Episode #119: Tax Implications in Divorce | Interview with Tax Attorney Hubert Johnson

Brian Walters: Thanks for tuning in again to For Better, Worse, or Divorce Podcast, where we provide you with tips and insights on how to navigate divorce and child custody situations. I’m Brian Walters, and today I’m happy to be joined by Hubert Johnson. He’s the founder of Guardian Tax Law. He’s a former prosecutor, tax attorney, and also a lecturer for tax professionals. He’s handled thousands of complicated tax cases and has represented clients before the Department of Justice, FBAR, large business cases, and complicated IRS and state tax issues.

He’s here to do a deep dive on tax issues and family law, and we’re excited to have him today. I should note he’s an attorney, not a CPA. Like I’m an attorney, not a CPA, so this isn’t tax advice per se, but it’s more of a discussion of pitfalls and things to be on the lookout for in a divorce or child custody situation when you have taxes. So welcome, Hubert. Tell us a little bit about yourself. Where do you live and practice? Give me something interesting, “I was on law review at law school,” or something that only lawyers would be interested in. So tell us a little bit about yourself.

Hubert Johnson: Familiar with divorce, I’ve actually divorced twice and remarried my first wife, so life is fun to say the least. Something fun, my first divorce happened because my first wife had a full-on mental breakdown a month before the bar exam, so I ended up taking the bar. We were in Idaho at the time and then had to move back to California, and I had to retake it. Then I took the California bar, and so I’m done taking bar exams.

Brian Walters: I’m like you. One in Texas, and that was plenty. And I’ve had chances over the years to, specifically in California, to either practice out there or take the bar out there, and I have opted not to. My first law partner took them both. His family’s from Southern California, and he went and took the California one and came over and took the Texas one. I think there’s part of it that is the same MPRE or whatever it is, but he got them both out of the way and then ironically never practiced law in California at all, and now doesn’t practice law anywhere. He’s just in business. So that’s not a fun experience, I would say. So glad you’re done with it. Are you guys in Idaho or California, or somewhere else?

Hubert Johnson: We’re actually in Tucson, Arizona, and I still have my license in California, but we practice all across the country since it’s federal law. And we also help with state taxes. And most of the states, only Oregon and Washington, insist we be licensed in the state, and that’s the same for CPAs and the professionals.

Brian Walters: Yeah, exactly. I went through Tucson a couple of years ago and spent the night there. It was a really, really pretty place. Like Texas, probably better in the spring, fall, and winter than summer, but still a nice place for sure. Well, let’s talk about what happens. For taxes, mostly we’re talking about divorces. There are some issues that could come up. I’ll deal with those toward the end, about if you’re not married and you just have a child together, and how child support or those types of things might be tax-related.

But when you’re going through a divorce, my experience with it is that there have generally been two kinds of situations that can cause problems. The most common two I should say, which are when there’s a business entirely or partially by one or both of the spouses. And then secondly, when there is an issue with an unpaid tax liability that’s either known or could be unknown, there are some others, and we can talk about those, but let’s start with those two. So maybe just a discussion if that’s been your experience, that those are two of the most common issues when you’re going through a divorce and having to deal with those.

Hubert Johnson: Sure. Absolutely. So starting with the business, as you mentioned, when people own a business, the other partner usually has no idea what’s going on.

Brian Walters: Right.

Hubert Johnson: And it’s very common for the owner not to have a clue what’s going on either.

Brian Walters: Right.

Hubert Johnson: So if you are heading into a situation where you’re looking at divorce, my number one advice is get good information, get it early, and especially if you have a CPA or someone that’s looking… that’s been their CPA for a while, and sometimes it’s a CPA, that’s a problem. Two people hang on to the same CPA for too long, especially if you’re going into a divorce situation, get your expert. Have someone take a second look at what’s going on. And if your partner won’t disclose to you what’s going on, that’s a huge red flag, and the best way to avoid that is to file separately. Not everyone knows you can file separately even though you’re married and living in the same home. But if you suspect there’s going to be some massive tax issues down the road from your partner, filing separately can save you so many headaches down the road.

Brian Walters: Right. And just so people are clear, I think this is probably especially useful if you’re married to someone and you don’t really know too much about what’s going on with the case or with their business. I see several things that happen. One is that a person’s identity is often tied up in their ownership or involvement in a business. And so there will be situations where let’s say the husband’s the business owner and the wife is, like you said, generally not that involved, and it’s not her day-to-day thing. I’ve seen it happen both ways. I’ve seen husbands in this scenario come in and say basically over the years, exaggerate how well the business is doing, sort of, “Hey, look how great I am. Look how successful I am.” Maybe it’s a sense of optimism about where the business is going.

