20 Aug

Tax Returns and Divorce Cases

One of the most common documents utilized in a financial investigation is the income tax return. It’s a key document in any divorce case, so the personal income tax return is always examined. And if there is a business, the tax return for that entity should be examined too.

What can we learn from the tax return? Maybe more than you imagine. Today I’m going to walk through the lines on the personal tax return (Form 1040) and some ways that these items can be analyzed to search for hidden income and hidden assets.

  1. Wages – The figures reported on the income tax return should be matched to the W-2. The W-2 and the pay stubs will provide additional information on the employers, pay rates, total pay, certain benefits, and taxes withheld. Additional analysis may include tracing bank deposits to ensure that all wages were used for the benefit of the family.
  2. Taxable Interest and Tax Exempt Interest – These items of income must be considered when calculating income available for support. They are also important because they can point to bank, investment, and brokerage accounts that may not have been specifically disclosed in the family law case.
  3. Dividends – Like interest, this item of income must be considered in calculations of income available for support, and can point to bank, investment, and brokerage accounts that may not have been disclosed.
  4. Taxable Refunds or Credits – Refunds should be examined to determine if they were shared by the parties, and the expert should evaluate whether a spouse is having unusually large amounts withheld from paychecks. This could be a technique used to hide funds until after the divorce is final.
  5. Alimony Received – This relates to a prior marriage, and will likely not be a factor in the current marriage and divorce.
  6. Business Income or Loss – This form shows income or loss from a sole proprietorship or single member LLC. A business lifestyle analysis may be needed to evaluate this.
  7. Capital Gains or Loss – Along with interest and dividends mentioned above, this portion of the income tax return can point to assets in investment and brokerage accounts.
  8. Other Gains or Loss – This line item often relates to sales of property used in business, so it should be evaluated to determine if other assets or income streams exist.
  9. Distributions from IRAs, pensions, or annuities – Any activity on these lines should be evaluated to determine if all retirement accounts have been disclosed and considered.
  10. Income from Rental Real Estate – This item should be investigated in the same way as many business interests, so refer to Chapter 12 for information regarding the business lifestyle analysis.
  11. Income from Royalties, Partnerships, S-Corporations, or Trusts – This item should also be analyzed in the same fashion as business interests.
  12. Farm Income or Loss – This is also a business interest that might need a detailed analysis.
  13. Unemployment Compensation – Information about unemployment benefits should be used in conjunction with wage information to determine if all of the income benefitted the family.
  14. Social Security Benefits – Two figures are reported for Social Security, the total amount received and the taxable amount. The total amount received is the important figure for an analysis of income.
  15. Other Income – Many types of income could fall under this category, so any income reported on this line on the income tax return should be carefully evaluated.

The personal income tax returns can also be useful when quantifying the spending of the family for the lifestyle analysis. The items of most interest include:

  1. Mortgage interest deduction – This item helps verify real estate owned (the asset side) and loans outstanding (the liability side). It also allows the financial expert to calculate an estimated monthly payment.
  2. State and local income tax deduction – The accounting expert can match the deduction to the underlying accounting records. The deduction should be evaluated to determine if it is excessive and/or used to hide cash until the divorce is complete.
  3. Real estate tax deduction – Similar to mortgage interest, this line item points to the ownership of real estate.

Income tax returns can be audited or amended, or both.  The taxpayer can also be notified by the taxing authorities that there is an error or omission in the tax return, and taxes have been underpaid or overpaid. The family law attorney should inquire as to whether any of these have happened, and request documentation of the notices, audit results, and/or amended income tax return.  Inquiries should also be made about whether there are any unpaid taxes, interest, and penalties, or any existing tax liens.

In addition to the income tax return itself,  the 1099s that were used to help prepare the tax return can provide useful information. 1099s are issued for items such as rent, royalties, non-employee compensation (subcontractor or self-employed income), fees received by an attorney, dividends, interest, government payments, and a variety of other kinds of income. The 1099s might provide information on real estate or other valuable assets owned, investment accounts, the activity within the accounts, and the account balances.

17 Aug

What to Do After a Fraud Investigation

After a fraud investigator is done with her work and has issued the expert report, company management and retained attorneys must decide what to do with the information presented. If the case is already in litigation, the use of the report is obvious. If the company has not yet taken action, a few options should be considered.

