Hidden Assets In Divorce

By: Carley F. Mealey, CPA, CVA

At some point during every divorce, there comes a time to value the marital estate.  Sometimes identifying the assets is more difficult than the actual valuation. Obvious assets include the marital residence, joint bank accounts, retirement and investment accounts, and possibly a business interest.  However, there are also “hidden” assets that may be overlooked, undervalued, or disguised:

Transferred assets

The most common way to hide assets is through a “sale” or gift to family members or trusted friends with the understanding that the property will be reclaimed after the divorce is finalized.

Keep in mind that jewelry collections, antiques, artwork, hobby equipment, and collectible items can have substantial value and are easy to hide. Also, cash can be converted to traveler’s checks or money orders to avoid being included in joint bank accounts.

Prepaid expenses

One common asset-hiding technique is the prepayment of large expenses prior to the date of commencement.  These big-ticket expenses could include property taxes, insurance premiums, season tickets, timeshares, dues, and membership fees.  Also, income tax refunds from the prior year can be substantial for owners of S Corporations with declining earnings.

For small business owners, prepaid expenses can result from over-paying legitimate vendors and not recording subsequent refunds.  For cash-basis tax payers, the prepayment of expenses will also artificially reduce profitability.

Deferred assets

Accrued vacation pay, frequent flyer miles and credit card membership reward points earned during the course of the marriage are often overlooked.  Your spouse may also attempt to delay the timing of bonuses or incentive pay in order to exclude them from negotiations.

Phony transactions

Business owners have the opportunity to skim money by “paying” ghost vendors and later voiding the checks. 

The search for hidden assets can be time consuming and frustrating, especially if you’re unsure where to start.  A qualified forensic expert can assist in locating assets, tracing income, and providing valuable testimony at trial and during settlement negotiations.

If you have concerns that your spouse may be hiding or disguising assets, immediate action is necessary. The more time that passes may mean less access to documentation and records that would substantiate your claim to these assets.  Fortunately, you have certain rights and access that only a spouse has.  No one else is privy to current and dated  correspondence, bank records, credit card statements, personal property tax bills, or government records.  Preserve all of the records you can, even if you don’t understand their usefulness.  There may be documents and financial records that exist only in electronic form.

A forensic computer examiner can find, preserve and present these records in order to determine whether income and assets have been fully disclosed.  If a forensic expert is asked to analyze the financial records to determine a party’s true income or to trace marital assets, examination of these documents could be critical:

·     Insurance documents

·     Internet surfing histories

·     Credit reports

·     Offshore/Canadian bank accounts

·     Cellular phone bills

·     Tax returns

·     Personal computers

·     IRS notices

·     Laptop computers

·     Safe deposit boxes

·     Cellular phones

·     Credit card receipts

·     Text messages

·     Credit card statements

·     Emails

·     ATM receipts

·     Email addresses

·     Bank statements

·     Employment contracts

·     Brokerage account statements

·     Benefit statements

·     Business accounting records

Many items of value will be listed on a general homeowners’ policy, but may also come with their own insurance policies.  Take the time to review these documents or discuss coverage with your agent.  Not only will this help you itemize large marital assets, but a stated insurance value can be useful in negotiating a marital settlement or to assist in identifying assets which may warrant a current fair market appraisal.

Another effective way to identify hidden assets is by reviewing your spouse’s credit report.  Make sure you identify any unfamiliar accounts, as these could be an indicator of additional marital assets.  If your spouse has opened a new primary bank account, you can easily find this information by writing him/her a check and then reviewing the clearinghouse information on the back of your canceled check. Your spouse’s employer may be willing to give you information related to your spouse’s direct deposit. Remember that bank accounts and assets held in minor children’s names and social security numbers have been used to avoid detection and this information should be utilized in any public records searches.

Public records searches are also useful for identifying real estate and personal property holdings.  The Department of Motor vehicles can provide information related to ownership and liens on automobiles, watercraft, motorcycles, and trailers.  The FAA provides similar information related to aircraft.  If you believe your spouse has an ownership interest in a business, you can verify this by accessing records through the Secretary of State.  If your spouse has ever been arrested, criminal court records may include a financial worksheet used for bonding and public defender eligibility determinations.  The criminal documents and pleadings are also public record and may contain important information.

Do not make the mistake of assuming your spouse is too honest to commit fraud.  A healthy degree of skepticism could result in a more fair settlement of the marital estate.

