Marital Standard of Living
Marital Standard of Living, Marital Balance Sheet, and Taxation
Forensic accountants will play a critical role in revealing the true financial picture during a divorce.
In addition to preparing exhaustive income calculation for either or both spouses for the purpose of arriving to a fair and appropriate alimony and/or child support amount, a forensic accountant may also help by conducting a marital or lifestyle spending analysis.
Conducting Marital or Lifestyle Spending Analysis
The forensic accountant shall conduct in-depth investigations to ascertain the lifestyle of the couple. This is accomplished through a series of in-depth interviews with either or both spouses and by examining all personal financial records with a critical eye.
Generally, the initial client interviews provide the forensic accountant with information regarding the number of adults and children in the household, employment of nannies, an overview of major expenses (vacation and entertainment), and the couple’s attitude towards savings.
Review of financial records for the stated period may include (but is not limited to) the following:
- Identification and collection of information of all accounts which were used to make a marital expenditure, including savings, checking, credit cards, business accounts (for personal expenses), and investment accounts.
- Classification of all expenses into relevant and appropriate categories. This is usually completed with the help of QuickBooks, Quicken, or other similar write-up programs. The categories can either be customized or be as per the ones listed on court forms, such as Case Information Statement.
- Checking the classifications completed for any inaccuracies and making corrections, wherever necessary.
- Adjustments to remove non-lifestyle and non-recurring expenses such as irregular maintenance, large repairs, business expenses, home improvements, expenses made from personal accounts, income taxes, and savings. Taxes and savings are generally not included as marital spending and treated as separate because these are indeterminate and unknown until the child and spousal support amount are defined.
- Adjusting for marital expenses paid through business accounts.
- Adjusting for marital expenses paid through cash. Businesses often generate cash which is not deposited into accounts and is instead applied towards paying for marital expenses. Based on client discussions, an estimate of such cash payments is determined and added back to the marital spending analysis.
- Annual and monthly averages of monthly spending may not prove to be the absolute reflection if more than a single year is included in the marital and lifestyle spending analysis. To this effect, adjustments are made to normalize spending to arrive at actual figures, and information regarding mortgage payments, furniture, typical maintenance, regular repairs, equipment, phone, utilities, automobile expenses, and personal expenses is required.
- Sometimes, forensic accountants are requested to allocate total expenses to the wife, children, or husband in order to make a better determination of spousal and child support needs.
- Preparation of going-forward budget after ascertaining levels of spousal and child support among other factors may also be carried out. This may be based on taking certain scenarios into account as well, such as the date when the marital home shall be sold, and the date and amount (including mortgage) when the receiver of spousal (and/or child support) shall purchase a replacement residence.
Constructing the Marital Balance Sheet
Forensic accountants are often requested to compile together a marital balance sheet to better facilitate the division of assets and liabilities. This balance sheet shall include all marital assets and liabilities, such as the following:
- Bank accounts
- Real estate
- Furniture, jewelry, furs, collectibles, and related items
- Retirement accounts
- Automobiles, boats, and related items
- Investment accounts
Business and business interests Valuations
- Employee benefits, including restricted stock units, appropriation of stock options, performance shares, and other long term incentive plans
- Liabilities, typically, include notes payable, mortgages, credit card balances, and personal loans.
A forensic accountant may be required to review account statements because often assets and liabilities valuations vary.
The accountant may also be required to utilize the service of appraisers who deal in personal property, real estate, and retirement plans, or human resources, and employee benefit coordinators, in the case of employee benefits.
In addition, Kelley Blue Book and other similar services may be used to obtain current value and depreciation of automobiles, boats, and other such related items. However, it is important to note that forensic accountants should never accept third-party information without using sound professional judgment and asking relevant questions.
Sometimes, forensic accountants are required to gain a thorough understanding of finances where allegations of dissipation or wasting marital assets are made, or where numerous accounts and multiple income sources are involved.
This shall be concluded by interviewing all relevant individuals, assembling and analyzing documents and records, preparing appropriate schedules, and communicating the results to the concerned parties.
Additionally, there are some assets that are exempt from equitable distribution on account of being brought into the marriage by one party, such as a family-owned business. Some assets, such as gifts or inheritance, acquired after the marriage are also exempt.
