Attorney Yonatan Levoritz recently had an article on tax fraud published in the New York Law Journal. The article has been redistributed below. Click here to see it in the original publication.
Client tax fraud is a problem, and one more common than many attorneys realize. The duty to report fraud to the court is incumbent upon the attorney. Most judges prefer not to take on fraud issues, leaving it to the attorneys to sort them out with the parties so that clients come before the bench with “clean hands” as required under NYCRR §130-1.01a(b).1
In A.S. v. K.S.,2 in which I represented the plaintiff for a brief time, Brooklyn Supreme Court Justice Jeffrey Sunshine took the admirable step of addressing the issue of “clean hands,” a welcome development as the issue needs more discussion and guidelines should be developed to avoid fraud being perpetrated upon the court.
This article will address the duty of the attorney to alert the court to tax fraud, the problem courts face in addressing the issue of tax impacting, and the effect that tax impacting has on clients. It would behoove the New York Legislature to review its guidelines, and perhaps look to the law in New Jersey, where debt is imputed to both parties.
In A.S., a matrimonial action, the husband and wife owned a business that generated significant cash income, and they declared significantly less income than the income they spent through the business. The difference between the parties’ earned and declared income was approximately $220,000 annually. The plaintiff-husband was on Social Security disability and was not employed, except occasionally working at the family business and raising the children. He sought temporary pendente lite maintenance pursuant to Domestic Relations Law §236(B). (See DLR §236(B)(5-a)(h)).
While the New York State Legislature drafted Domestic Relations Law to provide for an award of temporary maintenance based on the greater of the needs of the recipient spouse or the parties’ lifestyle during the marriage, and the Appellate Division has routinely held that pendente lite counsel fees should be awarded to balance the equities,3 Sunshine determined that the best way to establish support would be to hold a hearing, the most Solomonic approach given that the attorneys were caught between the Rules of Professional Conduct and representing their clients zealously. The hearing was set to address the issue of false documents and avoid punishing or rewarding either party as a result of their misconduct. That is precisely what courts should do when parties are in pari delicto.
Tax Fraud and Clean Hands
Counsel in this case had reported to the court that both parties had committed tax fraud. The parties here claimed approximately $54,228 in combined annual income, with expenses of approximately $137,459 per year. Yet they were able to increase their savings approximately $600,000 over the prior five years, while declaring a maximum income of $20,000 on their tax returns. Any attorney aware of these facts should, at the very least, admit that the information provided by the client could not possibly be accurate.
The court in A.S. focused on the issue that plaintiff’s counsel “put forth the proposition that since the defendant-wife allegedly cheated the government in an amount greater than plaintiff did, plaintiff [was] entitled to counsel fees as the non-monied spouse and an award of maintenance,”4 and implied that plaintiff’s counsel may have violated New York Rule of Professional Responsibility 1.6.
In the author’s opinion, the judge applied the wrong approach to resolve the issue of the economically dependent spouse’s entitlement to an award of pendente lite maintenance.
The law on all of the issues presented—except the tax impact, which is addressed below—is clear. Significantly, on the issue of lawyer ethics, the law explicitly states that if a litigant or attorney makes a statement to the tribunal and later learns it is false, the attorney must inform the court and opposing counsel of the error and take affirmative remedial steps to correct the issue. (See Ethics Opinion 2013-2, and Rule 1.6 of the Rules of Professional Conduct.)
Pendente Lite and Distribution
When the court cannot ascertain the payor spouse’s income, whether or not as a result of fraud, temporary maintenance in the amount of the greater of the lifestyle of the parties during the marriage or the recipient spouse’s needs should be awarded.5
In A.S., the court stated:
The Court is well aware of the statutory maintenance guidelines (D.R.L. §236(B)[5-a]) and the child support standards act ((D.R.L. §240(1-b)). These two statutes provide a formulaic, predictable basis for the establishment of both maintenance and child support awards, yet both statutes and case law allow for alternative methods in determinating [sic] said awards where the income of the parties cannot be determined.6
Regarding the allegedly missing money, the court stated:
The plaintiff husband collects Social Security disability benefits claiming a mental illness and the defendant claims that the plaintiff transferred $400,000.00 of marital monies in dissipation or secretion of marital assets overseas which resulted in a loss of those funds. Plaintiff claims it was a failed business venture. However, that is really an issue of Equitable Distribution, since there is an issue of fact as to whether the funds were lost in a business venture or whether the money was secreted by the Husband.
Whether the missing funds constituted an issue of equitable distribution was an issue of fact to be resolved through discovery.7Moreover, DRL §236 expressly provides that waste is an issue in determining equitable distribution, which can only be addressed at trial, since there is no pretrial equitable distribution.