Internal Discipline

It is natural to want to dismiss an employee as soon as it is apparent that the person has committed a fraud. It is often safer for the company to have the suspect off-site, so that no more fraud can occur, but it is important to realize that this may also hamper the gathering of information. For this reason, some companies decide not to immediately terminate the employee. If the employee is still actively employed by the company when the fraud investigator’s report is issued, a decision must be made about her or his future. The company could decide to do nothing if sufficient evidence is not available or if the evidence exonerates the employee.

The next possibility is discipline, while maintaining the person’s employment with the company. This might include a warning, suspension, demotion, change of duties, probationary period, or pay cut. Labor and employment attorneys must be involved in this process to ensure that no laws are broken in the process of punishing the employee.

Terminating the employee may be a viable option as well. In companies with strong zero-tolerance policies, this might be the standard reaction to most fraud cases. It is easy to see why management may not want the employee at the company, especially if the company is very small. Trust has been broken, and management may not believe that it can be mended, so the employee is better off terminated.

It is important for management to remember that swiftly disciplining an employee who has engaged in fraud or unethical behavior can have a deterrent effect. Employees may think twice in the future before committing fraud if they know that management takes swift actions in these cases.

Insurance Claims

It is always advisable for a company to check its business insurance policy for coverage related to employee theft. This should be done as soon as a potential fraud is identified. Insurance companies often have clauses that require a fraud to be reported soon after it is suspected, so it is best to contact them immediately. Unfortunately, many companies have no coverage or inadequate coverage for cases of employee dishonesty. An assessment of risk goes with the purchase of every insurance policy, and lower coverage (or no coverage) for internal fraud is a risk that management may be willing to take.

The fraud investigator’s report should be sufficient to substantiate an insurance claim by the company. The claims process can often be made easier if the company puts insurance company claims personnel directly into contact with the fraud investigator. In this way, any questions or concerns can be resolved quickly.

Civil Legal Action

Upon gathering evidence to support an opinion on allegations of fraud, a company may decide that pursuing a civil suit against the perpetrator is the best course of action. If this happens, a fraud investigator’s assistance may be needed to help gather the right documents. During the process of discovery, each side of a case is trying to find out as much as they can about the situation, requesting documents and demanding that certain questions are answered.

A fraud investigator can be a big help in putting together a request for production of documents. Because the investigator has familiarity with the case, she or he is in a good position to know what documents could bolster the case and fill in any holes discovered during the investigation.

It is important that document requests are specific enough that they clearly identify the information that is being asked for, yet not so specific that the company or person responding can avoid providing the documents. For example, certain ledgers or accounting records may have common names, yet be called by a company-specific identifier. It is important to identify those records by both the common name and the company-specific name (if known), so that the opposition cannot say they don’t know what is being requested.

Criminal Charges

A defrauded person or company can refer a case to law enforcement and can help increase the chances of the case being prosecuted but ultimately does not make the decision to prosecute. That decision lies solely in the hands of law enforcement. The larger the fraud or the more egregious the case, the more likely that law enforcement may seriously look at it. Local law enforcement is often reluctant to get involved with white collar crime cases because of lack of resources, lack of expertise, and a focus on violent crimes.

It is more common for the FBI or a state law enforcement agency to give serious consideration to a white collar case. However, they often do not have a lot of time or resources to devote to an investigation. If the company comes to them with a report from an independent fraud examiner, complete with supporting documentation, it is sometimes easier to get law enforcement to consider the case. Simply put, law enforcement resources are stretched thin at all levels, and the more work the company can do for law enforcement, the easier it might be to have them consider criminal charges.

14 Aug

Net Worth Method of Proof for Unreported Income

When an IRS auditor or criminal investigator suspects that a taxpayer has unreported sources of income, he or she looks for ways to calculate that unreported income. One way is the net worth method of proof.

Forensic accountants and fraud investigators can use the same method to calculate unreported income in other types of cases, such as divorce. In this video, Tracy describes how the calculation is done and how the results may be used.

10 Aug

Skills of a Fraud Investigator

How do I become a fraud investigator? What skills does a forensic accountant need? I get asked these questions a lot, so today I’m going to give my thoughts on some of the important qualifications and skills a fraud investigator might have.

The educational background of a good fraud investigator can fall into a wide range of disciplines. Fraud investigators have degrees in accounting, finance, police science, law, and criminal justice. There is no widely accepted course of study for fraud investigators, although those degree programs that offer a strong foundation in accounting and finance seem to prepare students well for the numerical component of investigations.

