Usually, income in divorce is simple to establish. We look at a person’s paystubs, W-2’s, and tax returns to determine income. But sometimes a person’s income can be more difficult to determine. If someone has their own business, is receiving income “under the table,” or has complicated financial arrangements that allow for hiding income we will need to do some forensic accounting to determine their income.
The Internal Revenue Service deals with this problem a lot. A lot of people try to avoid paying taxes by hiding income. Additionally, income derived from criminal enterprises is taxable and the IRS is often able to put criminals in jail to convicting them of tax evasion. To establish hidden income, the IRS as developed three methods of calculating hidden. These methods are useful in divorce cases.
When the person’s income leaves a definite paper trail, the “Specific Items Method” can be used. With this method we examine business records, tax documents, and bank and investment statements. We then add up the deposits. The problem with this method is that these documents are either not available or the income does not appear in the documents. This method works when someone has their own business. But if someone is dealing in cash and putting the money in their pockets, it will not show up in documents.
The Expenditure Method takes the opposite approach. Instead of looking for deposits, we look for money spent. Often the person will be magically spending far more than their claimed income. Also, expenditures can be established by examining third party records. If the person is paying by cash, sometimes the records can be subpoenaed from the third party who keeps records of payments received from the person.
If documents are not available, or do not adequately show income, we can try the Net Worth Method. We identify the person’s assets and subtract the person’s liabilities. If the net worth has increased, say, $100,000 in one year, we can conclude that they had at least $100,000 of income that year. This method can work for higher levels of hidden income. Poor people who deal in cash spend it on consumables like food and gas without accumulating assets.
Identifying hidden income in divorce is often difficult and expensive. It requires a lot of attorney time and often requires a forensic accounting.