Reviewing Buy-Sell Agreements

While the Buffalo metropolitan area has not felt the dramatic economic downturn that the majority of the nation has felt, the impact on the value of businesses during these economic cycles can be subject to a wide swings in either direction.  This can be the result of national AND local economic conditions, the outlook for the particular industry within which the company operates, the availability of working capital, and the local labor force, just to name a few factors.  Even for businesses that are flourishing and growing, the perceived value of a company can fluctuate because less liquidity, less financing, and less demand translates into lower values.

Any market condition presents a good opportunity to discuss with business owners the importance of reviewing their buy-sell agreements and, particularly, the selected value or the formula they use in that agreement to measure the worth of a business under various exit transactions.  Whether selling a business interest internally to other remaining shareholders or externally to third party buyers, they should consider having their businesses valued, review their buy-sell plan, and adjust their exit strategies at least bi-annually.  Failure to do so could mean delayed retirement, unfulfilled estate plans and an inability to transfer true/real value at a market price.

There are 3 key steps in conducting a buy-sell review: 1) Review the language in the agreement 2) Value the business 3) Review the plan’s funding.

Review the Language in the Agreement

· Does the agreement include a provision for disability?  Is the definition the same as the disability insurance funding?

· Is a business valuation required or is there simply a set value which may be too low or too high?

· Does the agreement take into account the recent changes in the estate & gift tax laws?

· Does the agreement coordinate with the planned funding?

Valuing the Business

The single most neglected area in a buy-sell agreement is the valuation of the business.  It is neglected because many owners assume the business is worth whatever is on the balance sheet.  

There can be very different perceived values, depending upon the type of event or exit transaction for measuring the value of the business; i.e., divorce, sale to insiders, sale third parties, disaster losses, contractual damages, and estate and gift purposes, to name a few.  The third party buyer could be an investment buyer, or, a strategic buyer, in which case, the values are likely different, as are the measurements involved.

There are three main methods that can be used to value a business: 1) the income approach where the value of the business can be found in the earnings of the company; 2) the asset approach where the value is in the company’s assets and not necessarily its earnings; and 3) the market approach where the value is determined based on other relevant market transactions that have recently taken place.  Your business valuation expert will determine the appropriate method based on  company specific criteria such as the type of business, purpose of valuation, etc.

Things you should look for in the business valuation:

· Make sure the valuation analyst took into consideration not just the national and state economy but also our local economy.  Buffalo’s economy is very different from that of Niagara Falls, New York City or even Rochester.  This difference could have a significant impact on value.

· How has the analyst accounted for recent earnings that were negatively impacted due to the recession?  Has an analysis of projected future cash flows been considered?

· What is the industry outlook for the company?  How has the analyst accounted for projections that show strong future results or perhaps a slower than average recovery?  Even if the company has strong earnings now, they may not be representative of future results.

We are seeing lower business values now compared to 3-4 years ago.  Lack of traditional sources of financing, increasing costs of doing business, decline in lender risk tolerance. 

These economy-driven changes in value can cause less than optimal outcomes such as: 1) overpaying for your partner’s ownership interest or 2) not being able to purchase the interest because of reduced credit lines and overall lack of financing.

Review Funding

Funding for the exit plan may come in different forms, but it is important to determine the sources in advance and put them in the agreement.  Then they must be updated as external and internal conditions change over time. For example, funding can come from earnings and be paid out over a period of years, or can come from bank financing, or pre-funded in the form of life insurance.

A business valuation is essential to the exit planning process.  Without an accurate idea of the company’s true value, the exit plan is more theory than real fair market value.  Likewise, without an adequate funding strategy, a buy-sell agreement is only an expensive piece of paper.

cmealey@songinvaluation.com or (716) 630-0600 x 208

Tax Tips For The Divorcing Couple

When you are caught in the throes of a divorce, the last thing on your mind is how you are going to file your taxes in April.  What you do not know can hurt you, so take the time now to identify possible issues you may face.

Can we still file a JOINT return?  Unless you have been legally separated before December 31, you may still elect to file a joint return.  The real question is, should you?  By filing a joint return, you and your spouse are agreeing to be “jointly and separately liable for any errors, omissions or deficiencies” on the tax return.  If you are concerned that your spouse might be under-reporting income or over-reporting deductions, it may be wise to consider alternative filing statuses.  If you choose to file separate tax returns from your spouse, you have the option of filing an amended joint return within three years from the original filing to receive any tax benefits you gave up by filing separately.

Is filing SEPARATELY my only option?  If you provided more than half the cost of keeping up a home for a child, dependent parent, or other qualifying relative for more than half the year, you may be able to file using the Head of Household status.  Keep in mind, if you choose to file as Married Filing Separately, special rules apply effecting your ability to chose between the standard and itemized deductions as well as disallowing dependent care credits, education credits or deductions, earned income credits, the taxability of previously exempt interest income, and even your ability to make Roth IRA contributions or conversions. 

