Forensic Accounting in Divorce Actions

Emotions run high in matrimonial engagements. A spouse may be motivated to cheat his or her spouse out of a fair share of marital property or may wish to humiliate or emotionally devastate the soon-to-be ex-spouse. Forensic accountants are often retained by attorneys to help represent the spouse who didn’t have access to or involvement in the family’s “fiscal matters.”

In order for an equitable distribution of marital assets to occur, a determination must be made regarding the nature and scope of the marital assets.

The Scope of Forensic Accounting

Forensic analysis includes:

• Reviewing financial data to determine its accuracy and reasonableness

• Determining each spouse’s standard of living and disposable income

• Tracing and locating hidden assets

• Determining which assets may be considered separate from marital property

From a valuation perspective, the role of the forensic accountant in a marital dissolution is critical as it relates to real estate and a closely-held business -- especially if the business is a professional practice -- and to any other property whose value is not apparent.

None of Your Business

When one spouse controls a closely-held business, the underreporting of marital assets and income is a common occurrence. In such circumstances, knowledgeable forensic accountants can help uncover common patterns that dishonest spouses employ to understate income, assets and the related value of their business.

Examples of fraudulent activity might include:

• Making cash payments (for no consideration) to individuals who agree to return the money to the dishonest spouse after the divorce proceeding is final

• Generating salary payments to a nonexistent employee

• Skimming cash from the business

• Delaying solidifying contractual relationships until after the divorce decree is final, with the intent of understating or suppressing the business’s worth

Other questionable business transactions could include large one-time purchases that are written off, excessive salary levels for an owner or the payment of personal expenses with an associated business deduction.

The Checklist

In order to provide the forensic accountant with sufficient ammunition to pursue the alleged dishonest spouse’s activity, the following information should be provided:

• Education and employment histories of the spouse

• A list of all financial institutions (including account numbers) with whom the spouse has ever had a relationship

• Lifestyle and expense level for entertainment, travel, etc.

• Detailed information regarding personal and business relationships

• All sources of income, whether earned or passive

Methods

A forensic accountant will incorporate accounting, auditing and investigative skills in an effort to ascertain if assets are being hidden. By comparing total personal expenditures to reported income, he or she can employ the expenditure method and may be able to prove the existence of hidden assets and income. Financial statements and income information derived from tax returns will show if reported income was sufficient to support the family.

With the net worth method, a forensic accountant compares the family’s net worth from the beginning of a measuring period to its end. The increase or decrease in net worth is reconciled to the reported income for the given time frame to determine the likelihood of the existence of hidden assets.

Lastly, the bank deposit method is employed where sizeable deposits have been made to bank and investment accounts without associated disbursements.

A Word on Separate Property

Forensic accountants also need to engage their skills to determine whether alleged marital property should actually be characterized as separate property or vice versa. These disputes are highly fact sensitive and also depend on the specific property laws of the state governing the asset's disposition.

Somerset stands ready to provide the forensic accounting services you and your clients need. Contact us for more information.

This newsletter is provided by Somerset for our clients and other interested persons upon request. Since technical information is presented in generalized fashion, no final conclusion on these topics should be made without further review. For additional information on the issues discussed, please contact Steve Riddle, Tom Thieme, Rex Collins or Doug Ayres of our Litigation & Valuation Team. This document is not intended or written to be used, and cannot be used, for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

Somerset CPAs, P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.somersetcpas.com

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