Not every divorce needs a forensic accountant. But if your divorce involves a business, complicated compensation, questions about your spouse's actual income, significant assets, or money that you can't account for, a forensic accountant can become an important part of the case.
I've handled divorce cases where understanding the finances was relatively straightforward. I've also handled cases where looking at a tax return told us only part of the story. That's where a forensic accountant may come in.
A forensic accountant is an accountant who analyzes financial information for purposes that may include litigation. In a New Jersey divorce, that can mean digging considerably deeper than simply preparing a tax return.
Depending upon the issues involved, a forensic accountant may analyze business records, tax returns, bank statements, investment accounts, compensation records and other financial documents.
The objective is to help us understand what the numbers actually show. And in a complicated divorce, that can be extremely important.
You probably don't need a forensic accountant simply because you're getting divorced. But there are certain situations where I may want one involved.
For example, your spouse may own a business. Maybe your spouse is self-employed and you're not sure the income reported on a tax return accurately reflects the money available to him or her. Perhaps significant amounts of money have moved between accounts and you don't understand where they went.
Maybe one spouse claims an asset is separate property and we need to trace where the money originally came from. Or perhaps the marital estate includes complicated investments, real estate interests or other financial holdings that require additional analysis.
In cases like these, an accountant with experience in divorce-related financial analysis may be able to help us understand what's really going on.
Business valuation is one of the major reasons forensic accountants become involved in divorce cases.
Suppose your spouse owns a medical practice. Or a dental practice. Or a law firm. Or a closely held family business. You can't necessarily look at the balance in the business checking account and say: "That's what the business is worth."
A business may have accounts receivable, equipment, liabilities, intellectual property, ownership agreements and other tangible and intangible components. Depending upon the type of business, professional or enterprise goodwill may also become an issue.
A qualified financial expert can analyze the relevant financial information and apply appropriate valuation methods to develop an opinion concerning the value of the business interest.
There isn't one valuation method that's automatically appropriate for every business. Depending upon the circumstances, a valuation professional may consider an income approach, market approach, asset approach, or other accepted methodology.
The appropriate analysis depends upon the particular business and the information available. That's important because two businesses with identical annual revenue aren't necessarily worth the same amount.
One might have substantial debt. Another might own valuable assets. One may depend heavily upon the personal efforts of its owner. Another may have employees, contracts and systems that allow it to operate more independently. The details matter.
Business value isn't the only reason I might want a forensic accountant involved. Sometimes the bigger question is: "How much does my spouse actually earn?"
This can become particularly important when someone owns a business or is self-employed. A tax return provides important information, but it doesn't necessarily answer every question about income available for support purposes.
A forensic accountant may examine business and personal financial records to develop a clearer picture of cash flow and income. That analysis can become important when we're dealing with issues such as alimony or child support.
New Jersey divorce cases have involved forensic accountants performing both business valuations and cash-flow analyses, which illustrates why these are separate questions. A business can have one value for equitable-distribution purposes while its owner has a separate level of income or cash flow that may be relevant to support.
This is another situation where forensic accounting can become useful.
Maybe you notice substantial transfers you don't recognize. Maybe money regularly moved between business and personal accounts. Perhaps an investment account was much larger several years ago and nobody can adequately explain what happened to the funds.
That doesn't automatically mean your spouse is hiding money. There may be a perfectly legitimate explanation. But when substantial assets can't be accounted for, we need to understand what happened.
A forensic accountant may be able to trace transactions through financial records and help identify where money came from and where it went.
Tracing can also become important when we're trying to determine whether an asset is marital or separate.
Suppose one spouse inherited $500,000 during the marriage. Years later, some of that money has been transferred through several different accounts, used to purchase investments, or mixed with other funds.
Where is the inheritance now? Can we still identify it? What happened to it along the way?
Those questions can require a detailed review of financial records.
A forensic accountant may be able to reconstruct the movement of the money and provide an analysis that helps the attorneys evaluate the claim.
The financial analysis can become even more complicated when someone owns interests in several entities.
One business may pay another. Real estate may be owned through separate LLCs. Expenses may be allocated among different entities. One company may owe money to another.
There may be partnership interests, shareholder agreements, loans, capital accounts or other financial arrangements that aren't obvious from an individual tax return.
That's when I want someone who understands financial records looking at the entire picture rather than examining each document in isolation.
Sometimes people come into my office convinced that their spouse is hiding money. Occasionally they're right. Sometimes they're not. I don't want to begin with the assumption that every unexplained transaction is evidence of hidden assets. I want to begin with the records.
A forensic accountant can analyze the available financial information, identify inconsistencies or transactions that require further explanation, and help determine what additional records may be needed. That's a much stronger approach than simply accusing your spouse of hiding money without evidence.
Sometimes the parties may agree to retain a neutral financial expert rather than each hiring a separate accountant. That can potentially reduce expense and narrow financial disputes when both sides are comfortable with the arrangement.
In other cases, each spouse may retain his or her own expert. And sometimes an expert may be appointed through the court process.
Which approach makes sense depends upon the complexity of the finances, the level of disagreement between the parties and the issues the accountant is being asked to analyze.
Forensic accounting isn't free. Depending upon the complexity of the assignment, reviewing years of financial records, valuing a business, tracing assets and preparing an expert report can become expensive.
That's why I don't automatically recommend hiring a forensic accountant in every divorce. The cost needs to make sense in relation to what's at stake. If we're arguing over a relatively small financial issue, spending thousands of dollars on expert analysis may accomplish very little.
If your spouse owns a business worth millions of dollars, however, trying to save money by avoiding a proper valuation could potentially cost you considerably more. The expert should have a job worth doing.
A forensic accountant doesn't replace your divorce lawyer. And your divorce lawyer shouldn't pretend to be a forensic accountant.
My job is to understand the legal issues, develop the strategy, advocate for my client and determine what financial questions need to be answered. The accountant's job is to perform the appropriate financial analysis.
In a complicated financial divorce, those roles can complement each other. The lawyer identifies the legal issue. The accountant helps us understand the numbers. Then we can make better decisions based upon the actual financial information rather than assumptions.
When the financial side of a divorce becomes complicated, one of the most useful things we can do is stop guessing.
Get the records. Understand the business. Analyze the income. Trace the money. Determine what the assets are actually worth.
Not every New Jersey divorce requires that level of financial investigation. But when substantial money is involved, getting the financial analysis right can have a significant effect on equitable distribution, alimony, child support and the ultimate settlement of the case.
If you're preparing for divorce and want to understand the financial and legal issues you should be thinking about, my free Divorce Smarter Course will walk you through the major decisions involved in a New Jersey divorce.
Until next time,
Steve