The Importance of Forensic Accounting

Analysis in Matrimonial Matters

As forensic accountants, we may be called upon to determine the value of the marital estate. Frequently, we either receive an avalanche of documents or very few documents. How do we distinguish what is valuable versus what is not? Why is the information so important in our forensic analysis of the case? In this article, the author answers these questions and shares her experience.

[su_pullquote align=”right”]Resources:

Forensic Accounting Academy™

Forensic Accounting in Matrimonial Cases

Forensic Accounting in a Business Divorce

30 Things You Need To Know To Be A Successful Matrimonial Forensic Analyst

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As forensic accountants, we may be called upon to determine the value of the marital estate.  Frequently, we either receive an avalanche of documents or very few documents.  How do we distinguish what is valuable versus what is not?  Why is the information so important in our forensic analysis of the case?

Statement of Net Worth

The Statement of Net Worth forms the starting point for maintenance and child support in divorce actions.  It can be an integral component in determining temporary as well as permanent maintenance and child support.  Statutes vary from state to state.  In many states, if the couple’s lifestyle is above the respective state’s income cap, judges may, at their discretion, look to the expenses and income as reflected in each party’s Statement of Net Worth to determine maintenance (aka alimony).  Often, one spouse’s expenses significantly differ from the other spouse’s.  As forensics, it is our assignment to determine what the true expenses are and why they differ.

Frequently in high net worth divorces, the moneyed spouse does not disclose assets.  One of the more significant assets omitted would be those assets transferred as part of the “divorce planning” process by the moneyed spouse.  If so, how much, when, and where were these assets transferred or retitled?

Credit Card Statements

Attorneys ask for credit card statements time and again.  Cases have gone to trial without the analysis of the credit card information.  This is an area rife with marital dissipation.  In addition, if preparing a business valuation and there is the presence of business credit cards, there are personal expenses charged to the business account that should be taken into consideration for the Statement of Net Worth as well as for normalization adjustments in the business valuation.  I have seen one party state in his expenses “paid through the business”.  How much is paid through the business?

Insurance Policies

The forensic accountant would want to obtain the property insurance policy(ies) that covers collections, as well as any purchase receipts.  Purchase receipts can include antiques, paintings, jewelry, gold bars, etc.  The purchase receipts can confirm the existence of additional assets not included in the couple’s insurance policy.

Tax Returns

Is there a pattern in the previous year’s tax returns?  Have there been refunds on a consistent basis?  Where are the current year returns?  On extension?  How about requesting draft returns with relevant work papers from opposing counsel?  Can the client obtain them directly from the couple’s accountant?  I have seen instances whereby one spouse will overpay on his/her tax returns in the year of divorce and apply the joint refund to his/her personal returns the year following the divorce, effectively secreting away marital funds.

Separate Property Claims

Separate property is comprised of all assets held by a party prior to the date of the marriage and it is presumed to not constitute marital property.  The claimant has the burden of providing evidence of his/her separate property claim.  The separate property claim is a “credit’ to the spouse.  It is not includable in the marital estate for purposes of equitable distribution.  If there is any appreciation in the value of the property during the marriage as a result of the other spouses’ direct or indirect contributions, or transmutation or comingling, or other acts that may have caused the separate property to lose its separate characteristic, it must be clearly identified.

Separate property can be “contaminated”.  In other words, the separate property can lose its status by either transmutation and/or comingling, and, therefore, become marital property subject to distribution.

Transmutation is the process whereby the original separate property was converted, either deliberately or unwittingly, into marital property.  There may be subtle exceptions, such as the possibility that the change of title was for convenience only.  For example, if a spouse has an investment account prior to the marriage and adds the spouse to the title of the account, it is presumed that the account is marital, unless the claimant can prove otherwise.  One way to demonstrate this is to provide the actual statements to show that no marital monies were deposited into the account during the marriage.

Comingling is the process whereby the original separate property was comingled with the marital property.  For example, if the claimant purchased a home prior to the marriage (separate property) and, during the marriage, the mortgage was paid with marital monies and renovations were made with marital monies.  In order to determine the claimant’s separate property, the market value of the home at date of commencement would be compared to the value of the home at date of marriage.

It may also be possible to trace and determine the separate property component of other assets (i.e., bank accounts, investment accounts).

In one interesting case, a husband had approximately ten investment accounts prior to his marriage.  During the marriage, his wife invested some of her own monies by placing her monies into the husband’s separate property brokerage accounts.  At the time of divorce, she stated that she had discussions with the various brokers and purchased stock with her marital monies via the husband’s accounts.  I was engaged to determine whether all of the accounts could be claimed as marital monies.  Fortunately, the husband maintained thirty-five years of records (quite sloppily).  I was able to trace the flow of the wife’s monies from the husband’s accounts to her own investment accounts.  This demonstrated to the Court that whatever monies the wife had put in were paid back to her—either in cash or in the actual stock purchased, thus preserving the separate property.  The husband’s attorney, at trial, maintained that the wife’s use of the accounts was one of convenience.  Her name was not on the accounts and whatever monies she put in were reimbursed to her.

Tracing separate property claims can be quite time consuming and costly.  We should be cognizant of the cost to the client as it may not make economic sense if the separate property amount is not significant.

Stipulation of Settlement

A Stipulation of Settlement is an agreement by both parties in writing and signed by the judge assigned to the matter.

I am often called upon to review the Stipulation of Settlement.  Oftentimes, I find one of the most overlooked issues is the tax effect of the proposed settlement.  While it is true that equitable distribution is a nontaxable event, what about future asset transactions?  For example, if the couple maintained a large portfolio of stocks, we can be called upon to determine the cost basis and the current fair value of each individual stock.  There have been times when a portfolio has grown and one of the spouses is intimately familiar with the cost bases, yet the other is not.  Upon sale of the assets in the future, unbeknownst to the other spouse, there is a significant tax event and it was not taken into consideration during the drafting of the settlement agreement.

Another issue is the simple math that is incorporated into the Stipulation of Settlement.  Like checking our math in a business valuation, I have had clients come in for post-divorce work and the divorce decree was replete with mathematical errors in favor of the ex-spouse.

It is in the client’s best interest for us to request all relevant documentation and to review the information in a timely manner as initial documents often require further clarification or may uncover additional accounts we may have been unaware of.

Rosalia M. Labate CPA, CDFA, CVA, MAFF is the founder and principal of Rosalia M. Labate CPA P.C., with offices in Manhattan and Long Island, New York. Ms. Labate provides forensic, litigation, and valuation services to legal counsel and their clients. She specializes in matrimonial matters.
Ms. Labate can be reached at (516) 996-7788 or by e-mail to Rosalia@LabateCPA.com.