home to office or an undisclosed mail location discovered.
      5. Unexplained changes in behavior.
      6. New or flame up of old addictions.
      7. Increased time spent on home computer or laptop, including suspicious closing or shielding of the screen when the spouse walks in.
      8. Lying or deceptive behavior.
      9. Concealing details of transactions.
      10. Unusual cash withdrawals from bank accounts.
      11. Undisclosed loans to a friend or romantic partner that is to be “repaid” after the divorce
      12. Buying and then stashing, gold, collectible art, antiques, vehicles or other valuable items.
      13. Spending significant time in another city or country.
      14. Spouses income suddenly and drastically declines with the onset of marital difficulties
      15. Spouse acts defensively or elusively when questioned about financial matters
      16. Spouse intentionally provides incomplete responses to inquiries and discovery requests
      17. Has there been transparency and truthfulness about finances during the marriage and the divorce?
        1. Did both H and W take an active role in managing the family’s assets and tax filings?
        2. Or did solely H or W handle the finances during the marriage?
      18. Serious fraud only occurs in a very small number of cases
      19. Hidden or unaccounted for (missing) assets and misrepresentation of family income are two common areas of spousal financial fraud that, if left un-investigated, can lead to a disproportionate share of the marital assets going to the fraudulent spouse.
        1. Friends and relatives can be coaxed into assisting with the concealment of marital assets where the fraudulent spouse makes misrepresentations telling them that their soon to be ex is incurring massive amounts of debt or absconding with family bank accounts.
    • Necessary Elements for Fraud to Occur
      1. Perceived Opportunity – H or W believes they can commit the indiscretion without being caught.
      2. Pressure or Motive- usually of a social or financial nature.
        1. Often perpetrator believes they cannot share problems with anyone.
      3. Rationalization – so the perpetrator can maintain their self-image as basically an honest person that is caught in unfortunate circumstances.
    • Prosecution of Alaska Plastic Surgeon as an example:
    1. Around the time of the divorce, Brandner devised a scheme to hide more than five million dollars in assets using offshore accounts.
    2. Shortly after the divorce filing by his former wife, Brandner collected marital assets which he then secretly transported from Tacoma, Washington to Costa Rica by car.
    3. Once he arrived in Costa Rica, Brandner opened two bank accounts. In the bank accounts, he deposited approximately $350,000 cash.
    • He also placed 1000 ounces of gold in a bank safe deposit box.
    • Following his activities in Costa Rica, Brandner then traveled to Panama.
    • Once in Panama, Brandner opened another account using the name of a sham corporation.
    1. In 2008, Brandner made a deposit roughly $4.6 million into this account.
    • In subsequent court filings for the divorce and in tax filings with the IRS, Brandner did not disclose these accounts or assets.
    • Furthermore, Brandner failed to disclose the investment income earned on these accounts for tax purposes.
    • In 2011 after the divorce was final, Brandner attempted to repatriate the $4.6 million placed in the Panamanian accounts.
    • However, Brandner was stopped by agents from U.S. Department of Homeland Security Immigration and Customs Enforcement.
    1. Brandner made false statements to these agents regarding his control over the funds.
    • The funds were seized by customs agents.
    • In November 2015, Brandner was convicted by a federal jury of three counts of tax evasion and four counts of wire fraud.
    • Brandner was recently sentenced for his crimes.
    • Brandner will serve four years in federal prison.
    • In addition to the federal prison sentence, Brandner will serve two years of supervised release.
    • Brandner may face additional civil liability regarding potential restitution to his former wife.
    • In addition, as a licensed professional, Brandner may face professional repercussions.
    • Most professional ethics and review boards will revoke or suspend licensing credentials for individuals who have been convicted of a crime of moral turpitude.
    • Tax evasion and wire fraud are typically considered crimes of moral turpitude and, therefore, this additional collateral penalty may apply.
    • Common Methods Where Cash / Income is Fraudulently Concealed
      1. Customer account receivable payments diverted to a related entity
      2. Inventory sold to a related party at a non-arm’s length discount
      3. Cash sales not recorded to the books nor deposited to the bank
      4. Company pays owners personnel expenses
      5. Undisclosed business interests
    • Civil and Criminal Exposure for Divorce Related Fraud
      1. Penalties for spousal support fraud may for example include the client being sued for damages, criminal prosecution for fraud, income tax crimes and the setting aside of any fraudulently obtain marital agreements along with the cost of re-litigating the divorce, and payment of other sides attorney fees.
    • Defenses
      1. Argue that disclosure position alleged to be a purposeful misrepresentation was one of opinion rather than fact. See: Brown v. Brown, 863 S.W.2d 432
      2. If can be adequately supported, argue that the client did not know, or have reason to know, that a financial representation was false. See, Castro v. Castro, 31 Conn. App. 761, 627 A.2d 452
      3. Attempt to characterize any misrepresentation or omission as a mistake or oversight made without intent to deceive. See, In re Marriage of Broday, App. 3d, 628 N.E.2d 790
      4. As a general rule, fraud is more difficult to establish concerning a misstatement about an asset values than where assets are concealed.
    1. Asset Dissipation
      1. The judicial doctrine of dissipation (breach of fiduciary duty in CA) of marital assets is an attempt to balance a spouse’s right to freely transfer his or her own property against the need to protect the legal entitlement of the non-transferring spouse to marital property.
      2. In most states, a lifetime transfers made with either the intent to deprive the transferor’s spouse of his or her share of marital property, or where transfers are made in a manner that would not be equitable to permit them to stand, are prohibited or recoverable by state statute.
    • To make a ruling on whether or not dissipation has occurred the courts look at all the relevant factors including for example:
      1. Whether adequate arm’s length consideration is received in exchange for a transfer;
      2. The ratio of the transferred property’s value to the transferring spouse’s total wealth;
      3. The amount of time elapsing between the transfer of property and the divorce;
      4. The status of the marital relations between the spouses at the time of transfer; (i.e. Transfers during periods of marital strife)
      5. The source (SP, CP or Marital Property) of the property transferred; and
      6. Whether the transfer is in essence revocable or merely illusory (i.e., the transferring spouse in reality retains rights in or powers over the transferred property regardless of how the transaction is structured or documented).
      7. If a family relationship exists between the transferring spouse and party receiving the property.
    1. There are various legal codifications of what constitutes dissipation, however, they all involve minimizing the marital assets capable of division by a divorce court via hiding, depleting, or diverting them.
      1. Some examples include:
        1. Ruining or trashing personal items.
        2. Gifting, loaning of selling at far below fair market value, property to others.
        3. Funds spent on extramarital relationships.
        4. Excessive Gambling losses.
        5. Residence needlessly falling into foreclosure.
        6. Needless spending down of business and personal cash accounts.
        7. Destroying, losing or failing to properly maintain marital property.
      2. CPA’s as Forensic Accountants
        1. During divorce forensic accountants can be engaged to:
          1. follow the paper-trail of funds that may have absconded from marital accounts in support of a potential claim for dissipation of marital assets,
          2. determine the actual income of the family and if tax fraud has been occurring, (better left to Kovel Accountant)
          3. search for hidden assets
            1. W2 employees have earned deferred compensation plans, stock options, bonuses, expense accounts, or other fringe benefits that they occasionally fail to declare.
            2. Business owners may have both motive and ample opportunity to hide both income and assets from their spouse’s eyes
              1. Forensic accountant should ordinarily be hired to comb through the business’s records, determine the authenticity of the company books, and vet the  positions taken of the company tax returns.
            3. The higher the family net worth the more numerous or intentionally complicated the hiding places;
              1. I.E. Shell corporations, trusts, life insurance vehicles, hidden safety deposit boxes, and hidden offshore or domestic brokerage or bank accounts.
            4. verify and quantify any “co-mingling” of marital and separate assets,
          4. Prenuptial Agreements
            1. State law mandated property division as a result of dissolution of the marriage, place decisions regarding the division of marital property into the hands of third parties which conflict with the design and intention of an existing estate plan.
            2. Prenuptial agreements enable couples and their estate planners to plan out in advance property distributions and division in the event the marriage results in a divorce, which facilitates precision and certainty in designing an estate plan.
    • This is accomplished in California by opting out of state community property laws and contractually characterizing the property that exist at the inception of the marriage or that will be acquired during the marriage as separate or joint and defining the rights between the spouses in such property.
    1. Provisions need to be drafted to;
      1. characterize property obtained by gift or inheritance,
      2. received in exchange for other property,
      3. determine the character of any income generated from each category of assets,
      4. characterize changes in the value of property,
      5. and, determine in advance the effects of any income earned by each spouse traceable to their efforts or employment.
    2. Each state regulates prenuptial agreements and provides the law that is analyzed to construe or enforce the agreement ordinarily under contract principals.
      1. Jurisdictions that recognize prenuptial agreements will generally enforce them only where they are procedurally and substantively fair.
      2. Procedural fairness is concerned with the facts and circumstances at the time the agreement was entered into such as;
        1. full and fair financial disclosure by each of the parties prior to execution,
        2. Capacity of the parties.
        3. Free will of the parties.
          1. Absence of duress, fraud, or undue influence.
        4. Legality of the contract terms.
      3. Substantive fairness addresses the actual property distribution contract clauses to ensure that they are not legally “unconscionable,” as defined under state law.
