While consumers generally hate income tax returns because of their complexity, they can be invaluable sources of information in divorce proceedings. Not only do they provide insight into prior years’ earnings, they can also point to assets and sources of income. They may be used to unearth financial information that a spouse omitted from the financial disclosures, and can hold subtle clues to otherwise unknown financial details.
For example, assets are sometimes sold by the spouses to generate cash. Many times this may be a taxable transaction reported by the purchaser to the taxing authorities. Therefore, such a transaction will be required to be reported on the income tax return, and this may help unearth a hidden asset or provide clues to concealed cash.
Information on income and assets can be found within the personal income tax returns in the following areas:
- Form 1040 – The first two pages of the personal income tax return will show a summary of the taxpayer’s income, including wages, interest, dividends, capital gains, and income from businesses and investments.
- Schedule A – This form shows itemized deductions including medical expenses, real estate taxes, mortgage interest, charitable contributions, and more. Of particular interest are the deductions related to real estate, as these could lead to the discovery of previously undisclosed assets.
- Schedule B – This schedule shows interest and dividend income, and might help identify bank accounts, investment accounts, or other income-producing assets.
- Schedule C – Income from a sole proprietorship is reported on this schedule. A business reported on Schedule C may have a stream of income that must be considered, and may be an asset that should be valued.
- Schedule D – Capital gains are reported on this form. It includes gains or losses on stocks, bonds, and other traditional investments, as well as gains or losses on real estate or other assets. The dates of acquisition and sale of assets will be on this form, as well as the cost basis of the investments.
- Schedule E – This form is used to report rental income and income from investments in “pass through” entities, such as partnerships, LLCs, and S-Corporations. Income from trusts and estates will also be reported here. The items shown on this schedule can be important because they may indicate valuable assets or streams of income.
- Schedule F – Income from farming activities is reported on this schedule.
These forms are the most common, but there are many more that could be included with a personal tax return. In addition to these forms and schedules, the income tax return may include supporting schedules and worksheets that may point to assets and sources of income. Documents in support of numbers reported on the schedules may also be attached to the tax return, and these might include W- 2 wage statements, 1099s, and K-1s.
When examining income tax returns in a divorce, it is important to make sure that all relevant forms and schedules are disclosed in discovery. In addition, any amended returns should be produced, and proof of payment of tax liabilities or receipt of tax refunds should be disclosed.
Ideally, the family lawyer will have the assistance of a qualified accountant who can evaluate the income tax returns to ensure that all schedules were produced, and to interpret the data and look for important financial details.