Hidden assets rarely remain hidden. In divorce proceedings, business disputes and fraud investigations, people’s spending habits often tell a different story from official reports, such as tax returns and legal declarations. Forensic accountants can use lifestyle analysis to identify such inconsistencies. Here’s how they trace unexplained funds and develop evidence to support litigation and financial recovery efforts.
Uncover discrepancies
Forensic accountants generally begin lifestyle analyses by reconstructing their subject’s finances over a specific period. They compare known income and legitimate cash sources with spending, debt payments, investments and net worth changes.
These fraud experts might analyze bank and brokerage statements, canceled checks, credit card activity, loan applications and real estate records. Their goal is to distinguish income from nontaxable or non-income sources, such as gifts, inheritances, insurance proceeds, loan proceeds and transfers between accounts. The IRS recognizes bank deposits, cash expenditures and net worth as accepted methods for reconstructing a person’s income.
For example, say someone reports annual income of $150,000 but consistently spends $250,000 without accumulating additional debt. That gap doesn’t necessarily indicate wrongdoing. However, if the difference can’t be explained by legitimate resources (such as savings or gifts), undisclosed income or assets may be in play.
Develop a broader picture
Personal financial statements are only part of a lifestyle analysis. A forensic accountant may compare records from multiple sources to identify ownership interests and transactions that might deserve further investigation. Depending on the investigation’s subject and purpose, relevant evidence may include:
- Tax returns and supporting schedules,
- Property, vehicle and business ownership records,
- Insurance policies,
- Payment-app, online marketplace and digital-wallet activity,
- Trusts, privately held business interests and accounts held by third parties, and
- Travel and luxury goods purchases.
Tax returns can be particularly useful because they may disclose interest, dividends, capital gains, rental income, business interests and foreign financial activity. However, investigators don’t simply assume a tax return is complete or even honest. They reconcile it with independent records and look for income or assets that may have been omitted.
Digital assets increasingly merit attention as more people own them. Cryptocurrency and related assets can represent significant value, and blockchain records may help investigators follow transactions if they’ve identified relevant wallet addresses or exchange accounts. However, tracing can become harder when investigators can’t link wallet addresses to a specific individual or when assets pass through services designed to obscure transaction activity.
In some cases, public records, social media posts and interviews may provide useful leads. Photos of expensive vacations, property improvements, vehicles or collectibles can conflict with claims of limited financial resources. What’s more, coworkers and business associates may have noticed changes in a subject’s spending or behavior.
Use evidence carefully
Investigators must handle these clues carefully. A photo posted on social media showing the subject driving a new sports car isn’t conclusive evidence of ownership. And interviews with business colleagues may be limited by privacy, confidentiality or privilege.
Investigators must preserve electronic evidence in its original format so that dates, source information and metadata remain available. They usually need consent, formal discovery, a subpoena or a court order to view private financial and tax records. So forensic accountants often work closely with legal counsel to obtain records and document a defensible chain of evidence.
Act before assets move
Lifestyle analysis is most effective when it begins early — before records disappear or assets are transferred. If you suspect fraud or concealed income, hire an experienced forensic accounting professional. We can help identify important records and quantify unexplained financial activity. We can also clearly present our findings to you, your board, attorneys and insurers, and any members of law enforcement or courts involved.
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We highly recommend you confer with your Miller Kaplan advisor to understand your specific situation and how this may impact you
