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Bench & Bar of Minnesota is the official publication of the Minnesota State Bar Association.

Finding “Lost” Money: Five Creative Techniques for Proving a Party’s True Income in Litigation

Believe it or not, some people are not always very honest when it comes to full disclosure of their income.  Sure, ascertaining the opposing party’s income is easy when they are a salaried employee who receives a W-2 at the end of the year.  But what about the owner of Joe’s Custom Basket Weaving?  Or JoAnn’s Look-Like-You Lawn Ornaments?  It is fairly easy to hide income for a party who is self-employed and doesn’t want a spouse, creditors, the opposing party, or the IRS to know how much they really earn.  Unfortunately for the income-hiders, such deception can only go so far.  This article is designed to give the practitioner some helpful tips on how to prove that Joe (or JoAnn) is actually making more money than they claim.

There are two major advantages to finding money earned by the other party but not disclosed in the litigation.  The first is obvious:  In bankruptcy matters, collections, and other matters you increase your client’s chances of getting paid. In a dissolution-of-marriage action, you show that the other party should be paying more (or receiving less) child support or spousal maintenance, or that the opposing party should be assigned heavier responsibility for marital debt.1

The second advantage is you gain a credibility edge for your client.  Since judges frequently base their decisions on which party is more credible, you can help your client’s case substantially if you can prove that the opposing party is dishonest.

Where to Look

1 Current Tax Returns.  Any litigant who is dealing with a self-employed opposing party would be well-served by obtaining and scrutinizing the opposing party’s business tax returns, in particular Schedule C:  Profit or Loss From Business.  If your litigation budget can support it, hiring an accountant to review the tax return for questionable items may also produce a mother lode of useful information.  Schedule C is useful because the tax filer must itemize their expenses, and this is where business owners can (and frequently do) express creativity.  Unless the tax return is audited, the tax filer does not have to produce a shred of evidence to the IRS that he actually spent $100,000 on “supplies,” or that she spent the equivalent of her entire grocery budget for business “meals and entertainment.”  Another category that bears scrutiny includes travel (the fact that vacations are generally not deductible as a business expense does not seem to stop the more creative tax filer from claiming it on Schedule C). “Car and truck expenses” can also be a hiding spot for payments made on a personal vehicle.  Sometimes, the same expense will show up in two or more categories, thereby artificially inflating the party’s expense totals.  Examine line 16a, “Mortgage.” Does the party claim the entire mortgage on their home as a business expense?  The careful practitioner will request backup documentation of any questionable deductions on Schedule C.  Once discovery is completed, the combination of Schedule C and the party’s responses to Requests for Production can provide ample fodder for cross-examination at trial.

In the family law arena, the definition of gross income in child-support matters is noteworthy.  The pertinent statute, Minn. Stat. §518A.30, defines income from self-employment as “gross receipts minus costs of goods sold minus ordinary and necessary expenses required for self-employment or business operation.”  The statute goes on to clarify, “[s]pecifically excluded from ordinary and necessary expenses are … depreciation expenses … or any other business expenses determined by the court to be inappropriate or excessive for determining a gross income for purposes of calculating child support.”  The person who wants to use an expense to reduce their gross income for purposes of determining child support has the burden of proving that that expense is ordinary and necessary. 2

2 Past Years’ Tax Returns. When the going gets tough, the tough start hiding income … or something like that.  Past years’ tax returns can give a good overall view of an individual’s earning capacity as well as their earnings performance before they had incentive to hide or reduce income.  While this information is in no way dispositive on the issue of whether a person is hiding income, it can certainly bolster that position, especially if supported by bank records, invoices, credit applications, etc.  An ideal situation is one that shows an annual earning history of $100,000 to $125,000 consistently for five years prior to the litigation.  Then—boom!—suddenly the primary breadwinner is earning $50,000.  If it looks suspicious to you, odds are, it will look suspicious to the judge, too.

