Forensic Accounting

As Chartered Business Valuators (CBV), we often hear allegations that a spouse has not fully disclosed their assets or income in a family law proceeding. The failure to fully disclose assets can lead to an unequal division of net family property and non-disclosure of income sources could result in inequitable child and spousal support payment levels. These two issues are related as an undisclosed asset could also be a source of income, such as a business investment or real estate. Similarly, undisclosed income may point to matrimonial property that has not been disclosed.

What is a lifestyle analysis?

A lifestyle analysis is a technique used by CBVs to uncover undisclosed assets and income. To perform a lifestyle analysis, the CBV assesses whether a spouse’s disclosed assets and sources of income reconcile with their standard of living. Conducting a lifestyle analysis may be beneficial as it can lead to an increase in the equalization payment and additional income for support purposes, including a gross-up on income that was not reported for income tax purposes.

When should a lifestyle analysis be considered?

Some common situations where a lifestyle analysis should be considered are as follows:

1. A spouse’s disclosed income appears low relative to their lifestyle either during the marriage or post-separation.
2. A spouse’s expenses as set out in their sworn financial statement exceed the amount of disclosed income without a reasonable explanation of how the excess expenses are funded.
3. Cash income was openly acknowledged during the marriage.
4. The disclosed level of Net Family Property does not appear reasonable in light of a spouse’s historical income and/or spending.
5. A spouse has ties to a foreign country, and it is suspected that funds or assets were diverted to foreign bank accounts, investments, or family members.

How it’s done

Three commonly used methods to conduct a lifestyle analysis are as follows:

Sources and uses method

The sources and uses method (sometimes referred to as a cashflow analysis) is used to determine whether a spouse’s spending exceeds their disclosed sources of income. Over a specific period, all sources of income are reviewed, such as salary and dividends, investment income, real estate rentals, loans, gifts, inheritances, and insurance proceeds. A thorough review of all uses of funds is also done, such as living expenses, vacations, loan repayments, gifts, and major expenditures such as vehicles and home renovations. Where uses of funds exceed disclosed sources of funds, it may be appropriate to consider the difference to be unreported income.

In addition to identifying undisclosed income, the sources and uses method can also be effective for discovering undisclosed assets. If a transfer to an unknown account is identified, further investigation could lead to the discovery of an undisclosed bank account, investment, or cryptocurrency holdings. Further, while reviewing the uses of funds, missing expenses funded by cash income may also be identified. For example, if there are suspiciously few grocery or dining out purchases reported on the bank or credit card statements, and no cash withdrawals that could plausibly have been used for such purchases, these purchases may have been funded with unreported cash income.

Asset method

The asset method considers the change in the spouse’s net worth between two dates, and whether the change is fully accounted for by:

• Disclosed sources and uses of funds
• Changes in the market values of assets

For example, if there is concern that a spouse has not fully disclosed assets at the separation date, their sworn financial statement can be compared to an earlier reporting of net worth, such as a loan application, to see if there has been an unexplained decline. Similarly, if it is suspected that post-separation income has been underreported, the sworn financial statement can be compared to a later measure of net worth to see if there has been an unexplained increase that is attributable to undisclosed income.

Bank deposit method

The bank deposit method is used to identify deposits from unknown sources into the bank account. The CBV reviews the spouse’s bank statements and identifies deposits from known sources by reviewing deposit books, copies of cheques, paystubs, other bank account statements, etc. The spouse can then be questioned about any deposits that the CBV was unable to trace to a known source and asked to provide supporting documentation. Then, deposits from known sources are deducted from total deposits to calculate the deposits from unknown sources, which may be assumed to be unreported income. An obvious limitation to this method is that it only identifies undisclosed income that was deposited into a bank account.

Scenario

Here’s an example where a lifestyle analysis would be a worthwhile exercise. Counsel for Spouse A contacts a CBV and provides the following information:

• Spouse B is a small business owner in the residential construction industry.
• During the marriage, Spouse B always had a wallet full of cash but seemingly never withdrew money from the bank. This cash was used by the family to pay for everyday living expenses such as groceries, restaurant meals, clothing, and entertainment. Envelopes of cash were also kept in a safe in the house.
• Spouse B’s sworn financial statement reports $100,000 of employment income in the year following separation.
• Since separation, Spouse B has moved to a luxury residence, taken multiple vacations abroad, joined a private golf club, and funded large legal bills.