      4. Most states will not allow a waiver of;
        1. child support or predetermined child custody jurisdiction.
      5. Tax and other Considerations when Dividing Property in Divorce and Inherent in Support Obligations
        1. Overall Goal
          1. For high net worth couples, the division and distribution of marital property is often the most crucial aspect affecting the execution of a divorce or separation agreement.
          2. Unless a martial property division meets either the requirements of IRC Sec. 1041 or Sec. 2516, income taxes or gift taxes can apply respectively.
    • Tax practitioners need to be sufficiently knowledgeable and competent in order to clearly explain to a divorcing client the specific tax ramifications they will face in order to avoid any post-divorce malpractice exposure causing tax surprises.
    1. Mistakes in rending professional advice on property divisions, support obligations or tax or financial fraud inherent in a particular divorce scenario can produce unintended consequences to the client that the tax practitioner will most likely be unable to reverse or mitigate.
    1. Marital Property
      1. Full Disclosure Required in a Divorce
        1. All CP and common law states require the disclosure of all material information that is necessary to facilitate either, the parties to negotiate and mutually agree upon, or the courts to adjudicate, an informed division of marital property.
        2. California Fam. Code §721 mandates that California married couples are subject to the fiduciary rules imposed on persons in a confidential relationship.
        3. California Fam. Code §1100(e) requires spouses to make a full disclosure of all material facts and information regarding the existence, characterization, and valuation of all assets in which the community has or may have an interest.
        4. To ensure compliance with full-disclosure requirements, advisers should counsel that the parties to inventory all property, including intangible assets such as advanced degrees, patents and goodwill, that can result in the generation of substantial income over future post-divorce years.
          1. Courts are demonstrating an increased willingness either to classify the intangibles assets as property subject to valuation and distribution or to require spouses that solely benefit related to an intangible asset to reimburse the non-benefiting spouse with a like allocation of CP assets.
        5. Property acquired spouses during marriage generally qualifies as marital property. Except for retirement assets covered under ERISA, state laws ultimately dictate the legal division of marital assets in a divorce.
    • State laws differ on which spouses gets what in a divorce. Most of the variation among the states concerns whether the divorce takes place in an;
      1. equitable distribution (common law) state or
      2. in a community property state.
        1. Nine states are currently community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
        2. Community property is a state statute mandated concurrent form of ownership between H and W
        3. Earnings of the H and W are considered CP and thus are equally divided between the spouses during marriage.
        4. Assets bought by one spouse during marriage with CP funds earned during marriage are CP.
        5. Separate property (SP) of each spouse brought into a CP state remains SP, as long as SP is properly segregated (not commingled) and thus separately identifiable.
          1. Income from SP is SP income.
          2. CP state (See California Fam. Code §125), may treat property acquired during marriage in a common law state as CP for CA marital property division purposes if it would have been CP had it been acquired in a CP state.
    • SP in a CP state may include property owned before marriage and property acquired during the marriage with solely the proceeds from the sale of SP.
    1. Each spouse may inherit or receive by gift property that will be classified as SP at divorce if not commingled and thus separately identifiable.
    2. Watch for SP assets improved with CP funds or labor which may result in an allocation of CP value to the marital balance sheet
      1. Business owned before marriage
        1. Labor of a spouse that improves value of business during marriage is a CP asset.
      2. If a business predates the marriage, it will likely be entitled to a SP allocation and CP allocation.
        1. The SP and CP allocations depends on several factors.
        2. Example of Factors Considered:
          1. How long before the marriage was the business started?
          2. What was the FMV and profitability of the business before marriage?
    • What was the business’ average cash flow before and after marriage?
    1. How much of the value change during the marriage resulted from the CP efforts of SP owner spouse?
    2. How much SP money was invested into it during the marriage?
    3. How much CP money was invested during the marriage?
    • What were market conditions at marriage and at time of divorce?
    1. The remaining 41 states are common law states.
      1. Community property (CP) law may never the less be relevant to common law states where property is acquired in a CP states and subsequently brought into non CP State because may remain CP for common law state and tax purposes.
    2. Equitable Division States
      1. In equitable distribution states, the courts decide what is a fair, reasonable, and equitable division of assets.
      2. The courts focus on factors such as;
        1. How long the marriage lasted?
        2. Title of assets or the source of the money used to acquire it is not controlling.
        3. Burden of identifying and proving the existence of assets on parties to the divorce.
        4. Retraining needed to make a spouse employable
        5. Tax consequences of any propose asset distribution or debt allocation
        6. The effect of any pre or post nuptial agreement
          1. Assets acquired during the marriage that are deemed not covered by a valid pre or post nuptial agreement are subject to equitable division.
        7. H or W may prove to the court that the other spouse fraudulently transferred assets with divorce on the horizon and have an equal amount of remaining marital assets awarded to him or her
        8. Both H and W responsible for debts incurred during the marriage.
        9. What property each spouse brought into the marriage
        10. The earnings power of each spouse during the marriage
        11. Responsibilities of each spouse for raising children
    • In summary, equitable distribution is described as a fair, but not necessarily equal, court mandated distribution of marital property.
    1. 1041
      1. Generally, under Sec. 1041(a), a property transfer to a former spouse deemed to be incident to divorce will not result in the recognition of taxable gain or loss or transfer (gift) taxes. A transfer is incident to a divorce if;
        1. the transfer occurs within one year after the date on which the marriage ceases;
        2. or is directly related to the cessation of marriage, which requires that the transfer:
          1. is made pursuant to a divorce or separation instrument, and
          2. occurs not more than six years after the date on which the marriage ceases.
        3. Transfer Taxes
          1. A transfer of marital property under a property settlement agreement that is incorporated into a divorce decree is not subject to gift / transfer tax.
          2. In Harris, 340 U.S. 106 (1950), the U.S. Supreme Court held a transfer made pursuant to a court decree, is not a promise or agreement between the spouses resulting in a “gift” under gift tax law.
    • If a transfer is not made under a property settlement agreement incorporated into a divorce decree (such that is qualifies for IRC Sec 1041), it may be exempted from gift tax under IRC Sec. 2516.
    1. Sec. 2516 provides that marital property settlements are deemed as made for full and adequate consideration if;
      1. the transfers are made pursuant to a written agreement and
      2. the divorce occurs within a three-year period beginning one year before the spouses enter into the agreement.
    2. Under Sec. 2516, the transfer does not have to occur during the three-year period, all that is required is that the transfer may be made any time later, as long as it is pursuant to an agreement entered into during the three-year period.
    1. Fraudulent and Other Property Transfers that can be Set Aside by a Divorce Court or Taxing Authority
      1. Transfers During Periods of Martial Difficulty
        1. A transfer of property solely by one spouse during a period of marital difficulty, whether or not divorce is on the horizon, might be held to have not been made unconditionally by the non-donor spouse and result in a reimbursement requirement to the non-donor spouse being imposed on the donor spouse.
        2. In the majority of states, the non-donor spouse may have legally set aside a gratuitous transfer of property made during a period of marital strife as a deemed fraudulent transfer.
      2. Transferee Liability
        1. Example Case Margie Reed Harper, TC Memo 1993-126
          1. H was audited in March and April of 1981 over suspected unreported income related to illegal drug trafficking. H and W fast tracked a divorce in July of 1981. H was not present but filed an answer and a waiver and a division of property was not requested as the parties had not reached a settlement agreement at that point. The presiding family law judge was not informed that a property settlement was pending.  The Judge warned W that she could not seek any type of support from H and dissolved the marriage.
          2. In August of 1981, H transferred his ownership of real property to W’s daughter and the conveyance read: Conveyance pursuant to property settlement agreement and dissolution of marriage. In September of 1981 H transferred to W various assets that he owned without consideration. Immediately following these transfers H was insolvent
          3. In 1985, H was indicted for tax fraud and incarcerated for 18 months.
          4. In 1990, the IRS made a jeopardy assessment against W as transferee of assets from H via a Statutory Notice of Deficiency to which W filed a tax court petition.
          5. Citing Phillips v. Commissioner, 283 U.S. 589, 592, 593 n. 3 (1931) the court held that pursuant to section 6901(a)(1)(A), the IRS may collect from a transferee of assets (W) the unpaid income tax liability of the transferor (H).
          6. Case law has defined a transferee as an individual who takes or receives property of another “without full, fair and adequate consideration to the prejudice of creditors” United States v. Floersch, 276 F.2d 714, 717 (10th Cir. 1960).
          7. Where the IRS meets its burden of proof, the transferee (W) is liable for the transferor’s (H’s) taxes owed up and until the transfer, as well as any additions to tax, penalties and interest, limited to the value of the assets transferred.
          8. IRS must rely on state law to make a determination as to the transferee’s liability for the transferor’s obligation.
          9. Under Florida case law, gifts and transfers made for the purpose or intent to delay, hinder, or defraud creditors is void, Schad v. Commissioner, 87 T.C. 609, 614 (1986).