3 Credit Applications. A purchaser completing a credit application, whether for a business or personal loan, automobile loan, or credit card must disclose their income.  Of course, the purchaser is not going to understate their income, as that might cause the application to be rejected.  Most likely, income disclosed is going to be accurate or possibly an overstatement of actual earnings.  Well-phrased interrogatories can produce information regarding recent credit applications.  If you have reason to believe that a recent credit account has been opened by the opposing party, and the party fails to disclose that information in an interrogatory, a request for the party’s credit report will disclose what accounts exist.  If you are successful in nailing down even one solid lie by the other party (“I don’t have any credit cards.”  “Aha!  What about this monthly payment to AmEx that shows up on your last three bank statements?”) getting the court to order an unwilling party to produce their credit report will become a much simpler task.  The credit report will show all open credit accounts, and will give you a good starting point for issuing subpoenas.  Remember that unless the credit application is fairly recent (generally within the past five years), it will not be worth your time, effort, or money to issue a subpoena.  Showing the judge that the opposing party claimed to make $100,000 ten years ago is not likely to make much of an impression, unless the $100,000 was a gross exaggeration.  Also, remember that judges sometimes tend to be a bit jaded and even come to expect a little dishonesty in litigation cases.  So don’t expect the judge to be impressed when you prove, beyond a doubt, that the opposing party actually earns $45,000 per year when they claimed to earn $42,000.

The same can be true for other “party admissions”: statements by the opposing party in correspondence or emails that they earn a certain amount which is inconsistent with the income they claim to be earning in the litigation action.  It is not unheard of for a party to have made such statements to your client prior to the relationship going sour.

4 Expenses & Lifestyle. Let’s say the opposing party claims to earn $12,000 per year.  Through diligent discovery, however, you are able to unearth evidence that they had monthly expenses of $4,000 and were not using credit cards or getting assistance from friends or family.  Just where did this money come from?  The answer is obvious:  they earned it.  A person who has expenses in an amount that exceeds their claimed income, when they are not living off an ever-increasing credit card balance, bank loan, or the kindness of friends and family, and who cannot offer a legitimate explanation for this discrepancy, is likely hiding income.  The really great thing about income-hiders is that, because they tend to be self-interested, they also tend to be unwilling to reduce their own standard of living to align it with their claimed income.  They will, generally, maintain the expensive car, the top-tier cable services, the habit of dining out frequently, expensive hobbies, and other expenses which can be easily tracked through bank and credit card records.

Income hiders who see themselves as more clever than the average litigator or judge may think they are adequately covering their tracks by having the expensive car or other luxuries titled in Aunt Gertrude’s name.  Again, a little digging can go a long way.  If bank records or the monthly invoice show that the opposing party was the one making the payments on the expensive car, guess what?  Busted.  If need be (and if you have a sizeable litigation budget) you can also take Aunt Gertrude’s deposition.  While I do not recommend ever taking someone’s deposition for the purpose of harassing someone, I also would not hesitate to do so just because it might upset Aunt Gertrude.  Maybe the threat of familial disharmony, which might result from Aunt Gertrude’s deposition, might be enough to make the opposing party come clean about their income.

5 Bank Statements. Not only can bank statements give you a good idea of where (and how much) money is being spent, they can also be a good source of two other vital pieces of information:  whether money is being funneled elsewhere (Aunt Gertrude, perhaps?) and what deposits are being made.  Someone who claims to earn $12,000 per year, and yet has deposits into their checking account exceeding $4,000 per month, has some explaining to do.  As does the individual who surreptitiously pays their mother’s mortgage, or aunt’s car payment, or just makes random deposits into a relative’s bank account.

A Word of Caution

As wonderful and easy as all of this sounds, it will take time—a lot of time.  And it will potentially cost a lot in attorney’s fees.  While you can (and should) ask the court to order the income-hider pay your attorney’s fees, which were necessitated by their income-hiding, you cannot guarantee either that a) it will be ordered, or b) that you will ever collect your attorney’s fees from the opposing party.  So proceed with caution and always weigh the potential benefits you expect to receive from doing in-depth discovery against the time and expense involved.

Phyllis “Phyl” Bean is an attorney in solo practice with 19 years of litigation experience.  She was awarded her J.D. in 1991 from George Mason University School of Law, where she served as a staff member of the George Mason University Law Review. She is admitted to practice in Minnesota, Florida, Virginia, and the District of Columbia and concentrates her practice in the area of family law, including adoption, divorce, custody and support.

Notes

1 See “I Due:  Characterizing Debt in Marital Dissolution,” by Phyl Bean, Bench & Bar of Minnesota (March 2008).
2 Minn. Stat. Ann. §518A.30.

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