A lot of people facing divorce ask the question: What do I do when our tax return shows that we only make a small amount of money, but I know we really make a lot more? There is a common misconception that the tax return holds the power in determining how much family income exists for a divorce. Fortunately, family courts have figured out that there are many creative ways that people earn income from cash-based businesses to having businesses hold and pay for personal-use assets for write-off purposes or other industry-specific income streams. If you are in a situation that you and/or your spouse don’t fit in a “traditional” W-2 employee position and you are not sure how much income really exists for support, then you may need to consider doing an income available for support analysis and/or a standard of living analysis.
Some states have a marital standard of living analysis that is used to determine support levels, but this same analysis can be used as a forensic tool to show that the income on the tax return does not reflect what is actually being earned according to a tax return. This can give the courts a better idea of income, for settlement calculation purposes. This analysis is done from the perspective of how much money your lifestyle costs and if you net the expenses of that lifestyle out against what you show as your income. Does it match what is left in your assets and debts? If there is a material difference from what you see on the tax return, then there are some blanks that need to be filled in. Sometimes these blanks are things like inheritance, gifts, settlements from lawsuits, or other things that legitimately may not be reflected on a tax return. It is good to at least do a reasonableness check if you think there is a material difference and the number on the tax return is what is being used for negotiating a settlement.
Back of the napkin example: Couple’s tax return shows that they make $100k, so approximately net of taxes they bring home $75k/year, which is about $6250/month. They own their home with a mortgage (including property taxes and insurance) of $3000/month ($36k/year), vacation home with a mortgage of $1,000/month ($12k/year) (including property taxes and insurance), two cars that cost $500/month ($6k/year), have one child in private school that costs $12k/year, go on one international trip annually and a couple of domestic trips for ~$10k/year, have no debt, and save $20k/year. This adds up to $96k for the year before you add in groceries, gas, utilities, healthcare, personal maintenance, sports, etc. Clearly, there is more to this story that needs to be explained.
Another analysis that is common when a business owner is involved or there are more complex income streams is an income available for support analysis. For example, if one of the parties in a divorce is either the sole owner or the majority shareholder of a company, it is not unusual to have personal expenses paid for by the business. These are typically things like cars, insurance, cell phone expenses, travel, meals, etc. Since these expenses are paid by the business then the company has less income, resulting in lower income on the corporate tax returns. Then the company also distributes less income to the shareholder so less money going to the government there as well while personal expenses are covered. The couple’s tax return will show less income than is really being realized. When this is occurring, it is recommended that an income available for support analysis is done.
An income available for support analysis in this situation looks at the financial records of a company and determines how much money is available to distribute to the owner in net income factoring in the dollars that are directly paid to a vendor for the benefit of the owner. A forensic accountant is typically hired to do this analysis and can be included in a business valuation engagement since typically personal expenses are removed for purposes of calculating the value of the business.
Another example of when an income available for support analysis is done is when someone has equity compensation as a part of their employee compensation (e.g., restricted stock units or stock options). The value on the vesting date is included in the W-2 income. Typically, this income is earned over a period of time according to a vesting schedule and is very particular to each grant. How much of this is considered community property, as well as how much should be considered as income available for support should be looked at by a professional that does this regularly.
If you are concerned that your tax information does not paint the complete picture for your family income, please consult a Certified Divorce Financial Analyst or Forensic Accountant in your jurisdiction to determine what type of analysis will be required in your particular situation.
