Among the many things that astonished me as I began practicing divorce law, were the stupendous number of people who openly and flagrantly cheat on their taxes and, apparently, never get caught.
First, there are massive numbers of folks who just don’t report all of their income. I think this seems to hold true for anyone in a cash business. Think mom and pop (or larger) stores, gas stations, car washes, landscaping businesses, etc etc.
Next, there are also those folks who take imaginary deductions (as opposed to imaginative deductions). These deductions can be amazing in their scope. Travel expenses for trips that didn’t occur, costs of goods sold that hadn’t been purchased, all phantom deductions.
Then there are the businesses who run personal expenses through the books. The family’s personal expenses are paid on a business credit card; the family cars belong to the business; gasoline and repairs for the cars are paid by the business; everyone’s cell phones are covered too. Additionally, there are often kids on the payroll who have never set foot on the premises, but are earning five, ten, fifteen thousand dollars a year.
In many cases, the spouse may know that cheating is going on, but seldom knows how much is being taken or exactly how it is being done. This obviously presents a problem for calculating support (and the value of the business) in divorce cases. It also presents a problem for both the husband and wife with the taxing authorities if the case goes to trial. In Massachusetts, judges are required to turn folks in to the IRS if the judge has proof that the income has been under-reported. This means that if the judge hears evidence that she believes proves that tax cheating has occurred, she is required to turn the individual(s) in.
The best protection for the spouse is to have never signed a joint tax return with the cheater. I usually have my clients stop filing jointly if there is any question of illegality (or even a question of under-reporting) going on, but this only protects for the immediate past. To be truly protected, the spouse has to satisfy certain IRS qualifications, and this past summer, the IRS actually broadened these protections for the so-called “innocent spouse.”
The threat of being reported to the IRS by the judge, implicit in cases where fraud has occurred, has caused many a settlement on the courthouse steps.