Why Asset Tracing?
Under Colorado's Uniform Dissolution of Marriage Act, separate assets are not subject to equitable distribution. Therefore, a spouse who can establish that assets are separate, to the court's satisfaction, gets to keep them. The task at divorce is to show that assets now in existence are the same separate property that existed at the time of marriage or were acquired in exchange for property acquired before the marriage or in exchange for property acquired by gift, bequest, devise, or descent. The "Disposition of Property" Section 14-10-113 of Colorado's Uniform Dissolution of Marriage Act establishes a rebuttable presumption that "all property acquired by either spouse subsequent to the marriage" is marital property. How does one overcome this presumption? The answer is asset tracing.
Asset tracing is an accounting process that traces an asset from its separate property beginnings through all of its mutations and demonstrates that the resulting asset in existence at the date of divorce is either separate, marital, or a combination of the two.
Purpose of This Book
The purpose of this book is to give practical and theoretical guidance to attorneys and expert accounting witnesses who are called upon to produce an asset tracing accounting. A successful asset tracing requires timely communication and coordination between the legal and accounting professions. The author hopes that the methodologies and case studies found in this book will be helpful in coordinating efforts between the two professions.
While the asset tracing cases presented in this book are based specifically on the Colorado Statutes, the principles and methodologies used can be adapted to other jurisdictions.
The Colorado Statutes do not provide any definitive standard for asset tracing. The statute merely states that the "presumption of marital property is overcome by a showing that the property was acquired by a method listed in subsection (2) of the section". No Colorado cases have addressed specifically just how much of a showing is required. To date, the author has not found any specific published guidance in the area of producing an asset tracing accounting. The methodologies in this book have been developed by the author over a number of years based on involvement as an expert witness in numerous divorce cases.
The task of producing an asset tracing accounting can be compared to other traditional tasks performed by accountants. For example, accountants produce financial statements as an accounting for the financial performance of a business. This accounting process uses accounting methodologies and techniques that have been developed over time by the accounting profession. The rules and standards used to produce financial statements are called "Generally Accepted Accounting Principles". When financial statements are correctly prepared using the above standards, they are said to be in accordance with generally accepted accounting principles. When accountants prepare tax returns they are also, in effect, producing an accounting based on applicable tax statutes and case law. In both the above examples, assets are traced from the beginning to the end of a period of time.
So when accountants are called upon to produce an asset tracing accounting in a marital dissolution, it is only logical that they draw upon methodologies commonly used to produce other accountings and apply the rules and guidance found in the Colorado Statutes and case law. A properly prepared asset tracing would therefore be said to be in accordance with Colorado Statutes and case law, presented by using generally accepted accounting methodologies.
Interface of the Accounting and Legal Professions
The practical problems in producing a successful asset tracing accounting, in the author's experience, come from attorneys not understanding accounting concepts used in asset tracing and accountants not understanding the legal concepts that provided the rules for asset tracing. Too often, attorneys give accountants ten to fifteen minutes of verbal guidance on the legal aspects of asset tracing and send them away to produce an accounting. Usually, unless the accountant is experienced in asset tracing cases or is an accomplished conceptual thinker, the asset tracing accounting produced is seriously deficient. In addition, by the time the attorney usually has a chance to review the accountant's work, it is late in the litigation process, the accountant has spent thousands of dollars in fees, and it would be prohibitively time-consuming and expensive to correct any problems with the accounting.
To avoid the above described problems, it is important, at the outset of an asset tracing engagement, for the attorney and accountant to conceptually understand and agree to the asset tracing methodologies to be used by the accountant. It is equally important for the accountant to understand when he or she needs to consult the attorney on legal issues and principles involved in the asset tracing. In the authors opinion, it is primarily the accountant's responsibility to consult the attorney for guidance on legal principles. This is because the accountant will usually be the first to encounter legal issues while trying to properly classify transactions in the asset tracing accounting process.
The asset tracing process usually starts by one or both spouses making a claim to separate property. These claims may first be made by the spouses to each other or by the spouses' respective attorneys. Claims of separate property may be made upon the parties mandatory filing of the Affidavit With Respect to Financial Affairs exchanged between the parties. Item 16 on the Affidavit With Respect to Financial Affairs lists the parties' assets. The form contains three columns entitled, Husband's, Wife's, and Joint. The Husband's column, according to the form, should contain assets that the husband "acquired before the marriage, or by gift, or by inheritance, only." The wife's column, according to the form, should contain assets that the wife "acquired before the marriage, or by gift, or by inheritance, only." The Joint column, according to the form, should contain assets "acquired during the marriage, other than by gift or inheritance." In the author's opinion, the Affidavit With Respect to Financial Affairs contains only enough information to alert the parties to the possibility of the existence of separate property. In the author's experience, more times than not, the form is prepared incorrectly or consists mostly of "Unknown" or "TBD" (to be determined) notations. Based on being alerted to the possible existence of separate property, the attorney and accountant involved should first compare any separate property claims and known information to the Colorado Statutes defining separate property.
Definition of Separate Property Under the Colorado Statutes
Separate property is defined by exception under Section 14-10-113 of the Colorado Uniform Dissolution of Marriage Act as follows:
(2) For purposes of this article only, "marital property" means all property acquired by either spouse subsequent to the marriage except:
(a) Property acquired by gift, bequest, devise or descent;
(b) Property acquired in exchange for property acquired prior to the marriage or in exchange for property acquired by gift, bequest, devise, or descent;
(c) Property acquired by a spouse after a decree of legal separation; and
(d) Property excluded by valid agreement of the parties.
