As an attorney and author who has written and lectured extensively about the tax aspects of marriage and divorce, I frequently receive questions from couples contemplating marriage.
One of my standard recommendations is that they consider the tax consequences beforehand, especially when one of them or both of them are remarrying. My advice: Before they commit to a walk down the aisle, each should consider whether to ask the other for copies of tax returns. In my experience, it's particularly important for women to do that.
To illustrate how I would advise them, let's say it's going to be a second or third marriage for both John and Marsha -- something that's not uncommon nowadays.
Something else that's no longer uncommon is that her holdings considerably exceed his. Possible reasons why she's wealthier? Much-married and several-times-widowed Marsha inherited assets from her spouses; or a couple of divorces resulted in her receiving several sizable settlements; or she was one of the Facebook staffers who were enormously enriched by its initial public offering.
Mindful of the possibility of divorce, Marsha had John assent to a prenuptial agreement (just as she did in advance of earlier marriages). What else might Marsha do? I counsel her to ask for copies of John's federal and state returns. Depending on what they reveal, she might decide that it's prudent to stay single or, if they do wed, to file separate returns.
Following are summaries of scenarios I created that, albeit unromantic, are based on actual events.
Fear of filing: It turns out that John hasn't filed returns, something that's common across all levels of society. It's vital that Marsha know his potential liability for back taxes, penalties and interest. Also, he must specify when he will file returns and arrange for installment payments that will square him with federal and state tax agencies.
My advice, should Marsha wed: She files separate returns and doesn't mix her assets with his assets. Also, she asks John to fill her in on what other shoes might drop.
A less troubling scenario that's nonetheless problematic: While John has filed 1040s, he owes considerable amounts in back taxes, and interest charges continue to mount. Marsha's tactics, assuming they wed: Again, file separately and not comingle assets until he has squared accounts with the IRS. There's a snag if they file jointly and are due a refund; the IRS can apply the refund to his back taxes.
John has filed returns and owes no back taxes: Marsha should still scrutinize certain deductions and other items on his returns. Let's focus on some of the easier ones.
Alimony payments: John's returns reveal that he makes alimony payments to his ex-wives that he didn't mention to Marsha;
Dependency exemptions for children not living with John due to divorce or separation: A divorce settlement (or settlements) allows him as a noncustodial parent to claim such exemptions. He never told Marsha about those children;
Gambling: John's returns show substantial amounts of gambling winnings for "other income" on line 21 of the 1040 form. Those returns also show offsetting deductions for gambling losses on line 28 of Schedule A. Losses are deductible only up to the amount of winnings. Does he have nondeductible losses that far exceed winnings? Perhaps the amounts wagered indicate that John gambles compulsively;
Schedule C: John files a Schedule C for his dental practice. A cursory review of amounts entered for business receipts and expenses suggests he's understating gross receipts and overstating expenses. Whereas dentists in his area typically claim expenses equal to about 50 percent of gross receipts, his expenses equal about 75 percent of gross receipts. A plausible explanation for the discrepancy is that John doesn't deposit currency payments received from patients into the practice's bank account, and he tells his accountant to use bank deposits to calculate gross receipts. Is John trying to pull one on the IRS?
Schedule A: Line 4 shows he claims hefty itemized deductions for medical expenses (allowable to most persons only for the part above 10 percent of adjusted gross income). Deductions could be easily explained as attributable to payments for insurance premiums and expenses usually not covered by insurance -- for instance, dental work, hearing aids, glasses, medically required home improvements or private duty nurses. Or the reason for substantial write-offs might be that, like Tony Soprano, John sees a shrink several times a week. Not to imply that there's anything wrong with those visits; still -- like the restorative powers of chicken soup -- it can't hurt and might help for Marsha to determine how much John has in common with Tony or, worse yet, Norman Bates.
Donations: John's a chintzy contributor, whereas Marsha is a generous giver. This may not be a deal breaker, but they should discuss charitable donations before marriage.
Withholding: Each year, John receives big refunds, deliberately as a form of forced savings or simply by neglecting to claim enough exemptions on his W-4. But interest-free loans to the IRS are anathema for someone like Marsha, who meticulously monitors her withholding from wages and outlays for estimated payments. Her returns may show small balances due. It's preferable that they discuss before marriage how they'll handle withholding.
In the midst of all these thorns, there are some roses. Assume John has a substantial capital loss carryforward and no unrealized capital gains. At $3,000 a year, it will take many years to use up John's carryforward. She, however, has a substantial unrealized capital gain. Marriage means Marsha can realize the gain and offset it against John's carryforward.
Similarly, suppose he operates a business that's unprofitable. He has a hefty net operating loss carryforward; but not enough other income to absorb the carryforward. Marsha has sizable income. Marriage enables him to apply his carryforward against her income.
Julian Block writes and practices law in Larchmont, N.Y. He is frequently quoted in the New York Times, the Wall Street Journal, and the Washington Post, and has been cited as: "a leading tax professional" (New York Times); "an accomplished writer on taxes" (Wall Street Journal); and "an authority on tax planning" (Financial Planning Magazine).
His tax guides include "Tax Tips for Marriage and Divorce," "Easy Tax Guide for Writers, Photographers, and Other Freelancers," and "Home Seller's Guide to Tax Savings." For information about his books, go to julianblocktaxexpert.com.