Before calculating income for child support, a lawyer should review his or her state’s guidelines. Failure to do so could result in your client paying more.
Mark Machnic, Certified Divorce Financial Analyst
I have been frequently asked by lawyers to assist them with the calculation of income for child support purposes when one or both of the spouses have K-1 income from either a Partnership or S-Corporation. As easy as it may sound, it is more complex than simply looking at Schedule K-1.
Pass-through income is shown in box 1, Ordinary business income (loss), on Schedule K-1. In Indiana this could result in overstatement of the income used to calculated child support. The amount in box 1 is often not actually the amount the taxpayer actually receives. The Indiana case of Tebbe v. Tebbe 815 N.E.2d 180 (Ind.Ct.App.2004) deals with the issue of pass-through income. It states that, “(1) undisbursed pass-through income of a minority shareholder in an S-corporation should not be included in child support calculations unless the trial court finds that the corporation is being used to shield income and (2) pass-through S-corporation income that is merely disbursed to offset pass-through shareholder tax liability, and which does not increase the shareholder’s actual income, should not be included in child support calculations.”
Calculating Income for Child Support: Tax Liability and Distribution
A calculation must be performed to determine the tax liability that is generated from the income in box 1 of the Schedule K-1. Once the tax liability is determined, it is compared to the figure in box 16 under code D on the K-1. Box 16 represents items affecting shareholder basis and code D is distributions. This would be the actual amount the taxpayer received. This amount is compared to the calculated tax liability. If the amounts are the same, there is no K-1 income used for child support purposes. The distribution was for the purpose of offsetting the tax liability. If the amount in box 16, code D is less than the calculated tax liability, once again, there is no K-1 income used for child support purposes. Finally, if the amount of distributions is more than the tax liability, the amount above the calculated tax liability is used as income for the child support calculation. The result of this calculation falls under the premise that the children should receive the same amount of income that they would have received it the marriage remained intact.
To continue with calculating income for child support, the result of the K-1 income is added to the taxpayers other income, which may include W-2 wages, interest, dividends, and other miscellaneous income. A key element to an owner of a company may be their in-kind benefits. These are benefits that the owner receives from the company that are free or at a greatly reduced cost. Examples would include medical & dental insurance, life insurance, a company vehicle, and profit-sharing. These benefits that the owner receives are also added to their income to determine the income available for child support.
The Indiana Child Support Guidelines
A factor that also needs to be determined in calculating the income for child support is whether or not the parent pays excess taxes. A calculation is done to determine the amount of taxes the parent pays. These include Federal, State, Social Security, and Medicare taxes. The total of all these taxes paid is divided by the taxable income of the parent. The Indiana Child Support Guidelines use an assumed total tax rate of 21.88 per cent. If the parents calculated tax rate is above this amount, an adjustment is made to reduce income by the excess tax rate.
When preparing child support calculations for clients, it is important to know how the numbers are determined. As you can see, there are a lot of different variables involved. Indiana also allows a credit on this calculation if the spouse receiving the child support does not have a mortgage on their property. The guidelines of your state should be reviewed to determine how the support is calculated and the various credits that are available. Failure to do so could result in your client paying substantially more money than required and could result in legal action against your as their attorney.
Mark R. Machnic is a Certified Divorce Financial Analyst (CDFA), a Certified Forensic Financial Analyst (CFFA), a Certified Valuation Analyst (CVA), and a Certified Public Accountant (CPA). Mr. Machnic is the owner of Business and Matrimonial Valuation Services, LLC, located in Highland, Indiana.
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Does this also apply in Illinois? Especially the part about an instance where the party getting support (in this case the ex wife) has no home mortgage then the husband’s responsibility to pay child support might be lowered. This can be misleading since a wife who was a homemaker, who supported her husband’s business, or who worked part time or was underemployed because of her role as Mother might not qualify for a home loan. A lender told me that in order for maintenance or alimony to count as income it must be court mandated. Since, a trial would likely be when the issue is settled the wife could scramble to provide a roof by exhausting non-marital assets, borrowing from family or retirement to pay for her home in full at the time of purchase thinking she will return the money at settlement when she qualifies for a loan or when she can find employment to satisfy the lender of creditworthiness thus injuring herself in terms of child support. Should she take out a home equity mortgage 6 months after the closing as is allowed in IL but before trial so that the lack of a home mortgage doesn’t work in favor of the Husband? Would a record of regular repayment to family satisfy the judge in the same way as payment to a financial institution if the loan can be verified with cancelled checks, IRA records and the like? Please advise. Thank you for your informative article and expert advise. Sincerely, Stephanie