This article was originally printed in the ABA Section of Family Law eNewsletter, January 2013.
We’ve all seen it before: A spouse owns and operates one or more businesses. Divorce is filed, and the “out” spouse is told that the businesses have little or no value. Further, there is no income available to pay support, thanks to the poor financial condition of the businesses.
How can this be when the married couple has lived a good life for years, always having more than enough money to pay for homes, living expenses, and vacations? It’s the case of the disappearing income and asset values, brought on by the divorce.
Fortunately, there are ways to ferret out truth behind the financial picture that is being presented. It likely will not be easy. The “in” spouse controls the money, the information, and the documents. Getting him to turn over financial documents that will prove there is income and value will be difficult.
He may refuse to put up money to pay for a business valuation or other investigation into the business interests. He might bleed the spouse dry, hoping she won’t be able to fund the attorneys and experts necessary to evaluate the business. He hopes she will give up and take a meager settlement. After all, it’s better than nothing!
Sources of Information
The first step in sorting out the truth about the income and assets is getting reliable information. The financial statements and income tax returns are a good starting point, but it is important to remember that this information can be manipulated. Even when an outside accounting firm is compiling or auditing the financial data, it is still subject to manipulation by the owner.
Financial statements and tax returns should be compared side-by-side to look for unusual changes in revenue and expenses. A drop in revenue around the time of separation may be suspect. Remember that a business owner may underreport income, but may still report all expenses in an effort to reduce the net income of the business. The expense items may hold clues to the real level of revenue.
The best source of information is third party data, which generally is not subject to manipulation by the business owner. Bank statements and credit card statements tend to show at least part of the truth about the money. An examination of check copies obtained directly from the bank will show exactly where the money went, and that information is nearly impossible to manipulate.
Another key document may be loan applications. The spouse may apply for new financing, either personally or for a business, and the application may yield valuable information. The spouse has an interest in showing the bank a positive financial picture. What if that picture conflicts with what is being reported in the divorce? At the very least, the spouse is likely lying to someone – – either the bank or the divorce court. You may also be able to use the loan application to find additional assets and streams of income.
Other documentation such as insurance policies may also indicate value. Look for business valuations or appraisals that were done in the recent past. Consider whether the business owner has been buying new equipment or real estate, or otherwise investing in a business he claims is failing. These investments may actually point to success or expansion. Be creative in trying to find any documentation that may provide clues to the true financial condition of the individual and the business.
Lifestyle of the Spouses
What if the business owner has been careful with the records, and the financial statements and bank statements seem to support his contention that he’s not making any money? One way to dig into the issue of hidden income is a lifestyle analysis. The spouse may have a lifestyle that is in contrast to his claims of poverty.
Examine all personal expenses, making reasonable estimates where hard data is not available, and ask yourself whether the reported income could support this lifestyle. The net worth of the spouse should also be examined during the lifestyle analysis. Are his assets increasing or decreasing in value? Is he funding his lifestyle by depleting assets? Is he incurring debt to fund the lifestyle?
Remember though, that a change in net worth may not tell the full story on its face. For example, suppose the spouse is contending that he is using bank loans to fund his lifestyle. That might seem to support his contention that he has no income. However, think carefully about the process of getting a personal loan from a bank. Banks generally require the applicant to have income sufficient to pay back a personal loan. Would a bank loan the spouse money if he truly had no source of income to pay it back?
Don’t forget that the spouse could have his business pay his personal expenses. This is a clever way to manipulate the finances in a divorce. He has no need to take a paycheck if the business pays his personal expenses, so his claims of “no income” may appear to be supported. The payment of personal expenses will reduce the net income of the business if the expenses are being recorded as business expenses. This reduced income may appear to support the contention that the business is unprofitable, and may also result in a lower business valuation for asset division.
Look for Inconsistencies
The key is to continuously look for information that is inconsistent with the picture being presented by the spouse who controls the business interests. Remember that the spouse in control of the business and the finances has an extreme advantage. He can manipulate the money and the accounting records to his advantage. He can control exactly what evidence the spouse sees.
It may not be necessary to prove beyond a shadow of a doubt where the money is going and what the value of the business interests is. It may be enough to prove that the data and documents are inconsistent, and therefore the spouse is not credible in the divorce. Such a showing may be enough to persuade the court to take a closer look, and may yield a better or fairer settlement for the spouse.
Tracy L. Coenen, CPA, CFF is a forensic accountant and fraud investigator with Sequence Inc. She specializes in cases of embezzlement, financial statement fraud, white collar crime, securities fraud, and family law. She can be reached at 312.498.3661 or [email protected]