          10. Florida fraudulent conveyances case law list the following badges of fraud:
            1. The existence or threat of litigation
            2. A familial relationship between the transferor and transferee
            3. Grossly inadequate, or complete lack of consideration
            4. Secrecy and concealment of the transfer
            5. Retention of rights of possession of the property by the transferor
            6. The insolvency or indebtedness of the transferor at the time of the transfer
            7. The transfer of all or substantially all of the debtor’s estate
          11. The court pointed to the following badges of fraud in holding for the IRS.
            1. H was substantially indebted to the Government and was insolvent at the time of transfer to W
            2. The transfer from H to W lacked consideration and was to a family member
            3. H was aware that the IRS was auditing him with regard to substantial unpaid Federal tax liabilities
          12. Alter Ego or Nominee of the Transferor
            1. Another scheme (potentially criminal) to attempt to avoid / evade tax collection is where H and or W transfer property to a third party (ordinarily a friend or family) in a non-arm’s-length transaction (often at far less than fair market value with the non-documented understanding that the transaction is in name only and the asset is to be returned at a later date), where a large tax liability is owed or likely to soon be assessed.
            2. The IRS where faced with this scenario can claim that the third party is merely an alter ego or nominee of the transferor and issue a lien and begin to levy against the third party.
    • The relevant factors in making an alter ego or nominee determination include;
      1. Whether the acquiring taxpayer used personal funds to acquire the property.
      2. The adequacy and source of consideration.
      3. The likelihood the property was placed in the nominee’s name in anticipation of a collection action.
      4. Whether the acquiring party or rather the transferring party constructively enjoyed the benefits of possession and control over the property.
      5. The relationship between the taxpayer and the acquiring party.
      6. The formalities, or lack thereof, over the transfer of ownership.
      7. Who is paying the maintenance expenses, using the property as collateral, paying state and local taxes on the property.
    1. Allocation of Estimated Tax Payments / Applied Overpayments in Divorce
      1. Where a divorcing couple has historically filed joint returns but intends to file married filing separate returns for the first time due to a pending divorce, any estimated tax payments made for the year are ordinarily credited by the taxing authorities to the first person listed on the previous year’s joint tax return. This person is viewed as the “taxpayer,” and is ordinarily the husband. Issues can arise when the wife is listed second and earns a majority of the couple’s income.
      2. Even if the parties agree in advance to some alternate allocation (other than 100% to the “taxpayer” spouse) there ordinarily is no reliable way to inform the taxing authorities of any agreed upon allocation of the estimated tax payments between the spouses other than 100% to the “taxpayer” spouse.
    • This situation is further exacerbated where “taxpayer” spouse file his or her tax return early in the tax season and gets a refund credited for 100% of the estimated taxes before the non “taxpayer” spouse files his or her tax return.
    1. While IRS publication 505, which concerns Withholding and Estimated Tax, indicates that couples can divide estimated tax payments, including applied refunds of prior year overpayments, in any way in which they so agree, the IRS will often ignore these calculations and simply allocate the entire overpayment to the “taxpayer” spouse without allocating any of the overpayment to the non “taxpayer” spouse.
    2. In seeming start contradiction to the IRS’s actions, IRC Sec. 6402(a) dictates that overpayments should be credited against the tax liability of the taxpayer that gave rise to the overpayment. If both spouses contributed to the overpayment on a prior jointly filed return, the overpayment theoretically needs to be apportioned to each spouse’s current tax liability in proportion to each’s contribution to the prior year’s overpayment.
    3. A potential solution to IRS ignoring agreed upon allocations problem could be to treat the current year estimated taxes including any prior year overpayment as a marital asset specifically allocated to the “taxpayer” spouse with the non “taxpayer” spouse receiving a like amount of some other form of martial asset in the property settlement. This approach could prove more manageable than providing an allocation of estimates and overpayments between the spouses to the IRS, which they often seem to overlook.
    1. Retirement Accounts
      1. The law provides for a lot of options to divide retirement accounts between divorcing spouses. However, many retirement accounts have fairly complex rules regarding division and some are unable to be divided at all.
      2. This creates a compliance minefield for clients and advisors alike.
    • CPAs and Attorneys that master the key legal concepts and tax issues surrounding the dividing retirement assets in divorce have a valuable service to offer.  (Many Divorce Attorneys Outsource this Work)
    1. When a retirement benefit to be split is made up of both premarital and post marital earned benefits, a “coverture fraction” is used to determine the portion of retirement benefits earned during the marriage.
      1. The numerator of the “coverture fraction” is the total period the participant spouse was in the plan during the marriage.
      2. The denominator of the ‘coverture fraction” is the total time the participant was in the plan from their year of enrollment up until the cessation of marriage (ordinarily the date of legal separation).
    2. Where a defined contribution plan is to be divided, the “coverture fraction” is converted to a percentage and then multiplied by the account balance to determine the value of the account that is attributable to the marriage that is to be divided.
    3. Where a defined benefit plan is to be divided, the “coverture” percentage is multiplied by the projected monthly pension benefit earned form plan enrolment to date of separation to determine the portion of the projected monthly benefit earned during the marriage. The present value of the of the projected monthly pension benefit earned during the marriage can also be calculated in a similar manner.
    • Qualified Domestic Relations Orders
      1. Where a retirement benefit is legally capable of being divided and an offset out of other marital property is not desired or not possible to the spouse not entitled to a pension benefit, a qualified domestic relations order (QDRO) can be drafted by a legal professional with experience in this field (often assisted by a CPA).
      2. QDROs are court orders directing a retirement plan administrator to pay benefits to an alternate payee (non-benefit earning souse).
      3. QDROs are commonly used for most qualified plans such as 401(k) or 403(b) pension plans.
      4. Plans divided via a QDROs are ordinarily free of immediate tax consequences via code section 1041.
      5. Benefits are taxable to recipient as ordinary income.
      6. QDRO prohibited from requiring the plan to do anything for the non-benefit earning spouse that it does not already provide its existing plan participants.
        1. E. QDRO will not be honored where drafted to pay out a lump sum if it the plan does not offer a lump-sum payout option to its other plan participants.
      7. QDRO is executed by the divorce court and then supplied to the plan administrator.
        1. The plan administrator ultimately determines whether the QDRO meets the plan’s requirements so it’s a great idea where possible to have plan administrators preapprove a draft QDRO before it is ultimately served on the court for execution.
      8. Support Obligations
        1. Alimony, Separate Maintenance and Child Support
          1. At divorce the higher earning spouse will often be required to make various types of spousal and family support payments to the lower-earning spouse.
          2. Qualified alimony and court ordered separate maintenance payments are deductible by the payer and are taxable income to the payee under IRC Secs. 71(a) and 215(a).
          3. Child support and/or property distribution payments are nondeductible to the payor spouse and are not taxable income to the recipient spouse.
          4. Generally, taxpayers are left free to choose the tax effect of alimony.
            1. It can be drafted to either be deductible to the payer and taxable to the recipient or receive the same tax treatment as child support
            2. No such flexibility exists for child support payments or property settlements.
          5. Palimony
            1. Payments made to former live-in companion, commonly called palimony, do not qualify as alimony because the payments are not between spouses.
              1. Palimony payment are generally considered gifts that may be subject to gift tax unless the payments are specifically designated as for services where they will be taxable income to the recipient.
            2. Understanding and Minimize the Risk of Criminal Prosecution for Tax Crimes in Divorce
              1. Joint Liability for Tax Fraud, Tax, Penalties and Interest
            3. Consider the following hypo: H typically prepares H and W’s married filing joint returns on turbo tax with very little involvement from W. W typically just signs where H says so. H decides that he wants to take steps to “further” reduce H and W’s tax burden.  Since H is a W2 employee and has run out of ideas for additional unreimbursed employee expenses and Schedule A – Itemized deductions, husband invents a hypothetical “paper only” business where no real business assets exist as a method whereby he can write off more of his “personal expenses” as business expenses.
              1. In anticipation of paying less taxes in late December of year 1, H takes his friends golfing for the week and purchases a new 911 Porsche (curb weight 3,153 lbs.). H titles the Porsche under his “consulting business” and in preparing year 1 taxes in year 2 writes of the golfing as 100% deductible “business promotion” and claims section 179 expense on the Porsche, claiming 100% business use on vehicle weighing over 6,000 pounds in the amount of $89,400 on H and W’s Joint Tax Return.
                1. In year 4, when H and W are audited over a very suspicious Schedule C loss that seems to magically offset H and W’s ample W2 income, the IRS auditor quickly realizes that there is no “consulting” business and that the deductions were personal in nature. IRS auditor stops the audit and refers the issue to the Criminal Investigation Division.
                  1. Is W exposed for possible criminal prosecution as well?
                  2. Short answer yes… She signed the tax returns under penalties or perjury.
                    1. See Jurat next to both H and W’s signatures.
                    2. Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete.
    • Subsequent divorce will not protect W, since filed joint returns during year at issue.
    1. If W is smart, at the first sign of criminal exposure, she will independently contact an experienced criminal tax defense attorney that will ordinarily counsel her to consider filing an innocent spouse claim and possibly an injured spouse claim as well.
