Proving Hidden Assets, Cash Flow, and Expert Testimony
In family law cases, conclusive and coherent presentations need to be made to the court when income from a business is hidden.
It is important for the analysis to be simple and easy to understand. It should also clearly prove the existence and the extent of hidden income.
Many clients suspect their spouse’s hidden income and let their family law attorney know about the same. This income is alleged to be from exaggerated business expenses or unreported business revenue.
Reducing income before the divorce (through manipulation of financial accounts) allows it to escape calculation, resulting in lower valuation for the business and reduced alimony and child support. This gives the business a controlling spouse (in-spouse) an unfair advantage over the other party (out-spouse) during negotiations.
It is vital for the divorce attorney to ascertain the reality of any hidden income quickly, or they risk settling for an indefensible position, which will likely harm their credibility with the judge.
How Do Judges React?
In many contested divorces, the ‘in-spouse’ is alleged by the ‘out-spouse’ to have hidden income. Sometimes, these allegations come from actual knowledge, but often they are just an exercise in retaliation or a fishing expedition.
Many judges are predisposed to declaring ‘no hidden income’ because of these common retaliatory efforts. Most claims of hidden income are seldom clearly proven and it becomes difficult for a judge to rule effectively with no certainty as to the amount.
Reducing Business Revenue
‘Tanking a business’ is a fairly common measure undertaken during pre-divorce planning. This causes the business owner to reduce business income prior to the date of separation, divorce filing date, or a leading event, such as the start of an extra-marital affair.
It is the forensic accountant’s job to determine this date where the materialization of divorce becomes apparent to the in-spouse because the income from the business may well be driven down way before the agreed date of separation.
It may become possible to use data from prior years to assess the value and income generated from a business if it can be confirmed or proven that a business was knowingly ‘tanked’ on a date prior to the dissolution date.
However, the forensic accountant shall need clear evidence or reliable testimony to this effect, or else the argument is at the risk of becoming qualitative which can be then be argued by each side.
Requesting Business Documents for Investigation
If the forensic accountant and divorce attorney come to an agreement that an investigation is necessary to reveal hidden income from a business, then the following documents would be requested for:
- Last three year’s business tax returns
- Financial statements, income statements, and balance sheet for the previous three years
- Previous two year’s detailed general ledger
- Copy of accounting data file, or if QuickBooks is used, then the electronic backup file
- Aging schedule for accounts receivable at the Date of Separation
- Aging schedule of accounts receivables at the current date
- Aging schedule for accounts payable at the Date of Separation
- Aging schedule of accounts payable at the current date
- Canceled checks and bank statements of all accounts for the previous three years
- Personal tax returns of the previous three years
- Last three year’s sales tax returns
- List of all business assets, including cars, trailers, trucks, and computers, among others
- List of all owned properties, including the ones on rent
- All Debts
- Last two year’s payroll reports
- Suppliers list with contact information
- Customers list with their addresses
Analyzing the Results of Investigation
Forensic accountants perform a thorough analysis of the data collected once the requested documents have been furnished.
These analytical procedures comprise of analysis and comparisons of all tax returns, business documents, and schedules, after taking client representations and expectations into account.
Sometimes upon analysis, the documents can contradict each other during examination and comparison. These contradictions provide evidence to the presence of hidden income, but they need to be modeled into the nearest dollar amount for the benefit of the court.
Investigation into Cash Flow Analysis
Cash flow is the perfect financial area to investigate the possibility of hidden income. Cash flow analysis can be carried out in the best possible manner by experienced forensic accountants, which can then be used to determine fair and appropriate spousal or child support. In addition, analysis of business cash flow is vital to accurately value the subject business.
The key component of a forensic accountant’s role in marital dissolution cases is developing gross controllable cash flow reports for either or both spouses. The report is generally inclusive of all income elements available for child and spousal support, such as:
- Salary and wages
- Income from interest and dividend
- Partnerships or rental income
- Income from businesses owned by the spouse (wholly or partially)
Financial accountants also investigate all other elements of cash flow that are available to a spouse, in addition to reporting the income amount as per financial statements and tax returns. An important step in this investigation for spouses who are also business owners is analyzing prerequisites paid through business accounts.
Personal expenses paid by the business in relation to automobile costs, entertainment, and travel expenses are some of the common perks.