As stated in Altenkirch v. Altenkirch, 225 A.D.2d 725, 726, 640 N.Y.S.2d 193, 194 (2d Dep’t 1996):
We note that until discovery is complete and the parties have had an opportunity to present their respective cases, a determination of the status of the corporate assets in question for purposes of equitable distribution would be premature.8
It was clear parties in A.S. knew about the transaction in question, since the funds were issued from the parties’ joint account and there were savings being generated. In addition, the wife raised the purported missing-money issue as an afterthought, knew of the missing funds and had made deposits to and withdrawals from the account. More significantly, all transactions occurred some 10 months before the motion for pendente lite relief was filed, and the wife only raised the issue in response to the husband’s request for support.
NYCRR §202.16(k)(6) provides that a decision should be rendered on a motion for pendente lite spousal maintenance within one-half the time of standard motions; as such, decisions should be issued within 30 days, not the standard 60 days.9
In A.S., the motion was adjourned for a hearing some seven months after submission, and dependent parties suffered economic distress (without receiving support or a place to live). Out of nearly 100 cases reviewed, only one was found in which a court directed that a hearing on a party’s entitlement to pendente lite support be held. In A.S., it was important for Sunshine to deviate from prior practice and hold a hearing.
Concerning income, the expenses paid through the parties’ business were submitted to the A.S. court as evidence. This was more than sufficient as a matter of law to prove that the parties were paying personal expenses through the business.10
In addition to considering income the parties used to pay expenses to calculate child support, maintenance, and the division of court-ordered expenses such as forensic evaluations and an attorney for the child or children, courts have to consider the tax consequences of the award.11
The New York Legislature clearly defines income under DRL §240(1-b)(b)(5) and under the law, income includes taxes a person is supposed to pay.12
The Legislature presumed, perhaps mistakenly, that litigants would pay their taxes or that courts’ temporary maintenance orders would convert the net sum of income to “income as defined in the child support standards act.” However, statutes aside, courts in general appear not to be adding taxes to the payor spouse’s income and are not forcing litigants to come before the court with clean hands. In fact, litigants should not be able to seek any relief in a court of equity until they have clean hands.13
On the issue of how to address tax evasion when handling child support, spousal support, counsel fees, and other court-ordered disbursements and payments, courts should add back the New York state, federal and other taxes to the net income of the parties. Any other result violates the Equal Protection Clause since it would treat taxpayers and non-taxpayers differently.
As stated by the U.S. Supreme Court in F.S. Royster Guano Co. v. Commonwealth of Virginia:
It is unnecessary to say that the “equal protection of the laws” required by the Fourteenth Amendment does not prevent the states from resorting to classification for the purposes of legislation … But the classification must be reasonable, not arbitrary, and must rest upon some ground of difference having a fair and substantial relation to the object of the legislation, so that all persons similarly circumstanced shall be treated alike.14
When a court uses a taxpayer’s gross income to determine his or her spousal maintenance or child support obligations the court deducts in statutory taxes about 10 percent for FICA, but does not reduce the taxpayer’s income for the federal and state taxes. Thus, after making support payments, the taxpayer will have deducted another 50 to 60 percent of their income for taxes, forcing the taxpayer to pay, in some cases, as much as 70 percent of their net income.15
On the other hand, courts allow the nonpaying spouse to pay as much as 50 to 60 percent less than the payor spouse, since their income is determined based upon the needs of the children, lifestyle, or some number that the court can justify, as opposed to ordering a complete audit, computing income on a tax adjusted basis, and deeming the sums not paid to the government to be marital debt subject to equitable distribution. Providing such an advantage to a person seeking to defraud his or her children, spouse, and the court is contrary to public policy.
The notion that income can be imputed to a party is a valid theory.16 After reviewing Appellate Division cases on the issues of imputation of income and cases where courts refuse the payor spouse’s income claims, not one case was found regarding imputation of income based upon the parties’ failure to pay taxes or the fact that income was not being determined by the court as would be set forth in most recent federal income tax return. Therefore, in each of those cases the court rejected the income claimed, but did not tax impact the award. So, while courts have no issue tax impacting retirement accounts or the sale of a business to reduce the award by taxes to be paid, the courts by no means reinstate income taxes to New York state or the federal government to be paid by those appearing before the court with unclean hands.
While the court in A.S. v. K.S acknowledged that the parties did not pay taxes,17 it did not use the information to come as close as possible to meeting the statutory mandate based on the parties’ incomes “as should have been declared on their most recent federal income tax return” under DRL §240(1-b)(b)(5)(i). Nor did the court find that it could not determine the parties’ combined parental income, and then apply the standard established by DRL §236(B)(5-a)(g), which is the greater of lifestyle or needs.18
Courts outside of New York provide a useful source of guidance on this issue. For example, New Jersey courts have recognized that in cases where married individuals have filed a fraudulent tax return, the debt accruing from such conduct can properly be attributed to both spouses,19 a notion that New York should adopt along with mandatory audits to ensure Equal Protection under DRL 240 and 236. In this way, all parties are treated the same, are forced to wash their unclean hands and pay their fair share of taxes.
