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The Winning Edge
I N S I G H T S F O R AT T O R N E Y S A N D J U D G E S
Winter 2017
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Divorce and Income Determination: Forensic Accounting to the Rescue
Matrimonial attorneys know better than anyone that
divorce can bring out the worst in people. Despite
their best efforts to work amicably, divorcing husbands
and wives often end up being less than forthcoming.
In some cases, one spouse has been planning the
divorce for a while. They might have tried to hide
or divert assets and/or earnings from the other
spouse in an effort to decrease the marital assets or
minimize their earnings. This, in turn, would reduce
the amount of alimony or child support they may
have to pay.
Determining a spouse’s assets and earnings is not
always an easy task. It gets even more complicated
when one or both of the spouses owns a business.
Forensic accountants are sometimes called in to
prepare an income determination calculation for
a business owning spouse or both spouses. When
one spouse owns and controls a business, there is
considerable opportunity for them to intermingle
business and personal expenses. In addition, they
may have created various income streams that the
other spouse might not be aware of.
Some common examples of income components
that may be manipulated, as well as personal
expenses paid by a business, include:
• Distributions charged as loans
• Payroll to other family members or friends
• Automobile expenses
• Cell phone expenses
• Vacations disguised as company travel
• Home improvements and/or maintenance
• Non-business related professional fees, such as
divorce fees or other personal matters
• Household employees
• Shopping and/or gifts
• Personal life insurance
•Cash
• Double counting expenses
A Case of Misstated Income
We were recently engaged by the divorce attorney
for “Mr. Smith” to analyze the estimated income of
“Mrs. Smith,” a real estate agent in Virginia.
According to Schedule C of Mrs. Smith’s 2015 tax
return, she claimed that her income from her real
estate business was approximately $95,000. Mr.
Smith believed that Mrs. Smith artificially lowered
The Winning Edge
her income so he would be responsible for
alimony payments.
• Child care expenses recorded as wages to
an assistant
After Gross Mendelsohn was engaged, we first
examined the gross profit margin (income as a
percentage of gross receipts) for years 2011 through
2015. While the gross profit margin had reached a high
of 80% in 2012, it was only 30% for the year ended
December 31, 2015. This big variance was a red flag.
• Cleaning of personal residence recorded as
repairs and maintenance
We then requested and received documents from
Mrs. Smith supporting the claimed income and
expenses for the year ended December 31, 2015.
From this, we were able to isolate what we believed
to be significant personal non-business expenses
and discovered some manipulation/overstatement
of expenses.
During our analysis of the documents provided,
we noted numerous transactions showing what
appeared to be cash withdrawals via either an ATM
or as cash back as part of another transaction.
These withdrawals, totaling approximately $3,000,
were undocumented; therefore, we were unable to
substantiate them as valid business expenses.
In addition, we noted a significant number of
questionable expenses either charged on a
corporate credit card or paid for with a business
check. Based on our review of the charges and
canceled checks, we identified approximately
$74,000 in questionable expenses. These included
payments by the business for items such as:
• Remodeling of personal residence (after Mr.
Smith had moved out of the residence) recorded
as repairs and maintenance
• Vacations taken by Mrs. Smith
• Activities for Mr. and Mrs. Smith’s children such
as numerous sports leagues and swim lessons
• Legal fees paid to Mrs. Smith’s divorce attorney
• Numerous charges for personal items such as
sunglasses, movie tickets, groceries, nail salons,
haircuts and iTunes
While on the surface it might seem like expenses
labeled as “professional fees,” “wages” and
“repairs and maintenance” are normal expenses for
a real estate agent, we dug deeper to find that none
of these expenses were related to Mrs. Smith’s real
estate business. Therefore, they should not have
been deducted on her tax return when determining
her income.
We also noted that Mrs. Smith’s Schedule C from
her tax return was prepared on the cash method of
accounting, meaning that expenses are deducted
in the year they are actually paid. According to the
supporting documentation provided, Mrs. Smith
claimed approximately $44,000 in home staging
expenses, although we were only able to identify
$12,000 in payments. As a result, this expense was
overstated by approximately $32,000.
Finally, Mrs. Smith deducted expenses twice in some
cases on her Schedule C, once supported by the
original invoice and a second time supported by a
canceled check for the same invoice.
Results of the Case
After our analysis was completed, we concluded that
Mrs. Smith’s actual income was not $95,000 as she
had reported on Schedule C of her tax return, but
that it was closer to $225,000.
Winter 2017
We submitted an expert report to Mr. Smith’s
attorney and one of our forensic accountants
testified about our findings during the divorce
proceedings. In the end, the judge agreed with
our assessment and determined that Mrs. Smith’s
income should have been $225,000. As a result, Mr.
Smith was awarded alimony, potentially saving him
tens of thousands of dollars had he just accepted his
former wife’s income claim.
Richard Wolf, CPA, CGMA, CFE, CVA,
specializes in forensic accounting and
fraud investigations. He also performs
business valuations. A member of the
firm’s Forensics & Litigation Support
Group, he is a Certified Fraud Examiner
and Certified Valuation Analyst. Contact Richard
at 800.899.4623 or [email protected].
6 Questions to Ask a Forensic Accountant About a
Business-owning Spouse
In my many years of practice as an expert
specializing in matrimonial disputes, there’s little I
haven’t seen in the way of business-owning spouses
trying to hide assets. From the creative and clever to
the sometimes fraudulent, I suspect that these will
always exist in some form or fashion.
Instead of providing a comprehensive list of schemes,
I’d like to share six basic questions that can go a long
way toward uncovering improper asset hiding or
protection strategies in marital disputes.
1. Is the spouse under reporting income and
overstating business expenses?
Here’s a few:
• One business owner spent hundreds of
thousands of dollars on unnecessary equipment
and maintenance, in effect pre-paying 10 years’
worth of costs.
2. Does the spouse have a relationship with
another person and is he/she spending or
wasting marital assets on that person?
• A partner in a small company that sold used
automobiles paid his brother more than market
price for inventory.
3. After separation, is the spouse exhibiting a
pattern of purchase activity, like overspending or
unnecessary spending on the business that has
a clear effect on depressing the value of marital
assets?
• An owner’s girlfriend lived in a house, rent-free,
that the owner bought.
4. Are family members surreptitiously colluding
with the spouse to hide marital assets?
• A husband paid hundreds of thousands of
dollars in college tuition through his construction
company for his children from a prior marriage.
5. Has the spouse properly disclosed and valued
intangible marital assets like patents or other
intellectual property?
6 Basic Questions that Will Get to the Root
of an Asset Hiding Scheme
6. Has the spouse properly disclosed, valued and
classified stock options and other investments
that can be counted as marital assets?
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Variations on a Theme
If any one of these questions raises even the
slightest inkling that your client is being taken
advantage of by their spouse when it comes to
properly splitting assets, it’s time to call in a forensic
accountant. Our work involves peeling back the
layers of records, statements, bills, transactions
and the like to identify questionable practices or to
uncover outright fraud.
While the spouse’s strategies or tactics for hiding
assets may be clever or complicated, they’re all
really nothing more than variations around one of
the six themes or questions discussed above.
If you do run across a particularly clever asset hiding
scheme however, please let me know.
Mark Vogel, CPA/ABV/CFF, CMA, CVA,
provides business valuation, litigation
support and forensic accounting
services to individuals and businesses.
He has extensive experience in
matrimonial disputes, including serving in expert
witness and business valuation roles. Contact Mark
at 800.899.4623 or [email protected].
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