Techniques for Discovering Hidden Assets and Unreported Income During the Divorce Process
Sunday, June 15, 2014
Posted by: Darlys S. Harmon-Vaught, Ed.D, CDFA, CFE
Financial issues involved in a divorce - especially high net worth cases - can often become rather complicated. Unreported income and hidden assets are often alleged in divorce proceedings, usually by the spouse who is either not running a business or has not been in charge of the family finances.
It is not uncommon for a spouse to hide assets, especially if the divorce has been planned for quite a while. People hide assets for a variety of reasons, but essentially, they have property or money that they do not want to have discovered.
There are numerous ways to find hidden assets, but typically assets are either placed in the hands of third parties or behind false documents. The process of finding assets or proving unreported income is often one of the most difficult assignments during the divorce process. Being familiar with ways individuals move assets into the hands of third parties or behind false documents and techniques to find those hidden assets can result in the discovery of this property.
The cost of such discovery work must be weighed carefully against the potential benefits. It is important for a budget to be planned for two levels of investigation. At the first level, formal discovery procedures such as interrogatories, depositions, subpoenas, requests to produce and motions to compel can provide information to review and analyze the marital and non-marital estates.
If an individual does not have a detailed list of assets and debts along with documents to prove the whereabouts of these assets, the discovery in identifying the "easy to find" estate can become costly. At this point, a decision has to be made as to whether further money should be spent on the second level of discovery, which investigates and traces transfer of ownership of assets into other individuals' or entities' names.
Is the cost of the investigation worth the potential value of the assets which are assumed, at this point, to be hidden? Through diligent and effective preparation, it is possible to discover assets not disclosed or acknowledged by the other party. It is important to create realistic expectations with the client as to the ability to discover assets which have been actively concealed, and the reality that - despite best efforts - it is sometimes impossible to locate willfully hidden assets.
In divorce situations, careful consideration must be given to answer any questions about potential hidden assets. What types of assets may be hidden? How are assets hidden? What techniques can be used to locate hidden assets?
WHAT ASSETS MAY BE HIDDEN?
The most common types of assets hidden are cash, bonds, mutual funds, cash value in insurance policies and variable annuities, stocks, travelers' checks, Series EE savings bonds, and bearer municipal bonds.
Conversion of cash into personal property such as art, jewelry, collectibles, antiques, vehicles, boats and planes are also possibilities. Hobby equipment, gun collections, original paintings, collector quality carpets and tools are examples of asset conversion that often are overlooked or undervalued.
HOW ARE ASSETS HIDDEN?
Methods of concealing assets are as varied as the personalities of the individuals involved. In their attempts to veil assets, spouses may often involve relatives or acquaintances who may or may not be aware of their complicity in the diversion of personal assets. It is not unusual to discover the placing of personal possessions or investment certificates into safety deposit boxes in the name of a family member or friend.
Paying down mortgages and credit card balances is yet another method of hiding funds in plain sight. Repayments of phony debts to friends or relatives can appear to be legitimate use of resources. Expenses for paramours such as gifts, travel, rent or tuition for college or classes may be disguised as valid outlays of funds. Assets may be transferred into the name of another family member, friend or corporate entity.
Custodial accounts established under a child's social security number as well as transfer of assets into pension, profit-sharing, 401(k), and Keogh plans are all strategies for cloaking liquid assets from the opposing party's view. Employees can work in collusion with their employers to delay business contracts, raises or bonuses until after the divorce.
The transfer of large sums of money to trusts is one way individuals may attempt to disguise assets. Another is to gift money to individuals with the anticipation of having the money returned at a later date. These patently deceptive strategies may be fraudulent as well.
Spouses who own businesses may use the corporate entity to conceal assets. Skimming cash from the business, paying salary to nonexistent employees and then voiding the checks after the divorce, and paying salaries or fees to relatives or close friends for services that may never have actually been rendered then receiving the money back after the divorce is final are all strategies used by business owners to veil cash.
The value of a business prior to a divorce can be lowered artificially by delaying the signing of lucrative long-term business contracts until after a divorce settlement is reached. Unreported income on tax returns and financial statements can reduce the perceived value of a business to the detriment of the other party in the divorce.
WHAT TECHNIQUES CAN BE USED TO LOCATE HIDDEN ASSETS?
Prior to searching for hidden assets, the investigator must have accurate and timely personal identification information for the other spouse. This includes full legal name and variations (nicknames, abbreviations, common misspellings) as well as known aliases. Current and recent address information is essential. While some searches only need the name and not the address, it is always good to have both pieces of information.
Because assets may have been transferred to family members, the names and addresses of close relatives, their social security numbers and dates of birth will be valuable information in tracing movement of property or cash between the spouse and family.