The information provided indicates that Spouse B has been living beyond their disclosed means and has likely continued to earn undisclosed cash income since the date of separation. In this instance, the CBV could use the sources and uses method to determine whether Spouse B’s high level of spending post-separation can be fully attributed to known sources of funds, or if a portion relates to undisclosed income. The CBV’s steps would be as follows:

1. Review any financial disclosure received to date by counsel.
2. Prepare a preliminary information request list setting out requested bank, investment, and credit card statements, income tax returns, corporate financial statements, and other documents relating to the financial accounts and income sources that have been disclosed. The list will also set out specific information and questions related to known large purchases such as the source of funds used for Spouse B’s vacations, golf club initiation and dues, and legal bills.
3. Once the preliminary information is received, review the bank, investment, and credit card activity to identify and classify sources and uses of funds.
4. Prepare a second information request including statements for any newly discovered accounts, and questions about deposits from unidentified sources, transfers to unidentified recipients or accounts, large or unusual cash withdrawals, and normal lifestyle expenses that are conspicuously missing.
5. Arrange for an interview of Spouse B so that additional questions can be asked, and undertakings made.
6. Once the final disclosure is received, complete the analysis and produce a court-ready expert report detailing conclusions reached with respect to spending in excess of known sources of income and the estimated quantum of unreported income.

The lifestyle analysis demonstrated that Spouse B used their known sources of income to fund the rent and utilities for their new residence, vacations, golf, and legal fees. No unexplained cash deposits were present on the bank statements. However, minimal expenses were observed for groceries and dining out. By reviewing invoices and receipts kept by Spouse A during the marriage and making reasonable estimates of the cost and frequency of expenses post-separation, the CBV estimated an additional $25,000 of expenses relating to this spending. As the cash income was not subject to income tax, the CBV grossed up the expenses to the equivalent of $44,000 of pre-tax income.

In addition, the review of Spouse B’s credit card statements in the year prior to separation revealed that an additional $15,000 was used to purchase cryptocurrency. Counsel was able to use this information to obtain a court order to compel disclosure of the cryptocurrency holdings, which were valued at $30,000 at the separation date and added to Spouse B’s assets.

Lifestyle analyses in the courts

In Iacobelli v. Iacobelli 2020 ONSC 3625, 2020 CarswellOnt 8126, the husband was a partner with his mother in a window coverings business. The wife was not employed during the marriage. The husband acknowledged that during the marriage he earned cash income from the business that he did not declare for tax purposes but advised that this practice ceased after separation and that his income decreased to $50,000 per year. The wife alleged that the husband had been significantly understating his income since the separation. Both the husband and wife retained experts to determine the husband’s income.

The wife and her family members prepared a list of the family expenses based on bank statements and credit card statements for the last seven years of the marriage and provided it to the wife’s expert. The expert used a lifestyle analysis to consider the family expenses during the marriage and compared it to the husband’s declared level of income. The expert then grossed up the difference between the expenses and income to estimate the additional pre-tax income required each year to pay the expenses.

The husband’s expert also performed a lifestyle analysis; however this evidence was not preferred by the Court as it only addressed two years and it was largely dependent on representations made by the husband, who was shown in court to be untrustworthy.

Accordingly, the Court found the evidence of the wife’s expert to be much more compelling than that of the husband’s expert. Justice McDermot commented, “In a situation where unclear and unreliable evidence is provided as to a support payor’s income, often the lifestyle of a family is the only place where an accurate finding of that income can be determined. In the present case, that is definitely the situation. Mr. Iacobelli failed to fulfill his duty to provide a clear picture as to his income. Therefore, as he was the only wage earner, his income can only be determined from the family’s lifestyle. Did they live as if he made about $50,000 per year as he asserts his income to be at present?”

Conclusion

Where a spouse is not forthcoming with full disclosure of their income or assets, a lifestyle analysis can be used to identify and quantify unreported amounts. The method selected by the CBV should consider the likely magnitude of the undisclosed amounts, the availability of the necessary information, and the availability of funds for the forensic accounting work. An effective lifestyle analysis can be persuasive evidence in court and lead to increased income for support purposes and a larger equalization payment.

About the author

Matthew Downey, CPA, CA, CBV, CFF is a Senior Manager with the Fuller Landau LLP Business Valuations  group in Toronto. He can be reached at mdowney@fullerllp.com or 416-645-6513.