How do I qualify for HEAD OF HOUSEHOLD status if we are still married?  The IRS says that in order to qualify, you must either be unmarried or considered unmarried on the last day of the year.  So how does this work?  If you and your spouse lived apart for the last six months of the year, you would be considered unmarried for the purpose of this filing status under the Abandoned Spouse rule.  If you meet the other two requirements for this status, you would be eligible to file as Head of Household.  The other two requirements are 1) paying more than half of the cost of keeping up a home as of the last day of the tax year 2) a dependent child or other relative lived with you for more than half the year or you have a dependent parent (dependent parents are not required to live with you).

So when do I file as SINGLE?  You would be required to file as Single if you are unmarried as of December 31 or if you are legally separated as of the end of the year and you do not qualify for another filing status.

So, who gets to claim the children?  Generally, the right to the dependency exemption for the children goes to the custodial parent.  For official or unofficial joint custody arrangements, the exemption goes to the parent in whose home the child spent the most number of nights.  If custody is truly equal, the parent with the highest adjusted gross income gets the deduction.  Beginning with tax year 2009, it is no longer required that the custodial parent provide more than half of the child’s support.  Instead, the only requirement is that the child cannot provide more than half of his own support.

What if we agreed I would have tax rights for the children even though they live with my spouse?  If you and your spouse have agreed to share or transfer tax rights for the children, a copy of Form 8332 must be signed by the custodial parent and attached to the tax return of the noncustodial parent.  This election can be for the current year or for future years.  This form can also be used to revoke the assignment of the dependency exemption.

My spouse transferred the house to me.  Do I have to pay capital gains tax?  No gain or loss is recognized on the transfer of property between spouses either as related to the divorce or if transferred within one year of the termination of the marriage.  This pertains to property transferred directly or indirectly through a trust.[1]

We made joint estimated tax payments last year.  Can I apply those payments to my current tax liability?  If you and your spouse made joint estimated tax payments but are not filing as Married Filing Jointly you may still be able to claim some or all of those payments on your return.  The IRS says that the allocation of estimated tax payments can be made in any way that is agreed upon by your and your spouse.  If you are unable to agree, the IRS regulation 1.6015(b)-1(b) provides that the estimated tax payments are to be allocated based on your percentage of the combined tax liability of you and your spouse.

This is just the tip of the iceberg.  Every divorce is different and so is the impact on your income tax situation.  Contact me to discuss the right year-end tax planning for your specific needs.  716-630-0600 x 208

cmealey@songincpa.com or (716) 630-0600 x 208

---

[1] IRS Code 1041(a)

'Tis The Season .... For Stealing?

There is a direct correlation between tight financial times and the probability of your business suffering a loss due to employee theft. Whether the catalyst is the economic recession or an upcoming holiday, financial pressures on the family budget could put your company at risk.

The median loss for privately owned companies is $231,000 according to the Association of Certified Fraud Examiners (ACFE). Isn’t my company too small to be a target? The reported median loss for businesses with less than 100 employees is $155,000 and small businesses represent 31% of all victim organizations!

So how do I know if my company is at risk? Employee theft tends to occur in situations where the person is having financial difficulties (36%), has the opportunity and access (22% worked in the accounting department) and believes the chances of getting caught are low (detection time on cash thefts is between 17-30 months).

My bookkeeper has been with us for 10 years, doesn’t that mean my company is safe? Over 50% of perpetrators have worked for their employer for at least 5 years. However, the longer the person was employed, the greater the reported loss amount. Employees holding positions for 6-10 years stole and average of $231,000. 50% of perpetrators were over the age of 40 and the majority (33%) were between 41-50 years old.

So what should I look for? Billings to fictitious vendors, check tampering (forgery or alterations), cash related thefts, product related thefts, and payroll frauds (payment to fictitious employees or double paychecks to actual employees) are most commonly see in small businesses.

How can I protect my company? The key to deterring employee theft is good internal controls. The problem some businesses face is there simply aren’t enough employees to make implementing the controls possible. Surprise audits are the most effective tool for deterring and detecting employee theft, but how many companies can afford to keep an internal auditor on payroll?

It’s not always possible for the business owners to handle every piece of operations, but it’s a good idea to get more involved with high-risk activities (verifying cash receipts, making deposits, reconciling bank accounts, checking purchases and inventory) on a consistent basis or to obtain the assistance of an independent CPA.

How can I make my controls better and my company safer? Every business is different, but there are several simple controls that can be implemented for little or no cost.  Contact us today for a free consultation and a little more peace of mind.

cmealey@songincpa.com or (716) 630-0600 x 208