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Discovery of Hidden Assets in Divorce

DISCOVERY OF HIDDEN ASSETS IN DIVORCE

As counsel you need to be aware of lies and deception in the high asset divorce context. If you represent the non-breadwinner spouse be on high alert. Your job as counsel is to be on the lookout for deception by the breadwinner spouse who will often try to misrepresent asset and income valuation to suit his or her objectives. At a basic level the breadwinner spouse will generally want to show the least amount of personal income possible in a divorcing year. This will help to reduce an alimony claim by your client. Additionally, if the bread-winner spouse owns his or her business, which is often the case, then that spouse is going to want to undervalue their business. There are many ways for the breadwinner spouse to effectuate either of these tactics. Counsel needs to know what to look out for.

First and foremost, you as counsel should sit down with your client to have a discussion about the bread-winner spouse's integrity and moral aptitude. Ask your client about the other sides willingness to lie. Is the other side the kind of person who is willing to omit assets at the low end of the deception scale? Ask if the other side is willing to lie under oath or lie on their taxes? These are more significant lies. Your client will have a better idea than you regarding the other side/s integrity. If your client is of the disposition that the other side may lie and you have significant alimony or property claims at stake then you should likely obtain a forensic accountant.

After obtaining a forensic accountant, you need to advise your client of the fact that the costs of this forensic accountant as well as your own fees may become large. However, given what is at stake, likely makes sense to incur this expense. Notify the opposing party as soon as you have retained a forensic accountant. By putting the other side on notice that you have retained a forensic accountant you will often times persuade the opposing party to refrain from any deceptive tactics. Opposing counsel should advise their client of the penalties of deceiving you or the court as to the existence and value of property and income. Such penalties include the trial judge awarding the entirety of an omitted asset to the non-deceiving client, an unequal division of community property, a larger than normal alimony award, and other sanctions and penalties. Your possession of a forensic accountant will help to keep the other side honest through the litigation process.

If the other side persists in his or her desire to lie then you need to hold his or her feet to the fire. Conduct a deposition early on and put this party under oath. Once you have them committed to their fraudulent position slap them with their lies on cross examination in trial. Leading up to trial use their perjured transcript as a weapon to achieve a favorable settlement as you threaten severe sanctions. Few litigants are willing to be impeached or otherwise made a liar on the stand in trial. Their fear of your impeachment process will be your leverage in negotiations.

As counsel you will need to obtain the parties financials from a period of time in which there was no marital strife. It is likely that there was a time, perhaps two or three years ago, when divorce was not anticipated. At this time the financials will not have been manipulated in anticipation of divorce. Once you have these financials you can use these as a benchmark from which to compare older and more recent financials from the divorcing year. Significant changes between these two time periods should be analyzed in some detail.

When you speak to your own client you should find out some things right off the bat. You will want to know if the bread-winner spouse maintains complete control of the finances. Find out about cash transactions, both as to how much and often and where the cash is stored. Find out how close the relationship is between the business owner spouse and his CPA. Find out about any trusts which may exist. Find out what kind of personal expenses the business owner spouse has been running through the business. There are many red herrings to look out for which will signal to you that the bread-winner spouse is up to no good. Generally speaking the bread-winner spouse is going to want to hide and understate certain assets. These are going to be the assets that can be expected to remain with him or her post-divorce. This will almost always be the business that only the bread-winner spouse is capable of running. This bread-winner spouse is going to want to overstate debts related to this business. Greater debt reduces the value of the business thereby reducing the non-breadwinner's financial interest in such business. The breadwinner spouse will also try to underreport revenue and over report expenses. By doing these two things the value of the business will also decline thereby reducing the non-employee spouse's community interest and potentially limiting alimony claims as the same time.

There are various tactics which are somewhat typical of individuals trying to accomplish these deceptive goals. At a basic strategy a litigant may stock away unrecorded cash. This is difficult for you and your forensic accountant to uncover because there is no paper trail. Once you get your hands on the books and the underlying financials you will not be able to discover this as the cash was never reported on any ledger in the first place. That being said it is difficult for the breadwinner spouse to stock away large amounts of cash as to do so requires complex money laundering schemes and off shore accounts. Such tactics can be uncovered by reviewing customer lists, goods purchased and sold, as well as comparing prior year financials to the current year. Spouses will also be less likely to engage in this type of activity given the fact that the lie consummated here is very bold, placing the perpetrator of such lie in jeopardy both with the family courts as well as the IRS.

If the deceptive spouse tries to hide away cash which has already been recorded he or she may have more problems. These ledgers in which the cash was initially accounted for are discoverable as are tax returns, bank statements, and other financial statements which will typically uncover this fraud.