Maybe it’s just wanting to pump yourself up, but I see that occurring sometimes. And the problem with that is that then the spouse comes to me and says, “Well, this is a super successful business, and it should be worth a lot of money, and I’m going to be set once we get divorced.” And we look at the situation, and maybe that’s not the case. Maybe the business hasn’t been doing well or hasn’t been doing well recently or has been sucking all of the cash out of the business to maintain a lifestyle that isn’t really justified and now there’s a business with a bunch of debt. So let’s say in that particular situation where you’ve got a business not performing as well as hoped for. Maybe even carrying tax liability, what’s something that someone should be concerned about in a divorce when that’s going on with the business?

Hubert Johnson: Well, first of all, that debt will follow them personally. So, sales tax is the number one thing. Sales tax will follow the owners and the people tied to the business personally. Secondly, payroll taxes, half of which can be assessed to the owners or the people responsible personally. And if you’re filing jointly with your spouse, you will be held responsible as well. So getting that information and making sure you are not going to have to pay out of pocket for this is very important. And the IRS doesn’t care what’s in a marital settlement agreement. If someone says, “I’ll pay the taxes,” the IRS is still going to go after both people ’cause you’re both responsible.

So, making sure that the taxes are paid, that the business is on track, or divorcing yourself from it, completely stepping away, is the best way to go. Too many people hear about this innocent spouse, and they think, “Oh, I’ll just apply for that.” Huge problem. Most people do not qualify. To qualify as an innocent spouse, you really need to have not seen the money, not benefited from it. It doesn’t matter whether you knew or not that the taxes were paid. If you benefited from the money coming into joint accounts, you’re going to be held responsible. But if someone’s taking that money and using it for their personal use outside of the family and the home, and you never see a penny of it, that’s where an innocent spouse can come in.

Brian Walters: Yeah, I agree. And just to go into some of the background of this, ’cause some folks may not be that familiar with it. Let’s say you’re an employee of a company and you make $100,000. Well, the business that they work for has to take out and send money to the IRS. And so generally at the end of the year in April, you square up and you might owe a little bit or get a little bit of a refund, but you’re generally in the same ballpark. It’s very different for business owners. It’s an honor system until you get caught or audited, but there are several things you can do to get yourself into trouble. And I think most of the time, the non-payment of taxes is probably not even like, “Oh, I’m going to cheat the IRS.”

It’s just like, “Oh, well, I had a bad month or quarter, and I’ll catch up with it next time,” is my guess. But I didn’t even think about sales tax, but that’s a good one. And give people an example, if your business sells a million dollars worth of clothes and you have an 8% sales tax, you’re supposed to send the government $80,000. It’s generally the state and local authorities for those sales taxes, but you collect that 8% from the people buying it, then you’re supposed to send it in. Well, if you’re having a hard month or a hard quarter or something, you might say, “Well, I’m going to take that to pay the mortgage and go on the family vacation we have planned, and I’ll make it up next month.” And then maybe next month isn’t good either, and you get yourself into a spiral.

Payroll taxes is another one. When you see that, if you’re an employee, you see here’s your $8,000 you’re supposed to get this month, but you’re not getting an $8,000 check. You’re getting 6,000 because I, the employer, sent 2000 of that to the IRS on your behalf. And same deal, you’re supposed to do that when it’s withdrawn. I remember when we were a small firm, we had to do it every month or quarter. And then as we got more employees and got bigger, we had to do it every month then every… Now I think we have to send it in as soon as we run payroll, so twice a month or whatever. But again, it’s tempting not to do that. And if you don’t do it, the IRS doesn’t call you up the next day and say, “Where’s your payroll tax that you’re supposed to send?” ‘Cause they frankly don’t know what you’re doing with taxes. So that’s another one.

And you’re exactly right. If that’s an example, if you take that money and say, “Well, we’re going to go on a trip to Disney World with the kids and spend $10,000 on that trip,” and you don’t tell your wife that you’re taking the payroll taxes to do that, she’s not going to get out of it on innocent spouse because she benefited from the vacation. So it’s a problem. And the last one, and one that may be the most difficult of all for some people is when you’re a business owner and you’re not paid a salary, you’re just taking the profits from the company or distributions, you’re supposed to send every quarter the IRS big check for approximately whatever percentage, 30 or 40%, whatever the number is of your estimated taxes for that year. And then in April, you square it up. And again, it should be pretty similar.

