Forensic Experts Can Find Hidden Cash and Unreported Income
As lawyers who handle family law cases know, divorce can be ugly — particularly when it comes to money. One of the greatest challenges for attorneys and their clients is when one spouse hides cash or underreports income to deprive the other spouse of his or her equitable share of the marital estate or to minimize support payments. In such cases, forensic accounting expertise can be essential.
Hunt for hidden cash
When there’s a question about a spouse’s honesty, forensic experts usually start by searching for hidden cash. Spouses with unreported income who are also business owners almost always receive such income as cash. To avoid detection, the business might not record the income in its books or deposit the cash in its bank account — or it might delay depositing cash.
Experts (as well as IRS investigators) typically rely on certain forensic accounting techniques to prove that cash is missing and to estimate how much the owner isn’t reporting. These methods include:
Bank deposits. This method involves reconstructing income. The expert analyzes the spouse’s bank deposits, canceled checks and currency transactions, accounting for cash payments made from undeposited currency receipts, as well as nonincome sources of cash. Nonincome cash sources might be loans, gifts, inheritances or insurance proceeds.
Source and funds application. Here, the business owner’s personal sources and uses of cash are analyzed. This approach can be effective in determining where the owner’s income and other funds came from, and how they eventually were used. If the owner is spending more money than he or she is taking in, the excess represents unreported income.
Net worth. The expert assumes that an unsubstantiated increase in a business owner’s net worth is attributable to unreported income. He or she estimates the spouse’s net worth using telltale documents such as bank and brokerage statements, real estate records, and loan or credit card applications. The expert starts with the amount of gain in net worth, and then subtracts any reported income. Then this amount is adjusted to reflect any nondeductible expenditures, such as capital asset acquisitions, and nonincome sources of funds.
Percentage markup. The expert estimates net income by applying a benchmark profit percentage to sales or some other base amount. In most cases, this method is used as a reasonableness check to corroborate the results of other approaches.
Income and outputs
Looking for cash is only one part of the forensic accountant’s job. He or she also seeks any and all concealed sources of income.
A forensic expert can employ accounting techniques to reconstruct unreported income by examining potential sources of that income. For example, Liz suspects that her estranged spouse Nick is underreporting income from his HVAC systems manufacturing company, Hot Air. Liz employs a forensic expert who, after looking over records that are readily available, suspects there’s something fishy about the company’s supply chain.
The expert asks Liz’s lawyer to subpoena the records of Hot Air’s vendors. He finds that the company has purchased more parts than its official sales records would indicate it needed and uses that information to reconstruct Hot Air’s sales. The sales turn out to be 25% higher than the company has reported.
Access the right information
Although experienced forensic experts are capable of finding even the most carefully hidden cash and income, they rely on the legal expertise of attorneys to ensure they have the right information. If discovery isn’t adequate, the ultimate split may not be fair. So when you hire an expert, do it early in the discovery process so you understand what your expert needs and have a plan for gaining access to it. •