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.

23 Jul

Pay Support or Go to Jail?

Last week Dukes of Hazzard star John Schneider asked a judge to send him to jail because he can’t pay the spousal support he owes. Schneider apparently owes over $150,000 in alimony to his ex-wife Elly Schneider. He was previously sentenced to 3 days in jail for contempt for his failure to pay, but was let out right away because of jail overcrowding.

The court set certain conditions for him to avoid additional jail time, including paying Elly half of the earnings he is owed from Maven Entertainment, filing certain tax returns, and making certain financial disclosures.

But John would rather do time behind bars because he says he can’t pay. He says he’s taken out all sorts of loans and can’t do it anymore. When they divorced, he was ordered to pay nearly $19,000 per month in alimony. Read More

05 Jul

Determining Income in Divorce and Child Support Cases

When attempting to calculate the income of a party in a divorce or child support case, it is important to remember that income is not determined simply on the basis of historical earnings. It is necessary to also consider the future prospects for income, and how the income scenario may change following the divorce. For example, one of the spouses may encounter a job change with a related change in earnings. Even if a change is not the result of the divorce, it still must be considered as changes in earnings may change a spouse’s ability to pay support.

In evaluating historical income, it is necessary to consider whether historical income was abnormally high or low for some reason. For example, suppose a business run by the spouse had lower net income in the past because there was a substantial investment to increase the capacity of the business. The investment included operating expenses and depreciation of fixed assets, which lowered historical earnings, but created an opportunity for the company to generate higher income in the future. Thus, the projection of future earnings must not rely solely on the historical earnings, but must consider the future prospects for income. Read More

07 Jun

Terrence Howard and the Case of the Missing Spousal Support

Empire star Terrence Howard illustrates why it’s so important to pay up when the court orders you to pay spousal support. His divorce from Michelle Ghent has been interesting for years. Back in 2012, Howard signed a spousal support agreement, but later he said that he only signed it because Ghent was blackmailing him. A judge believed him and threw out the agreement.

Ghent appealed, and last year she won that appeal. The agreement was reinstated, so spousal support was back on.

And apparently Terrence Howard is awfully far behind in his payments to Ghent. Their agreement called for support of $5,800 per month plus additional amounts (up to $4 million per year!) depending on his earnings. Ghent is going to court to ask for $909,418 in back support. She says he hasn’t paid what he owes since she won the appeal, and that he’s hiding his income from the Empire series. She says he’s made $9.7 million from the show over the last 5 years. Read More

04 Jun

Budgets for Living Expenses in Divorce

It can be difficult to come up with a budget for your future living expenses when getting divorced. Most people don’t know how much they have been spending on various things like clothing, groceries, and dining out. It can also be difficult because we need to consider the spouse’s reasonable needs in the future. Things can become even more complicated if the earnings of the parties aren’t sufficient to support two households at the same level they had during the marriage.

Nonetheless, budgets or projections of future spending should be prepared, and a financial expert should take steps to verify the figures and determine if they are reasonable.

What historical period should be evaluated when creating the budget? It is typical to evaluate one to five years of data, but there is no hard and fast rule for the time period that should be analyzed. Contrary to the position advanced in some divorces, future needs are not necessarily based only on expenditures in the last year of marriage. What if spending had been increasing by 10% per year for each of the last five years of the marriage? A case could be made that future needs should reflect a similar increase. Read More

17 May

Accountants and Family Law Cases

Family law cases involving complex financial issues often require the assistance of a financial expert for the following issues:

  • Preparing a financial disclosure, including creating a marital balance sheet
  • Comparing balance sheets from period-to-period to evaluate changes in assets and liabilities
  • Analyzing financial disclosures or affidavits prepared by the spouses
  • Calculating the historical income of the spouses
  • Determining income (or the ability to pay) in order to calculate support
  • Determining the standard of living (or the need for support)
  • Valuing business entities or other assets (such as real estate, pensions, and the like)
  • Identifying assets and determining whether they are non-marital (separate) or subject to division (marital or community)
  • Tracing and finding funds or other assets
  • Analyzing claims of dissipation, wasteful spending, or fraudulent conveyance
  • Evaluating the income tax impact of various scenarios
  • Assessing the work of an opposing financial expert
  • Other litigation assistance, such as assistance with drafting discovery demands and interrogatories or preparing for the depositions of individuals with financial information

In addition to these financial issues, an accounting expert could also play the following roles in family law cases:

  • Assisting with settlement activities, evaluating the financial impact of a settlement offer, making certain calculations, and giving opinions on various settlement scenarios.
  • Mediating a divorce case with financial issues to help the parties reach a settlement.
  • Acting as a neutral expert in the divorce, providing an objective opinion on financial matters. The parties may agree together on the financial neutral, or the court may appoint the accountant.
  • Participating in post-court activity, aiding in the evaluation of financial disputes, including things like allegations of fraud during the divorce process or motions for modification of support.

 

15 May

Divorce: Grab the Documents

Miles Mason, a Memphis divorce attorney, has a great article on his blog called Grab the Documents: What Spouses Need to Copy for Divorce Lawyers. Divorcing spouses always wonder what documents they need to take, and the list provided by Miles is a great roadmap. Read the article for details and descriptions on each item, but below is the basic list.

Documents are going to include both paper and digital records. If you have access to any bank, credit card, or investment accounts online, it’s advisable to go into the accounts and download all available statements and supporting documentation. Do it right away in case you lose access to that account later. Read More

14 May

Finding Hidden Income in a Cash Business

I love working on divorce cases where one spouse is trying to hide money.

When a business owner has a cash business and is getting divorced, sometimes the income coincidentally (or not so coincidentally!) drops dramatically.

What can we do to investigate that? It’s hard. The business owner knows that cash leaves no paper trail and is difficult to prove.

But all is not lost. There are techniques we can use to find indirect proof of the amount of cash a business should be generating (even if the owner isn’t reporting all of it). Read More

30 Apr

Why Hire a Forensic Accountant in a Family Law Case?

Some family law attorneys are reluctant to retain forensic accountants in their cases. Money may be a factor, but sometimes the need for an outside expert is not clear. While law firms may have paralegals or attorneys on staff who are very knowledgeable about financial issues, the outside forensic accountant offers several advantages:

  1. Experience in financial investigations means the work can be completed quicker and more efficiently. The results are often presented better since experts present their results in court and are used to making things understandable for non-accountants.
  2. An outside expert can testify, while law firm personnel cannot. Even though the family lawyer might not intend for the case to go to trial, it is always a possibility, and therefore it pays to have a financial professional who could testify if necessary.
  3. An outside expert is generally perceived as more objective. Ethical forensic accountants attempt to be independent and objective in their opinions, which bolsters the credibility of the calculations.
  4. Forensic accountants have experience finding red flags and issues. Their analysis is often more thorough, and their ability to spot problems is often more developed. This can be invaluable for finding issues that were previously unknown.

Sometimes it seems like the numbers aren’t complicated and an expert witness isn’t required. But one of the most important things your forensic accountant may do is properly present the numbers. Non-experts don’t often know how to present the numbers in the best way. Someone who does fraud investigations and expert witness engagements all the time will likely have a better way of presenting the data.