    2. Family law attorneys need to very carefully evaluate the ramifications of “on-the-record” incriminating financial disclosures in a marital dissolution, and should use an abundance of caution (including the possibility of seeking a consultation from qualified criminal tax defense counsel) before concluding that “innocent spouse” protections will truly protect their client from the criminal and civil consequence of past-unreported income on married filing joint returns or on any entity or other tax filing where fraud occurred that their client signed or was merely involved with for that matter.
    1. On the Record Admissions / Evidence of Tax Crimes in Divorce
    1. S. v. Hoover, 83 Aftr 2d 99-2214 (175 F.3d 564) as an example
      1. Hoover and his W began highly contested divorce proceedings in 1989.
      2. As a result of the divorce, W was granted certain assets of the couple’s farm.
        1. In the process of W securing these assets, Hoover’s tax and dairy records were subpoenaed
        2. and resulted in a federal criminal tax investigation.
    • Dairy farmer’s conviction for filing false returns and statements was affirmed
    1. Taxpayer confirmed by appeals court to have acted willfully where he admitted during divorce proceedings that he
      1. substantially underreported business income,
      2. didn’t file returns
      3. asked his H and R Block return preparer not to show draft returns that they had prepared to IRS, and
      4. falsely stated on college financial aid application that he had no income where he had earned over $100,000 of unreported income that year and had only $13 in assets.
      5. Hoover also was found to have hid money from the IRS and W by;
        1. putting property and bank accounts in the names of other people, including his sons via joint accounts.
        2. Instructing creditors to write checks made out to his sons, but in reality he kept all the funds for himself.
      6. He admitted during a deposition in his divorce that his tax returns were not truthful and that he had earned substantial unreported income from his dairy business.
      7. Hoover’s argument at appeals that his true motivation was to hide his income and assets from his ex-wife and not to commit willful evasion was not persuasive given the tax savings windfalls to himself he had enjoyed at the expense of the government.
    2. Spousal Privilege and Divorce
      1. Under Pereira v. United States, 347 U.S. 1, 7 (1954), the spousal privilege continues only for the duration of the marriage; divorce removes the bar against one spouse testifying against another.
      2. Rationale for the continuing survival of the privilege is the concept that the trust and confidence between spouses should not be betrayed, and that the policy of fostering family stability benefits both the family unit and thus the public.
    • U.S. v. Fisher, 36 Aftr 2d 75-5269 (518 F.2d 836), (CA2), 06/30/1975
      1. Fisher attempting to appeal his conviction on §7201 tax evasion for the years 1967 through 1970 tax years argued wife’s testimony against him should have been disqualified.
      2. On appeal, former wife’s testimony was held to be admissible in a criminal tax evasion trial against former husband.
        1. No spousal privilege existed since H and W were divorcing at the time of the testimony and thus the marriage was all but over.
        2. Under Peek v. United States, 321 F.2d 934, H waived spousal privilege by his counsel’s failure to object when his wife was first called to the stand.
      3. IRS Whistleblower Program
        1. The IRS offers qualified tax fraud whistleblowers between 15% to 30% of the recovery from a tax cheat resulting from a tip. These awards increase the likelihood of courtroom personnel reporting testimony / evidence regarding tax fraud to the IRS in the hope of receiving a Whistleblower’s Award pursuant to I.R.C. § 7623.
      4. Innocent Spouse Treatment
        1. By requesting innocent spouse relief on Married Filing Joint (MFJ) return(s), H or W can possibly be relieved of joint and several civil liability for tax, penalties and interest, and potential criminal liability, if their spouse (or former spouse) acted alone in improperly or fraudulently claiming deductions or omitted income (committing fraud) on a MFJ return.
          1. Ordinary income purposely reported as capital gain, purposely overstated (net operating loss / capital loss) carrybacks and carryovers, purposely claiming credits the taxpayer is not entitled to are additional examples of tax fraud.
          2. The electing spouse did not knowingly participate in the filing of a fraudulent joint return.
        2. Generally, where H or W qualifies for innocent spouse relief the service will proceed civilly (and potentially criminally) solely against the guilty spouse (or former spouse).
    • However, H and W remain joint and severally liable (and potentially criminally) for any tax, penalties and interest, that does not qualify for innocent spouse relief.
    1. To qualify, the taxpayer must be able to show that they were not aware of the understatement on the return at issue and that there were no circumstances at the time that should have made the taxpayer suspicious.
    2. The taxpayer must establish that existing circumstances make it inequitable to hold them responsible for the tax debt.
    3. Innocent spouse relief is still available where H and W still married and living together.
    • Separation of Liability
      1. This alternate provision enables a H or W that has filed a joint return, who are subsequently divorced, separated or widowed or that have lived apart for at least one year, to limit (through a separate allocation) their liability for deficiencies on the joint return(s) at issue.
      2. Under this provision a spouse can attempt to elect to limit the total tax debt flowing from a joint return to that spouse’s allocable portion of the deficiency as if H and W had filed separate returns.
      3. No relief will be provided related to an ex spouse’s tax liability to the extent that the taxpayer seeking relief actually knew about the unreported / underreported income items when they signed the joint return, unless they can show that they signed the joint return under duress in which case the return is deemed not to be a joint return.
      4. Any available relief to electing spouse is decreases by the fair market value of any assets that the non-innocent spouse transferred to the taxpayer deemed to be for the purpose of avoiding paying the tax at issue.
        1. Disqualifying property transfers can occur several years after the year of the understatement such as receipt of life insurance proceeds on the non-electing spouse.
        2. Disqualifying property also includes assets transferred between H and W as a part of a fraudulent scheme.
    • Equitable Relief
      1. This third provision enables a joint return filer to avoid liability for unpaid tax, penalties and interest stemming from joint returns that were filed, but not paid, or alternatively for tax debt that does not qualify under the provisions above where it would not be equitable to hold a taxpayer accountable for the tax debt.
      2. Equitable relief is even available when there is no additional deficiency because the joint return filed was accurate, however the tax due was not paid through no fault of the electing spouse.
        1. To qualify for the electing taxpayer must demonstrate that at the time the return was filed, they had no knowledge and had no reason to know that the tax would not be paid, and demonstrate it was not unreasonable for the electing spouse to have believed that the tax was paid by the non-electing spouse.
      3. It is also available when there is a deficiency (original return was not accurate / even fraudulent), but the electing spouse doesn’t qualify for the above two options.
      4. Economic Hardship
        1. One method to argue that it would be inequitable to hold the electing spouse liable would be to demonstrate that they would suffer economic hardship if relief is not granted.
        2. Economic hardship exists where the electing spouse, in having to pay the tax liability, or some portion of it, would result in their inability to provide for their basic reasonable living expenses based on their individual circumstances.
        3. An electing spouse’s income of less than 250 percent of the federal poverty guidelines supports the hardship argument unless the electing spouse has sufficient assets from which they could service the back tax debt and meet their ongoing reasonable living expenses.
        4. Detrimental Facts to Hardship Analysis
          1. Whether the electing spouse shares expenses or has expenses paid by another individual is also relevant to the hardship analysis.
          2. Whether requesting spouse enjoyed the benefits of a lavish lifestyle i.e. owns luxury assets and takes expensive vacations.
        5. Claiming Innocent Spouse Treatment, Separation of Liability, Equitable Relief
          1. In order to obtain relief a timely election must be submitted on IRS Form 8857. A statement should be attached detailing why the electing spouse should qualify for relief. In general, the spouse seeking relief must generally file the 8857 within two years after the IRS begins collection action against the electing spouse. An exception is available for a qualifying spouse electing equitable relief of an unpaid liability up until expiration of the 10-year period of limitations on collections.
          2. An election can be filed before a collection action has started, but not before the service is auditing a return or where there may be an outstanding tax liability.
          3. A collection action includes a § 6330 opportunity for hearing before levy notice, an offset of a liability against an overpayment, a collection suit, or the filing of a claim in a bankruptcy or foreclosure proceeding to which the electing spouse is a party or that involves property of the electing spouse.
          4. The issuance of a notice of deficiency, tax lien or demand for payment, does not, in itself, constitute a collection activity.
          5. A valid election cannot be grounds for a refund.
        6. Reason to Know
          1. An electing spouse will be deemed to have reason to know of an understatement if a reasonable person in similar circumstances would have known of the understatement.
          2. The is a facts and circumstances analysis and the factors analyzed are as follows:
            1. The nature of the erroneous item and the amount of the erroneous item relative to other return positions.
            2. H and W’s historical financial situation.
            3. The electing spouse’s educational background and business experience.
            4. The extent of the electing spouse’s participation in the activity that resulted in the erroneous item.
            5. Whether the electing spouse inquired, at or before signing the return, regarding income or deductions or credits include on or omitted from the return that a reasonable taxpayer would inquire about.
            6. Whether an erroneous or fraudulent position on a return was a comported with, or deviated from a recurring pattern of return positons on prior years’ returns.
            7. The presence of a pattern of personal spending that appears lavish or unusual when compared to the couples historical spending patterns.