However, in most jurisdictions, the burden of proof in support of these claims lies with the person claiming the exemption.
Forensic accountants can prove to be very useful in compiling all work papers and documents and communicating the relevant information to the client, counsel, and court. This communication can be in the form of a written report and oral presentations.
Financial Impact of Tax Issues
Every divorce needs to account for tax issues and their related impact on finances. The long-term tax effects on either or both parties can have devastating consequences if the Property Settlement Agreement is not dealt with or structured properly. There are sections in the Internal Revenue Code that deal specifically with divorce.
You can get guidance and advice from forensic accountants and tax professionals with respect to these tax issues pertaining to your divorce. The items listed below, though not exhaustive, provide an insight into a few tax issues and considerations:
The 2017 Tax Cuts and Jobs Act (TCJA) states that alimony and child support must be examined and considered differently as compared to past.
With effect from January 1st, 2019, alimony payments have ceased to be deductible to the payer. This, in turn, results in higher tax liabilities on account of higher taxable income.
Similarly, recipients no longer have to include alimony as part of their taxable income, thereby reducing the tax burden. This change is bound to result in lower alimony levels going forward.
However, there are no changes to tax implication for child support payments under the TCJA. The payments are neither deductible to the payer nor taxable to the recipient.
There are many other areas of the tax law that have been amended and which could impact after-tax income. This would affect the calculation of child support amount.
For instance, there has been a recent modification made to child tax credit by TCJA. Standard deductions have been increased and personal exemptions have been completely eliminated.
- Alimony can now be structured into components, including cash payments. For instance, the total alimony payment can be in the form of paying for expenses, mortgage payments, and cash payment.
- Recapture for pre-December 31, 2018 agreements may be triggered by structuring alimony payments to prevent them from falling outside the IRS rules. Failure to properly set up fluctuating alimony payments in the first two years of payments may trigger a recapture, making the payments non-deductible to the alimony payer and not an income to the alimony recipient. The result of alimony recapture can have devastating consequences and tax implications, even if the intentions of everyone involved were good.
- Marital residence tax treatment if one of the spouses continues staying in it after divorce is finalized. For instance, what will the tax consequences be, if the home is sold (as agreed by both parties) prior to the divorce being finalized, immediately after the final decree, or later in the future.
- Transfer of all marital assets, excluding the marital residence. The IRS has separate rules which govern the taxability of assets. Unintended tax results could be triggered with a failure to stay within these rules.
- Ensuring same tax basis in the Division of Assets, such as investment accounts. Failure to do this shall result in a greater tax burden for one spouse.
- Ensuring correct separation while dividing retirement accounts to avoid all unintended consequences.
- To provide guidance on the tax treatment of employee benefits, such as restricted stock units, stock options, performance shares, or any other benefits from long-term incentive plans.
- To receive a tax deduction by structuring and attributing (the portion allowed of) paid professional fees under tax planning.
Analyzing Corporate Benefits
There are various occupations where the compensation is structured into multiple layers, such as for investment professionals and corporate executives.
These layers usually include the base salary, all cash bonuses, and other benefits, such as restricted stock units, stock options, long-term incentive plans, and performance shares.
Forensic accountants can aid in compiling all relevant data as well as calculating the valuation of these benefits. There are various methods that are employed with respect to valuation, including complicated and less complex mathematical models.
When dealing with such employee benefits, it is the responsibility of a forensic accountant to clearly understand and apply an acceptable methodology depending upon the laws of the state they are working in.
Here is a simple overview of the complex application process employed by a forensic accountant while dealing with layered corporate benefits:
- Reviewing each type of benefit in the plan documents
- Determining whether benefits are marital or premarital, by taking vest dates, grant dates, and performance criteria into account. This means identifying whether benefits are granted on past or future performance
- Calculating all vested and non-vested units
- Calculating total value using appropriate price of each share
- Determining tax implications and analyzing various strategies of equitable distributions, wherever applicable
It is possible for a business-owning spouse to be so concerned and focused on protecting the financial interests that they are inclined towards committing fraud.
Sometimes, business owners in the middle of a divorce attempt concealing assets by transferring them, or understating revenue and overstating expenses.
You may require the assistance of a capable and experienced forensic accountant if you suspect your spouse to be inclined towards such behavior.