Spouses commit fraud for an age-old reason—greed. Many spouses can easily rationalize hiding assets or committing fraud against their spouse due to hostility that arises between the parties in a divorce proceeding. As qualified divorce attorneys, it is important to educate yourself and your clients on the behaviors or conditions that can lead to questions on the possible existence of fraud or hidden assets.
There are several behaviors that can serve as red flags to the possible existence of fraud. You and your client have a good reason to be suspicious if one spouse:
- Has exclusive control of all the financial accounts and redirects financial mail from home to a PO Box or work address;
- Is controlling with money and secretive about financial affairs;
- Intentionally provides incomplete responses to inquiries and discovery requests;
- Lives a lifestyle in excess of reported income and purchases new "toys," such as cars, boats, etc., which are above the standard of living;
- Income declines with the onset of marital difficulties; and
- Has multiple bank accounts with many transfers and large deposits and withdrawals.
Hiring a qualified forensic accountant to analyze income tax returns and the corresponding support documents can be one way to determine whether a spouse is concealing assets or income that should be considered to arrive at a fair property settlement and evaluate support. The following are a few examples of items a forensic accountant is likely to look at during the investigation process.
Wages, Salaries, Tips and Other Income
Reported wages and income on the tax returns should match W-2s and 1099s. These should also match deposits to determine whether all wages were used for the benefit of the couple or whether there are funds in another account. Consider the following example:
Tom is an employee and receives biweekly paychecks. An examination uncovers that for each of the past 12 months, Fred has deposited identical $2,473.97 amounts twice a month into the couple's checking account. Because these numbers look about right (when deductions for taxes, benefits and other items are considered), and because Fred receives a W-2 form at the end of the year, it is easy to pass over this area with a simple cursory examination. However, one very easily missed fact would have been overlooked: biweekly pay does not mean Fred gets two paychecks per month (24 checks per year). It means he gets a paycheck every two weeks (26 paychecks per year). This means twice a year there should have been three deposits to the couple's checking account.
Capital Gains and Losses
Sales of investments (i.e. publicly traded stocks) and other property sales are reported as capital gains or losses. The schedule on the tax returns lists certain detail regarding these transactions, such as the date the asset was purchased, its original cost, the date sold and the proceeds received from the sale. It is important to match these sales transactions to their supporting documents. It is possible to uncover an unreported brokerage account or distributions from a fund that was not disclosed as income to the other spouse. It is also important to determine where the source of funds came from to purchase the investments and the disposition of the cash from the sale proceeds. To hide cash, the first step is to convert property to cash. Consider the following example:
Paul and Mary have been married for 10 years and during that time Paul has controlled most of the finances. As such, Mary does not know the nature of the couple's assets. When the couple goes through a divorce, Mary hires a forensic accountant, who asks for information about stock and bond holdings. Paul claims there are no current holdings; however, the accountant notices a capital loss carryover on the couple's tax return. Upon investigation, the loss carryover is from a sale that occurred six years ago, and there has been no investment activity reported on the tax returns for the past two years. The sale itself is not necessarily a concern; however, Paul has not disclosed in his current net worth statement the whereabouts of six-year-old proceeds.
If there is a business ownership in the marital estate, one of the first areas a forensic accountant will examine is the compensation of company offers and shareholders, paying particular attention to the compensation of the ex-spouse. Some business owners - depending on the tax implications to the business—may prefer to pay themselves a smaller wage to allow for greater dividend potential. If the company is to be valued as a multiple of net earnings or cash flow, this will not cause the forensic accountant much of a problem. However, if the business owner realizes this, he may switch to paying himself a higher salary, which reduces the amount of earnings and resulting value of the company. It is also possible for a business owner to manipulate the expenses of the business during the year(s) of divorce proceedings to make it appear as though business earnings have significantly declined to avoid paying more in a matrimonial settlement. Consider the following example:
Bill's company reports sales of $500,000 and net earnings of $75,000. If the average company in Bill's industry is valued at five times net annual earnings, this company is theoretically worth $375,000. However, if the forensic accountant succeeds in proving the owner is taking an excessive salary or doing some "erroneous" accounting in order to reduce net earnings, and that the net earnings are actually $100,000, then the accountant has succeeded in raising the theoretical worth of the company to $500,000, which, if divided equally between husband and wife, means a gain of $62,500 for the client.
Forensic accounting is important, if, for no other reason, because of the unique nature of divorce. There are very few "friendly" divorces, and divorce actions can bring out the viciousness and greediness in people when confronted in battle over the division of marital property or support obligations. Division of marital property requires valuation, and to best serve your client, it is important to make sure all assets have been accounted for in order to obtain the best possible settlement. If the opposing spouse exhibits some of the characteristics listed above, you will be doing your client a great service by enlisting the aid of a qualified forensic accountant to investigate the possibility of hidden assets or income.