Family Matters with Reese Law Podcasts
Episode 7: Family Law Tax Matters
Mary Szpanka, CPA has been serving the Washington DC Metro area for over 40 years. She has received numerous awards and recognitions for her distinguished technical and interpersonal skills. Mary Szpanka, CPA provides tax advice, planning and preparation and accounting services for individuals, small and large business (sole proprietorships, corporations, partnerships), trusts and estates. Mary also provides in-depth financial guidance to couples or individuals going through divorce.
Catherine Reese: Good morning, I'm Kate Reese with Reese Law, and as the law firm, of course, there is a disclaimer involved in the podcast. The material in the podcast is not offered, nor should it be construed as legal advice. The material in our podcast has been prepared and published for informational purposes only. You should not act to rely on information contained in these materials without specifically seeking professional advice first.
Welcome to Reese Law. We are a family law firm based in Fairfax with an office in Prince William and we practice Family Law. In episode seven of our podcast, we will be talking with Mary Szpanka. Mary is a Summa Cum Laude graduate in her field and is a certified public accountant with over 40 years of experience in the D.C. metro area.
She has been named Outstanding CPA of the Year by Virginia Society of CPAs. Mary focuses on solo practice of tax issues and divorce, financial guidance and the collaborative process, as well as traditional settlement and litigation matters. Today, we are going to be discussing aspects of tax law, the interface with family law.
Hi, Mary, thank you for joining us at this very busy time. I know tax season's already kicked in. First of all, filing status; a lot of people are confused about what they can or can't do, especially if they're separated, but not yet divorced or there are children in place. There are options for people in both groups; married and unmarried. Correct?
Mary Szpanka: That is correct. For tax reporting; it's very important to understand that your marital status as of December 31st controls the entire tax year. And what I mean by marital status is when the court has actually decreed the divorce. So if that court has not set the decree, you are still married on December 31st and you have choices how to file your tax returns.
So let's take them separately. Let's say that you are married on December 31st, there are choices and each spouse needs to make his or her own choice how to file what is best for them. First of all, you're married. You may file jointly with your spouse. Bear in mind, when you do, that you are separately and separately liable for everything reported on that tax return, including any taxes due. The second choice is you can file separately reporting only your income and only your deductions, the tax rates are higher and that's what's important.
But that may be your choice if you don't want to take responsibility for your spouse's income or deductions. The third choice is if you qualify as a head of household filing status, your rates are even lower. But you have to meet the qualifications. And those in brief are you must have one or more qualifying dependents that are legally related to you, you must have been living in separate quarters from your spouse for the last six months of the calendar year, and you must have paid at least half of that household expense in order to claim head of household status.
So let's say that you are divorced on December 31st, then for that whole taxable year, you may file singly or if you qualify as head of household, as we talked about above, then you can file head of household status.
Catherine Reese: Okay, so deductions, I know they can get messy if people try to claim things they shouldn't claim. But just what are the rules that pertain to the filing status and deductions?
Mary Szpanka: Okay, all right, so let's say that you are married and you have that choice, as we talked about above, you can file jointly or if you're filing separately, then there are different sets of rules and you need to be aware of those because married filing separately can reduce or absolutely eliminate some of the tax benefits that you are eligible to have if filing jointly. For example, both must file a standard deduction or both must itemize. You can't pick and choose one or the other. The child care credit is only allowed for the custodial parent. If your income is largely different between the spouses, the spouse with the larger income will pay much higher taxes filing separately.
The child credit can only be claimed by the parent who has the dependent child.
Catherine Reese: Okay, does Virginia have an exemption deduction?
Mary Szpanka: Virginia does, unlike the federal, which is a temporary exemption for the children of zero. Virginia has an exemption deduction of $930 per person on the return.
Catherine Reese: So is there no federal rule on exemptions or what can you tell me about; everybody thinks this federal exemption focus?
Mary Szpanka: Well, the tax law that was passed December of 17 set the federal exemption deduction at zero, but that is temporary laws that will what we call sunset in 2025. But claiming dependents allows these other benefits, like the child credit, child tax credit and so forth.
Catherine Reese: So if parties don't file jointly, filing separately instead, how are the deductions divided up other than the ones that you mentioned?
Mary Szpanka: Okay, first of all, it’s very important for the parties during the transition, during negotiation status to really sit down and talk about who's going to claim what income and what deductions. Obviously, earned income is personal to each spouse. Well, let's talk about the deductions.