Legal costs or accounting expenses unrelated to the business, such as divorce-related fees and personal tax return preparation are also classified under personal expenses.
In certain cases, this investigation may reveal the presence of hidden assets and unreported income. In such situations, a lifestyle analysis is performed which compares all reported income to the saving and spending patterns of the person who earned the income.
A net worth analysis is another popular method of investigation, which entails reconciliation of the income available for savings during a specific period with the increase in overall net worth during the time.
Detailed analysis of cash flow statements is also vital to conduct an accurate valuation of a business. There are many ways for a business owner to influence the cash flow or reported income in a closely-held business.
For instance, personal expenses can be paid through the business, a spouse can choose not to report the entire cash received or their income, pay themselves wages well above or far below the market grade for their position, or make salary payments to friends and family members that aren’t employed by the business.
Based on adequate documentation and thorough investigations, it is possible for forensic accountants to normalize the earnings of a business by making relevant adjustments. These normalized earnings can then be used to calculate various values by using different methodologies.
Presenting the Facts in Court
Any presentation made to a judge needs to be clear and easy to understand. The fewer exhibits in a divorce lawsuit, the better it is.
Forensic accountants can simplify complex issues and summarize them to become easily understandable by using spreadsheets, bar or line chart, or a single diagram.
One of the best products to make court presentations is Visio. This is a Microsoft Office Product designed to assist in simplifying complex financial issues. You can easily present your findings through a color pie chart, audit diagram, or a cause and effect diagram with Visio.
It is essential to show the reported income against the actual (estimated) income in a single excel spreadsheet. This spreadsheet summarizes the various findings by the forensic accountant. Professional forensic accountants understand that making facts simple to comprehend is important to a divorce case.
The spreadsheet should use a limited number of cells and data to present the data. It is also recommended for the spreadsheet to be turned into a colored line or bar chart to better illustrate the financial findings.
A simple, short, and illustrated presentation can have a better impact and allow the court to understand the issues clearly. It also helps clarify efforts made towards forensic work and leads to positive results for the client.
Assisting in Trial Preparation and Deposition
It is fairly common for forensic accountants to be involved in business valuation, lifestyle analysis, income determination, preparing marital balance sheet, analyzing corporate benefits, and tracing assets in more complex divorce cases.
In addition, forensic accountants also help with the ever-present tax implications.
There will always be the likely situation of the opposing side submitting various reports. A forensic accountant can go a long way in reviewing these reports and identifying those with results, positions, and differences that are in contradiction, and also aid in preparing a rebuttal report if requested.
Forensic accountants are also helpful in developing questions and strategies (with your attorney) to oppose the other expert’s deposition and to challenge their testimony during a trial.
In addition, a forensic accountant shall also work with your attorney to navigate through the complex financial issues that require addressing and help formulate questions and strategies for deposition and trial.
Providing Expert Testimony
Forensic accountants can be called upon to provide testimony at both deposition and trial if a case does not settle even after making extensive efforts.
Testifying can be an intimidating and stressful experience, regardless of whether it is at a deposition or at trial. Depositions are usually the less formal of the two, but you need to be equally well-prepared to perform well and effectively at both.
Forensic accountants are well-prepared since they know the reports and all related documentation from cover to cover, which supports reasoning and conclusion of the divorce attorney.
Forensic accountants also work with attorneys in respect to formulating questions which they anticipate would be asked during cross- and direct-examination.
Other factors of importance include courtroom demeanor. Experts are usually knowledgeable in the ways of the court. If not, the attorney advises the forensic accountant on the time of arrival, dress code, documents to bring, and the manner in which questions must be answered and cross-examination handled.
What Personal Skills should you look for in a Forensic Accountant?
The world of divorce is emotional, adversarial, and typically filled with surprises at every turn. The forensic accountant is a key player of the divorce resolution team because from a financial standpoint divorces can be extremely expensive and complicated.
As such, there are some traits which must be exhibited by a forensic accountant. These include, but are not limited to, professional skepticism, organizational skills, close attention to detail, and sound professional judgment.
Your forensic accountant may be called upon to perform in one or all the areas mentioned above. They may also require taking on additional tasks, such as getting involved in negotiations and/or mediations or reviewing the property settlement agreements.
You should ask your divorce attorney for a referral if you feel the need for a forensic accountant’s services to help get a better understanding of the financial implications during your divorce.