It will come as no surprise to you that when married couples begin the process of splitting up, there is also often a process of hiding of assets and income, an obfuscation of the truth designed to result in paying less in alimony or sharing less of assets when the divorce becomes final.
So, if you find yourself in this situation, what steps can you (or your advisors) take to uncover the truth, find the hidden assets or income and obtain your fair share in the proceedings? Particularly, when as required by the courts, you need to have proof of such matters to convince a judge of the wrongdoing.
Closing the loop
The most important tip in locating hidden assets and income is to "close the loop" on both business and personal finances. In other words, it is necessary to make sure you can identify all sources and uses of income and assets for the individuals in question. If an individual's lifestyle is beyond the disclosed level of income capacity and other income you have discovered, it is likely the loop has not been closed.
For example, it is not uncommon for a spouse to claim that income only amounts to a couple of thousand dollars per month. However, in examining the lifestyle the couple lead during the marriage, you may find that the patterns of spending (homes lived in, makes and models of cars driven, toys such as boats or recreational vehicles owned, and vacations taken) could not possibly be supported by the level of income claimed.
While it is not uncommon for business owners to run such items through their businesses, doing so artificially deflates the level of income the business owner has enjoyed, or the number and values of assets owned. It may also artificially deflate the levels of income the person will be expected to enjoy after the marriage. To properly account for actual income enjoyed by the couple, a thorough investigation of the business's books and records must also be undertaken.
This brings up an interesting point, which is that one of the most common ways to hide income or assets is through titling assets in other names, whether they be businesses, trusts, or the names of relatives. To close the loop, you must make sure that all the business and personal records have been examined to identify where such transfers of assets may have occurred.
Because business owners have an easier way to hide marital assets and income, you will likely need the help of legal and accounting experts to help close the loop. Nevertheless, there are some steps you can take to help them in the process, which will save them time and consequently, will save you money.
Get familiar with all financial accounts
- Become familiar with the accounting system for the business in question. Also, become familiar with the system used to account for the personal finances in the marriage. Make a list of all sources of accounting systems, and to the extent you can, a list of all banks used by both the business and the couple personally, as well as all of the assets you are aware of.
- No investigation can get underway without a starting point and creating this list gives you a place to begin. Identify all sources of information regarding the person's sources and uses of income. Focus on the sources and uses of cash both for their business as well as personally.
Some sources of information to gather would likely include:
- Federal and state tax returns for:
- Sub Charter S Corporations
- C Corporations
- Schedule C on individual returns
- Monthly, quarterly, and annual financial statements including:
- Balance Sheets
- Income Statements
- Cash Flow Statements
- General Ledgers (especially useful if they are maintained by self-employed individuals)
- Other subsidiary ledgers:
- Cash receipt ledgers
- Cash disbursement ledgers
- Accounts payable ledgers
- Accounts receivable ledgers
- Credit card billing statements
- Checking and savings account statements
- Brokerage account statements
- Invoices or receipts evidencing personal expenditures (cash vs check or wire)
- Review the accounting documents for detailed information regarding where and when cash was expended by the business and personally. Focus on sources of cash that cannot be accounted for by regular payroll or draws from the business.
- Identify and summarize by year the cash expended by the business for the personal benefit of the owner and for cash expended personally that cannot be accounted for from ordinary payroll or draws.
Follow the cash
Once the initial documents have been gathered, the second most important tip is to "follow the cash." Don't get lost or hung up in the complexities or differences between "accrual" accounting versus cash accounting, as they could show very different results. The ultimate question is "Where did the money come from and where did it go?"
Typically, the most useful documents in this analysis are the general ledgers and cash disbursement journals of the business and the checking accounts utilized personally. Look for and focus, at least initially, on large disbursements and try to verify the actual use of such funds. And since many times accounting records can be changed, don't always trust the legitimacy of the accounting records, without verifying such disbursements through the examination of invoices or other source documents.
Interviews of individuals close to the owner regarding assets acquired via unknown or suspicious sources can also be an effective method of identifying additional income levels. When tracing hidden assets and income, there are several problem areas which are frequently encountered. It is useful to become aware of "gimmicks" employed by individuals to hide assets and income from a spouse, creditors and/or the government.
The following "red flags" should be an alert to the possibility of hidden assets and income:
- Does the individual either personally or via the business pay for items or services with cash that does not run through a checking account? If so, the likelihood of hidden assets and hidden income increases dramatically. By not running cash receipts or disbursements through a bank account, it is easy to hide revenue. The revenue of the business should make sense when compared with the number of people employed and the amount of work or production accomplished. If the revenue appears too low to justify the productive output, the possibility exists that cash receipts are being diverted and never deposited into the checking account.
- If a business or an individual pays for a significant portion of the expenses with cash via a reimbursed cash fund, the receipts of the reimbursed cash fund should be analyzed. With this type of a system, it is easy to divert cash of personal use and claim it as an expense of the business.
- Large amounts expended in a business for travel, entertainment, and advertising can be a sign of personal and social expenses being run through the business.
- Retained earnings of a business should always be investigated. It is possible to charge personal expenses directly against retained earnings. This causes tax problems, but it is a method employed by some business owners.
- If a company has been in business for several years and the retained earnings balance is rather low when compared to the revenue of the company, the possibility exists that net income has been manipulated to avoid taxes and hide income. It is especially important to work through this problem when placing a value on the business.
- It is important to review the salaries taken by the owners and key employees of the business. It is possible to identify a reasonable salary for a business by reviewing one of the many online statistical publications. if the salaries taken by the owners appear to be unreasonably low, it may be because they are taking income from the business via alternative sources.
- Another commonly used method of diverting cash from a business is via amounts paid to family members as salary or wages. It is important to review the time commitment, effort, and skill level of each family member receiving compensation from the business.
- Other expense categories worthy of investigation include:
- Insurance expenses
- Vehicle(s) expenses
- Cafeteria plans
When unexplained sources of income or disbursements of cash have occurred, it is important to investigate such items more thoroughly. For example, if while examining bank statements you can identify transfers to other bank accounts for which you do not have records, it is usually wise to work through your attorney to subpoena the additional bank for statements from the newly identified accounts to make sure that all assets or sources of income are accounted for.
It is not uncommon to perform some of the above mentioned steps multiple times throughout the process as new transfers of funds, and uses of cash are identified that need to be investigated. It is also wise, when as many names as possible have been identified, to perform asset searches using the names indicated to see if anything else pops up that merits attention.
Keep in mind that obtaining the necessary proof of income levels can be costly and complicated process. As such, it is important to always weigh the potential costs with the potential benefits from continuing to push forward. Such complications can be minimized by using an expert, and we always stand ready to help.