First of all, to take a deduction, it must be an expense that you're liable to pay. Number two, you need to have paid it.
Catherine Reese: That makes sense.
Mary Szpanka: Some people just forget that. And I think we'll probably talk in a minute about what if it's from a joint account?
Catherine Reese: Exactly. That was my next question. So if you're dividing income and deductions from a joint account, who has the right to claim what?
Mary Szpanka: Okay, actually, both have the right to claim those deductions because a joint account may have been funded mostly by one spouse or the other. But under federal law, tax rules, a joint account really is owned by both spouses. So here again, I emphasize the spouses really need to discuss these items during the negotiations before they file the tax returns. Having said that, if there is no property settlement agreement or temporary agreement on these issues, it's common not required, but common to split joint income, for instance, interest income, dividend income, usually equally doesn't have to be. However, strictly income, cash it out and really, that spouse is the one who should be reporting the income on his or her tax return.
Catherine Reese: Clearly, then you would hope that they wouldn't even question the fact that that's the way that would have to work now.
Mary Szpanka: But they do. I would like to make one big point here is that sometimes deductions are only in one spouse's name. For instance, it's not so common, but you may have a mortgage in only one of the spouse's name, but both spouses own the property. So we have situations there where there is an exception to the normal rule. Where it says where you need to be liable for that mortgage, but if the spouse who is not on that mortgage owns the property, he or she has what we call an equitable interest, we care about paying that, and so the law does allow a deduction for his or her share of the mortgage interest and real estate taxes.
Catherine Reese: And is that pretty much how capital gains would work if they sold the marital home? Not that it really matters who's on the mortgage, but the fact that it was the marital home and it's titled Tenants by the entirety. Some people want to do pro rata, meaning I made 60% of the income. I should get 60% of the assets but they never think they should get 60% of the debts. I don't understand that math exactly. But capital gains, anything particular to know about that other than the fact that, yes, you have to count it even if you moved out of the house?
Mary Szpanka: Well, if I say yes and no, and our favorite answer to any question, family law, tax law is it depends.
Back again, I want to emphasize the spouses really need to talk about this part of the negotiations and have it in the property settlement agreement. So let's do an example, let's say that the joint parties, both spouses, do sell the marital home, and they, for instance don't agree on how to split it, then it is often a 50/50 situation.
But what happens often enough is that the sale of the marital home has been deferred after the one spouse has moved out and the other spouse remains in the home and that remaining spouse pays the mortgage, then the pay down of that mortgage is disproportionate and needs to be addressed in the property settlement agreement. The law does not say you have to report 50/50 on reporting the sale. So put it in that property settlement agreement, very important.
Catherine Reese: And in fact, there's statute and law in Virginia that says does the person who continues to make the payments get a benefit or not? And there's a test. And they have had to have done other things as well, like be able to prove that it came from their individual income, because if they paid it with marital money, then they were just the vehicle and not the source that comes up. But you've got to always make sure that that issue of the proof is pursued rather than just handing over the money.
But that's part of what the attorneys do and of course, part of what the financials are familiar with. So if there's no mention in the order or agreement about cap gains, then it's kind of like the other areas that we've talked about where it's a free for all and if they can't reach an agreement, the IRS will catch it; it’s a question of when they will catch it and how long it will take it to get fixed. But it's a problem because the IRS never sees the husband and the wife as two separate beings. They pretty much always see them as being one unit, one unit who has one tax bill, one unit who has one house, et cetera. Am I right about that?
Mary Szpanka: Well, you are, unless they file separately and of course if they own joint property, then yes, then it's joint by definition, joint property and both need to report his or her share of whatever capital gain, interest, income and so forth.
Catherine Reese: Well, let's talk about children for a minute. I'd like to know about who gets to claim the credits and the exemptions and what children qualify? So that's kind of a double question. Let's just take the first part.
Mary Szpanka: All right, claiming of the children here again, I want to mention again that federal tax law right now is a temporary deduction for the children. However, it does allow the child credit, the child tax and child care credit and so forth. So it is important. So who's a qualifying child? Must be legally your child- critical element. It could be an eligible foster child. The child needs to be under 19 or if a full time student under 24. Who’s a full time student? It's a student who attended school five months during five months of the year.
It could be January through May graduated on May the 4th, but technically met the rules. And if the parent provided the support for the child through the whole year, then that parent gets to deduct the exemption for the child. If the child is disabled, the child needs to live with the taxpayer here again. Unless the agreement is in the property settlement agreement, the child cannot provide his or her own support. Now it's the parents providing the support and the child cannot claim they cannot file a joint return with somebody else. In other words, the child got married in September after graduation, then the parent says, “Well, wait a minute, you’re just eliminated my exemption deduction.”
