Whenever a divorcing client comes in and tells me that their spouse has said, “We don’t need lawyers,” I become wary. When that other spouse is self-employed, I become downright suspicious. If their career is in high finance, my suspicion grows twofold.
My reaction is based on years of seeing this same pattern play out. I’m not a financial divorce specialist, but I am an experienced divorce therapist and one of the main reasons I began working with people (primarily women) in this realm is that I saw the less financially-savvy spouse or the “outspouse” (the term used by the court for the spouse who does not own the business from which income may be hidden) fall victim to the spouse in charge of the finances or business owner.
The reason the knowledgeable spouse doesn’t want attorneys (or accountants) involved, is that they don’t want their scheme(s) to be uncovered.
Divorce is hard enough, especially if an affair is involved, but add to it an additional layer of deception and betrayal, and it can make the trusting spouse wonder if the entire marriage had been a sham. It’s nothing short of devastating.
People hide income to avoid paying taxes (a federal crime) and, during a divorce, people hide income and assets to avoid paying higher child and spousal support.
In March of this year, a new book came out by forensic accounting expert, Mark Kohn. The book is entitled, How They Stash the Cash, and it is filled with anecdotes from some of Mark’s cases. The book provides the tools and methods used by most people when they hide income. These include having two sets of books, hiding files in secret places, and funneling money into hidden business entities.
Mark feels strongly that hidden income can be uncovered, and the one-down or outspouse can receive his or her fair share of income.
If you are concerned that your spouse is covering up finances, consult with your attorney first to make sure that a search would be worth your time and money. Forensic accountants can be quite costly so you’d need to weigh whether you’d want to pursue $20,000 in assets if it was going to cost you $10,000, for example. Some people would absolutely pursue that while others may not feel it’s worth it.
Some red flags to watch for:
1. If your spouse is self-employed and/or more knowledgeable about the family finances than you are and is overly averse to using attorneys in your divorce.
2. Look at the lifestyle, and compare this with the reported income. If there is a mismatch, further investigation is warranted.
3. Look at the ratio of living expenses to income. If a mortgage payment is 75% of the reported income, it’s a good bet that there is hidden income.
4. Observe whether a business owner has multiple tax entities that do not seem to be necessary.
5. Observe whether there are unusual business expenses. In one of Mark’s cases, a business expensed $15,000 for a transplant of four trees–but the business operated in a treeless industrial park. Upon further investigation, it was revealed that this was a personal expense.
Why doesn’t the IRS catch these people?
According to Mark, there are four main reasons that the IRS does not usually uncover hidden income:
1. The IRS does not hire private investigators and issue subpoenas at early stages of their review.
2. The IRS is discouraged from cases in which the taxpayer already has large net operating losses, which often is the case when income is hidden. (Because the true income is hidden, the business reports losses.)
3. The IRS does not have access to lifestyle information, from which a discrepancy between lifestyle and income could be noted.
4. The IRS does not usually investigate cases when a taxpayer is already reporting high income.
Here are some brief anecdotes of how spouses might be hiding cash:
Jim operated a restaurant in an office complex. While he and his wife, Patricia, lived in a nice home and enjoyed a middle-class lifestyle, the last few years’ tax returns for the restaurant showed little to no income. In response to divorce litigation, Jim wanted to sell the restaurant — partly in order to claim no income and partly to avoid accounting for his suspicious tax returns. Apparently, selling the restaurant seemed easier than dealing with either of those issues.
Patricia’s lawyer hired a private investigator, who feigned interest in buying Jim’s restaurant. When the private investigator asked to see the tax returns for the past few years, Jim assured him that the numbers on the tax returns were not real. To verify the actual earnings of the restaurant, Jim produced bags and bags of cash register tapes from the previous years, reflecting the real daily sales of the business. Jim’s tax returns were fabricated, but the register tapes told the full story. Jim’s case settled quickly, and in Patricia’s favor.
David worked as a financial planner, and his income was deposited into his personal corporation, from which he received his salary. David had been partially hiding his income from the IRS using a tax scheme; but as divorce proceedings progressed, David expanded his scheme until his income was altogether invisible.
As a financial planner, David understood how to avoid taxes to the point that he paid virtually no income tax. He used the same method to attempt to convince the divorce court that he earned very little income.
David’s scheme operated on a simple principle. The IRS has different divisions that handle their audits—one division handles small corporations; another division handles partnerships; and another division handles personal income tax returns. Unless something attracts the attention of the IRS, a corporate auditor will not look at the personal tax returns of the corporate shareholders, and a partnership auditor will not look at the personal tax returns of the partnership’s partners. Each division stays within its division, unless there is reason to go outside of the division.
David filed three sets of income tax returns: corporate, partnership, and personal. All three sets of tax returns appeared to be properly filed. The corporate division looked at the corporate return; the partnership division looked at the partnership return; and the individual division looked at the individual personal return. There was never any reason to audit the tax returns, because on their own, they looked correct. David consistently reported low income with virtually no income taxes owed. When the IRS divisions looked at the tax returns separately, they did not notice anything out of the ordinary. But when the fraud was discovered by David’s wife’s legal counsel, David was ordered to pay support based on his $350,000 annual income.
Mark’s advice for spouses who have a feeling their spouse is hiding income:
1. Hire a private investigator: While private investigators can be expensive, they are useful in obtaining physical observations or documentary support. In cases where there are suspicions of clandestine real estate acquisitions, secret bank accounts, or business deliveries to customers that are not on the books, a private investigator can be of great assistance. In one case, Mark’s client’s private investigator uncovered an email exposing her husband’s interest in an Oregon shopping center that had never been disclosed. While the husband confided that he had not gone through with the deal, he was so rattled by his wife’s attorney’s knowledge of his interest in the shopping center that he decided to settle before his wife’s lawyer could uncover anything else.
2. Dig through the garbage–a treasure trove for people looking to find hidden income. One client’s spouse set up secret accounts in his mother’s name and deposited money into them without his mother’s knowledge. This strategy would not have come to light without the diligence of a private investigator, who conducted a trash search and found an empty gift box with a card from a Florida law firm thanking David for his business. David’s wife’s lawyer subpoenaed the Florida law firm for all invoices that they issued to David or to any entity in which David had any interest. The Florida law firm complied by providing invoices relating to various Florida limited liability corporations. More subpoenas were issued and, eventually, the entire scheme became clear.
3. Search for hidden files: Hidden income usually manifests itself as income that is hidden from the IRS, but it usually is not completely hidden. A good businessperson wants to know how his or her business is doing in order to improve any deficiency. To understand how the business is really doing, one needs real numbers. Therefore, while false numbers are given to the tax preparer so that the income is hidden from the IRS, the real numbers are used by the owner, sometimes with the help of a different financial person, to analyze the progress of his or her business. As such, real numbers usually exist somewhere. Obtaining those real numbers during a divorce is often very difficult. The outspouse may issue a request for documents from the inspouse, and the inspouse may deny that any secret documents exist. What often occurs, however, is that as a marriage starts to fail, the outspouse secretly collects and copies business documents in case they are needed later.