Searching for unreported income is tough task

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The million dollar question in many litigation disputes, be it family law, a shareholder divorce, or other corporate wrangling, often centers around unreported income. Are there sales that aren’t being recorded on the books? Is the individual receiving cash for work done? Is revenue hidden to shield it from being considered by the court?

It would be lovely to be able to wave a magic wand and have all the “hidden” income magically appear. Unfortunately, that’s just not going to happen in this lifetime. The search for unreported revenue and earnings is a difficult one.

It’s one thing to examine transactions that have been recorded on the books and dig into the details of those transactions. It’s another thing altogether to try to find something that isn’t even recorded on the books. Where does a fraud investigator begin?

The Motivation

The motivation for hiding revenue is often quite simple: lower revenue can mean higher claimed losses or a diminished ability to pay another party. In family law, one party may wish to decrease her or his earnings in order to avoid a higher alimony or child support order. Decreased earnings in a business interest may also serve to decrease the apparent value of a business, thereby affecting the amount that may ultimately be paid out to the spouse who is not retaining the business.

In a corporate dispute, smaller revenue may make damage claims bigger, if the damages are based upon lost revenues. A separation of shareholders may also be significantly impacted by depressed revenue because this would likely decrease the value of the business operations, and therefore affect any buyout figures.

The Methods

The most common way an employee hides earnings is by getting paid in cash and failing to report that income. In other cases, an employee may ask the employer to withhold issuing a paycheck for a period of time, with a promise to later catch up on the payroll.

I’ve seen almost non-existent paychecks with a promise of a “bonus” when litigation is complete.

For a company interested in depressing revenues, it is probably a little more complicated.

Customers need to be invoiced for products and services, so paperwork has to be created at some point. Yet it’s not difficult to follow up this paperwork with adjusting entries in the accounting system that serve to wipe out the associated revenue.

In the case of a corporation trying to conceal revenue, there typically is some sort of paper trail available. However, it’s not likely that the owner will readily produce that documentation. Obviously, if there are overt steps taken to conceal or disguise income, the perpetrator of the fraud is not likely to be forthcoming in providing documentation that shows the concealment.

How cool would it be to open a company’s accounting records and be able to immediately point out the proof that hidden income exists? That just doesn’t happen, unfortunately.

So we’re left to look for clues in the documents that are provided.

Next week, part 2 of this column will delve into the use of lifestyle and expense analyses to track down unreported income.