Whether it be part of divorce proceedings or in determining child support between unmarried parents, the amount of alimony or child support payments depends, in large part, on the parties’ respective incomes. When both parties receive straight W2 wages, the determination is quite simple, as the parties’ end of year W2 and/or periodic paystubs provide sufficient information to glean one’s true earnings, taking into account deductions for insurance or retirement accounts, etc. While the calculus becomes slightly more problematic when an individual receives yearly bonuses and/or commissions, so long as these payments are parsed out and individually analyzed, likely via three or five year averages, they do not present much trouble, especially because these earnings will be clearly set forth in the individual’s income documentation. However, when an individual either owns their own business or receives additional benefits in the form of reimbursements or expense accounts, it becomes paramount that the individual’s income is “normalized” in order to ensure that their true earnings are captured in setting support awards.
“Normalized Income” is an accounting term which has a specific definition as it pertains to valuing a company and its true net income. Within the context of family law, however, normalizing a parties’ income is congruous with the concept of engaging in a Cash Flow Analysis or in “adding back” expenses paid on an individual’s behalf, wherein the objective is to determine the true earnings of a party by clearly defining their compensation beyond the actual funds received by way of their paycheck. While a forensic accountant is often used to engage in this sort of analysis, it is important for litigants to understand the need and mechanisms behind such an analysis.
The most common scenario wherein an individual’s income needs to be normalized is when they are the owner of a business. However, in any situation where an individual receives reimbursements for certain expenses or has some form of an expense account, normalization of income is necessary. The key is to initially identify what common expenses should be accounted for, as true business expenses are not appropriate add backs to an individual’s income. For example, if an individual is required to travel for business, the payment of the cost of a flight or car service would not be an appropriate expense to add back as additional income because it is solely a business expense, whereas a food allowance would be a legitimate expense to add back as it is understood that the individual would have expended funds on food regardless of whether they were travelling and the reimbursement is, therefore, an added benefit which creates additional income, even if it is by way of a reduction in actual expenses.
The typical expenses that must be added back to an individual’s income vary depending upon the nature of employment (i.e. self-employed vs. W2 wage earner) and the extent of the additional benefits. In its simplest form, normalizing income would include adding back employer or business paid expenses for car payments, cell phones, gas, insurance, etc. In essence, any expense which one would typically expect a normal W2 wage earning family to incur which is instead paid by an employer or by a business must be added back to an individual’s earnings to determine their true income. The rationale behind this process is that the benefits paid on the individual’s behalf resulted in decreased expenses and were a part of the parties’ lifestyle. This is especially important where the individual owns a business as paying the expenses, as opposed to making higher income payments, can be used to manipulate the individual’s true earnings, even if the decision to do so is born out of proper tax planning and not for some nefarious purpose.
Because the wide array of scenarios wherein normalizing an individual’s income cannot be fully reviewed in an article of this nature, it is imperative that an individual involved in support proceedings, through a divorce or otherwise, consults with an experienced family law attorney to ensure that their interests are being fully protected and that the other party’s income is being fully considered.
Contact a Miller & Gaudio Divorce Attorney Today to discuss your rights and obligations for receiving or paying support.