            8. Culpable spouse’s evasiveness and or deceit over H and W’s finances.
            9. A large variance between H and W’s reported income and their actual lifestyle.
            10. The poor mental or physical health of the electing spouse is also relevant and the IRS will consider “the nature, extent, and duration of the condition, including the ongoing economic impact of the illness.
            11. Where a divorce decree assigns the sole liability for H and W’s tax debt to the non-electing spouse, this weighs in favor of relief especially where electing spouse has complied with the law themselves for a significant period of time subsequent to the divorce unless the electing spouse knew or had reason to know, the non-electing spouse would not pay the income tax liability.
          3. Grounds to be Excused from Reason to Know (Actual Knowledge)
            1. Electing spouse was the victim of domestic abuse and as a result of the prior abuse did not challenge the treatment of any item on the return out of fear of retaliation by non-electing spouse.
            2. Non electing spouse maintained control over the household finances by restricting the electing spouse’s access to financial information and not able to challenge return out of fear of retaliation because of history of domestic abuse.
            3. Domestic abuse includes physical, psychological, sexual, or emotional abuse, and includes actions aimed to control, isolate, humiliate and intimidate the electing spouse, as well as efforts to undermine the electing spouse’s ability to reason independently.  History of drug or alcohol abuse of non-electing spouse also relevant. Abuse of the electing spouse’s child or other family members living in the same household may under the law equate to abuse of the electing spouse.
            4. Duress (discussed elsewhere)
          4. Remaining Joint and Several Liability to Non-Electing Spouse
            1. A non-electing spouse remains jointly and severally liable for the entire tax, even if the other spouse successfully made an election on an 8857.
          5. Notice to Non Electing spouse
            1. Upon receiving the 8857 the IRS is required to place the non-electing spouse on notice and inform them of their right to supply any information relevant to the services determination.
            2. The IRS will share with the non-electing spouse any information provided by the electing spouse unless this would impair tax administration.
            3. The IRS will also inform non-electing spouse of any preliminary and final determinations on the request.
            4. The Tax court will allow the non-electing spouse access to any legal proceeds as a party to the determination and accept the filing of a notice of intervention challenging the entitlement to relief from joint liability.
          6. Tax Court Review of IRS denial of election
            1. Electing spouse that is denied may obtain Tax Court review of the IRS’s final determination on a § 6015 relief from joint and several liability election including an equitable relief request.
            2. A tax court petition requesting the court’s review must ordinarily be filed within 90 days after receipt of notice of the IRS’s final determination of the allowable liability relief. A petition is also timely if mailed within a reasonable time after the service has not responded for six months to the 6015 relief election or request.
    • Bar on Collection Activity and Tolling of Statutes of limitations.
      1. Once a 6015 relief election is filed, the IRS may not, unless in its judgement determines that collection will be jeopardized by delay, levy or bring a collection proceeding to collect tax that is directly related to the pending election until the 90-day period expires after denying the election or equitable relief request and, if tax court petition is timely filed contesting the denial, until the tax court renders a decision.
      2. The running of the 10-year collection statute is tolled during the period the IRS is procedurally barred from collection and for an additional 60 days afterward.
      3. The IRS is not barred from collection efforts and thus there is no tolling of the 10-year statute of limitations where a spouse is solely requesting equitable relief and such relief is denied.
    • Injured Spouse Treatment
      1. Requests a taxpayer’s share of a joint tax refund.
    1. Risk to Client and Associated Professionals (Judge, Attorneys and CPAs) in subsequent IRS Criminal Investigation Sparked by a Divorce Proceeding
      1. Risk to Client
        1. If persuasive evidence of tax fraud comes to the attention of a judge presiding over a divorce (or his staff), the judge or member of his staff may report the fraud to the IRS or state taxing authorities.
        2. IRS agents are trained to scrutinize public divorce court documents for evidence of under-reported income or tax fraud.
    • If, the client (innocent – or even more interesting – not so innocent spouse) decides to demand a property settlement or support based on actual, but previously unreported income, both the client and divorce counsel need to clearly understand the risks of a criminal tax investigation ensuing at a later date.
    1. Some divorcing spouses directly tip the IRS about their spouse’s tax fraud out of a desire for revenge or pure vindictiveness.
      1. They may even be eligible for a reward as participants in the IRS Whistleblower program.
    2. If a client’s intentional failure (fraud) in disclosing financial resources to the court is discovered, it is extremely difficult, if not impossible, for that client to recover the almost assured loss of credibility in the eyes of the court and there is the exposure to potential Perjury charges.
    3. If false, misleading, or incomplete financial evidence is submitted, followed by the court making a consequently faulty judgment or the parties negotiating a faulty settlement agreement, then the final divorce is always subject to being reopened at some point in the future and retried at great additional expense and at potentially great disadvantage to the non-disclosing spouse.
    • Also consider the chances of a potential subsequent criminal tax investigation being opened if evidence of fraud becomes part of the public record.
    • Risk of Criminal Tax Audit
    1. Commonly Charged Tax Crimes in Divorce
      1. Tax evasion.
        1. (Federal) A defendant can be convicted of attempting to evade tax if, a tax deficiency can be proven to exist between the return at issue and the correct amount of tax as proven by the government, the government can prove that the defendant took affirmative actions in an attempt to evade or defeat the correct amount of tax and the defendant acted willfully.
      2. Willful failure to collect or pay tax.
        1. (Federal) A defendant who is required to file a return and who willfully fails to file the return by the due date (or extended due date) can be convicted of failure to file a return.
        2. California Tax Code § 19706 makes explicit that a felony occurs if any person willfully fails to file any return with intent to evade any tax imposed by the state income tax laws.
      3. Filing False Returns or False Documents
        1. (Federal) A defendant can be convicted of making and subscribing a false return or other document if it can be proven that they willfully made and subscribed a return, the return contained a statement or included another document that included a statement that it is made under the penalties of perjury, and it can be proven that the defendant did not believe that the document was true and correct as to every material matter at the time of signature. Tax Preparers can also be convicted of the same crime if it can be proven that they aided or assisted in the preparation or presentation of a false return or other document. This creates an inherent conflict of interest between the tax preparer and the defendant taxpayer.
        1. The general conspiracy statute is 18 U.S.C. § 371, which criminalizes two different types of conduct. The statute makes it an offense “f two or more persons conspire either to commit any offense against the United States, or to defraud the United States, or any agency thereof in any manner or for any purpose.” The first part of this statute is called the Offense Clause. It prohibits one from conspiring to commit any federal offense (i.e. one that is defined elsewhere). The second part is called the Defraud Clause—it seeks to prohibit a conspiracy to “defraud the United States.” It does not require proving that the taxpayer committed any other offense; it “stands on its own” as it were.
      4. Risk to Judge

    If either during the course of discovery or at trial, a family law judge learns that a witness or a party has committed tax fraud does the judge have a duty to report it to the taxing authorities?  The judicial decision to report tax evasion

    is complicated, where judges are faced with overlapping federal and state laws and ethical rules and rulings.  Most judges will exercise judicial restraint and invest serious contemplation of the issue before reaching any decision.

    1. Judicial Duties
      1. Duty to Maintain the Integrity and Independence of the Judiciary and Avoid Impropriety in Fact or Appearance.
        1. A court will often exercise a different level of scrutiny over attorneys before them as they are officers of the court than it will to the public who come before them having committed an apparent or alleged tax crime but are seeking the benefit of the legal process to obtain the shelter of law in their divorce.
        2. ABA Model Code of Judicial Conduct, Canon 2.4 Rule 2.15 obligates a judge to take action if they learn of misconduct by other judges or lawyers. If the judge determines another judge has violated the Code of Judicial Conduct or a lawyer before them has violated the Code of Professional Conduct and the particular conduct raises a substantial question as to the judge’s or lawyer’s honesty, trustworthiness or fitness, the judge is required to inform the appropriate authorities. Judges that become aware of such violations, may find themselves accused of engaging in unethical conduct if they fail to make such a report where they are required to.  The rational for the imposition of this duty on a judge is to ensure that the public has confidence in the legal system and process.  Some judges feel that they are required to extend this duty to report to witnesses and parties that appear before them where they learn that a tax crime may have been committed though the evidence or testimony before the court. However, in most states, including California, under state law and ethics rulings, a civil judge’s duty to report illegal conduct, including tax evasion, is not mandatory but rather is left to the judge’s discretion.
        3. A courtroom is not a “duty free zone” where a crime may be admitted with impunity.
        4. A blanket judicial attitude of “hear no evil, see no evil, report no evil” would not inspire public confidence in the judicial system.
        5. A judge can often perceive a duty to report crime or fraud to uphold the integrity of the judicial system.
        6. But note federal misprision of felony statute exposure below which could make it a felony for the judge not to report the issue.
