When attempting to calculate the income of a party in a divorce or child support case, it is important to remember that income is not determined simply on the basis of historical earnings. It is necessary to also consider the future prospects for income, and how the income scenario may change following the divorce. For example, one of the spouses may encounter a job change with a related change in earnings. Even if a change is not the result of the divorce, it still must be considered as changes in earnings may change a spouse’s ability to pay support.
In evaluating historical income, it is necessary to consider whether historical income was abnormally high or low for some reason. For example, suppose a business run by the spouse had lower net income in the past because there was a substantial investment to increase the capacity of the business. The investment included operating expenses and depreciation of fixed assets, which lowered historical earnings, but created an opportunity for the company to generate higher income in the future. Thus, the projection of future earnings must not rely solely on the historical earnings, but must consider the future prospects for income.
Of course, it is also important to consider whether one or both of the spouses has intentionally manipulated or decreased income in anticipation of divorce. This is not the same thing as hiding income or assets. Instead, this refers to the manipulation of a known income stream. For example, a law firm partner may temporarily, purposely decrease his salary in order to manipulate his income for support calculations. The intention would likely be to restore the salary sometime after the family law case concludes. A salesperson may ask the employer to temporarily suspend commission payouts.
Another common issue is the spouse who is accused of not working at full capacity. An allegation may be made that he or she has the ability to earn a greater income if employed at a different job or working longer hours.
Income for the purpose of family law proceedings can be calculated in one of four ways. These four methods have been developed for use by the Internal Revenue Service in calculating unreported income in tax cases. Because these methods are routinely used by the IRS in civil and criminal income tax cases, they are considered reliable when done properly. The four methods include:
- Specific Items Method – Transaction details are analyzed to identify specific items of income. Documents for known bank, brokerage, investment, and credit card accounts are examined to identify sources of funds. The detailed transactions are analyzed, categorized, and summarized. The data is accumulated in a spreadsheet or database so that it can be quickly sorted, summed, and subtotaled to provide insight into the data.
- Bank Deposits Method – All bank deposits are summed, adjusting the total to remove deposits that are transfers from other accounts or deposits from sources that do not represent income. The total of the bank deposits (less transfers between accounts) may represent the total income of the party.
- Expenditures Method – Bank, brokerage, investment, and credit card account documents are examined to identify uses of funds, also called expenditures. The detailed transactions are analyzed, categorized, and summarized as noted above. Expenditures are accumulated, and the expert determines the level of income that is required to fund those expenditures. If known sources of income are not sufficient to pay the expenses, the financial expert must consider whether undisclosed sources of income exist.
- Net Worth Method– This analysis evaluates the change in an individual’s net worth, and compares it to the known sources of income and the known expenditures. If the net worth increases beyond what is expected based on known sources of income, this may indicate unreported income.