Goldman's
Critical Support -- Summer 2002
When
do you Need a Forensic Review in a Divorce Case?
A forensic review is an investigation relating to a legal
proceeding. Just as a forensic medical examiner studies evidence to look for
causes of death and clues that would identify criminals, forensic accountants
study evidence to look for hidden or undisclosed assets and income, and assist
in determining the ownership of assets held in dispute.
Spouses in divorce cases commonly feel that they are being
taken advantage of. When one of the spouses (the “in-spouse") owns a
business, the non-owner spouse may suspect the business is being used to hide
assets or income.
If the business is being valued for
purposes of a settlement, it may be necessary to perform a forensic examination
prior to performing the valuation. A valuation done with misstated information
will itself be misstated. Since the value of the business being divided depends
on its ability to generate income, you need a fair picture of that ability. This
usually involves a detailed review of the books and records, and adjusting for
unusual items or owner quirks. For example, expensive gifts for an illicit
lover, paid for by the business, should be added back to profit in order to get
a fair representation of the business’ true results.
Weigh costs, benefits of an investigation
The emotions of the parties often
outweigh the potential value of what they are fighting over. It is important to
initially determine what you really stand to gain by the investigation, and
whether the investigation will be cost-effective. There are many different
levels of service that can be provided – an overview or financial
consultation, a “quick and dirty” desktop valuation, a business
investigation that specifically searches for hidden assets and income, a
personal lifestyle investigation, or a full and complete business valuation.
In general, you should not engage a forensic examiner unless the following
four conditions are met:
- You
have a reasonable suspicion that assets or income is being hidden
- The
in-spouse has significant control over the management of the business
- A
valuation is needed
- The
benefit will outweigh the cost.
Who knows what evil lurks…
The non-owner spouse typically knows
very little about the business or investments, and has an exaggerated view of
their operation and profitability. Nevertheless, this spouse may have access to
important business records such as tax returns and financial statements, bank
and credit card statements, brokerage records, names of employees,
identification of key customers and suppliers, and other key business
relationships. This spouse may know quite a bit about the family's lifestyle,
personal assets, and spending patterns that so often point to fraud.
Most business owners receive perks from
their businesses. Some of these include payment of personal expenses, travel and
entertainment, automobiles, telephones, computers, repairs, club memberships,
etc. The likelihood that there will be abuses usually correlates to the
percentage of business done in cash and the strength of the company’s
controls. Single-owner businesses often have more opportunity for abuse than
when there are multiple shareholders watching over each other and splitting the
pot, although it is common for partners to “help each other out” by hiding
such abuses when a marriage is on the rocks.
When potential tax fraud is an issue, the non-business spouse must weigh many
factors in deciding how much he or she really wants to know and expose. In one
extreme case that I worked on, the wife was so anxious to follow a
“scorched-earth” approach that she insisted on turning over significant
evidence of intentional tax fraud to the IRS, even though she was not eligible
for innocent-spouse protection -- and the most likely outcome was the seizure of
marital assets and the probable loss of her potential source of support. In more
normal cases, the parties would rather settle than have an expert testify in
open court about fraudulent activity.
Legal strategies for hiding assets, income
It is possible for the in-spouse to hide
assets and income without committing tax fraud. Tactics include:
- Deferring
receipt of payments from willing customers
- Accelerating
expense payments
- Accelerating
expansion plans
- Increasing
investments in advertising or research and development
- Buying
market share through lower pricing
- Accelerating
maintenance or equipment replacement
- Pre-funding
benefit plans
- Paying
advance deposits
Those (and others) are common ways of
making a business look bad in the short-term while setting the stage for future
(post-divorce) benefits. Business owners have been known to “park” assets by
selling them at a loss to friendly companies, with an understanding that they
can buy them back after the divorce case has settled. Companies that experience
deteriorating profitability prior to the initiation of a divorce action,
especially if economic conditions do not support the deterioration, may warrant
a forensic review to determine if income has been shifted across time periods.
High income, but not an owner
In certain cases, a forensic review may
be warranted even if neither spouse owns a business. If at least one spouse is
highly compensated, understanding his or her habits can be of interest – does
this spouse travel a lot; divert or invest significant amounts of compensation;
own real estate in varied locations; maintain multiple bank accounts, brokerage
accounts, or safe deposit boxes; or give other indications of hiding assets?
Has this spouse deferred compensation until after the divorce?
In addition to searching for hidden
assets and income, you can use a forensic examination to accomplish the
following:
- Determine total family disposable income when there are items such as
tax-free income, business perks, and cash from rental activities or
partnerships -- which often generate cash but show as a loss on income tax
returns.
- Identify
the standard of living of the parties for purposes of alimony and child
support.
- Validate
or refute claims of separate property by tracing ownership.
The criteria for determining whether a
forensic examination is needed in non-business cases are:
- Whether
one of the spouses is likely to be hiding significant assets or income
- Whether
there is a disputable claim to the ownership of separate property.
In either case, the benefits of the examination must exceed
the cost of the engagement. Spouses should be discouraged from using forensic
reviews merely for revenge or emotional gratification. But when warranted, a
forensic review can bring about a much more equitable settlement than the
underdog spouse could have hoped to achieve.
© Michael Goldman
2002
For more information,
please go to www.michaelgoldman.com
Editorial material in these newsletters is intended to be informative, and
should not be construed as advice. For advice on any specific matter, please
consult your financial or legal adviser.
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