Specific questions may reveal the likelihood of hidden assets evident through lifestyle. Does the spouse travel? If so, where? In what type of hotels do they stay, and what are their activities as they travel? Who makes up their group of friends and what type of people are they? Does the spouse get an automatic transfer of funds or an allowance? Does the spouse deposit a paycheck into a separate account?
Other telling information can be gleaned from answers to questions such as these. Is a credit card statement being mailed to the spouse's work address? Are large amounts of cash floating around? Is cash used to pay for purchases? Who are the spouse's accountant and lawyer? Has the other party provided honest reports on prior tax returns? Is there ownership of a business? If so, is it a cash business? Is there a Subchapter S Corporation?
With this basic information in hand, the investigator can pursue specific information from many sources. Here's a quick list of information sources which should be reviewed.
1. Income Tax returns: This should be the first place to look for possible clues as to the existence of hidden assets. The return provides the roadmap to the discovery of income earning assets and asset sales. The return should also describe the source of income, whether it be interest, dividends, rental income and gain or loss from the sale of a stock. Each page of the tax return should be carefully examined for information.
A. Income from wages-sources of income
B. W2s-Detail the salary received by a party and the existence of deferred compensation plans as well as other executive extras
C. Interest and dividend income-where is it coming from? Interest and dividend income exceeding a specified amount must be reported on income tax returns.
D. Interest from tax free bonds
E. Taxable Refunds of state and local taxes: If so, who received the refund and how was it used? Sometimes, refunds are used to fund retirement accounts.
F. Overpayment of state and federal taxes that are credited for future tax years and then refunded.
G. Retirement plan distributions-Did the party receive a distribution from a deferred compensation plan or IRA? If so, how were the funds used? Trace them to determine their ultimate disposition.
H. An entry on the alternative minimum tax line (line 5 on the 1040) might indicate that the taxpayer may have tax preference and can lead to the discovery of hidden assets.
I. Form 6521 contains the alternative minimum tax calculation. This calculation was designed to prevent taxpayers from using shelters and credits to reduce or eliminate tax that would normally be due by providing for a separate taxing method, creating tax preferences. Other lines on this form might indicate accelerated depreciation on real estate, mining exploration and development costs, research and experimental expenditures and incentive stock options. If a stock option has been exercised, its value will be reflected on this form.
J. Form 4797 will indicate the sale amount of a business item and the gain or loss from the sale of business assets
K. State and local income tax: May reflect income generated in another state or income generated by assets located in another state
L. Real estate and personal property taxes-Are taxes being paid on properties that are not listed on an asset statement?
M. Interest paid, mortgage interest and points-Schedule A: Deduction of interest reflects the existence of loans. Such deductions may lead to the disposition of loan proceeds or to the loan application filed for the purchase of an undisclosed asset.
Points could reflect that a refinancing occurred. Determine which property was refinanced and the disposition of any cash received as a result. If the party owns real estate but no mortgage interest is paid, one should inquire as to the manner of acquisition of the property and the source of payment.
N. Property used to earn income or for business purpose appear on Schedule A
O. Investment interest paid could reflect the existence of a liability related to an investment or a margin account
P. Casualty and theft loss: If a loss is reported, inquire into the disposition of the insurance proceeds.
Q. Miscellaneous deductions: safety deposit rental expense, other expenses incurred to produce income and tax advice. Estate planning advice may be deductible. This could lead to the existence of an estate planning file that could contain information about the entire estate.
R. Schedule B, Interest and Dividend Income, Lines11 and 12: Regarding foreign accounts and foreign trusts. An entry on this line may be the only clue about what is commonly called a "foreign asset protection trust".
S. Schedule C, Profit or Loss from Business: Could reveal a side business that is used to fund a Keogh plan to increase retirement plan deductions
T. Schedule D, Capital Gains and Losses: Reflects the sale of property for gain or loss: Trace the proceeds from any sale.
U. Schedule E, Supplemental Income and Loss: Shows rental properties and income from partnerships, S corporations, estates and trusts as well as existence of investments in partnerships and "S" corporations. The schedule may also reflect passive activity carryovers which should be considered an additional asset.
2. Savings accounts and money market funds: Observe deposits and withdrawals in savings accounts or money market funds. Deposits could point to a hidden asset such as a stock that pays a dividend or a bond that pays interest.
3. Checking account statements and cancelled checks: Notice cancelled checks and to whom they are payable. The purchase of an investment or property might be revealed. Request that the front and back of the checks be copied by the financial institution in order to understand into what account the checks were deposited. This can provide additional account number and financial institution information.
