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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.
Asset
Tracing in Colorado and Other States
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)[1] of the section".[2] No Colorado cases have addressed specifically just
how much of a showing is required.[3] 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.
How to Start
the Asset Tracing 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.
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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.
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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:
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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.
Methodology
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.
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