If a business exists, which is often the case in a high asset divorce, then look for the business owner to understate revenue in the divorcing year. The higher the business revenue and lower the business expenses the more valuable the business. The business owner will try to deflate revenue to reduce the value of the business. To do this the business owner can defer revenue expected in the divorcing year to the following year(s). This tactic is not uncommon as to do so is not such a bold undertaking. Different accounting methods allow for business owners to do just this and not fall afoul of IRS regulations. Business owners can present arguments for why they would do such thing, such as to defer tax obligations, as other plausible explanations for their activities. In this way they argue to diminish their contemptuous nature.

A common ploy by the business owner will be to run substantial personal expenses through his business. Keep in mind that the business owner spouse will do this in non-divorcing years as well so as to obtain the write off even if these write-offs do not satisfy IRS regulations. By running substantial personal expenses and bonuses through the business the business owner can reduce the value of the business on the books. These expenditures should be backed out when valuing the business to show a normalized value. If the business owner has paid himself a large bonus during the same year in which he claims the business has had a downturn you will know that he or she is likely up to no good. Use the bonus as fodder for impeachment.

A business owner spouse may set up false accounts for fictitious employees or fictitious vendors. Always look at the books supplied to the IRS as a business owner will presumably be more reluctant to engage in criminal tax fraud then in fraud related to the divorce. If the business owner is chummy with his CPA then this activity is more likely as this operation may require the assistance of whoever is in charge of the businesses controller or accounts payable clerk.

The business owner may try to overstate debts. By comparing across years if debt is unusually high in the divorcing year then you should be suspicious. If this is the case then you will need to dig deeper. Request documentation supporting such debt. If no such documentation exists then you know that this debt has been misrepresented. The business owner may also try to show all assets as expenses as opposed to assets. In this way reducing the aggregate business value. Keep an eye out for these tangible assets and make sure they appear on the balance sheet. The business owner will have better luck by omitting intangible assets. The reason for this is because GAAP may not require the intangible assets to appear on the books or tax records until they are actually sold. Look for these intangible assets in marketing material and credit applications.

As counsel you need to keep an eye out for trusts. These trusts will often have income. This taxable income is then paid by the same trust. Thus the income from the trust never touches the personal income tax return of the ultimate beneficiary. In this way these trusts are easier to hide. You will need to first find out about the existence of any trusts by way of interrogatories. Then follow through by deposing the parties CPA as the CPA who prepares the parties tax returns will know of any trust's existence. It is highly unlikely that a CPA will commit perjury and risk his license for the benefit of his client. If you catch the opposing party in a lie then exploit him or her hard. Use this as leverage to negotiate a favorable settlement.

More commonly, as counsel, you will see the bread winner spouse attempt to inflate bad debt. Business owners will try to increase bad debt in divorcing years so as to decrease their income thereby decreasing alimony claims against them. These businesses often operate on the accrual basis accounting system. Under the accrual basis bad debt in a given year is estimated based on bad debt percentages in prior years. These write-downs decrease accounts receivable thereby reducing personal income. Given this accrual basis there is no way to determine exactly what specific debt is written off. To determine whether the business owner is over inflating this expense the lawyer or accountant need to compare this year to past years. Compare the percentage of bad debt written off in comparison to gross revenue in the divorcing year as opposed to prior years. To further investigate and analyze look to see what debts were in fact sent to a collection agency. Find out if write offs were eventually collected. Find out if the business continued to sell to the business responsible for the bad debt. Look to industry standards with respect to how much debt is typically written off given a certain amount of revenue.

As a practitioner, always be wary if you notice that the business owner spouse changed accounting practices in a divorce year. For instance, a business may change cost accounting methods in a divorce year. The common formulas for expensing cost of goods sold is either First in First Out or Last in Last Out. In this way the business can chose how to match a cost for a specific good. By modifying the formula a business may be able to decrease earnings in a divorcing year.

If you and or your forensic accountant discover irregularities in the way in which a business expenses financials, typically by over expensing items then adjustments will be in order for purposes of determining the true value of the business. Look to see if the business owner's salary is unusually large compared to other similar businesses. Look to see if the business is expensing lots of items which are not true business expenses. When you see these over expenditures note that they will need to be backed out of the equation so as to reduce total expenses. This will have a net effect of increasing the value of the business.

I wrote this article for my own, Eric Roy's, benefit. I am not a forensic accountant. If you wish for a more exhaustive and thorough explanation of this material please speak a forensic accountant who regularly testifies in divorce matters.

Categories: Family Law