Divorce courts will generally consider a number of factors in determining how much child support or alimony that one spouse should pay to the other.
By Steve Mangan – CPA- (Minnesota)
Divorcing couples continue to search for ways to maintain a standard of living that mirrors that which they enjoyed during their marriage. In order to do so, one must determine the lifestyle shared, or unshared, during their marriage. This lifestyle can be complicated to determine as partners anticipating divorce may shelter activities from their spouse.
CPA’s offer a wide variety of services including:
a) Preparation of disposable income and living expense schedules
b) Assisting in negotiating support schedules, and
c) Providing tax advice to clients and their attorney relative to support
In order to calculate child support and/or alimony, the standard of living experienced by both parties during the marriage must be determined.
Divorce courts will generally consider a number of factors in determining how much child support or alimony that one spouse should pay to the other. Although guidelines may vary from state to state, here are a few factors typically considered in the determination process:
1. Amount of disposable earnings of each spouse
2. Cost of living incurred by each spouse
3. Although not considered in every state, any misconduct uncovered by either spouse
4. How long the couple was married
5. Child care expense responsibility for the lower earning spouse
6. Age, health, and emotional stability of each party
7. The amount of financial contributions each party made during the marriage
8. The distribution of assets; both marital and non-marital resulting from the divorce
Disposable income and living expenses play an important role in determining the amount of funds available for support. For the spouse with the higher income, the amount available to pay alimony and child support is computed as follows:
Disposable Income – Living Expenses
= Amount available for child support
The spouse with the higher earnings will usually pay for all of his/her living expenses before paying for alimony or child support to the former spouse. These expenses include such bare necessities such as food, clothing and shelter. Should there be sufficient earnings, after basic needs are met; additional expenses such as travel and entertainment may be included, assuming this was a part of the couple’s lifestyle during the marriage. It is the general premise of many divorce judges, that the standard of living enjoyed by both parties during the marriage be preserved.
Disposable income is the amount of income left after having to pay living expenses which includes federal, state, and local taxes. In situations where the payer’s income fluctuates, courts have often considered income averaging when determining income for support purposes. This may be the case where a significant amount of the income is derived from self-employment. In addition, other types of disposable income include items such as earnings from 2 marital property, severance pay, retirement benefits, unemployment compensation, and stock options.
Determination of disposable income becomes more complex when one spouse operates a closely held business, subchapter S corporation or a partnership. The following are situations that can impact disposable income as a result of business ownership or partnership interests:
- Suppose a business owner finds it necessary to maintain a sizable amount of cash in the company’s operating account vs. paying wages or dividends to the owners. As a result, income would be reflected on the individual’s tax return with no cash to make the tax payments. This may be considered undistributed income available for support purposes.
- One area I have seen occur quite often is when a business owner uses company funds for non-company purchases and records the transaction as a loan from the company. While this may be an acceptable practice during the year as the ability to determine taxable income may not be available until closer to year-end, the continual advances to shareholders of a closely held business could be construed wages or dividends by a taxing authority. Should this loan continue to be reflected on the company books, it may mask the true amount of funds available for support.
- It is not uncommon for business owners to take distributions throughout the years rather than increase W-2 wages. Although scrutinized by the IRS, such distributions are sometimes possible due to non-cash transactions such as depreciation and Domestic Production Activities Deduction. Generally, distributions to shareholders have no affect on the company’s income. However, they are an indication of availability of cash.
Corporations will often maintain a substantial amount of retained earnings or equity due to continuous business growth. This equity, while not considered income, may warrant the need for business valuation services, which is beyond the scope of this article.
In each of these situations and other complex compensation issues, CPA’s have the ability to provide attorneys with reasonable insight for determining the amount of disposable income available for support.
A clear understanding of the tax code is important in determining the availability of funds for support payments. However, I would caution those privy to financial documents that what might appear on the surface to be a windfall could be a disaster in disguise. For example, the choice to sell the assets of a business vs. its stock could have a significant impact on one’s personal tax liability thanks to the introduction of alternative minimum tax (AMT). Further complications exist when tax attributes such as net operating losses (NOL’s), contribution carry forwards, and stock and loan basis limitations exist.
Our exposure to complex tax and accounting issues relating to individuals and business owners enables us to present you with information that might not otherwise be available. Together we can assist those struggling with the divorce process in determining the fairest solution within a complex environment.
Steven H. Mangan, CPA, is a tax and accounting firm offering professional services to both individuals and businesses. Licensed in 1983, he has helped business owners and individuals comply with today’s ever-changing tax laws, increasing profits, and minimizing taxes. He can be found at: www.shmcpa-mn.com
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