(3) All property acquired by either spouse subsequent to the marriage and prior to a decree of legal separation is presumed to be marital property, regardless of whether title is held individually or by the spouses in some form of coownership such as joint tenancy, tenancy in common, tenancy by the entirety, and community property. The presumption of marital property is overcome by a showing that the property was acquired by a method listed in subsection (2) of this section.
(4) An asset of a spouse acquired prior to the marriage or in accordance with subsection (2)(a) or (2)(b) of this section shall be considered as marital property, for purposes of this article only, to the extent that its present value exceeds its value at the time of the marriage or at the time of acquisition if acquired after the marriage.
(5) For purposes of this section only, property shall be valued as of the date of the decree or as of the date of the hearing on disposition of property if such hearing precedes the date of the decree.
The Nature of Separate Property Under the Colorado Statutes
By studying the Colorado Statutes on separate and marital property, certain attributes of separate property become apparent:
Because under 14-10-113 (4), appreciation of separate property under 14-10-113 (2) and (2)(a and b) is considered marital property, separate property does not increase after it is initially created. It can only stay the same or decrease in value.
Separate property created under 14-10-113 (2)(c and d) can increase in value after it is initially created. It can stay the same, increase or decrease in value.
Separate property can acquire a marital component and become a combination of separate and marital.
The following Separate/Marital Property Decision Tree was created by the author to test separate property claims against Section 14-10-113 of the Colorado Statutes.
The Accounting Methodologies Used In Asset Tracing
Once an asset is initially determined to be separate or a combination of separate and marital property, an asset tracing accounting should be performed. Webster's New World Dictionary defines accounting as "a system, science, or art of keeping, analyzing, and explaining commercial accounts." It further defines account as "a record of business transactions, statement of money received, paid, or owed."
The accounting methodology used in asset tracing involves categorizing all transactions that have occurred to a separate asset, from its creation until the end of the marriage, into separate and marital property components. The categorization of each transaction must be consistent with the Colorado Statutes, case law and the facts and circumstances surrounding the asset.
An analysis of Section 14-10-113 results in the deductive reasoning that there are three categories of transactions or events that affect separate property. They are as follows:
1. Transactions/events that create separate property
2. Transactions/events that create a marital component to separate property
3. Transactions/events that reduce the separate or marital component of property
The follow transaction/event classifications code list was created by the author to facilitate transaction classifications. Each item on the list is discussed in detail in Chapter Two of this book. This list should cover most of the situations encountered in asset tracing engagements.
Computer Spreadsheet Format to Trace Individual Assets
The following spreadsheet format is an example of how an individual asset can be traced through a marriage using the above described accounting methodologies:
In this example, an asset tracing accounting of an individual retirement account is demonstrated. The spreadsheet columns are described as follows:
The "Description" column is used to describe the transactions or events that must be accounted for.
The "Event Code" column is used to classify each transaction using the Transaction/Event Codes list. The use of this list documents each transaction back to the applicable Statutory authority.
The "Source Document Code" column can be used to reference the source documents or evidence used in classifying each transaction.
The "Separate" and "Marital" property columns are utilized to account for the respective separate and marital components of each transaction affecting the asset.
While the above computer spreadsheet format will be adequate to trace most individual assets and liabilities, occasionally a more comprehensive asset tracing format may be needed.
Comprehensive Format to Trace Multiple Assets
Case Study 8 found in Chapter Three, demonstrates a comprehensive asset tracing for all financial transactions during a marriage. The underlying asset tracing principles remain the same as for an individual asset tracing. The form of the accounting changes to deal with the complexity of the task. The individual asset tracing demonstrated above was accomplished with the use of a computerized spreadsheet. The comprehensive asset tracing Case Study 8 utilizes a traditional departmental balance sheet and income statement approach. Departmental balance sheets and income statements are set up for the husband's separate property, the wife's separate property, and marital property. Each transaction during the marriage is categorized into one or more of the departments. As in the individual asset cases, each transaction is classified using the Transaction/Event Codes and further tested by using the Separate/Marital Property Decision Tree.
The comprehensive asset tracing method demonstrated in Case Study 8 is appropriate only when adequate financial records exist, material amounts of separate property exist, and the method can be cost justified.
Before undertaking a comprehensive property tracing, it is imperative that the accountant understand, at the outset of the engagement, conceptually where he or she is headed. It is not cost effective to classify hundreds or even thousands of transactions only to find that the format and methodology initially used was inappropriate. The accountant should also make a special effort to ensure that each step of the asset tracing process follows a logical and simple path. The accountant should be mindful that every entry in the asset tracing accounting, as well as each element of the methodology itself, is subject to scrutiny at deposition and at trial. Do not combine multiple transactions into sweeping journal entries! A good opposing attorney will have you struggling on the witness stand attempting to locate each element of a journal entry that may affect multiple assets. It is a lonely feeling to be on the witness stand flipping back and forth in a general ledger while everyone in court is waiting on you to answer a seemingly simple question.
The author suggests testing each element of the accountant's asset tracing methodology by the following standard:
Can each element be explained in less than five minutes?
Does the explanation appeal to common sense?
Can the explanation be understood by a non-accountant of average intelligence?
Differences in Asset Tracing Approach Between Petitioners and Respondents
Under the Colorado Statutes, the presumption that property existing at the end of marriage is marital property, is overcome by the party claiming separate property showing that the separate property was acquired under section 14-10-113 (2) of the Statute. In other words, the party claiming separate property has the burden of proving his or her claim of separate property. Therefore, the accounting expert will usually perform detailed asset tracing for his or her client's separate property claims and only verify or refute separate property claims of the opposing party.