Catherine Reese: You owe me some money.
Mary Szpanka: You owe me some money. Thank you very much for the college tuition.
Catherine Reese: I appreciate it a lot. All right, let's see as far as what happens if the other party claims deductions. I've seen this in my practice a few times, and I remember the IRS really wouldn't take a position.
It took a long time to get it resolved. So when that happens, what should people do besides run to you? That's what I would do if I did my thing.
Mary Szpanka: Get a professional to represent you. Well, let's take a situation where I'm not going to pick on dad, but let's just say that dad decided that he was going to claim all the children and he took all those benefits, the child credit, the child care credit, everything that goes along with claiming that dependents. If you notice on your tax return, you put the child's Social Security number. And the reason for that is now mom filed her tax return. Her return will be rejected. And the audience will get back to her saying, can't claim children or just says these children have already been claimed. What happens then? The mom and dad get to get into a battle.
Let's take an example of the mortgage interest. Mortgage interest is reported to the IRS on form 1098. And so let's say that mom took all the interest deduction and then dad decided he was going to take some. You will get a notice from the IRS saying, “Hello, guys. There's too much being deducted according to this form 1098.” And here again, it's not for the IRS to decide. It throws it back to the couple. You go back to your attorneys or they need to agree, how are you going to resolve this and then file amended returns.
Catherine Reese: I think people are often surprised that the IRS doesn't fix it for them. But think of the quagmire. You've got to get involved with the opposing side and come to a resolution and everybody has their own theories on why they should get to claim what they want. Now, we did have a change on spousal support law not that long ago, right?
Mary Szpanka: Yes, we did. Major change.
Catherine Reese: It caused a lot of panic and havoc because it used to be that and I'm just going to be sexist for the purposes of this example. So let's just say that the husband makes more money than the wife and that he has to pay the support and he used to get to deduct that from his adjusted gross income, which reduces taxable income and caused him to have less taxes. But the wife would have to claim it as income, even if it was the only line item on her tax return. Sometimes people have thought they didn't need to file because they didn't have a job, didn't have an income source, but they had an income source. It was the spousal support and so they'd have to claim that. So rather than getting, say, $7,000 a month in support, you're actually getting. This is not five, because you have to pay the taxes at some point, either estimated or at the end of the year, that you could have penalties or interest if you don't do estimates, right
Mary Szpanka: That's correct.
Catherine Reese: So now it's treated like child support where all the spousal support is paid with after tax dollars, just like child support, and then the person receiving doesn't have to claim either of those, right?
Mary Szpanka: That is correct. The law that was passed December 17 said that all agreements not decree, but it says agreements that were settled after 2018, that the spousal support is nondeductible nor taxable by the recipient. Child support never was deductible taxable income just to make a differentiation there.
Catherine Reese: Now, is there a sunset provision related to that? I know everybody was hoping it was going to be around for very long.
Mary Szpanka: Not yet there was not a sunset provision on that in that part of that law and it won’t change.
Catherine Reese: Well, in fact, the courts have adjusted for it in that many cases that I've seen and it's been reported what they may do is choose to give more money to the recipient or less money to the recipient. And in this case, it would be less money to the recipient because they don't have the tax obligation anymore. So you're saying I need $10,000 a month, and if you're including your taxes and you pull that line item out, you only need $8,000 a month, for example. So the courts have been adjusting. So I don't know how long that will continue. I think that was just in relation to the shock of what transpired there.
Let’s see; I think we talked about if an asset is only in the other party's name, the income got to be divided by the property settlement agreement or court order, even though the 1099 is another spouse's is in one spouse's name. And what are the rules about amending tax returns? Because here's my thought, tell me where I got this wrong. I was an accountant a long time ago. For one thing, you have a certain period of time that you have to amend, and then the other thing is that you can only go backwards in one situation. Like you can file married, filing separate and then jump to married filing joint. But you can't go backwards. Am I getting that right?
Mary Szpanka: Right, and you have three years after the date of filing or due date, whichever is later on in order to amend those returns.
Catherine Reese: What if the amendment is to the benefit of the IRS? Do they give you more time?
Mary Szpanka: No, three years for them to change your return or for you to change your return.