But again, that’s really tempting too, you got a payment due September 15 for a quarter million dollars, and you only have 150 in the bank, or you only have 250 in the bank, but you want to buy everybody nice Christmas presents and whatever, you want to pay the mortgage. So you only send the IRS 150 instead of 250, or you say, “Well, I’ll send it in October.” Again, nobody from the IRS calls you up and says, “Where’s your money?” It’s something you may not have to deal with till next year, and so I’ve found people get themselves into trouble. Now, I think there are some people who probably just say, “I’m just not going to pay the IRS. I don’t believe in taxes or whatever. I’m going to run it through the Cayman Islands or something like that.” But that’s in my experience, and you have a lot more experience than I do about this; that’s generally how I think people get themselves in trouble most of the time. Or do you have a different experience with that?

Hubert Johnson: No. Estimating tax experience, it’s even worse than you’re talking about because Congress in November of 2023, in a bipartisan manner, decided to increase the penalty for paying insufficient estimated tax payments or not having enough withholding. They changed it from 3% to 8%, and that was effective for 2024. So people not paying enough in 2024 are going to get surprised for the first time come April. It’s going to surprise a lot of people who figured, “I’ll just pay it at the end of the year.” But if you’re not making those payments throughout the year, that 8% penalty is going to hurt a lot of people. So it is very important that you’re paying in throughout the year. You can pay everything else off by April 15th, not owe a penny, and you’re still going to get hit with this 8% penalty, and that’s on top of everything else.

Brian Walters: I didn’t even realize that myself. And that makes sense because with higher interest rates, you could just park the money and earn 4% or 5%, 6% somewhere, and then just pay the 3% penalty and make money off of it. So I guess they decided they weren’t going to allow that. But yeah, that can add up quickly on top of owning the money or, yeah, that’s a big problem. I think another issue that people sometimes get surprised about in divorces or capital gains, which is the increase, I’m going to define it, you tell me if I get it wrong or right, that would be the increase in the value of an asset. For example, if I bought Apple stock 10 years ago at $100 a share and it’s now worth $200, I don’t pay that doubling and tax on that doubling in value until I sell it.

Although there’s been some discussion about… I don’t think that’s going anywhere, about making people pay as they go on that. I think Norway has that now, but not the U.S. But that’s a hidden little bomb in there that if you think, “Oh, look, I got a million dollars in Apple stock.” And then you say, “All right, well, I want to turn that into cash,” and you go to sell it and suddenly you’re paying taxes on let’s say the $500,000 in gain on it under that scenario, suddenly you don’t have a million dollars to play with anymore. Now you’ve got a lot less than that. Am I explaining that pretty correctly?

Hubert Johnson: Oh, yeah. And so you need to really look at that when you’re doing the division of assets to make sure that you’re getting fair value for the assets. So if you take real estate, et cetera, and I just had a case where lady owns millions of dollars in real estate, and she has to sell it mainly because she can’t afford the property taxes, which is another factor to consider there when you have property and it not producing income, which changes over time. Just taking a house, you have to deal with the capital gains. You have to deal with the property taxes, repairs, and maintenance. There’s a lot to figure into how much this asset is actually worth, and am I getting a fair exchange here?

Brian Walters: Absolutely. And being in Texas, we have no state income tax, including state capital gains tax, but we do actually have pretty high real estate taxes. So that is something to really, really consider as you go through a divorce is “Do I really want this piece of real estate? It looks great. Oh, wow, I’m going to be a landlord or something like that. I’ve got this $100,000 house I’m going to rent out, and I’m going to get 1500 bucks a month on it”. And then once you actually sit down at the end of the year, you’re like, “Wait, well, that $1,500 a month, that’s not in my bank account.” A lot of that went to real estate, insurance, upkeep, mortgage payments, payers, all of those kinds of things. And there are quite a few states, California and most notoriously, state income taxes on capital gains that I think are at the same rate as ordinary income. I’m not a California tax attorney, but that’s my understanding of it.

And that can be a whole other thing. If you live in one of those states, you may have to pay more than you think because at the federal level, you do get a break on capital gains, right? You don’t pay it at the 39.6% or the top number you pay. I think it’s 20% now at least for longer-term capital gains. So you do get a break on the amount of taxes, but it’s still there. And it’s when we do a spreadsheet on who gets what, sometimes you put a tax effect on them, sometimes you don’t, but you need to be aware of that. And if you’ve got your tax professional or your tax attorney or your divorce attorney, whatever the situation is, they should make you aware of that, and that some of those things are worth more than others.

