Published in Family Advocate – Spring 2024
Financial issues create stress and anxiety for most clients going through the divorce process. How will the assets be divided? Will one party be able to refinance the house and buy the other out? What will happen to the retirement and investment accounts? How much child support or spousal support will be paid?
Issues surrounding support are some of the most highly contested. While you might think it would be easy to figure support given the guidelines in place in each state, it can get complicated quickly. Traditional jobs that pay predictable wages or salaries are simple to plug into the guidelines and formulas. When jobs fall outside these parameters and include things like overtime, bonuses, commissions, executive perks, and other variable pay, you are left making estimates and judgment calls.
The “gig economy” and various types of self-employment or business ownership complicate things further. Now you’re dealing with income that can vary greatly from month to month and year to year. Business expenses, self-employment taxes, and benefits provided to the business owner make the picture even less clear. Throw in the possibility of manipulation of income and expenses to reduce support, and your head is spinning trying to sort out the numbers.
What Is Included in Income?
When preparing for support calculations, it is important to be sure that you are including all income in the analysis. Sometimes opposing attorneys want to exclude certain types of pay from the calculations. They say that overtime or bonuses aren’t guaranteed and therefore shouldn’t come into play. Other income outside of wages from employment may be conveniently overlooked or excluded too. But even if certain types of income may ultimately be excluded by the court when making support calculations, it is still important to evaluate them during your process of analyzing income and support.
Income can be either earned or unearned. Earned income is generated from working or providing personal services and includes things such as:
- Wages, salaries, tips, commissions, bonuses, and other taxable employee pay
- Net earnings from self-employment, including entities established as sole proprietorships, partnerships, corporations, LLCs, or some other form of business
- Income from real estate ventures in which a spouse is an active participant
- Royalties, earnings under endorsement deals, and other unusual forms of income
Unearned income generally includes any earnings that do not originate from a spouse’s job or active business venture such as:
- Income from investments in which neither spouse actively works or participates, such as interest and dividends from savings accounts, investment accounts, or stock ownership in public companies
- Capital gains from the sale of investments
- Income from trusts or estates
- Inheritances
- Income from real estate ventures in which neither spouse actively works or participates
- Retirement earnings such as annuities, pensions, or Social Security
- Unemployment or workers’ compensation income
- Disability income insurance benefits
- Settlements and awards
- Proceeds of life insurance policies
- Prizes or lottery winnings
Some of these sources of income are going to be automatically excluded from support calculations based on state guidelines. However, it may still be important to know the value of these sources of income as you are gaining an understanding of the overall financial picture.
Income from investments is often debated in divorce and child custody cases, especially if the amount of money is substantial. Dividends, interest, capital gains, and distributions can all be the source of disagreement, with differing opinions on what constitutes active involvement and whether the income is includable in support calculations.
Business income is a hot button issue as well, especially if the income appears to be manipulated to impact support calculations. Mysteriously, revenue goes down, customers have allegedly been lost, the business is suffering, and we might even hear how the business is “under water” or “worthless.” In other situations, the business still turns a profit, but the owner doesn’t take the profits out, in an attempt to “play poor” and say that he or she has no personal income from the company.
And then there’s the issue of having the business pay all personal expenses. The business owner gets the benefit of having all things paid for and shown as fake business expenses on the tax return, but once again, there is no personal income reported from the company. Another common tactic is “borrowing” money from the company, rather than receiving a paycheck or distribution of profits.
All of these schemes to reduce the party’s income on paper can be defeated, but it takes documentation and careful analysis. If the judge only sees tax returns that show a loss or a very small amount of income and no evidence to refute that, the support will be calculated accordingly. It may take an analysis of bank statements or accounting records to show that the business owner is financially benefitting, either through direct receipt of cash or through the payment of personal expenses.
Discovery for Income
Information is your best ally in the quest to properly calculate the income that will form the basis for support calculations in the divorce. The more documentation you can access in support of the income, the more likely you will uncover all sources of income and the more solid your numbers will be.