Catherine Reese: Yes, because it's expected that once that there's a problem, that you're going to do something about it and you get it addressed. That makes sense. That's a fair amount of time. And it's enough time to negotiate a new resolution where there hasn't been one. Now, the term innocent spouse, that is a tax term, you can file as innocent spouse. We were talking earlier about filing joint returns, if you want to, with regard to their income, but if you think that there is some shady business dealings or whatnot, you might not want to sign on to that. But what exactly is innocent spouse and how much protection does it really give you? That's a complicated one probably.
Mary Szpanka: It is a complicated one, but the tax law and the tax code are pretty clear about defining what qualifies as an innocent spouse claim. So it's not really return. It's a claim. And what the law says there is that if your spouse had unreported income, that no one you had no knowledge of the income nor benefited from that income, and that's the hard to prove element. But if you had no reason to even have any idea that this income was there that was unreported, then you qualify to file a claim. That doesn't mean you'll prevail. It just means you can file the claim saying there was no way I knew she dealt with drugs. She had all this income, but we lived in a two hundred thousand dollar home and I didn't get any diamonds, whatever. So the idea is had no benefit from that.
Catherine Reese: Yes, because that twenty thousand dollar necklace went with his job salary of forty thousand dollars.
Mary Szpanka: It’s hard to prove sometimes.
Catherine Reese: I always refer people to specialists such as yourself for these complicated questions, because what about the fact the mortgage was being paid and the roof over the head, it's really hard to say you got no benefit. So the question often seems to come down in the legal world to knowledge. What was your knowledge? When was your knowledge obtained and what did you learn at that time? And usually you find that the people had suspicions along the way but they didn't ‘know.’ So it's quite interesting. So in the end, what is the best way to have a clean tax return? Because really nobody wants to fight with the IRS, we just we sit there, their initials on an envelope and we're like, “Oh, my God, we don't even know what's in the envelope yet.” But right before opening the envelope, should I open it addressed to you? Yes. Then yes you should.
Mary Szpanka: Yes you should. Do not ignore notices from the IRS. Yes, it's scary, as you said, do I open this up? “Oh, no. They're the enemies after me.” Not only open the envelope, but address what it's asking you to do, if only to say, “I got your notice, I understand there's an issue and I'm working on it.” let them know that. You don't need to say any more at that point, but just let them know. Oh, I recognize there's an issue here. So I've emphasized before and I'm going to underscore it one more time, it is very, very important to talk about the tax issues during your negotiation with your attorneys.
Put them in the property settlement agreement. You can't probably address every single situation, but certainly the PSA, the property settlement agreement, should address prior tax returns in case they get challenged, should address who's going to take what and recognize what income during the transitional years. And, for instance, claiming the children after the divorce is final. Very important to address these items with legal counsel or have the court addresses it in the final hearing and gets these items settled before you file the tax return.
Catherine Reese: Yes, and it's not that hard to do in the process, especially in the collaborative process, because the information flows very easily between the parties and we learn about the parties goals, individual goals and joint goals. And that helps us get to a fair outcome because it's really kind of hard to say in a negotiation. I'll do 50/50 on everything under the sun, but no, the tax paying that's all on. Nobody does that. They're either in for a penny or in for a pound to get things resolved. And the taxes, when they're left out there hanging in the wind can cause terrible problems because the parties may completely disagree, but thought the other party understood. You know, I made all the money.
So I'm, of course, going to claim everything. Why didn't you know that? Well, it's not the law. It's a theory. And so it needs to be hashed out and discussed or the kids are with me more. So therefore, I should get to claim them all the time, even though the other parts that you mentioned have not been met. So it does really need some clarification.
Well, I want to thank you for being our guest today and sharing your knowledge on tax considerations. And thank you for joining us on Family Matters with Reese Law. We'd like you to subscribe to our podcast. It's on channels that you'd never miss an episode. You can also visit our website at reeselawoffice.com.
You can contact Mary at our Fairfax office; 703-864-8027. Or you can reach her at firstname.lastname@example.org for more information about tax planning and resolution of tax matters and how you can best work with a financial neutral or as having her as your own expert in a case to make sure matters get addressed. Because Mary does not just collaborative law like Reese Law, but she also does litigation work as needed as we also do. There's really not an area family law or a case in family law that doesn't have some sort of tax consequences to it. And it's important to understand that because you don't understand the bottom line of the deal you're getting if you don't address the tax portion.
So thank you very much for joining us. For Family Matters today with Reese Law, I'm Kate Reese. Have a wonderful day. Thank you.