Hubert Johnson: One thing you mentioned, just something, this is advice I’m giving to pretty much all business owners, very few people are actually doing this. Large corporations do this. People with a lot of staff and good cash flow are planning and doing their P&Ls at least quarterly. So if you’re not on top of your books, you should be using QuickBooks, some other type of program, be doing your books at least quarterly, ideally monthly, so you have an idea what’s going on with your business. But that’s going to help you determine accurately what your estimated tax payments should be and put you ahead of the ballgame. And if you do have a bad month or something, you can pay less in estimated tax payments. You can plan for this.

You can use tax avoidance strategies. But across the board, if you’re doing a CPA once a year and you have a business or you have a rental and you don’t know what it’s really costing you, they’re doing you a disservice. You need to be going to see them at least quarterly, and it makes it so much easier to file your taxes at the end of the year rather than waiting till October when you do your extension or September of the next year, and then the information’s outdated. So I’m really pushing CPAs to be on top of this and help business owners really have their finger on the pulse of their business.

Brian Walters: I totally agree. We do it monthly for exactly that reason. I’m actually pretty fanatical about getting our tax returns filed in April on time. I guess actually, March for the corporate one these days, and maybe it’s April. I know they changed the date on it. But anyway, I don’t like extensions personally or business-wise, and that’s really, I think, the best way to run things, but many people don’t. And if you’re busy running a business, it’s a little bit understandable. You’ve had a long day, and you know there’s money in the bank, then, “Well, I’m just not going to reconcile the bank statement and get the numbers fixed up. I’ll do it tomorrow,” or, “I’ll do it next month.” And then pretty soon you’re in the hole, and now you’ve got a problem. So one of the things, bankruptcy, I hear about that.

I’ve had people, we’ve had to tell them bad news sometimes in divorces, like, “It’s a mess. You guys don’t have any assets. You got a negative net worth. You got negative cash flow,” whatever the situation is. And sometimes I get the response of, “Oh, well, I’ll just declare bankruptcy and clear all this out,” or, “The business will declare bankruptcy and clear all this out.” My experience is that it’s not that simple, and there have been a number of forms of the bankruptcy code over the years. But if you know anything about bankruptcy, and I guess we’ll talk maybe on a personal level first and then business, my experience is it’s very difficult to just get rid of those debts. It might be possible to get them reorganized or get some additional time and get on a payment plan, but to just get rid of them and say, “Oh, forget that.” Especially when it comes to any taxes, to me, I don’t believe that’s very easy to do or even possible in some cases.

Hubert Johnson: It’s easier than you might think.

Brian Walters: Okay.

Hubert Johnson: So the general rule, and it varies by bankruptcy district. So we have bankruptcy districts all across the country. I’m sure there are multiple ones in Texas. So each bankruptcy district has slightly different roles and procedures, and there are huge differences between bankruptcy in California, New York and Florida. So it really does vary. You need to talk to a local bankruptcy attorney. But the general rule of thumb, if tax debt has been assessed for at least two years, you can move to address it in bankruptcy and have it wiped out and it has to be assessed.

So people who aren’t on top of their taxes, a lot of them have to file tax returns to file for bankruptcy, and it’s those unfiled returns that can’t be included, so personal debt. Now, if you have business debt and the business is closing down, you can just close out the business and walk away from hundreds of thousands of debt. So sometimes you can avoid bankruptcy, and that’s why we help people avoid bankruptcy, especially if they have a lot of other debt. But if they have a lot of other debt and creditors, it might make sense to go and look at a bankruptcy. So I actually tell people all the time, if you’re considering that, talk to a bankruptcy attorney. Get fully informed. It’s different where you are and you get good information before you.

Brian Walters: Yeah, I agree. And in fact, that’s essentially the main purpose of a corporation or an LLC or something like that, is to limit the debts to that entity and not be able to come after you personally.

Hubert Johnson: Like I mentioned, sales tax, payroll, tax are the two that can be assessed against you personally.

Brian Walters: Right.

Hubert Johnson: Don’t owe on those if you can help it.

Brian Walters: Absolutely. Okay, a couple of quick things I’ll go over, and then we’ll go to some common mistakes and some best practices. So, there are questions often about child support being taxable. That’s not my experience with it. You have to pay $2,000 a month in child support. That’s going to come out of the person paying it their after-tax money, and it’s going to go and not be taxable to the other spouse. Or spousal support or alimony, we rarely have that in Texas, but I know it can occur and it’s more common in other states. But my understanding is that it used to be tax-deductible, but it’s no longer that way.

The tax code was amended, I think in 2017 or ’18, to remove that, ’cause you could basically do tax arbitrage in a divorce and save 40% on a payout to a spouse by structuring it that way. And the IRS, I guess, decided they didn’t want to give that benefit to people anymore. So most of those types of interspousal payments or child support payments, in my experience that’s not going to have any tax benefit or cost to anybody. It’s directly for families. It’s not a tax thing. Mistakes to avoid in tax planning. We’ve talked about some of those directly, and indirectly, but what are some things that come to mind to you to avoid these kinds of problems we’ve been talking about?