Many excellent fraud examiners have a work history that is far more important than their educational background. On-the-job experience as a police detective, federal agent, insurance claims analyst, financial statement auditor, or financial analyst can lend itself well to a career in fraud investigations. It’s not unusual for practical experience in the field to play a much bigger part in the fraud investigator’s skills than any type of classroom training. The field of fraud examinations has an extremely varied range of educational and work experience. Other careers often have a few well-defined career paths, but the road to success as a fraud investigator can lead in many directions. Read More

08 Aug

Behavior of Upper Level Executives Who Commit Fraud

A while back we talked about behavioral red flags of fraud, which are the signs that someone might be involved in a fraud at work. Some of the most common red flags are living a lifestyle that exceeds a person’s earnings and unusual attitudes on the job (being combative, possessive of their work, etc.)

The same red flags don’t necessarily apply to upper-level executives, or they’re just not as easy to spot. In this video, Tracy talks about some of the warning signs we might see with top executives who are committing fraud. Most commonly, we see a higher level of greed and arrogance when committing fraud (which, coincidentally, may lead to the person’s downfall).

06 Aug

Faces of Milwaukee: The Face of Forensic Accounting

From the Faces of Milwaukee 2018 special feature in Milwaukee Magazine:

It wasn’t an accident that Tracy Coenen became a forensic accountant. She always had an interest in the criminal justice system, with an eye toward becoming a prison warden.

While attending Marquette University, a specialty class in the criminology program called Financial Crime Investigation was enough to hook Tracy.

She worked as a financial statement auditor at the “Big Six” firm Arthur Andersen before moving to a small forensic accounting firm to learn the art of fraud investigations. Tracy stepped out on her own more than 18 years ago to start Sequence Inc., where she works exclusively in the area of forensic accounting. Read More

03 Aug

Why My Clients Work With Me

It’s important to think about why your clients work with you. It can guide your marketing efforts and it can help you refine your service offerings.

My clients like the fact that what they see is what they get. I’m the forensic accountant who will do all the work on their project. They don’t have to worry about someone inexperienced learning the art of forensic accounting on their dime or possibly even botching their case. Experience is key, and my clients know that they get my experience.

My clients also like that: Read More

02 Aug

Interviewing in Fraud Investigations

Interviewing witnesses and suspects is a critical part of any fraud investigation. There are tons of resources out there to help fraud investigators learn how to be effective interviews. There are books, videos, courses, and certifications.  I’m going to quickly cover some of the high points of interviewing here.

Fraud investigators are continually in question-and-answer mode when trying to understand a company, its operations, the players, and the suspected fraud. Much of this is done informally, with an information exchange between employees and investigators.

A big part of interviewing involves having the right demeanor and body language. People who are uninvolved in the fraud and are giving you information want to feel comfortable doing so, and they want to know that the investigator is listening. That has to be accomplished while directing the discussions so that time is not wasted on much unnecessary commentary. There must be a focus on the items that will help solve the case.

The best interviewers are able to connect with those being interviewed in a way that makes them want to help and provide information. They have a way of guiding the discussion while listening to the person giving information. They do not interrupt a lot, and even when they need to focus the interviewee, they do it in a way that does not seem like an interruption. Excellent interviewers have the ability to put the interviewee at ease. They are professional in their demeanor, yet relaxed enough that the interviewee feels comfortable sharing information. Read More

26 Jul

Management’s Judgment and Financial Statement Fraud

With thousands of detailed accounting rules, how can there be financial statement fraud? There are areas of the financial statements that rely heavily on the judgment of management. They make estimates and decide how to apply the accounting rules. This leaves the door wide open for abuse.

Many accounting entries are pretty simple. It’s easy when the company buys a small item, gets an invoice for it, and pays it. We can record the amounts and the dates pretty simply based on that information.

But it gets more difficult when the situation is not so black and white. For example, when a company sells a long-term service contract to a customer, when is that revenue recognized? The revenue usually is going to be recorded over time, and the way to calculate this can vary.

Who is to say that management won’t decide to recognize the revenue using a schedule most beneficial to that company? There may be reasons for wanting to recognize that revenue sooner or later, and management has the ability to manipulate the situation.

24 Jul

What is Money Laundering?

Money laundering is fun to talk about. It just sounds cool to begin with. And the whole process is fascinating to me.

It is important to know that money laundering is not a fraud scheme. It is a crime that is committed to cover up other crimes, but it is not the same thing as fraud. The primary purpose of money laundering is to take money that has been received from criminal activities (dirty money) and make it appear legitimate (clean money).

Dirty money can come from illegal activities such as drug dealing, prostitution, robbery, bribery, illegal political contributions, tax evasion, or fraud. The laundering process hides the real origin of the money and makes it look like it came from a legitimate source. Read More