Forensic accountants have many tools to help them find evidence of hidden assets or fraud. But one of the most effective, particularly in divorce matters or legal disputes with former business partners, is using lifestyle analysis to find hidden income and assets. This method involves developing a financial profile of a subject and then examining mismatches between the person’s known resources and lifestyle.

Financial profiling

Forensic accountants develop a financial profile of a subject by examining:

Bank deposits. The expert reconstructs the subject’s income by analyzing bank deposits, canceled checks and currency transactions, as well as accounts for cash payments from undeposited receipts and non-income cash sources, such as gifts and insurance proceeds.

Expenditures. Here, the expert analyzes the subject’s personal income sources and uses of cash during a given time period. If the person is spending more than he or she is taking in, the excess likely is unreported income.

Assets. Experts assume that unsubstantiated increases in a subject’s net worth reflect unreported income. To estimate net worth, an expert reviews bank and brokerage statements, real estate records, and loan and credit card applications.

Tracing income

Proving that a person has unreported income is one thing. Tracing that income to assets or accounts that can be used to support a legal claim or enforce a judgment is another story. To do this, forensic accountants may scrutinize the assets noted above, as well as insurance policies, court filings, employment applications, credit reports and tax returns.

Tax returns can be particularly useful because people have strong incentives to prepare accurate returns. For example, they may fear being charged with tax evasion if they lie to the IRS. As a result, tax return entries often reveal clues about assets or income that someone is otherwise attempting to conceal. Another potentially fruitful strategy is to interview people with knowledge about the subject’s finances, such as accountants, real estate agents and business partners.

Note that building a financial profile of someone other than a spouse in a divorce matter or a former business partner in a legal dispute can be challenging. In the case of occupational fraud suspects, experts may know the individual’s salary and have access to publicly available information such as real estate sale and purchase records and court filings. But they need a court’s authorization to request bank and tax records and other personal data.

(This if Blog Post #904)