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.

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.

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.

19 Jul

Keeping Forensic Reports Simple

Making complex transactions easy to understand is no small task, but it is part of the job of any good fraud investigator. You can find the most earth-shattering proof of fraud, but if you cannot articulate your findings in a report that others can understand, your investigation results are not worth much.

Use graphs, charts, and tables to help illustrate your points. Even though you may not need a graph or chart to demonstrate your findings, consider that the reader of your report might benefit from it. Remember that people learn and comprehend in different ways, and that fact could be very important if your case ever goes in front of a jury.

One juror might understand your written words best, so it is important to make the report very reader-friendly with short, well-organized paragraphs. Other jurors might understand the most by listening to your court testimony, which should support and reiterate the written report. Other jurors might be most receptive to pictures or charts that demonstrate what you have found. Read More

12 Jun

The Fraud Investigation Report

Reporting the findings of a fraud investigation will require varying levels of detail and precision, depending on the specifics of the engagement. Yet it is fairly easy to develop a standard reporting process that can be followed by staff.

One option in some cases is providing an oral report to the client and counsel. This is not the most common way to report on the findings of a fraud investigation. However, it is appropriate in certain cases, such as ones in which legal counsel does not yet want a discoverable report in the file.

The results of a fraud investigation are usually detailed in a written report. When writing a report, the fraud investigator must remember who will be reading the report. It is important to consider that even though today the report may only be for a company’s internal purposes, somewhere down the road the report may be used by law enforcement or in court proceedings. So it is important to know the current audience for an investigation report, but it is also imperative to consider who might need the report in the future. 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

09 May

Why is Financial Statement Fraud Such a Big Deal?

The manipulation of a company’s financial statements does not occur as often as asset misappropriation schemes like payroll fraud, check kiting, or inventory theft. And the losses from financial statement fraud aren’t readily apparent to most people. When money is stolen directly (asset misappropriation), it’s easy to see what the harm is to the company.  Financial statement fraud schemes are much more costly than other types of fraud. Some may wonder what the losses in a financial statement fraud could be. After all, the employees involved are just manipulating numbers on paper, but there is really no harm to anyone, right? Wrong.

Financial statement fraud is so expensive because its effects are far-reaching. Just a few of the many effects of financial statement fraud include:

  • Bank offers a loan that is riskier than it believed.
  • Stock price becomes inflated.
  • Company pays higher bonuses than it should.
  • Executives issued more stock options than they deserve.

Read More

02 May

Accounting “Irregularities” Can Suggest Fraud

Numerous signs can point to the possibility of fraud. Literally hundreds of different types of fraud schemes exist, so the number of possible red flags of fraud is huge. Today we’ll talk about one area where you may see some red flags: irregularities in the accounting records and procedures.

Irregularities that point to the possibility of fraud can range from simple things like unreconciled accounts and unusual account balances to more complex problems like “on top entries,” which are made after the books are closed in order to manipulate the numbers ultimately reported on the financial statements.

An auto dealership had a controller who had not reconciled the bank accounts for nearly a year, despite management’s insistence that it be done. Management did not insist enough, and the problem persisted; the accounts remained unreconciled month after month. Unreconciled bank accounts usually signal one of two problems: the accounting staff is incompetent or understaffed, or there is a fraud-in-progress that will likely be exposed through a bank reconciliation. Both of these problems need to be corrected quickly.

In this case, it turned out that the controller simply couldn’t handle all of the responsibilities of her job. She was out of her league and was not doing the reconciliations because she did not have time and was likely afraid that the reconciliations would expose her incompetence. The reconciliations would have shown that she didn’t have a good handle on the company’s finances. Read More

19 Apr

Evaluating Fraud Tips

Insider fraud is most commonly detected in companies through a tip, either from an employee, a customer, a vendor, or an outside party. Anonymous hotlines are excellent tools for reporting fraud, but management must have a plan for evaluating these tips.

Some tipsters are okay with revealing their identities from the start. Others fear retribution or damage to their own reputations, so they prefer anonymous reporting. Just because a tip is anonymous, that does not mean it is any less credible than an allegation made by someone who is open about her or his identity. However, if someone is willing to reveal her or his identity when providing a tip, it may lend additional credibility to the information.

Employees are sometimes worried that a hotline or other anonymous reporting mechanism might lead people to make false reports about others. While this does happen sometimes, those reports usually appear suspicious and are quickly identified as meritless. Read More