In this podcast, Florida forensic accountants and business valuators Rod and Heather Moe discuss how to read a tax return and get the most out of discovery.
Hosted by: Diana Shepherd, Family Lawyer Magazine’s Editorial Director
Guest Speakers: Rod Moe and Heather Moe
There are many things family lawyers can learn from their clients’ tax returns. In this podcast, Florida forensic accountants and business valuators Rod and Heather Moe discuss how to read a tax return and get the most out of discovery. They also discuss what family lawyers need to know about the reformatting of the 1040, what you can learn from a W-2, how the pandemic has affected business valuations for clients going through divorce, and more.
The complete transcript follows, below.
My name is Diana Shepherd, and I am the Editorial Director of Family Lawyer Magazine. My guests today are south Florida forensic accountants and business valuators Rod Moe and Heather Moe, and they are here to discuss how to read a tax return and get the most out of discovery. With 45 years of experience in tax and accounting, Rod provides consultation services related to legal matters and serves as an expert witness. A licensed CPA since 2008, Heather assists in mediations as well as providing expert witness testimony in court and she is also accredited in business valuations.
My first questions are for Heather: has the tax return format changed over the years? And if so, what do family lawyers need to know about this?
Heather Moe: Yes, it has. In 2018 there was a reformatting of the 1040, which used to be a traditional two-page document with supporting schedules. In 2018 they had broken it down to five pages. Two pages were just like the traditional return that we’re used to, and then there were three additional schedules. They have just taken some of the adjustments and moved them to supporting schedules. The tax payments that taxpayers have withheld have been moved to additional pages.
Heather, what information can a family lawyer learn from the first two pages of the 1040?
Heather: Tax returns offer a wealth of information. They are a great source to review. Particularly on the first page, you can look and learn a lot about their income sources, whether they have employment such as wages on the first line, and then it breaks down between investment accounts, interest, and dividends, indicating that they have brokerage or some sort of savings account. You can also see if there is an IRA distribution, indicating that there are retirement accounts, and pension and annuity payments, which also indicates various sources of income. You can also see capital gains. Schedule D flows through and you can see that they have sold stock, possibly bitcoin or virtual currency. You can also see other sources of income such as self-employment, if they are a member of an LLC, or if they have rental income.
Since we are talking about tax schedules, Rod, which ones are crucial for family lawyers to understand, and why?
Rod Moe: As Heather said, there is a wealth of information in tax returns, and there are certain discovery procedures that you need to do. For example, on schedule three, where the tax payments are listed, we need to determine where those payments came from. Because they may have come from accounts that we are not aware of. Also, in looking at the cash payments, in some cases, people will overpay their estimated taxes in order to have a refund coming from the IRS. That represents an asset that needs to be divided between the parties.
On Schedule D it indicates what transactions have occurred with investments. It lets you know that there is likely some investment account out there. You should also look for cash loss carryovers which also need to be divided among the parties. If it was a joint loss, which can offset future income, each of the parties needs to share that.
Schedule C also notifies you of property that is owned and rented out. It lists the address of the property, the rental income, and the rental expenses. On the back of Schedule E is a section that lists the partnerships and S corporations that the parties have ownership in. It also lists estate and trust income, which is important because you need to know what state and trust assets there are. And in the case of the S corporations, it alerts you about which various business entities you need to receive tax information on so that you can determine if there are assets being held in those entities that need to be valued. You need to keep your eyes open and look at the sources of income and think about where that income comes from. What is the asset that is related to that?
Rod, are supporting tax documents – such as 1099s and K-1s from business operations and trusts and estates – as important to obtain as the tax returns? And if so, why?
Rod: Yes, they are very important to obtain because they provide more details and supporting schedules. It also provides addresses of properties and indicates the ownership percentage. It just gives you more details of the business entity. It is very important to look at those source documents, including W=2s.
Heather, what can you learn from a W-2?
Heather: W-2s are very crucial information. The tax return relays information that is taxable, but the W-2 will list out details that are not taxable, such as benefits and perks that an individual is receiving, or deferment of income that they’re making, such as retirement plan contributions, or deferred comp of salary. So you really need to review a W-2 in order to get the whole picture as far as the income of the parties.
