The divorce process is a time of mistrust for each spouse, and right or wrong, each may accuse the other of hiding assets. Assets are traditionally hidden in one of four ways:
(1) The person denies the existence of an asset;
(2) Assets are transferred to a third party, entity or separate account;
(3) The person claims the asset was lost or dissipated; and
(4) Creation of a false debt.
There are a number of methods used to locate hidden assets in the context of a divorce. The first place to look to discover hidden assets is the tax returns of a party and business interests involved in the dissolution. It is a good idea to closely examine tax years for the past five years. By reviewing the tax returns, you may discover assets that you had no knowledge of or that were not disclosed by your spouse. This is especially true in cases where one party has traditionally handled all the financial decisions for the married couple. The first two pages of a tax return can serve as a table of contents because they list the forms and schedules that are attached to the return. In reviewing tax returns to locate hidden assets, it is important to review the following:
• Schedule A – Itemized Deductions. Schedule A may identify unlisted assets or sources of income. For example, property taxes or interest deductions may reveal real property or a boat that one spouse does not know exists..
• Schedule B – Interest and Ordinary Dividends. Schedule B identifies assets and investments generating interest and dividends. It is important to know that some interest-generating accounts may be non-taxable and may not listed.
• Schedule C – Profit and Loss From a Business. A careful examination of Schedule C is essential to a determination of hidden assets or income. Normal household expenses may be passed through the business. Depreciation for real estate is generally not a cash outflow and is added back to net income to determine the actual income. The depreciation schedule may also reveal additional assets of the business as well as purchases deducted on a dollar-for-dollar basis as Section 179 items.
• Schedule D – Capital Gains and Losses. Schedule D is used to report gains and losses from stocks, bonds and real estate. Schedule D contains a wealth of information as to investment income held by the parties.
• Schedule E – Supplemental Income and Loss. Schedule E is used to report income from rental properties, royalties, partnership and S Corp income. It is a common practice to hide significant assets in such entities. Depreciation should be examined to determine whether this is an expense that should be added back to income.
• Form 1065 – Partnership Income. Form 1065 is used to report partnership income that can occur in the context of LLC’s or other partnership-type entities.
• Form 1120 and 1120S – Corporate Income. Form 1120 and 1120S are used to report partnership income.
• Form 2441 – Child Care Expenses.
It is a good practice to examine both federal and state income tax returns, 1099’s and W-2’s as well as amended returns to determine the true nature and extent of the assets and liabilities of the parties.
In the course of discovery (the process of obtaining documents and financial information from the opposing party), most spouses believe that their counterpart has somehow hidden or failed to disclose the existence of certain assets. It is common for divorcing parties to accuse the other of having a large amount of cash, expensive jewelry and the like. The proof and valuation of such assets can be extremely difficult and requires more than hearsay statements for the court. The following checklist of research items may assist in determining the whereabouts of hidden assets or if, in fact, they exist at all.
(1) Financial Statements – Any loans from lending institutions require sworn financial statements to be filled out. In most cases, the borrower will attempt to impress the lending institution with the extent of assets and may exaggerate the nature and extent of those itemized. Reviewing five years or so of financial statements, may put you on the trail of assets which are now unaccounted for and which show valuations substantially greater than what is now claimed.
(2) Personal Income Tax Returns – Reviewing personal and federal income tax returns and attached schedules filed during the past five years may indicate sources of interest or dividends. The returns may also reveal unknown sources of income from or loss from trusts, partnerships or real estate holdings. A review of W-2’s, 1099’s, 1098’s and K-1’s is essential to this process.
(3) Corporate Income Tax Returns – If one spouse is the principle owner of a closely-held corporation or a Subchapter S Corporation, the corporate tax returns should be reviewed for the following:
a. The party may be manipulating his or her salary by taking less pay and then taking loans from the corporation to make up the shortage;
b. The spouse may be charging personal expenses to corporate accounts which will be reimbursed or charged to the officer’s loan account;
c. The corporate returns should also be reviewed for excessive or unnecessary retained earnings (undistributed profits). These may be a disguise for available distributions or an artificially low salary level.
d. Reimbursement of prior capital contribution or repayment of loans to the corporation may also provide hidden cash flow to your spouse.