Hubert Johnson: Well, the worst thing I see in agreements is a 50/50 split of debt.

Brian Walters: Right.

Hubert Johnson: Because if one person doesn’t pay the IRS the state’s going to go after the other person just as much. If one person becomes eligible for, let’s say, an offer and compromise, and we’ve done that where we’ve wiped out tax debt for individuals and sometimes businesses, the other person is still liable. So if you have a joint debt and we wipe it out under one Social Security number, the other person is still liable for it-

Brian Walters: Right.

Hubert Johnson: Unless we wipe it out under both Social Security numbers. But if they’re living separately, we have to either do them… handle them as two separate cases, which we do. But if one partner, if they’re not working well together, I’ve had plenty of times where one person had a successful offer and the other person was left holding the bag.

Brian Walters: Yeah, that is the case. Lastly, the last question that we get is, what should a family law or divorce attorney do to help their clients? I think if we suspect there is a problem like the ones we’ve been discussing, we probably want to have them talk to somebody like you, probably have them necessary, talk to a CPA or their existing CPA if they have one to try to understand what these problems are and anticipate them and deal with them. And I think you should address them. I had a case a little while ago where the folks had not addressed back taxes and there was a business. It was a successful business, and they were convinced that there was nothing owed to the IRS. And so I don’t know, I didn’t handle their divorce, but I got to clean up the mess afterward, but they just didn’t address it. And so then out of the blue, four years later, the IRS sent them a letter saying, “You owe half a million dollars or so.”

Then there was a fight about who was going to pay for that, right? I represented the husband. Our position was, “Well, we’re both equally liable because it’s just not addressed, and everything else was split essentially 50/50.” And the ex-wife’s position was, “No, you should be liable.” And then in the middle of it, or actually toward the end of that conflict, the IRS eventually said and was convinced by a new CPA we had hired that actually there was no tax liability. So, “Never mind,” but, it’s just a waste of everybody’s time and money. But it’s a good example. If that had been directly addressed in the divorce decree, they could have known what was going to happen and focused on getting that tax liability dealt with and removed instead of fighting with each other about who was going to pay it, which ended up being a phantom tax debt. Although I can imagine getting that letter from the IRS. That would be ruining everybody’s day, no doubt. Any other thoughts that come to mind about what we’ve been discussing?

Hubert Johnson: Absolutely. You mentioned getting informed is my number one thing. If you think there’s an issue out there, talk to a tax professional. We do a free consultation where you can talk directly to a tax attorney. But more than ever, and this is something I have to give the IRS kudos for, which I don’t like to do, but you can go on to IRS.gov, set up your own tax account, and pull your transcripts. You do have to go and get verified, but again, you should be on there anyway and set up a PIN for your tax returns to fight identity theft as well. And identity theft happens a lot in divorce. So again, just making sure you’re protected so that nobody can file a tax return for you without your PIN. But get that information, and make a plan beforehand. We love it when people come to us early. We can set up a plan, and help them out more than anything else. And when they come to us late, yes, we’ll deal with the fires, but it’s always more painful.

Brian Walters: Absolutely. That’s interesting, you say that about logging into the IRS. I actually showed a potential client that yesterday. They filed jointly and she was worried that he might figure out that she was poking around their taxes. He owned the business, of course, and she asked me if she could log in and get the joint return, and for her only. Well, not for her only, but through her Social Security number, would he know she was requesting that information? I didn’t know the answer to that. I said, “Probably not. But I bet you if you read all the little wording, all the details, I bet you it tells you.” But yeah, just yesterday afternoon I was dealing with exactly that issue, so that’s very good advice.

Hubert Johnson: Very high confidentiality rules, and you have to… She has to log in under her Social Security number. You can pull your transcripts, but it doesn’t show on the records how often the information was accessed.

Brian Walters: Kind of what I guessed, but sounds like I guessed right. But I think it tells you that there is my guess for a choice. Okay. Well, that’s all that we have for today. I can’t thank you, Hubert, enough for joining us on this very informative episode. If you’re interested in reaching out to him directly, we’ll have his information linked in the bio of this episode. As always, if you have any follow-up questions to this episode or would just like to talk to one of us directly about your family law situation, reach out to us at podcast@waltersgilbreath.com or just contact us directly through our website, which is waltersgilbreath.com. I’m Brian Walters and thank you for listening.