Accordingly, since attorneys are presented with both a duty to tell the court the truth about the parties’ income and the duty to refrain from misleading either opposing counsel or the court, courts should seek to effectuate the plain meaning and legislative intent of governing statutes, and treat all people equally by adjusting income to what should have been reported on the parties’ last federal income tax return.20
1. A litigant must have “clean hands” in order to be awarded relief (see Farino v. Farino, 88 A.D.2d 902, 903 (2d Dep’t. 1982)). In cases involving joint tax liabilities, it is for the attorneys to prove that their clients have clean hands, for the tax returns to be amended, for back taxes to be paid as a marital debt, since both parties enjoyed the income, and if the income taxes are not joint, then the debt for marital income is deemed to be marital debt and should be divided by the parties at the time of divorce. http://www.njlawjournal.com/id=1202658120717/Should-the-Court-Report-Tax-Evasion-Revealed-in-Support-Cases?slreturn=20170126182010.
2. A.S. v. K.S., 54 Misc.3d 1201(A), at *2, 2016 WL 7409898 (Sup. Ct., Kings Cty., 2016) (slip copy).
3. See, e.g., Groesbeck v. Groesbeck, 51 A.D.3d 722, 724, 858 N.Y.S.2d 707, 709 (2d Dep’t 2008); Berge v. Berge, 159 A.D.2d 960, 961, 552 N.Y.S.2d 779, 780 (4th Dep’t 1990).
4. 54 Misc.3d 1201(A) at *4, n. 4.
5. See Davydova v. Sasonov, 109 A.D.3d 955, 956, 972 N.Y.S.2d 293, 295 (2d Dep’t 2013); Giokas v. Giokas, 73 A.D.3d 688, 689, 900 N.Y.S.2d 370, 372 (2d Dep’t 2010); Griggs v. Griggs, 44 A.D.3d 710, 714, 844 N.Y.S.2d 351, 352 (2d Dep’t 2007).
6. 54 Misc.3d 1201(A) at *3.
7. See, e.g., Treffiletti v. Treffiletti, 252 A.D.2d 635, 636, 675 N.Y.S.2d 192, 194 (3d Dep’t 1998) (finding that wife failed to provide any evidence that husband dissipated $110,000 in marital assets, requiring reduction in husband’s share of equitable distribution).
8. 225 A.D.2d 725, 726, 640 N.Y.S.2d 193, 194 (2d Dep’t 1996).
9. As stated in NYCRR §202.16(k)(6):
(6) The notice of motion submitted with any motion for or related to interim maintenance or child support shall contain a notation indicating the nature of the motion. Any such motion shall be determined within 30 days after the motion is submitted for decision.
10. See Bean v. Bean, 53 A.D.3d 718, 722-23, 860 N.Y.S.2d 683, 688-89 (3d Dep’t 2008) (citations omitted).
11. See DRL §236(B)(5)(d) (“[i]n determining an equitable disposition of property under paragraph c, the court shall consider: […] (11) the tax consequences to each party”); Cameron v. Cameron, 22 A.D.3d 911, 912, 802 N.Y.S.2d 542, 544 (3d Dep’t 2005).
12. See DRL §240(1-b)(b)(5) and DRL §240, DRL §236(B)(5-a)(b)(4)).
13. See Gevis v. Gevis,141 N.Y.S.2d 121, 123 (Sup. Ct., Bronx Cty. 1955) (citations omitted). Moreover, the court should not allow attorneys to act in a willfully blind manner and certify false information knowing it could not possibly be true—let alone claim that admitting the truth to the court may be a violation of the rules of professional ethics. A.S., 54 Misc.3d 1201(A), at *4, n. 4.
14. 253 U.S. 412, 415, 40 S.Ct. 560, 561-62 (1920).
16. See, e.g., Rohme v. Burns, 92 A.D.3d 946, 947, 939 N.Y.S.2d 532, 533 (2d Dep’t 2012); Baumgardner v. Baumgardner, 98 A.D.3d 929, 930-931, 951 N.Y.S.2d 64, 66 (2d Dep’t 2012).
17. A.S., 54 Misc.3d 1201(A), at *1.
18. See Davydova, 109 A.D.3d at 956.
19. See, e.g., Wadlow v. Wadlow, 200 N.J. Super. 372, 379, 491 A.2d 757, 761 (N.J. Super. Ct., App. Div. 1985).
20. See, DRL §240.