        7. Factors a Judge will / should / could consider when exercising Judicial discretion in choosing whether or not to report tax fraud:
          1. The nature and seriousness of the offense
          2. Whether the crime has a victim (especially if the victim is the other spouse before the court) and if so whether the victim is operating under a disability that would interfere the victim’s ability to report the crime;
    • Conclusiveness of the information or evidence before the Judge that a crime has been actually committed
    1. The recent, remote, or ongoing nature of the crime;
    2. Whether a danger to the community exists or the public trust is involved;
    1. Parties Victimized by Tax Evasion
      1. Cheating on tax returns and then lying about income on financial disclosures with a divorce court negatively effects the other litigant spouse’s confidence in the judicial system.
      2. When a parent seeks to shield income from his requirement to support his children or spouse by first committing tax evasion to understate income and then falsely representing to the divorce court his earnings ability as supported by fraudulent returns, it cuts against vital public policies and would appear to tilt the scale in favor of disclosure the tax fraud to the taxing authorities.
    2. Effect of Tax Fraud on the Public Interest
      1. Tax evasion has a public dimension where taxpayers that follow the rules effectively have to pay more in taxes than they would have, had everyone complied with tax law. Governments depend on tax revenue to provide vital services to its citizens.
    3. Judicial Immunity
      1. Randall v. Brigham, 74 U.S. (7 Wall.) 523, 536, 19 L.Ed. 285 (1869) – The doctrine of judicial immunity, which the Supreme Court of the United States has said “is as old as the law,” is essential to the impartial administration of justice.
      2. Earl v. Mills, 275 Ga. 503, 504, 570 S.E.2d 282 (2002) – Judges are “immune from liability in civil actions for acts performed in their judicial capacity.”
      3. a judge is not immune from liability for nonjudicial actions, i.e., actions not taken in the judge’s judicial capacity.
      4. A trial judge is acting within the scope of his discretion where he reports criminal activity to “appropriate authorities.”
      5. Antoine v. Byers & Anderson, 508 U.S. 429, 435 (1993) – The Supreme Court has declared that “discretionary decision making by judges” is what “the doctrine of judicial immunity is designed to protect”
    4. Conflict with Best Interest of the Child Standard
      1. If a couple before a family law court filed fraudulent joint tax returns, there is civil liability and criminal exposure to both the H and W. Any civil liability would be a marital debt, subject to allocation between H and W and distribution as part of the marital balance sheet. A criminal tax investigation / prosecution will certainly impair family finances and, if fraud is ultimately proven and tax charges are assessed against either parent, being incarcerated would certainly impair a parent’s ability to support a child and therefore a referral to the taxing authorities by a family law judge becoming aware that the tax fraud took place could be against the best interest of the child.
    5. Sanctions Other Than Reporting Tax Fraud to IRS
      1. A court may consider whether other sanctions available to the court should be imposed as an alternative to reporting tax fraud that the court becomes aware of to the taxing authorities. The fraudulent misrepresentation of a party’s income could justify an award of legal fees or a fine against an admitted tax-evading litigant.
    6. Federal Misprision Statute
      1. 18 U.S. Code § 4 – Misprision of felony
        1. Whoever, having knowledge of the actual commission of a felony cognizable by a court of the United States, conceals and does not as soon as possible make known the same to some judge or other person in civil or military authority under the United States, shall be fined under this title or imprisoned not more than three years, or both.
      2. The existence of the federal misprision of felony statute dictates a logical conclusion that federal public policy potentially requires a state family law judge, who learns a party before him or her has committed tax fraud, may be under a duty to notify the federal and state taxing authorities of the crime even considering the fact that the judge could potentially only be prosecuted under the statute through some affirmative act of concealment.
    7. Risk to Attorneys
      1. Risk to Family Law Attorneys
        1. Lawyer Learns of False Financial Information Submitted by Client to Court or Third Party
          1. A Lawyer is prohibited from offering evidence to a court or to a third party that he or she knows to be false.
          2. If the lawyer later learns evidence presented into evidence or given to a third party was false, the attorney is required to remedy the situation.
          3. Under Rule 3.3, Candor Toward the Tribunal, He or she may be required to reveal the falsity to the court or third party.
          4. Under Rule 4.1, Truthfulness in Statements to Others, a lawyer is required to disclose to a third party any fact known to him where disclosure becomes necessary to avoid assisting a client in committing a fraudulent act, such as hiding income or assets in a divorce.
          5. Where a lawyer is intending to continue to represent a client, while endeavoring to undo whatever harm has been done in reliance on a client’s false statement they are simultaneously

    obligated both to protect client confidences under Rule 1.6 in the process which can be extremely tricky.

    1. If a client outright refuses to allow the attorney to disclose the information to the affected parties that will correct the previous disclosure falsehood, the lawyer must withdraw from the representation, under rule 1.16, Declining or Terminating Representation.
    2. The attorney must generally use their independent judgment to determine whether or not their client’s financial disclosure in a divorce is credible.
    3. Therefore, prudent attorneys will gather and compare all necessary supporting documentary evidence including for example, entity and personal tax returns, corporate and personal financial statements, loan applications, accounting records, and bank records (etc.) for comparison to the divorce financial disclosure.
    4. A lawyer is ethically required to inform his or her client that they have an obligation to report all income and assets in the divorce financial disclosure statements, whether or not the income or assets are otherwise traceable.
    5. If tax returns, subsequently determined to be fraudulent, were submitted to a court or third party as evidence of

    past income, they must be amended to reflect true income which creates exposure for a subsequent criminal tax prosecution (seek a consultation with experienced criminal tax defense counsel).

    1. Becoming the Target of an Investigation
      1. If an attorney learns of a client’s past and much more dangerous ongoing criminal tax reporting activity and provides advice to the client on the best way to “deal with it” before a divorce court, the attorney can find themselves is a very precarious position not only with the court, but before the IRS and the federal government. Remember that attorney-client privilege does not extend to advice deemed to be given to a client in the planning or furtherance of criminal or fraudulent conduct.  Tax Crime exposure for Divorce Counsel includes:
      2. Conspiracy
        1. Conspiracy to impede collection of a federal tax under 18 U.S.C. § 371.
      3. Obstruction
        1. Obstructing or impeding the administration of the IRS, including the collection of tax owed under I.R.C. § 7212.
      4. Forfeiture
        1. The federal government has recently increased their exercise of their forfeiture power when addressing fraudulent and criminal citizens. Attorney’s fees may be subject to forfeiture as well.
      5. Other Ethical Dilemmas
        1. Providing Financial Advice
          1. Most Family law attorneys are not educationally qualified to provide sophisticated financial or tax advice.
          2. To this end many family law attorney engagement letters specifically disclaim responsibility for financial or tax advice.
    • Many of these disclaiming attorneys occasionally fail to refer their clients to CPAs or other qualified professionals to seek tax or financial advice.
    1. This creates an opportunity to be of value to Divorce Counsel by CPAs.
    1. Judge’s duty to Report any Attorney that has Violated the Professional Code of Conduct
    2. Extortion Charges versus Duty of Zealous Advocacy
      1. Family law cases often touch upon criminal tax issues. It may be a somewhat common occurrence that threats are made between the parties to directly or indirectly report the other spouse for tax fraud if certain demands are not met.
      2. Consider this Hypo: W’s counsel has advised H that if a marital settlement is not negotiated to W’s satisfaction, H, a Doctor, will face a whistleblower claim filed with the IRS for past fraudulent returns and may simultaneously face an investigation for the improper dispensing of prescription medicines.
        1. While this may appear to be zealous advocacy to some, this is a crime, extortion, subject to prosecution and also it is a basis to set aside any marital agreements obtained in this manner.
        2. Under Penal Code 518 PC, the California crime of extortion or blackmail occurs when a person uses force or threats to compel another person to give them money or other property.
    • California Penal Code § 519 provides
      1. Fear, such as will constitute extortion, may be induced by a threat of any of the following:
        1. To do an unlawful injury to the person or property of the individual threatened or of a third person.
        2. To accuse the individual threatened, or a relative of his or her, or a member of his or her family, of a crime.
        3. To expose, or to impute to him, her, or them a deformity, disgrace, or crime.
        4. To expose a secret affecting him, her, or them.
        5. To report his, her, or their immigration status or suspected immigration status.
      2. There are a host of threats that can lead to an extortion charge in a family law case. Some examples are;
        1. Threatening to reveal the criminal activity of the other party, most frequently related to tax fraud;
        2. Threatening to disclose private divorce issues to business associates, coworkers, and other third parties to cause embarrassment.
    • Threatening to reveal violations of professional regulations that could lead to professional discipline censure or sanction
    1. Threatening to divulge intimate secrets to family members, including secrets relate to the parties’ sex life, sexual preferences, etc.
    2. Threatening to use disruptive discovery techniques on a spouse’s business associates, customers and employees whom would then be in a position to draw embarrassing inferences regarding a spouse’s life issues and the couples intimate divorce details.
    3. Other threats aimed at tarnishing a person’s reputation or impacting a person’s ability to earn a living.
    1. Rule 5 – 100 California Rules of Professional Conduct
      1. A member shall not threaten to present criminal, administrative, or disciplinary charges to obtain an advantage in a civil dispute.
      2. It is not improper to actually make a report about the other party’s illegal conduct to the appropriate government agency, but it is improper for a lawyer to use the potential reporting as a means of gaining leverage and securing an advantage as to an issue in a civil case.
