To Have and to Hold But to Not Be Held Accountable

By:
Jacalyn F. Barnett, Esq.
Published Date:
Nov 1, 2016

New Year’s Eve is not just a time for fireworks and celebrations—it is also the moment when the IRS determines whether or not you are married. If you are married at the stroke of midnight, the IRS considers you to have been married for the whole year. Similarly, if your judgment of divorce was granted on New Year’s Eve, then you are considered to have been divorced for the entire calendar year, even though you were engaged in deadly wedlock for the whole year until that very night. So when you are making your New Year’s resolutions, make sure you carefully evaluate your tax status—not just your love status—and make sure to advise your clients to do likewise.

When you speak with clients at the end of the calendar year to discuss their estimated payments, which will be due before midnight strikes, listen as carefully to a client’s words as you would to a spouse’s words. Clients and spouses may not always tell you how they feel about loved ones, but their actions always will speak volumes. Is there a chance that their marriage may not be forever—or even for that tax year? If so, you can provide your clients with extraordinary guidance to help them perform real, meaningful financial planning.

Making the decision to divorce one’s spouse is rarely a spontaneous idea. Usually, a spouse ruminates on the possibility for some time before announcing his or her intention to end the marriage. Yet, the timing of when one learns that his or her spouse intends to seek a divorce can be critical in not only how the assets and liabilities of the marriage will be divided, but how interim and permanent spousal and child support are awarded.

Before taking any legal action, you truly need to understand the law, your rights, and your responsibilities. Signing a joint tax return is one of those very critical legal acts that too many individuals carelessly sleepwalk through—or act as if they are stuck powerlessly on a conveyor belt with no off-ramps.

Instead, signing a joint tax return should be a time of introspection and scrutiny. Ultimately, it is an annual act of faith that needs to be thoughtfully considered. If a spouse is not current on his or her tax obligations, co-signing (even with a perfect indemnification agreement) exposes that party to pay the spouse’s tax liabilities, as well as interest and penalties for any years in which they file joint tax returns.    

KOVEL ISSUE

Initially, it is important for all clients and individuals to understand that having a discussion with an attorney is privileged, but speaking with a tax professional is not always privileged.

A major case, United States v. Kovel, 296 F. 2d 918 (2d Cir. 1961), created an opportunity to extend the privilege to accountants who are assisting attorneys. Louis Kovel, a former IRS agent, was employed as an accountant at a tax law firm when he was subpoenaed before a grand jury investigating a client’s possible tax violations. Prosecutors successfully argued at trial that the attorney-client privilege did not extend to Kovel because he was not an attorney, but the appellate court reversed and found Kovel’s communications to have been privileged: “Accounting concepts are a foreign language to some lawyers in almost all cases, and to almost all lawyers in some cases.” Therefore, when there are vulnerable issues requiring an accountant’s assistance, hire an attorney first so that the attorney can engage an accountant, thereby extending the attorney-client privilege to the accountant’s work.  

Texts and emails are always, always ink; they are not erasable pencil entries. Look at the lingering issues remaining for Hillary Clinton over her emails. Digital fingerprints are everywhere.

UNTIL IT HAPPENS

Until both spouses actually execute a joint tax return, you do not know if it will actually happen.

There was one case in my practice several years ago where this issue made the critical difference in securing my client a large eight-figure settlement. My client was the second wife of an extremely successful widower with three children from his prior marriage. She had two children with him. The family had an extraordinary lifestyle, but like many good things, it did not last forever. Knowing how complicated their financial circumstances were and wanting to portray their lifestyle as accurately as possible to perpetuate this for my client and her children, I hired an accountant under the Kovel principles for my client.

Since her husband always had paid all their bills, we had agreed to participate in filing joint tax returns, but I insisted that the parties execute a tax indemnification agreement first—and that her independent accountant have an opportunity to meaningfully review the returns before she joined in its filing. In April, at the time of the filing of the tax extensions, we executed the tax indemnification agreement but insisted on reviewing the proposed tax returns prior to their execution so my client could ensure it was true and correct—per the warranty above the signature box. And though they were signing an indemnification agreement, which would allocate the responsibilities between the spouses, the parties would nonetheless remain jointly and severally liable to any taxing authority for any jointly filed tax returns.  

By mid-September of that year, I kept calling opposing counsel requesting the draft returns and was given one excuse after another for their delay. Finally, it was Oct. 11, and I still had not heard from counsel. With my usual caution, I had asked the Kovel accountant to prepare draft tax returns for the client as married filing separately just in case. Well, that night I received an email from my adversary informing me that the husband had changed his position and was filing as married filing separately, without my client. Therefore, my client was responsible for her own timely filed returns.

