In many valuation contexts, one side is looking for a higher value estimate and the other a lower one. The most obvious example of this is a divorce case. But it can also hold true in a shareholder dispute or fraud investigation.
Whether intentionally or not, the “lower value” side of these conflicts may obscure or ignore certain assets to bolster its case. To establish a fully rounded value estimate, financial experts have to look harder. They must enter the shadowy world of hidden assets.
What’s it worth?
Experts often start their searches with a net worth analysis that looks at changes in a person’s worth, reconciling those changes with income and expenses. The first step is to reconstruct this data, which may involve some detective work. Experts search for clues in a variety of places, including:
Employment and loan applications also can provide insights, including current and previous residences, family members’ names, and previous jobs. Experts then interview people such as the subject’s accountants, former spouses, former business partners and real estate agents.
Where are they?
Once they collect the financial data, experts typically have three standard ways of detecting hidden assets. One approach is the asset method. The subject’s net assets at the beginning of the year are compared with those at year end, adding known income and subtracting known expenses. A result other than zero indicates income from unknown sources.
Another approach is the expenditures method. Here the expert looks for discrepancies between the subject’s expenditures and his or her sources of funds, including salaries, commissions, investment dividends, inheritances, loans, gifts, and cash on hand at the beginning of the year. If the subject’s spending exceeds the available funds, an unknown source of funds exists.
Complicating matters, however, is the fact that many people pay cash for expenses such as entertainment and meals and don’t keep the receipts. If it appears that the subject is using skimmed funds to pay for cash items, a more in-depth investigation will be necessary.
A third way to uncover hidden assets lies in a careful examination of bank deposits. This method relies on the assumption that all money is either spent or deposited. The expert starts with net deposits to all accounts during the year and adds cash expenditures to arrive at total receipts for the year. If that amount exceeds funds from known sources, the difference represents an unknown source of funds. Bank-deposit scrutiny is particularly appropriate with cash-intensive businesses.
How about taxes?
Typically, experts also must review several years of tax returns for specific items and general trends. Of particular interest are income from wages; interest and dividends; and taxable refunds of federal, state and local taxes. The expert will also explore the existence and amounts of any distributed retirement plan assets. Whether the subject has incurred alternative minimum tax liability could also be revealing.
Tax return schedules also can contain a wealth of information. For example, Schedule A (itemized deductions) covers real estate and personal property taxes. The expert checks that reported amounts correspond to the underlying property. If they don’t, further investigation may lead to undisclosed assets.
Entries regarding state and local taxes may reveal income (or income-producing property) in other states. Experts can also glean critical information from Schedules B (interest and ordinary dividends), C (profit or loss from business), D (capital gains and losses) and E (supplemental income and loss).
Who’s to blame?
When it comes to hidden assets, the natural inclination is to blame someone. And certainly there are instances in which an acrimonious divorce or spiteful ownership dispute may lead one party to wrongfully hide items of value.
But, often, no wrongdoing has necessarily occurred; assets sometimes are obscured by conventional asset protection measures. Give an experienced financial expert the right data and time to process it and voila! what was lost from view can suddenly come to light.
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