Let’s talk about a situation where you have a monied spouse and a non-monied spouse in a divorce. Heather, if a lawyer is representing the “out” or non-monied spouse – who knows little to nothing about the couple’s finances – is it possible to request transcripts from the IRS? What does this involve?
Heather: Yes, the IRS has become more technologically savvy. They have an online portal, and it takes about 15 minutes to set up an account. You can request up to 10 years prior to the current tax year pretty much instantly. You can receive various types of transcripts, such as a tax return transcript, which shows the line items based on the tax return, and your adjusted gross income. You can receive a tax account transcript, which just shows your basic information about return type and marital status, and there’s also a record of account that combines both the tax return and tax account transcripts. And then you can also receive a wage and income transcript that shows the various sources of income from W-2, 1099, and so forth.
What types of transcripts can the non-monied spouse request, Heather?
Heather: The various types include the tax return transcripts, which indicate line-by-line the 1040 items that were reported when they filed their actual tax return; and the tax account transcript, which shows all payments that were made, the gross income, and the taxable income. This is all available for the current tax year and 10 years prior.
Rod, does a tax return show all income of a party, or are there other income sources domestically that do not appear on a tax return?
Rod: Yes, there are income sources that do not result in the attached documents and do not appear on the tax return. One thing I might add regarding a divorce where there is a sole proprietorship, there is a Schedule C that lists the items of income and expense that the individuals claim. And unlike a corporation, which must provide a balance sheet and account for all the debits and credits that came through, it should provide details supporting all items on Schedule C. I had a case where the ex-wife owned a business. I reviewed her business bank statements which showed several deposits to her business account which did not correspond to her business sales records. We determined that all those individual deposits were from the ex-wife’s boyfriend, who was providing substantial support to her. The ex-husband, who had been paying alimony for 20 years, should have been able to cease payments when the boyfriend started supporting his ex.
Of items that do not appear on the tax return, we also have other deferred income assets, such as life insurance policies. Although they continue to increase in value, there is no income received, so there is nothing to report on the tax returns We have a case of an individual where there’s a substantial judgment owed by the ex-husband to the ex-wife, and the husband is claiming that he is broke. And based upon the assets he received at the time of the divorce, he should have an excess of three and a half million dollars of assets. Nothing appears on the tax return, and the individual in the past has dealt with annuities and other deferred income investments that show nothing on the tax return. But it is an asset that could be used for paying off judgments. But unless you subpoena a third party – the brokers and the annuity companies – you would never know.
Rod, when attorneys are looking at tax returns in 2021, what should they pay special attention to?
Rod: They should pay special attention to loans that their clients may have received from the PPP. The IRS has said that on these loans (which may be forgiven, and most of them will be forgiven. I cannot imagine someone not applying for forgiveness), the expenses that were paid from the PPP loan cannot be deducted on the tax return. What ends up happening is the forgiven loan becomes an additional source of revenue, which increases the bottom line for the business. This is a one-time thing and is not going to be recurring. That needs to be considered in the income of the business owner spouse – otherwise, you end up overstating the income that would be available to pay alimony. And it is very important from the standpoint of the business-owning spouse to ensure that an adjustment is made to exclude the loan forgiveness from the income of that party going forward.
Let’s talk about COVID-19 and business valuation for a moment. Rod, how has the pandemic affected business valuations for clients currently going through a divorce?
Rod: First, COVID-19 has resulted in a big uptick in divorce work, because of the close proximity that couples need to maintain. In the case of a business valuation, there is a significant downturn in the revenue of a business and its profit because of COVID. People are having to stay at home. You may have had a business that was very profitable in the past and eventually will be profitable in the future – if they continue to stay in business. Discussions need to be had regarding this temporary reduction in value. If no adjustments were made, the non-business owner would be drastically short-changed going forward. So, if COVID-19 is something unique – and hopefully, this is going to be ending soon – it can create a lot of problems when trying to determine what the non-business owner spouse should be receiving.
Thank you, Rod and Heather, for taking the time to share your knowledge with our listeners! My guests have been Rod and Heather Moe, Certified Forensic CPAs and accredited Business Valuators who have worked with many divorce and family lawyers in south Florida. To learn more about how they can assist family lawyers with complex tax and valuation cases, please visit www.rodmoecpa.com.
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