Introduction to Tracing Comingled Accounts (Hybrid Accounts)

Divorce settlements commonly consider how best to divide the value of financial accounts (such as investment and retirement accounts) that arguably includes a comingled combination of marital and separate equity.  Comingled accounts are those where both marital and separate equity has been mixed together, creating a financial entanglement that can be difficult to unravel. Sometimes these accounts are referred to as ‘hybrid accounts’. Marital equity is attributed to both spouses, while separate equity is attributed to one spouse. As divorce financial analysts, our role is to provide clarity and precision to trace the value of these accounts to ensure a fair and equitable (though not necessarily equal) distribution of assets between both spouses.

Common causes of comingling accounts include:

• Account was owned by one spouse prior to the marriage and experienced deposits or withdrawals during the marriage
• Account was opened during the marriage and received separate investments or withdrawals during the marriage (for example, depositing an inheritance or paying expenses for a paramour)
• Account was opened during the marriage and continued to receive deposits from one spouse’s income after the date of separation
• A marital account and a separate account were merged at some point

Tracing of non-cash assets, such as real estate and small businesses, are governed by different case law and involve different techniques that are not discussed in this post.

Applying Best Practices to Each Trace

Forensic accounting adheres to Generally Accepted Accounting Principles (GAAP), focusing on consistency, reliability, and accuracy.  These principles guide the identification, measurement, and reporting of financial transactions, which is essential in tracing the origins and growth of funds within comingled accounts.

Accounting standards emphasize the importance of detailed documentation and transparent reporting.  Forensic accountants meticulously document all financial transactions, create comprehensive timelines, and generate detailed reports.  These reports outline the methodology used, the timeline of transactions, and the final determination of each spouse’s share of the comingled account.

Understanding Comingled Accounts

Comingled accounts often arise in marriages where individual and joint accounts are merged for convenience or investment purposes. These can include savings accounts, retirement funds, investment portfolios, and even property investments. The challenge lies in distinguishing what belongs to each party, particularly when contributions and withdrawals have occurred over many years.

The Importance of Accurate Tracing

Accurate tracing of comingled accounts is crucial because it determines the division of assets in a divorce settlement. Without a clear understanding of each party’s contributions and the growth of those assets, it is impossible to ensure a fair distribution. This process requires meticulous documentation and a thorough analysis of financial records.

Steps to Trace the Value of Comingled Accounts

The tracing process involves several steps, each requiring a keen eye for detail and a strong understanding of financial principles. Here are the key steps involved:

1. Gathering Financial Records

The first step is to gather all relevant financial records. This includes bank statements, investment account statements, tax returns, and any other documentation that shows the flow of funds into and out of the comingled accounts. The goal is to create a comprehensive timeline of all financial transactions.

2. Identifying Separate, Marital and Comingled Funds

Once the records are gathered, the next step is to identify which funds are separate (belonging to one spouse prior to marriage or acquired through inheritance or gifts), which are marital (acquired during the marriage), and which are comingled (separate and marital). This distinction is critical in determining the rightful ownership of the assets.

3. Establishing Financial Principles

Most states do not require or exclude any explicit methodology to trace comingled assets, but multiple methods have been proven effective on actual cases. To identify the best method or methods, the divorce financial analyst surveys the available data available and discusses the history of the comingled assets with the attorney and client.  Sometimes a blend of methods is selected.

Common methods that govern deposits and withdrawals:

• Direct tracing: Involves tracing marital and separate equity from its inception through the present, possibly through multiple assets as equity is transferred from one asset to another
• Exhaustive method / family expense presumption method / community out first method: Assumes that marital (or community) funds are used to pay for any marital (or community) expenses before these expenses are paid by separate funds
• Minimum sum balance method: Segments a balance of separate equity in an asset and retains a threshold of its equity to the extent that the asset’s overall balance never drops below that threshold value
• Clearinghouse method: Transfers separate equity of funds that are deposited temporarily into a marital (or community) asset and then out of that asset by withdrawing a similar value of funds in a relative proximity of time
• Lowest intermediate balance rule: Tracks separate equity deposited into a comingled asset and debits withdrawals from the separate equity first

Common methods that govern asset appreciation (or depreciation) and withdrawals:

• Pro-rata method: Involves a marital (or community) asset receiving a deposit of separate funds, or vice versa; from that point forward, the percentage of market appreciation and asset withdrawals in the account are assumed to be proportionate to the value of respective value of separate and marital equity
• Source of funds rule: Separate and marital interest in an asset is proportionate to the separate and marital contributions to the asset

Some funds do not provide details for how appreciation (or depreciation) accrued over the course of a financial statement (normally quarterly or annually for retirement accounts and monthly for other accounts). The divorce financial analyst needs to consider how consequential this may be to trace results and define assumptions.  Example assumptions include:

• Appreciation occurs at the end of the account statement period of performance
• Appreciation occurs at the beginning of the account statement period of performance
• Appreciate occurs throughout the account statement period and is best estimated by averaging end of account and beginning of account appreciation assumptions

4. Analyzing Transactions

With the funds identified and principles defined, the next step is to analyze the transactions within the comingled accounts. This involves tracing the source of each deposit and the purpose of each withdrawal. For example, if one spouse had a separate investment account that was later combined with a joint account, it is important to identify the original value of that investment and its growth over time.

5. Creating a Detailed Report

The final step is to create a detailed report that outlines the findings of the tracing process. This report should include a clear explanation of the methodology used, any assumptions reflected, the timeline of transactions, and the final determination of each spouse’s share of the comingled account. This report will be used in court to support the division of assets.

Challenges and Considerations

Tracing the value of comingled accounts is not without its challenges. One of the biggest obstacles is the lack of complete financial records, especially for accounts that have been active for many years. In such cases, forensic accounting techniques may be required to reconstruct the financial history.

Another consideration is the impact of market fluctuations on investment accounts. The value of these accounts can vary significantly over time, making it difficult to determine the exact portion attributable to each spouse. It is important to account for these fluctuations in asset appreciations and depreciations when tracing the value of comingled accounts.

An important consideration is case law, which varies from state to state.  An experienced attorney is key to identifying and defending the application of case law.  The divorce financial analyst translates the case law into assumptions and adapt the tracing model to reflect these assumptions. 

Professional Expertise

Given the complexity of tracing comingled accounts, it is advisable to seek the assistance of a professional financial analyst with experience in divorce cases. A Certified Divorce Financial Analyst (CDFA®) can provide the necessary expertise and objectivity to ensure a fair and accurate division of assets.

Conclusion

Divorce is a challenging process, but with the right approach, it is possible to navigate the financial maze of comingled accounts. By following a systematic and thorough tracing process, accountants can help ensure that both parties receive their fair share of the assets. This not only provides financial clarity but also contributes to a more amicable resolution of the divorce.

In the end, the goal is to achieve a fair and equitable division of assets that reflects the contributions of each spouse. With meticulous documentation, detailed analysis, adherence to accounting standards, and professional expertise, tracing the value of comingled accounts can be a manageable and successful endeavor, even in the most complex divorce cases.