4. Lifestyle analysis: Look at the lifestyle of the other party and match the income being reported. What kinds of clothes are being purchased? What kind of car is being driven? Is there a disparity between lifestyle and reported income? If there is, then the question arises as to how the more lavish lifestyle is being funded if the reported income could not support it. If debt has not increased, was money inherited? If neither of these are answers to the question, then there is a good possibility that unreported income is funding the lifestyle. This analysis might lend significant support to the existence of hidden assets.
5. Cash flow procedures in a business: How does money come in and who receives it? If one person opens the mail and records the payments with a second person making the deposit, then there is probably good internal control over the funds being recorded correctly. If, however, the same person opens the mail, writes the deposits and makes the deposits, then a red flag might be found.
Determine whether the checks are made payable to the name of the business or to the owner of the business. In situations where the owner might open the mail and where checks could be payable to the owner, one should compare the accounts receivable records to the cash receipts records.
Write offs of significant amounts should be reviewed to see if the write offs are valid or merely cover ups for receipts that were deposited into a personal bank account instead of the business account. The write offs should be supported by documents that indicate that there were attempts to collect, such as correspondence from the owner or from the business' attorney.
6. Credit card receipts for purchases
7. Credit reports for credit card accounts that are open but may not be in current use
9. Insurance statements for cash value of insurance policies
10. Bank statements to analyze deposit of cash and checks, ATM withdrawals and to whom checks are written
11. Off shore accounts: Assets and money sent offshore are can be difficult to discover. Offshore banks have secrecy laws that can make it virtually impossible to obtain information. A copy of the party's passport can reveal travel destinations where offshore accounts might be located.
12. Loan Applications and Personal Net worth Statements at Banks: Banks may require an annual financial statement from the spouse to maintain the line of financing in existence. Obtaining annual net worth updates through banking institutions can reveal changes in assets and debts from year to year.
13. Public Records Check: Public records are available in county courthouses, city halls and at state repositories. These records contain valuable information that is public and available to anyone who inquires. However, to be efficient with time and resources, one needs to be familiar with how to obtain the types of documents that will reveal asset holdings.
Local Level Searches: Search the County Records Office for property deeds and records. This is the best documented of all assets. The records are indexed by the name of the property owner and generally cross-indexed by the property address. The records include location, deeds of trust, liens and mortgage lender, title company and attorneys involved in each transaction.
Look for quit claim deeds that are filed when a piece of property is transferred to a family member or friend to be hidden. Know the wife's maiden name in case the property is transferred to a member of her family. The market value is not always easily determined from mortgage balances or tax assessments, so it is important to consult with a real estate broker or appraiser to help in determining the fair market value of a piece of property in question.
County Court Records may also be searched for information about any liens, judgments, bankruptcy, or business licensing in the name of the other party. The County Property Tax Assessor's Office may be consulted regarding real property valuation records.
State Level Searches: The Secretary of State's Office can provide information under the Uniform Commercial Code (UCC) concerning corporate records. The UCC is vital when investigating business dealings. Financial statements must be filed whenever transactions take place that involve the use of personal property as collateral for a loan or lease. These records are indexed by the name of the debtor and also list the names of secured parties with regard to the debt plus an accurate description of collateral being used as security for the loan or lease.
Filings usually remain active for five years. The filing may include a copy of a loan application or a copy of the loan check made out to the debtor. The debtor may deposit the loan check into the same account that is used for depositing payroll checks, stock dividend checks and rental income checks.
The State Motor Vehicle Division maintains information on motor vehicles, usually available for a fee. The registration will be in the name of the individual or the company. Search under the names of family members and friends. Motor vehicle titles will also show if there is any lien holder on the vehicle.
The state's Natural Resources Department titles boats and other water vessels and can provide the same ownership information as with motor vehicle records from the State Motor Vehicle Division. Parallel information is available from the Federal Aviation Administration for aircraft.
The Office of the Secretary of State holds corporate information. Corporations have no property exemptions with regard to seizure for payment of debt. Information regarding the corporation's operations and personnel is available. Names of directors, shareholders, officers or principals of corporations are also available. Most of the information available is based upon what was filed by those who formed or presently manage the corporation. Most states do not require verification of the identification of those who apply to form a corporation.
Whether termed as obscuring, hiding, obfuscating, veiling or concealing assets, the many methods used by one spouse to prevent access by the other to cash, real, personal or business property can present a seemingly insurmountable wall for attorneys seeking parity or equitable division of marital assets for their client. Due diligence demands exhaustive measures when unethical and/or fraudulent arrangements exist or are suspected. While it may be difficult to bring to light unreported income and hidden assets, clues can be found which are very meaningful to a trained eye, and can open the facts for fair final property settlements.
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