      3. California Lawyer Discipline Outcomes
        1. Admonition
          1. A written non-disciplinary reprimand issued by the Office of the Chief Trial Counsel or the State Bar Court pursuant to Rule 264, Rules of Procedure of the State Bar.
        2. Reproval
          1. A censure or reprimand issued by the Supreme Court or the State Bar Court that is not a matter of public record unless imposed after the initiation of formal disciplinary proceedings. No period of suspension is imposed.  The reproval may be imposed with duties or conditions.
    • Probation
      1. A status whereby a member retains the legal ability to practice law subject to his or her compliance with terms, conditions and duties for a specified period of time.
    1. Suspension
      1. A disciplinary action that prohibits a member from practicing law or from holding himself or herself out as a lawyer for a period of time set by the California Supreme Court.
        1. A suspension may be either stayed or actual.
      2. Disbarment
        1. A disciplinary action whereby the California Supreme Court expels an attorney from membership in the State Bar. The attorney’s name is stricken from the roll of California attorneys and the attorney becomes ineligible to practice law.
      3. Risk to CPA
        1. Divorce engagements commonly require CPAs to perform in one or both of the following two roles;
          1. as a forensic accountant charged with locating all pertinent assets and liabilities for marital division.
            1. CPA investigates and analyzes financial evidence and interviews related parties to ensure all marital assets and liabilities are properly disclosed in order to prevent financial fraud from occurring during the divorce.
            2. Forensic examination and evidence and testimony may be used at trial.
          2. as a tax expert relating to the separation of marital assets and support payments to minimize any associated tax burden.
        2. Conflicts of Interest in Representing Both Spouses
          1. Rule 1.110 of the AICPA Code of Professional Conduct and Circular 230 govern conflicts of interest.
            1. Firms must have a written policy by which partners and staff are informed or, and steps are laid out to mitigate, common potential conflicts of interest, such as those inherent in continuing to service divorcing clients.
          2. Per the AICPA Code, ET §102-2, a conflict of interest may occur where a member of a CPA firm “has a relationship with another person, entity, product, or service that could, in the member’s professional judgment, be viewed by the client, employer, or other appropriate parties as impairing the member’s objectivity”.
          3. This does not outright prohibit the provision of non-attest services, (I.E. tax services) as long as the member believes that the professional service can be performed with objectivity, and the relationship that could potentially be viewed as a conflict of interest is disclosed to the client and informed consent is obtained.
          4. Potential Conflicts of Interest Identified Under 10.29 of Circular 230
            1. The representation of one client will be directly adverse to another client
            2. There is a significant risk that the representation of one or more clients will be materially limited by the practitioner’s responsibilities to another client, a former client or third person, or by a personal interest of the practitioner.
            3. Under 10.29 the practitioner may still represent the client even where a conflict of interest exists if;
              1. the practitioner reasonably believes he or she will be able to provide competent and diligent representation to each affected client; and
              2. assuming the representation is not prohibited by law, each affected client waives the conflict of interest and gives informed consent, confirmed in writing by each affected client, at the time the existence of the conflict of interest is known by the practitioner.
            4. 29(b)(3) requires the written confirmation to be executed within a reasonable time after the informed consent, (no later than 30 days) and practitioners additionally required to retain on file the written informed consents for a minimum of 36 months from the date services are rendered to the affected clients.
            5. The written informed consents must be made available to the IRS upon request.
          5. What Constitutes Informed Consent
            1. What constitutes informed consent varies by jurisdiction and by the local ethical rules of the various legal or accounting organizations charged with regulating the particular profession at issue.
            2. For example, ABA Model Rule 1.4(b) states that a client must be provided;
              1. Relevant information to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.
            3. The overarching theme of these various professional rules is to require the professional to provide the client sufficient relevant information so that they fully comprehend the transactions involved in the professional service being rendered to enable the client to accurately gauge the scope of risk being undertaken by them in utilizing the practitioner to provide services in the face of an identified conflict of interest.
          6. Example of Common CPA Conflict of Interest in a Divorce Scenario
            1. CPA has prepared a joint Form 1040 for H and W for several years and routinely provides professional services to both H and W related to several separate and joint business ventures. CPA receives a call from H stating that H and W headed towards a divorce.
              1. H wants to discuss the preparation of a joint return for H and W and wants specific advice as to potential tax positions or other accounting, legal advice that could help H prevail over W in negotiating an advantageous marital assets division and support agreement.
              2. Could W (or more likely W’s Divorce Counsel) view H’s request of CPA as affecting his or her objectivity?
    • Could CPA’s service to H be viewed be materially limited by his responsibility to W?
    1. Any advantage secured for H will likely be disadvantageous to W.
    2. CPA will be unable to perform with 100% neutrality and thus will not be able to meet the objectivity, competency, and diligence standards required by Circular 230, the AICPA and most state prescribed ethical performance standards.
    3. Consequently, CPA should not prepare a joint return for H and W nor should he or she provide counsel to “seek an advantage by H over W in the coming divorce” even if both H and W are willing to sign informed consents.
    • Potential for prosecution for the unauthorized practice of law where legal advice provided related to the divorce even where advice is competent.
    1. Conflict of Interest Between CPA and Taxpayer Where Tax Fraud Later Discovered
      1. Where the CPA is the original preparer of returns subsequently found to be fraudulent before a divorce court, the CPA understandably has a strong motivation to protect their reputation with the taxing authorities at the expense of the client’s reputation with the divorce court and possibly at the expense of the client’s liberty where the IRS later peruses the public record underlying the divorce and discovers the tax fraud. This makes the CPA a great candidate to be government witness number one in establishing the client’s willful tax evasion especially where the client provided the CPA incomplete or worse yet a cooked set of books that the CPA relied on to prepare the tax return.
    2. Lack of Attorney Client Privilege for Return Preparation
      1. A preparer, even where they are an attorney, does not have attorney client privilege and anything that the client said to the preparer related to the preparation of the return can be used against the taxpayer in a court of law.
      2. If Subpoenaed as a witness, the CPA can face contempt of court charges if they refuse to testify which include indefinite arrest until the CPA decides to cooperate and or fines.
      3. The CPA’s tax advice privilege under Section 7525 is unavailable when a matter turns criminal.
      4. Only the client can waive federal section 7525 privilege and any state law based confidentiality privileges with the CPA. Thus, a CPA, should seek counsel when presented with a court or a taxing authorities request for documents or to answer questions / be deposed. The CPA should put the client on notice of the request and seek permission to allow themselves to be questioned or before disclosing any confidential matters or client documents. Without first obtaining permission, The CPA should not disclose or provide anything absent a valid court order or subpoena.
      5. A taxpayer’s delivery of personal papers to a CPA can effectively waive any Fifth Amendment production privilege that might exist.
    3. CPA Work Product Privilege in a Divorce
      1. When is the work product of a CPA related to a divorce privileged and thus non discoverable? This question frequently arises in CPA divorce engagements when serving in the capacity of a forensic accountant. CPA are also asked to review and sometimes prepare tax returns in a divorce engagement. A CPA hired to be an expert and to offer testimony in open court be definition has no work product privileges and thus his or her work product is discoverable before the divorce court and where a criminal tax issue subsequently arises. Where fraud may be evident in tax returns before the divorce court the enlightened attorney will choose to directly engage a qualified Criminal Tax Defense Attorney or Kovel Accountant whom is completely separate from the testifying expert.
    4. Filing Amended of Delinquent Returns During or on the eve of Divorce
    5. Amended Returns
      1. The decision to file amended returns to correct prior fraudulent positions likely to come to light in a divorce proceeding can be viewed by the taxing authorities as an admission of facts that can lend themselves perfectly to the taxing authorities establishing each and every element of various tax crimes.
        1. (See Quiet and Loud Disclosures Above)
      2. Filing amended returns may effectively mitigate the damage to the government caused by previous tax crimes however it will not function to erase them. A tax crimes was committed with the fraudulent filing of the original return.
      3. AICPA Statements on Standards for Tax Services No. 6, paragraph 11, states: “If a member believes that a taxpayer may face possible exposure to allegations of fraud or other criminal misconduct, the member should advise the taxpayer to consult with an attorney before the taxpayer takes any actions.”
      4. The quandary inherent in this guidance presents to the unwary CPA a golden opportunity to engage in the unauthorized practice of law if he or she alone makes a determination as to whether a taxpayer’s actions are criminal or are rather “just negligent”.
      5. If the CPA attempts to make this legal determination, the CPA will may obtain non-privileged communications or documents to the disadvantage of the taxpayer.
      6. The safest course of action is to have a criminal tax defense lawyer vet the client as to the facts behind the client being delinquent especially where there a large amounts of income involved, especially involving foreign income producing assets. A Kovel accountant can provide assistance to the tax attorney in making a determination if tax crimes have been committed, but should prepare returns for the client if a need for privilege exists. Delinquent returns never take aggressive positions that could potentially be viewed as evidence of willfulness.
    6. Delinquent Returns
      1. The somewhat less risky decision to file true accurate and complete delinquent returns in the face of a divorce can serve as an admission of the elements underlying the tax crime of failure to file.
