The Tax Return: Never Overlook Its Importance

The Tax Return: Never Overlook Its Importance – By Nancy Kaye, CDFA, CFP

The tax return presents a useful view of a year in time of the family’s finances. In the Collaborative Divorce process, the attorney for one of the divorcing parties and/or a Neutral Financial Specialist often request three years of tax returns to begin to take a financial look at the family.

The Neutral Financial Specialist on the Collaborative Divorce team can be an accountant trained in reviewing tax returns, an investment broker trained to review investments, or a Certified Financial Planner (CFP) trained in all financial aspects of individuals/families (taxes, investments, insurance, employee benefits).

The team may also include a Certified Divorce Financial Analyst (CDFA) trained to work collaboratively by maintaining neutrality. The CDFA is also skilled at analyzing and examining the future impact of any financial settlement on the couple as individuals as well as the children, to ensure post-divorce financial well-being.

The tax return, of course, will reflect the reported income of the family, including W-2 wages, bonuses, and self-employment income.  However, issues of unreported income aside, the tax return may also indicate other important facts that can have a significant impact when making income or asset calculations.  For example:

  • If a divorcing spouse works for a company that provides employee life insurance, the employee is taxed on any premium amount over $50,000.  The Neutral Financial Specialist needs to review all employee insurance benefits, including health and disability, to get the complete picture.
  • Certain corporate benefits, e.g., pension benefits or stock options, should be analyzed. Contributions made to an employer benefit plan may reduce income and may need to be added back to the taxable W-2 income, as all income is examined on a before-tax basis.
  • If contributions are made to an IRA or SEP retirement plan, the discretionary nature of these contributions needs to be considered.
  • If a spouse reports self-employment income, some deductions, e.g., depreciation of equipment or a car, should be added back to the gross income to get an accurate picture of available income. The Neutral Financial Specialist will ask about other benefits the self-employed person may be putting through the business to reduce income taxes.
  • A penalty for early withdrawal of a retirement account may indicate the family is living above their means. This knowledge can impact post-divorce financial planning.
  • A deduction for medical expenses is a telling detail that should be reviewed further.  Medical expenses must exceed 7.5% of adjusted gross income in order to be legally deducted from gross income. Special attention should be paid in the divorce financial planning process to accommodate these medical needs.
  • If one party is paying alimony/maintenance to a spouse from a previous marriage, such payments may reduce the income used to calculate child support.
  • Gains and losses reported on investments and dividend income can reveal key insights about the couple’s finances. However, market conditions affect performance as well and should be considered. The Neutral Financial Specialist will determine if the stock market has been good or bad, how investment decisions were made, and if interest rates were high or low. They will look for any “loss carryover” from prior years, a valuable piece of information for income tax and asset-planning purposes.
  • Declared losses, such as for gambling, can reveal a wasteful dissipation of assets that should be addressed.

With the help of the attorneys and CDFA, the couple will better understand their financial picture and obligations, and be equipped to come to a more equitable settlement.