Cash Flow Versus Income in Family Law Cases

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business-income-tax-divorceThis article was originally printed in the ABA Section of Family Law eNewsletter, March 2014.

There are many different definitions of income that can be used in family law cases. Local law will play a big part in defining income, but in more complicated cases, other definitions may come into play. The financial expert can help the attorneys and the court to understand the various types of income and why they should be included or excluded from income calculations in a family law case.

The Internal Revenue Code is often a starting point for defining and quantifying income in family law cases. Experienced family lawyers know this is only the tip of the iceberg and doesn’t cover many of the unusual situations that could arise in cases with complicated financial scenarios.

In simpler cases, wage income and business income will be straightforward and will form the basis for calculating child support and spousal support. Undistributed income from a business venture may be an area of contention, but local laws often provide at least basic guidance on including such income in support calculations.

In some situations, however,income reported on a personal or business income tax return is not reflective of the funds available to pay living expenses of the family. An example of the type of business venture that may exhibit this problem is real estate. Income tax laws related to real estate businesses are generally advantageous to the owners. That is, the level of deductions allowed to be taken for real estate ventures often result in little or no taxable income. However, the owners often find that the real estate venture provides ample cash flow, even in the absence of taxable income.

In the cash flow analysis, the forensic accountant will likely include items such as wages, interest, dividends, and cash distributions from business entities. The profit or loss from the business entities per the income tax return will be excluded from this analysis, as the focus is the cash received. Items such as company fringe benefits and perks will likely be included in the cash flow analysis. Capital gains and losses may or may not be included in a cash flow analysis, depending on the circumstances of the case and the activities from which the capital gains and losses were realized.

Such an analysis is aimed at showing the court that even though the party does not have taxable income, the party has ample cash flow from which living expenses are paid. That cash flow could be the basis for the calculation of spousal support and child support payments.

Unfortunately, “cash flow versus income” is an area of great contention in family law cases. One side will inevitably argue that the earnings per the income tax return are very low, and therefore a very low level of support should be paid. The other side will argue that the earnings on the income tax return are not reflective of the true income or cash flow of the spouse, so the cash flow should be the basis for
support.

As this is a gray area in family law, it is often difficult to predict how the court will interpret the financial facts. The financial expert should provide the court with multiple methods of calculating income. Ideally, each of the various methods will tend to support the results of the other methods of calculating income. Presenting the court with multiple methods of calculating income or cash flow available to pay support, all with results in a fairly narrow range, will be more persuasive then presenting only one method of calculating income.

Tracy L. Coenen, CPA, CFF is a forensic accountant and fraud investigator with Sequence Inc.. She specializes in cases of embezzlement, financial statement fraud, white collar crime, securities fraud, and family law. She can be reached at 312.498.3661 or [email protected]

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