In a blog post earlier this week about the Tax Implications of Divorce, I mentioned how the child tax exemption can be a big factor in a financial settlement.
Just yesterday, I came across another situation which highlights the importance of having a financial specialist involved in a divorce. This is a real situation.
In March 2010, a 15-year marriage was dissolved at the direction of a Douglas County judge. The divorce had been extremely contentious (this was not a collaborative case), and settlement negotiations broke down on the day of the divorce trial, and the case went before the judge to decide several issues -- primarily all financial. One of the key issues at hand was that the plaintiff in the case (the woman) had filed her tax return for 2008 (the year which she filed for divorce), but refused to provide a copy of the return to the defendant. Without that information, the defendant could not file his tax return, as the couple had several minor children, and he was unclear which -- if any -- of the children she had claimed as exemptions.
As the divorce dragged on, the defendant did not file his 2009 tax return either. When the case finally went to trial in 2010, one of the key financial issues was the unpaid tax liability from 2008 and 2009. The defendant's accountant had advised him that the 2008 liability was projected to be $20,000 (due to inadequate estimated tax payments, but also interest and penalties that had accrued from nonfiling and nonpayment). But the accountant projected that the liability could be reduced to approximately $10,000 if the wife's original 2008 return was amended and all relevant deductions were included (including home mortgage interest and all child tax exemptions -- it was found through a deposition and subsequent discovery that the wife had not claimed all the children when she filed the return).
The judge in the case ordered that the parties amend the 2008 returns to "married filing jointly," with the defendant assuming responsibility for paying the (reduced) tax liability as part of the overall financial settlement. When asked by the judge if she believed the financial settlement to be fair, the wife testified "yes."
Fast forward one year. The defendant's accountant drafted the revised tax return and the defendant presented it to his ex-wife to sign. She initially refused, but finally did so, when reminded of the court order. The defendant submitted the amended tax return to the IRS, and when the return was accepted, submitted a request for a payment plan, since he did not have sufficient cash to pay his tax obligations from 2010, 2009, and 2008 all at once (the total amount for all years exceeded $25,000).
One thing most people don't realize about financial settlements in a divorce is that certain entities don't recognize divorce settlements. Chief among these are the IRS and credit card companies. If you're a party to the obligation, they will pursue payment from you, whether you're responsible (according to the divorce judgment) or not.
What this meant to the plaintiff (the wife in the divorce action) is this: When she filed her 2010 tax return, she was notified that her refund would be garnished (seized) to apply towards the 2008 tax liability (from the amended joint tax return).
In a future blog post, I'll provide more details about what the plaintiff did next, and what the outcome was with the IRS, but the lesson is clear: Lawyers and judges aren't financial specialists. Heck, even accountants aren't financial specialists.
Having a joint financial specialist advising both parties in a divorce action (which is the case with collaborative divorce cases in Nebraska) is critical to not only making financial decisions in a divorce settlement, but also in explaining the impact of these decisions to both parties (and, sometimes, the lawyers involved).
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