(4) Partnership Income Tax Returns – An analysis of several years of partnership income tax returns (IRS Form 1065) may reveal sudden changes in the partnership interest or distributions. Such changes often occur at the time of divorce and then compensating adjustments are made after the dissolution is finalized.
(5) Cancelled Checks and Bank Statements for Personal, Partnership or Corporate Accounts – A review of three years of bank account statements is essential to analyze for hidden assets or cash flow distributions or unusual expenditures. The analysis may show cancelled checks for the purchase of property which you never knew existed or the transfer of assets to hidden accounts.
(6) Monthly Account Statements – Bank account statements opened during the past five years may show the transfer of money to hidden accounts. Look for any deposits or withdrawals which are unusual in amount, or in a pattern. A monthly withdrawal or deposit of money in odd amounts may reflect payment or income sources that you are not aware of.
(7) Security or Investment Account Statements – If one spouse has been buying stocks or bonds or dealing in commodities, the broker or brokerage firm will provide monthly or quarterly statements indicating all transactions. An analysis of these statements could show the existence of securities of which there was no knowledge or can raise questions as to the dispositions of the sale proceedings. Cross checking security transactions and bank accounts by date and amount will usually verify the source of the disposition of monies involved. If securities are sold and the proceeds are unaccounted for, you can be sure the money is out there somewhere.
(8) Expense Accounts – A corporate employer will frequently allow employees a great deal of latitude in their expense account reporting. The spouse may take advantage of this by exaggerating or even falsifying business expenditures. The employer maintains records as to expense account disbursements of the employee, over the years on a monthly basis. An analysis of these records may indicate the extent to which the employee is able to “live off” the expense account.
(9) Deferred Salary Increase, Uncollected Bonus, or Commissions – Employers are sometimes sympathetic to their divorcing employees and willing to bend the rules to defer salary increases, bonuses or commissions in order to reduce apparent income.
(10) Safe Deposit Box Activity – Banks maintain safe deposit records indicating when and who accesses the safe deposit box. These records will not indicate the contents of the box or what, if anything, has been removed.
(11) Cash Transactions and In-Kind Compensation – One spouse may be in a position where cash is paid or he or she may receive in-kind compensation where something of value, other than cash, is given in exchange for services. Such payments and non-cash items are rarely reported as income, but can significantly increase the bottom line.
(12) Children’s Bank Accounts – Quite often the spouse who wishes to hide money will open a custodial account in the name of his or her child. Deposits and withdrawals are made without any intent that the child has use of the account except in the case of the spouse’s death. The interest for these accounts is not shown on income tax returns, nor are returns filed for the child.
(13) Personal Knowledge of Your Spouse’s Habits – One of the most useful discovery tools is personal knowledge of your spouse’s habits with money. People who are attempting to hide money very seldom do so without making some sort of written record to account for their activity.
(14) False Income Tax Returns – Some divorcing spouses are inclined to alter income tax returns or to adjust financial information. It is always a good idea to authenticate and cross check tax returns. Copies of jointly filed tax returns may be obtained directly from the Internal Revenue Service on Form 4506-T.
(15) Phony Loans or Debts – Unscrupulous spouses may attempt to bury money with phony loans to friends or relatives. The money may be tied up with a long-term note or with a claimed likelihood of not being collectible.
(16) Retirement Plans – Pension or profit-sharing plans established in a closely held corporation should be carefully reviewed to determine whether the monies have been contributed to the account and invested according to the plan requirements.
(17) Defined Benefit and Pension Plans – Defined benefit pension plans can be used to hide a great deal of income.
(18) Estate, Gift and Inheritance Tax Returns – An analysis of the inheritance, estate or gift tax returns of relatives may show substantial assets that have not been accounted for in settlement negotiations. The returns may also show other hidden assets. A tracing of the estate’s distribution can show what has happened to the assets.
CONTACT PAUL F. SHERMAN FOR EXPERT ADVISE ON YOUR DIVORCE
We know you have more questions and we have the answers. If you would like to learn more about divorce, child custody or any family law matter, call the Law Offices of Paul F. Sherman at (503) 223-8441 for legal advice, or Contact Us for a free consultation.