Family Law Economics, Child Support, and Alimony: Ruminations on Income, Part I

My economics of the family course covers the money and property aspects of family law, like who gets what and why. It’s really similar to tax law, because both deal with money and assets, and how to keep more of them. Just like tax lawyers and accountants try to minimize income and assets to save their clients money on taxes, family law practitioners try to minimize what is reported so that their clients can keep more of their income and assets in a divorce. This is like a “family tax” where an ex-spouse gets a share of income and assets that can be even more than what the government takes in taxes. So, the strategies for tax planning can also be used in family law to help with alimony, child support, and dividing property. Just like the IRS looks out for income and asset planning, spouses in a divorce can also use strategies to get more for themselves. It’s like a game, and understanding this can help explain how people behave in a divorce. This article talks about how “income” is important for child support and alimony. For child support, factors like expenses and special needs are also important. For alimony, “income” is a major factor, but other things are important too. The law defines “gross income” for child support, but not for alimony. This could cause confusion. The law also doesn’t say which accounting method to use, which could be used to manipulate income. Overall, the law is unclear and could lead to unfair results. For the purpose of family law, the way income is calculated can be tricky. For example, if someone is paid in advance for work they will do over several years, should that money be considered income immediately, or spread out over the years the work will be done? The way income is calculated can have an impact on things like child support and alimony. There isn’t a perfect solution to this problem, but it’s important to try to be fair and not allow for manipulation of income for personal gain. Bonuses, commissions, allowances, overtime, tips, and similar payments count as income when they are received, not when they are earned. This could potentially be manipulated by someone trying to hide income. Additionally, the financial affidavit for family law cases is confusing because it includes items like accrued vacation pay and bonuses as possible assets, even though they are actually assets and not just potential ones. Deferred bonuses should be listed as assets, not income, on financial affidavits for child support or alimony purposes. This is because assets are only considered for a small deviation from the guideline amount, while income has a bigger impact. When it comes to business income, the guidelines are unclear about what expenses can be deducted, and they don’t specify which accounting method to use, which can make it confusing for experts to calculate income. The list of income sources is confusing and redundant. It’s not clear what “close corporations” are supposed to include. Also, including retained earnings as income for closely held corporations is troubling because the owner may not have control over distributions. A better way to organize this category would be to include different types of business structures and avoid creating incentives for manipulation. For example, sole proprietorships are not separate entities, so it’s harder to manipulate income and expenses. But there’s still a loophole for income to “disappear” through deductions, so it’s important to carefully analyze each deduction. In tax law, “ordinary and necessary expenses” are costs that are required to make money. “Ordinary” means typical and “necessary” means essential for the business to operate. This includes things like pencils and paper, but not big purchases like desks and tables. However, for tax purposes, big expenses can still be deducted. For example, businesses can deduct the cost of certain assets like property and equipment. This can lower their taxes and encourage them to invest and hire more people. The rules for deducting these expenses can also affect decisions businesses make. Spouses seeking family support have to prove that certain expenses are necessary for their family, even if they are not needed to make money. This can be tricky because it requires understanding tax terms. Sometimes, one spouse may try to lower their income to avoid paying family support, especially if the other spouse doesn’t know about it. A person is trying to manipulate their income and assets to lower their taxes and reduce the amount of money they have to pay to support their family in a divorce. They may use tactics like claiming renovation expenses and deferring income to make it look like they have less money than they really do. This can make it difficult for the other spouse to get the money they are entitled to in a divorce. It’s a tricky situation, and the other spouse may need a special type of accountant to help them figure it out. Some lawyers may not know enough about these tactics to help their client, so it’s important to find a lawyer who understands these issues and can fight for a fair outcome. C corporations are businesses that pay taxes on their income. They used to be taxed at a high rate, but a reduction in the dividend tax rate has made them more appealing. S corporations are another option and are taxed at a lower rate, but their earnings are considered income for family law purposes. This means that for family law, S corporations could end up being taxed more. So, C corporations are not as heavily taxed as they used to be, especially when considering family law consequences. Partnerships, LLCs, and joint ventures are treated as pass-through entities for taxes, meaning they don’t pay taxes themselves. Instead, the partners or members pay taxes on their share of the income. However, this can create issues in family law cases, as the reported taxable income may not accurately reflect the actual available income for support. This can be unfair for the partner or member who may have no control over the timing of distributions of income. Despite this, most authorities would consider the reported taxable income as the correct amount for family law purposes. Partnerships and trusts can complicate income allocation for tax and family law purposes. Special allocations in partnerships can distort a partner’s reported income, and trust income must be distributed to beneficiaries, even if the trust doesn’t have enough money to do so. This can affect how income is calculated for child support and alimony. It’s a complex issue that can be difficult to address for both the IRS and family law practitioners. Complex trusts are similar to C corporations in that they are not pass-through entities and are taxed as separate entities. This means that the income accumulated in a complex trust is not taxed to the beneficiaries and does not appear on their tax returns. However, for child support purposes, it is unclear whether this accumulated income should be considered as income.

In terms of accrual accounting, the trust has an obligation to the beneficiary and the accumulated income does increase the beneficiary’s wealth, even though it may not be readily available as cash. This is different from how retained earnings in a C corporation are treated.

Money is fungible, so even nonliquid wealth can free up other liquid assets. Therefore, it could be argued that accumulated income in a complex trust should be considered as income for family law purposes. However, for alimony purposes, the analysis is different, as the accumulated income is not available to the beneficiary spouse.

Ultimately, what appears on the spouse/beneficiary’s tax returns will likely be the basis for determining income for child support or alimony purposes. If a spouse has income from a trust, they may have to include it in their financial assets when calculating child support or alimony. But when the income is actually distributed and becomes taxable, they may have to include it again, leading to paying more child support or alimony. This is especially common with estates, which are a type of trust. A spouse may be able to control when they receive money from an estate, even if they’re not the one in charge of it. If a spouse has money in other countries, it can make things complicated when it comes to accounting during a divorce. Different countries have different tax rules and accounting principles, which can make it hard to figure out what counts as income. This can lead to confusion and manipulation, especially if there are a lot of foreign investments. In divorce cases, the court only looks at the current year’s income and assets, but they can also consider past years if they want to. Any money that was earned or saved during the marriage is considered a marital asset and may be divided between the spouses.

Source: https://www.floridabar.org/the-florida-bar-journal/family-law-economics-child-support-and-alimony-ruminations-on-income-part-i/