I called my adversary about this last minute change and it was abundantly clear that he and his client erroneously believed my client would be overwhelmed by the impending tax deadline and would then settle other divorce issues more favorably to him. In fact, opposing counsel seriously miscalculated his tactic. The husband’s returns were littered with improper business deductions for the tax year at issue and, as a result, the leverage totally changed. Without the shackles of the joint returns, we were free to expose the husband’s misrepresentations in his depositions, especially his significant deductions for alleged private plane business trips for which he had no flight logs. Because my client’s name was not even on those tax returns, she did not have to fear personal exposure due to his misrepresentations.

Sometimes, however, an indemnification agreement just isn’t enough. I had a client who had not lived with her husband for more than a dozen years, but he paid for absolutely everything—including all her professional bills. When he presented the draft tax return, it just defied mathematical possibility, so we told her and her husband that she could not sign the joint returns in good faith, irrespective of any tax indemnification agreement. 

When clients execute tax returns without an indemnification agreement, they can have major problems, not only with the taxing authorities but in the loss of leverage they otherwise would have had in their divorce proceedings.

One lovely woman came to interview me on Apr. 14 one year. While I do not like to be retained on the spot, I specifically advised her not to sign a tax return with her husband unless he at least signed the tax indemnification agreement I prepared for her. Since we had only met for 1 1/2 hours, she took the form—but not the advice. She signed the returns and later realized the significant fraud he had committed. Due to her joint participation, she could not even bring that fraud to the court’s attention, as she might otherwise have been able to do.  As a result of signing the joint returns, she was equally exposed to all the liabilities and—just as importantly, as the New York Court of Appeals recognized in Mahoney-Buntzman v. Buntzman, 12 N.Y.3d 415 (2009)—she was estopped from making an inconsistent claim about her husband’s income when she was seeking a greater sum of child support, a different allocation of add-on expenses for the children, and for spousal support in the matrimonial litigation.  

Topics to Consider for a Tax Indemnification Agreement

If a couple is filing jointly, the parties should try to agree on as many particulars as possible concerning the returns prior to their joint participation. Among other things, they should try to agree on the identity of the professionals, who will be involved, how the costs of the returns’ preparation and potential scrutiny will be handled, how any liabilities or refunds will be managed, and what documentation can or should be examined before execution of the returns. If there is any issue about filing together, the parties should have a calculation done to determine the difference between filing jointly or not. If there is no discernible reason to file separately and filing jointly would save the family substantial funds, that factor can be raised to a court as a waste of assets.

 As a matrimonial lawyer, I always remind clients that there is no romance without finance.  While fault grounds may no longer be a factor in dissolution of a marriage, financial fidelity issues still endure. One must always consider a spouse’s integrity before executing any joint document, especially one as significant as a tax return.


barnett2Jacalyn F. Barnett, Esq., earned a B.A. from the University of Wisconsin at Madison in 1974, studied at the University of London, and received her J.D. from Brooklyn Law School in 1977. Ms. Barnett has been a member of the bar in New York State and U.S. District Court, Southern and Eastern Districts of New York, since 1978. Prior to starting her own firm, the Law Office of Jacalyn F. Barnett, P.C., located in New York City, she was the head of the matrimonial department at the law firm of Shea & Gould. Jacalyn concentrates her legal practice in the areas of divorce, separation, custody, and paternity issues. She has been a frequent legal commentator on COURT-TV, Fox News, ABC News and MSNBC. She has appeared as a guest on such diverse television shows as ABC Eyewitness News, ABC World News Tonight, CBS Morning News, The Today Show, Bill O’Reilly, John Walsh Show, and CNBC Smart Money. She has been cited regularly in numerous periodicals and newspapers such as The New York Times, International Herald Tribune, Crain’s New York Business, The Wall Street Journal, Bride’s Magazine, Forbes, Harper’s Bazaar, L.A. Herald Examiner, L.A. Times, Manhattan Lawyer, Time Magazine, USA Today and Vogue Magazine. Jacalyn was selected for Crain’s New York Business 40 Under 40. She has served as a legal consultant to Salomon Smith Barney on “Women in Transition,” a nationwide educational program offering financial advice to women involved in divorce or widowhood and has testified as an expert witness on New York State law in Montreal, Canada. Jacalyn was recently the featured lecturer for the NYSSCPA Entertainment, Arts and Sports Committee for their seminar entitled, “How to Protect Your Client’s ASSets and Your Own.” She can be reached at jbarnett@jacalynbarnett.com or 212-685-5545.

 
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