Remember: Judges often have latitude in non-traditional earnings scenarios. If a source of income doesn’t specifically meet a definition of income under the statutes, it might still get included in the calculations if you can make the case for it. Get the information, present it simply and clearly, and you may have a chance of having that money included in the support calculation.
When evaluating income, your results will depend on requesting or subpoenaing the right documents. You must ask for them in the right way to be assured of getting the information you seek. If the requests are too broad, it is easy for the parties to skip providing some of the items and pretend they did not know what you meant. If the requests are too specific, there can be claims that a certain document is not exactly “that” item. There is an art to requesting financial documents that specifies the type of information or exact document and then gives a broader description of it to prevent a party from using a technicality to get out of providing the document.
For example, if specific accounting records of a business are being requested, you may ask for a list of Accounts Receivable as of December 31, 2023, but then further specify “or other listing of all amounts owed by customers” as of that date. In this example, a business owner could say that he or she does not have a report called Accounts Receivable, but your more general description of the information you seek would require him or her to produce the same information. Requests such as this take a little extra time to craft but will save you time in the long run because you won’t be making repeated requests or having arguments about what is covered under your original request.
Documents to Request
The document requests or subpoenas need to be thorough to ensure that all potential sources of income are included. The most basic types of documents that will be relevant in the vast majority of cases include pay stubs, W-2s, Social Security earnings records, 1099s, and income tax returns. If the completeness or truthfulness of any of these items is in question, it may be necessary to get bank statements. An analysis of the bank account will show the amounts being deposited to help verify the accuracy of other financial documents and could reveal sources of income that were previously unknown.
When a client’s situation includes income sources other than traditional employment, the document requests will need to expand. Situations involving significant investments, income-producing real estate, or business ownership will fall into this category. Think of anything that could be producing income or increasing in value. While the investment itself will typically be considered in the context of property division, there may also be an income component in terms of dividends or interest, capital gains, or cash received from the investment. Do not be too quick to assume that there is no income being received from an investment, especially if a party is receiving cash flow from it.
Document requests related to investments, real estate, or businesses owned may include the following:
- Copies of personal financial statements prepared for any purpose in the last three years
- List of all bank accounts in the party’s name or to which the party has access, including the bank name, bank location, account number, and type of account
- Detailed list of any investments, ownerships, or other interests in brokerage accounts, treasury bills, treasury bonds, stocks, stock options, stock warrants, bonds, debentures, guaranteed investment certificates, annuities, term deposits, bankers acceptances, limited partnerships, commercial partnerships, joint ventures, pension plans, 401(k) plans, individual retirement accounts, Employee Stock Option Plans (ESOP), profit-sharing plans, put options, call options, tax shelters, and any other investment of any nature, whether held directly, indirectly, or in any manner whatsoever
- List of all cryptocurrencies owned, including information on the wallet and the number of tokens or coins owned
- List of all cash transfer or peer-to-peer (P2P) payment applications (apps) used in the last 3 years, such as Cash App, Venmo, Zelle, PayPal, Wise, Google Pay, Apple Pay, or any other such app
- List of all real estate interests owned by the party directly, indirectly, or in any manner whatsoever
- Business ownership records (stock certificates, charters, operating agreements, joint venture agreements, corporate minutes, or other related documents)
- Business income tax returns (Form 1065, 1120, or 1120-S) for any business in which the spouse/parent has had an ownership interest for the last five years
- Financial statements for any business entity in which there is an interest, including professional practices, joint ventures, and co-ownerships for the last five years
This list of documents is a starting point for evaluating the sources of income. It is likely that account statements, detailed accounting records, or other financial documents will be necessary to fully evaluate the activity and potential income from it.
