The Role of 1040 Attachments in Matrimonial Disputes

Federal Form 1040 is the standard personal income tax form filed by US taxpayers, which details a variety of important information about a taxpayer’s financial condition for the tax year. Depending on individual circumstances, the IRS requires additional forms and schedules to be attached to Form 1040 when filed. In matrimonial disputes, where income determination and asset tracing play key roles in calculating alimony or the distribution of assets, it is important to know what these attachments may indicate about an individual’s finances during the year. It is also essential to understand what requests or inquiries should be made of the client based on the information in the tax return and what an expert will likely be looking for if one is engaged. Below are some common attachments to be aware of and how they may impact income and asset analysis in a divorce setting:

Schedule 1

Schedule 1 is frequently an attachment to the 1040 and provides an overview of any income and adjustments not generally listed on Page 1 of Form 1040. Further inquiries or documentation may be necessary to understand the nature of income received based on a review of this schedule. Some common items on this schedule include, but are not limited to, gambling winnings, stock options received, unemployment earnings, debt cancellation, and income received from businesses, including “pass-through” entities. Records requests should, therefore, be tailored accordingly.

Schedules C & E

Generally, if business income is included on Schedule 1, a Schedule C or Schedule E will also be attached. Schedule C documents business activity from sole proprietorships. Although these businesses may represent secondary sources of income for an individual, some organizations will continue to be reported on a Schedule C even as they grow in scope. However, business owners often adopt different entity structures through incorporation or partnership formation, often as a company scales. Details of the business income for these types of entities are reported separately on corporate (1120, 1120S) or partnership (1065) returns. Earnings from S Corporations and partnerships will be recorded on the individual’s Schedule E. Schedule E also documents income from passive sources, which includes income from rental real estate and pass-through entities. If either of these schedules are present, it indicates that the individual is earning income from sources not reported on their W-2s. Requests for additional information such as corporate or partnership tax returns, business bank account statements, financial statements, governance documents, and Schedule/Form K-1s are recommended.

Schedule B

If the individual holds financial assets, such as stocks or bonds that generate dividends or interest, Schedule B may also be attached. Though income found on this schedule may not be significant in isolation, its existence can indicate potentially undisclosed assets and have implications on premarital assets or potential dissipation claims. The value of these investments is not immediately evident by the amount of interest or dividends paid but demonstrates the existence of assets the taxpayer owned during the year. Document requests should thus include investment and brokerage statements, and additional inquiries should be made about the timing of when such investments were made and current balances verified.

Schedule D

If the taxpayer sells capital assets, gains and losses from the sales will be reported on Schedule D. Depending on the volume or type of activity, Schedule D may be supported by Form 8949. Similar to Schedule B, Schedule D can indicate if disclosures about asset holdings have been transparent or if any omissions need to be considered. Activity on Schedule D may also be important in examining premarital asset or dissipation claims, depending on when and how the assets were acquired. If the asset was purchased before the marriage and remained isolated from marital assets throughout, the party may be able to make a premarital asset claim. Conversely, if Schedule D shows that one party sold an asset purchased during the marriage and the individual does not disclose how the proceeds were used, the other party may be able to pursue a dissipation claim. Document requests should generally include all personal investment statements. However, in the case of other types of capital assets (such as vehicles or real estate), related sales records should also be requested. In some instances, engaging a forensic accountant may be necessary for asset tracing.

Form 4797

While Schedule D documents the sale of personal capital assets, Form 4797 documents the sale of business property. The form also covers property exchanges and gains or losses from certain dispositions from partnerships or S corporations. Inquiries into the nature and purpose of these sales can help assess the individual’s business interests and related income stream. The form can also be a clue into whether or not a major change in the business has taken place, particularly if there were critical business assets that were sold or otherwise disposed of during the year. These types of transactions can substantially impact the earning ability of a spouse or the valuation of their business in a marital dispute.

Form 8959

Taxpayers filing jointly, together earning above $250,000 ($125,000, if filing separately) in Medicare wages and self-employment income, pay an additional Medicare tax and would file form 8959. If this form is attached, it can provide insight into whether or not all W-2s have been provided and sources of income disclosed. Taxpayers earning below the threshold do not pay this tax, so if documentation received does not indicate at least this level of earnings even though this form is attached to the return, additional inquiries or requests may be necessary.

Though these represent some of the most common attachments to personal returns, they do not constitute an exhaustive list. Each taxpayer is different and has a unique financial situation to be considered, which has varying consequences in marital disputes. Forensic accountants and business valuators, like Marcum, can provide guidance to identify the potential financial issues involved, value a business owned by a spouse, or quantify income in a marital dispute.