      2. Since simple failure to file is only a federal misdemeanor rather than a felony even where easily established this crime is rarely prosecuted.
      3. Failure to file for California purposes is a Felony that I have seen prosecuted and have experience with defending in the investigation phase.
      4. Where the factors below from the “Spies evasion” doctrine are present federal misdemeanor non filing can be ramped up to federal felony tax evasion. The Spies evasion doctrine is a legal theory that finds a taxpayer criminally liable when he willfully
        1. (1) fails to file a tax return, and
        2. (2) his action is coupled with an “affirmative act of evasion,” like actively concealing or misleading the government.
      5. In Spies the Supreme Court identified at least seven examples of conduct that constituted affirmative acts of evasion. The Court stated: “think affirmative willful attempt may be inferred from conduct such as;
        1. keeping a double set of books,
        2. making false entries of alterations,
    • or false invoices or documents,
    1. destruction of books or records,
    2. concealment of assets or covering up sources of income,
    3. handling of one’s affairs to avoid making the records usual in transactions of the kind, and
    • any conduct, the likely effect of which would be to mislead or to conceal.” Spies v. United States, 317 U.S. 492, 499 (1943).
    1. What is an “affirmative act” for purposes of the Spies evasion doctrine?
      1. It may be any number of things, including but not limited to, making a false statement to the IRS, either oral or written. Importantly, the statement could be made before, after, or at the same time as filing the tax return. Thus, for example, a taxpayer makes an “affirmative” act of evasion after failing to file his income tax return when he lies to the IRS about how much income he earned. Accordingly, a taxpayer’s lying about earnings could also earn him jail time-and heavy penalties..
    2. Malpractice
      1. Lastly even where the CPA has made an error in preparing the client’s return they are not likely to throw themselves under the bus to protect the client at the risk of a malpractice suit.
    3. When to Punt
      1. Eggshell Audits
      2. Criminal Investigation
      3. Evidence of Tax Fraud Committed on Returns CPA Filed Surfaces
      4. Unauthorized Practice of Law
        1. Tripping into the unauthorized practice of law will run you afoul of AICPA Code of Professional Conduct, section 56.07, Article V-Due Care – “Competence represents the attainment and maintenance of a level of understanding and knowledge that enables a member to render services with facility and acumen”.
        2. Engaging in the unauthorized practice of law UPL can result in serious state criminal liability. For example, in Florida UPL is a third degree felony punishable by up to five years in jail!
          1. Engaging in UPL could serve to bar the collecting of fees for services rendered.
          2. Engaging in UPL could support a malpractice suit.
          3. Engaging in UPL could result in a denial of malpractice coverage in the event you are sued.
        3. Tax Crime Exposure
          1. Aiding and Abetting
            1. The basis for aiding and abetting violations is accomplice liability. An individual may be indicted as a principle for committing a substantive offense upon a showing of him or her to be an aider or abettor. In practice this means persons who have aided and assisted another in tax evasion by concealing another person’s sources of income or assets. To prevail in bringing a charge under the federal aiding and abetting statute, the government must prove beyond a reasonable doubt that:
              1. A substantive criminal offense was committed.
              2. The defendant, by affirmative conduct, participated in, counseled, or assisted in the commission of the substantive offense.
              3. The defendant shared with the principal the criminal intent to commit the substantive offense.
            2. An accused must associate themselves in some manner with a criminal venture to be convicted of aiding and abetting the commission of an offense. This is established by a showing of participation in the criminal venture that demonstrates a desire to seek and bring about the criminal result. However, the aider and abettor need not perform the substantive offense nor even know its details to be convicted or even be present when the offense is committed. To be successful in bringing an action for aiding and abetting, the government need only show that the defendant intentionally assisted in the commission of a specific crime in some substantial manor.
            3. In order to sustain a conviction the government must present evidence showing an underlying offense, this means aiding and abetting is not an independent crime. However, the principal who was aided and abetted does not need to be identified or convicted for the government to convict the party accused of aiding and abetting. Moreover, an outright acquittal of the principal will not bar the prosecution of the aider and abettor. Because the aiding and abetting statute does not create a separate offense, the applicable statute of limitations for bringing an aiding and abetting charge is the same as that of the underlying substantive crime that is at issue.
    • Actions for CPA to Take to Protect Themselves
      1. A team approach between a tax defense lawyer and a CPA is quite often appropriate yet so often not sought out by the CPA. As a team, the tax lawyer and the CPA can effectively use their unique skill sets and training to benefit the client.  The team approach will ordinarily yield the best results possible for the client and afford each professional the greatest liability protection.
      2. Know what services you legally can perform and what services you should refrain from performing.
      3. Do not allow yourself to believe if it has never happened to you or on of your clients, it will not happen! It only takes once!   CPAs go down for tax fraud on a regular basis. The federal justice system is unforgiving and unrelenting if they choose to go after you.
      4. Treat each divorce engagement as unique and avoid cookie cutter approaches.
      5. Be ever alert for conflicts of interest developing at any stage of an engagement.
      6. Do not let your client turn you into a reluctant, often uncompensated, witness.
      7. Never assume the client is what they purport to be. Keep a healthy skepticism and independent view point.
      8. Never say, do or document anything that you would not want raised in open court.
      9. Never cross the line for a client! See aiding and abetting above!
    1. Deductible vs Non Deductible Divorce Related Accounting and Legal Fees
      1. Deductible Versus Non Deductible Divorce Legal and Accounting Fees
        1. Tax Advice
          1. Expenses paid or incurred for tax advice/ compliance / counsel are deductible under §212.
          2. Legal fees paid to ascertain the tax consequences of settling a lawsuit are deductible.
            1. Deductions are allowed for legal advice as to the tax consequences of divorce and or separation.
          3. Legal fees allocable to understanding the tax ramifications where drafting an ante nuptial agreement are deductible under §212, but any legal fees allocable to negotiating a property settlement are not.
        2. Tax-motivated divorces and annulments
          1. Tax-motivated divorces and annulments may be disregarded for tax purposes by the taxing authorities
          2. Fraudulent Transfers
            1. Uniform Fraudulent Transfer Act (UFTA)
              1. The purpose of the act is to prevent a citizen from divesting themselves of assets while claims are pending, or in anticipation of future claims.
            2. UFTA 4(a)(1)
    • A transfer is fraudulent (whether the creditor’s claim arose before or after the transfer was made) if the debtor made the transfer with actual intent to hinder, delay, or defraud any creditor
    1. Example Case
      1. U.S. v. Baker, 116 AFTR 2d 2015-5674
        1. In February of 2007 the Bakers were asked to complete a Form 433-A, as the IRS was attempting to collect an assessment in excess of $5,000,000 related to H’s use of a Son of Boss tax shelter on his 2002 federal tax return. H and W simultaneously began to retitle assets. H’s interest in the family residence was transferred into two trusts listing the couple’s two minor children as beneficiaries.
        2. A federal district court held that transfers of a H’s property to W, as part of a divorce settlement were made to delay or defraud creditors (including the IRS). Court held that divorce was obtained to facilitate fraudulent asset transfers. Court noted that only W was represented by divorce counsel, that H and W continued to live together subsequent to the divorce in the same house that was transferred to W as part of a divorce settlement.  In the settlement H received a disproportionally small allocation of H and W’s assets while W received a disproportionately small amount of H and W’s debts.
        3. Family friends of H and W testified that H and W held themselves out and carried on as married couple after the divorce by sleeping in the master bedroom in the same bed, engaging in sexual relations, taking on extensive renovations of the home.
        4. The execution of a separation agreement by a judge in a divorce as fair and equitable between H and W does not “represent a determination that the agreement perpetrates no fraud upon the creditors of one spouse, particularly where the claims of creditors are not made known to the court.” In re Chevrie, 2001 WL 120132, at 10 (Bankr. N.D. Ill. Feb. 13, 2001).
        5. A fraudulent transfer may be held to have occurred when a divorce is merely a sham although procedurally complete, “but the transferor nonetheless favors transferring assets to the ex-spouse rather than seeing them go to a creditor body.” In re Hill, 342 B.R. 183, 196 (Bankr. D.N.J. 2006)
        6. Divorce and Need for Estate Planning Review
          1. Individuals contemplating or engaged in a divorce need to have a professional review of their estate plans and get out in front of the income and transfer tax issues that will certainly arise as a result of the divorce.
          2. Individuals faced with divorce need to consider the effects of the divorce on their will, life insurance, property rights, gift tax aspects of any property transfers incident to the divorce, and the effect of prenuptial agreements and what would happen if the individual dies before the divorce finalized.
          3. Most states’ have statutes that automatically invalidate will provisions that benefit the former ex-spouse following a divorce.
          4. It may be wise to invalidate or edit a will during the pendency of a divorce or unintended consequences could ensure if an individual happened to die before the divorce was final and assets went to the soon to be ex-spouse that were not intended. For the same reason beneficiary designations on life insurance should be changed. The way in which property is titled should be reviewed for the same reason as property could pass to the ex-spouse in an unintended fashion.

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