Analyzing the Income
It is not enough just to get the relevant financial documents. They have to be evaluated in detail to determine the truth about the finances. Income tax returns are often a very reliable source of financial information. But in some cases, the tax returns don’t tell the whole story. The same goes for other financial documents like bank statements. They need to be analyzed in detail and compared to other documents to figure out what they are really saying.
In the most straightforward scenario, the analysis is probably pretty quick. If someone receives only traditional wages with a constant rate of pay, it is easy to confirm historical earnings and calculate support. Things like raises, overtime earnings, or periods during which a party does not work will impact the analysis; but as a general rule, past earnings can be easily analyzed and future earnings are fairly predictable.
When historical earnings vary, it becomes more complicated. Items like bonuses, commissions, stock options, other incentive pay, or profit-sharing impact the calculation too. For example, commissioned salespeople can see wild fluctuations in their earnings based on changes in the economy, the industry, or the companies for which they work. A landscaping business will likely see income vary substantially throughout the year. Real estate developers may have modest income in some years but significant income in other years, depending on the progress of projects. Corporate executives can see variations in their income related to bonuses and other incentive pay, which are often tied to the earnings of the company.
If a party does not have consistent earnings and has a situation that needs more in-depth analysis, procedures to perform may include:
- Evaluating earnings over a period of one to ten years, paying attention to the total earnings and individual categories of earnings
- Looking for a trend in earnings between years
- Determining the reasons for any substantial changes in compensation
- Analyzing changes in earnings based on changes in rates of compensation, hours worked, and employers
- Evaluating how major changes in jobs and responsibilities have impacted annual earnings
- Comparing income tax returns and other documents to declarations, affidavits, or other representations made in the family law case
The analysis of a business interest will require more work and greater expertise. It may be appropriate to dig into the detailed accounting records to see if any evidence of manipulated financial statements exists. Bank and accounting records will likely show payments to the party from the business, and this information will be critical if you intend to present the court with evidence of the cash flow received from the business. These same records may also contain proof of personal expenses paid by the business.
In any event, relying only on the tax returns or financial statement of the business may not provide a complete picture of the finances for family court. Further analysis is required if you are to prove that the business owner receives financial benefits from the company that are not clearly reflected in the tax returns or financial statements.
For example, one type of business venture that may demonstrate 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 results 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.
Another example would be a business venture that shows income on a tax return, with the spouse alleging that the income should not be included in support calculations because no cash was distributed to him or her. Often the contention is that the funds were “reinvested in the business” and therefore not available to pay support. If an owner chooses to not distribute profits, this could unfairly impact support calculations.
A cash flow analysis is one procedure that may help shed light on the financial situation. The analysis could include not only wages and other taxable sources of income, but also cash distributions from business entities. Items such as company fringe benefits and perks will likely be included in the cash flow analysis.
Unfortunately, the issue of cash flow versus income is an area of great debate 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 do not reflect the true income or cash flow of the spouse, so the cash flow should be the basis for support.
It is difficult to predict how a judge will interpret the financial facts and whether he or she will be open to considering cash flow as an alternate measure of income. But you will not have a chance to make the argument if you didn’t get the documents or the analysis wasn’t done.
No matter the situation with employment or business ownership, the most important objectives are to get the relevant financial documents and evaluate them for information that matters. One of the biggest risks in the financial part of a family law matter is not having all the necessary information. Mitigate that risk by doing proper and complete document requests and subpoenas, and ensure that the documents received are thoroughly evaluated.
Tracy Coenen, CPA, CFF of Sequence Inc. Forensic Accounting has spent more than 25 years investigating fraud. She has personally completed more than 500 forensic accounting engagements in a wide variety of industries, including cases of embezzlement, financial statement fraud, investment fraud, divorce, and insurance fraud. Tracy has testified as a forensic accounting expert witness more than 90 times. She is the author of four books, including Lifestyle Analysis in Divorce Cases: Investigating Spending and Finding Hidden Income and Assets (Third Edition, ABA 2024).