Calculating Income in Divorce Cases
When it comes to calculating income for child or spousal support purposes in marital dissolution cases, the appropriate definitions of “income” varies based on state law. These calculations can involve significant complexity and uncertainty. So financial experts may be called in to help. This article explains some of the factors examined and what a financial expert brings to the table.
An often litigated issue in divorce cases is the calculation of income for support purposes. It can be for either spousal support or child support—or, in some instances, both. This is a tricky issue because the definition of “income” varies across the states and territories of the United States. Judges also are often granted significant flexibility when deciding on the appropriate amount of income to use for support purposes.
Federal Tax Code Guidance
For example, depending on the state or jurisdiction, capital gains might be specifically included in (or excluded from) “income” for support purposes. Usually the state definitions of income start with the federal income tax definition of income, outlined in Internal Revenue Code Section 61 as follows:
“(a) General definition
Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
(1) Compensation for services, including fees, commissions, fringe benefits, and similar items;
(2) Gross income derived from business;
(3) Gains derived from dealings in property;
(8) Alimony and separate maintenance payments;
(10) Income from life insurance and endowment contracts;
(12) Income from discharge of indebtedness;
(13) Distributive share of partnership gross income;
(14) Income in respect of a decedent; and
(15) Income from an interest in an estate or trust.”
Other Modifications to Income
Courts often make modifications to this list to fit the needs of the marital situation. For example, some “ordinary and necessary business expenses” might be questioned and disallowed, such as unnecessary travel and entertainment. Or the court might include income from pass-through entities, such as S corporations or partnerships. For the owner of a minority interest, the court might include the owner’s actual distributions. For a controlling owner, income for support could include all income earned attributable to the owner whether or not distributed;
Other items that judges might factor into a spouse’s income include:
• The value of unexercised (but appreciated) stock options,
• Imputed earnings on noninvested or poorly invested capital,
• Imputed debt relief,
• Gifts and inheritances, and
• Nonreported income, such as imputed receipts from a business that collects substantial cash from customers.
In addition, changes in the economy, industry or specific business can trigger a support modification. The ongoing challenge is determining the time period that should be the “indicator” of the ability to pay support going forward.
Experts Bring Objectivity, Know-How and Experience
Each state has its own rules on how to calculate the actual amount of spousal and child support to be paid. And because family courts are courts of equity, what’s included or excluded may vary depending on the facts and circumstances of the case. The guidelines listed above cover most of the bases when calculating income, however.
These calculations involve significant complexity and uncertainty. Financial experts may be called in to bring clarity and objectivity to the number crunching. Tax professionals and valuation analysts are commonly used as financial experts to:
Bring trust, integrity and competency that can give the judge a sound basis for making a decision.
Help during the settlement phase of the proceeding in advising both the attorney and client about the probable level of spousal and child support that can be anticipated if the case proceeds to trial. This input helps the attorney to have all of the facts and mathematical models on hand when he or she enters into the settlement process.
Once you’ve select an expert, it’s important to review the relevant rules relating to support income in the jurisdiction where the case is being litigated, along with the areas where subjectivity may exist. This discussion can help the parties brainstorm potential sources of income to include (or exclude) when drafting settlement options.
DOUGLAS P. SOSNOWSKI, CPA/ABV, ASA, CFF
Douglas P. Sosnowski provides business valuation, forensic accounting, and litigation support services for Brisbane Consulting Group. He has extensive valuation experience and has served as an expert witness, testifying in courts of law throughout the state of New York. Doug has experience consulting with publicly traded entities and valuing a variety of closely held companies in connection with mergers, acquisition and divestitures, business combinations, estate and gift tax planning, ESOPs and purchase price allocations. He also has experience in the quantification of lost income in determining business interruption claims for insurance adjusters. Doug is a member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and the American Society of Appraisers. Doug is a licensed financial advisor holding Series 7 and 66 securities licenses. He graduated with honors from the State University of New York at Buffalo earning his Bachelor of Science degree in business administration with concentrations in accounting and finance.