A complex child support proceeding may involve disputes over the parents’ net incomes or earning capacity, the child’s special needs, or other issues. In Pennsylvania, the key to calculating child support is the net income or earning capacity of the parents, with a secondary focus on the financial needs of the child. Determining net income can become complex when a parent derives income from bonuses, commissions draws, business distributions, or incentive compensation, such as restricted stock, RSUs, options, stock appreciation rights, and deferred compensation. Under some circumstances, the courts may consider the retained earnings of a business (undistributed profits), perquisites, investment income and capital gains.
In Pennsylvania, the child support guidelines determine the amount of basic support, which is enhanced with additional support for medical insurance and expenses, child care, private school tuition, summer camp, and extracurricular activities. In some cases, a budget analysis can expand or control the amount of child support to be paid, but only after the guidelines have been applied. The Pennsylvania child support guidelines are based on net income after deducting federal, state, local and payroll taxes and union dues. Net income is not the same as take-home pay.
Determining net income after taxes is one of the topics covered by Frumkes & Vertz on Divorce Taxation, the leading treatise on family law tax issues. Net income may be affected by the filing status of each parent, the allocation of tax deductions and credits, the treatment of income-generating assets (like rental property and family businesses), and constant changes in tax law. Divorce Taxation is updated annually to keep pace with the latest tax law developments affecting child support calculations.
High-income and complex child support cases may be different from routine cases that are governed by support guidelines. Net income is the foundation, under the guidelines formula, for determining child support, spousal support and alimony pendente lite, as well as a factor in dividing marital property. Not only must family law practitioners and their experts be capable of accurately calculating a parent’s net income, but also we must learn to detect income and property by closing examining tax returns and related financial documents.
Net income is also a natural starting point for post-divorce alimony determinations, as most states consider the net income available to the payor, as well as the needs of the recipient. When determining net income for high-income child support purposes, there are several important principles to keep in mind:
- Business Expenses. Parents who are business owners or professionals are likely to incur expenses to operate their business or practice. Business expenses might appear on a separate business tax return, or on Schedule C or E of the personal tax return, or even as unreimbursed employee expenses. Take the example of an independent insurance agent, who receives commission income. An agent might have to pay salary to the staff, office rent, advertising costs, and meals and entertainment. If those expenses are legitimately incurred to operate the business, they must be deducted from commissions before net income is calculated.
- Perquisites. On the other hand, many business owners and professionals pay personal expenses from their companies. It is not illegal to pay personal expenses from a business account, so long as the payment is reported as a wage or distribution to the owner. For instance, if the business pays car insurance for the owner’s personal vehicle, it is not a business expense. It should be included in the owner’s W-2 income, as a K-1 distribution, or as a dividend paid by the company. Divorcing business owners must keep scrupulous records of personal expenses that are paid from the business.
- Pass-Through Income. Many businesses, such as limited liability companies (or LLCs) and S corporations, are treated like partnerships for tax purposes. They do not pay corporate taxes like C corporations. Instead, their taxable income is reported on the individual income tax returns of the owners, who pay the tax, whether or not they actually receive their share of the profits. The owner’s share of a company’s taxable income is called “pass-through” income. The amount of profit that is actually paid to a business owner is a distribution. Both of these amounts are reported, generally, on the IRS Form K-1 that is issued to each owner. Frequently, distributions do not match pass-through income.
In high-income or complex child support cases, a dispute may arise from the discrepancy between pass-through income versus distributions to the owner. A business owner might have to prove that the company needed to retain earnings for business reasons, or that the company did not have the financial capacity to pay distributions. This issue may require expert testimony from a forensic accountant. And the owner must consider the trade-off between paying support on business distributions versus building the value of a business that retains its earnings.
To arrive at a fair child support resolution, you need a legal team who can uncover income sources, accurately calculate net income, and ensure that the one-size-fits-all guidelines are tailored to the specific needs of the family. At Pollock Begg, our attorneys have achieved countless successful outcomes, even when net income was difficult to prove. Brian Vertz has earned statewide recognition as an authority on child support. For prompt, effective help with your child support case in Western Pennsylvania, call Brian Vertz at (412) 471-9000 or use our contact form.