August 31, 2016
If a court needs to determine the income available for support, hereinafter referred to as IAFS, of a parent with a fixed salary or hourly wage from an employer, the calculation is relatively simple and the subsequent formula straightforward. However, if a party is self-employed and/or the owner of a business, manipulation of IAFS through various accounting maneuvers can drastically alter the dollar amount the court considers when setting child support and/or alimony. Discussed below are some of the methods used to create a more favorable IAFS number for the self-employed party that a family law practitioner should be aware of when negotiating over a child support amount and/or alimony, or when presenting a case to a court for a determination on the amount of child support and/or alimony.
Without too much discussion of basic accounting, the income of a business should be based on the income accrued during a certain time period. Expenses and expenditures can alter the bottom line, but the income itself does not actually vary based on those decisions; therefore, in theory a court should determine IAFS based on the accrued income of the business. While it is true that many annual or monthly expenses of a business are wholly legitimate, many one-time or less than annual expenses can be reflected on a particular year’s balance sheet in a manner that is favorable to that party.
One basic form of manipulation is the acceleration of certain expenditures in the effort to make a balance sheet look weaker for IAFS purposes. A party with a wholly owned business can easily pay off a loan faster, make a capital improvement, or purchase new equipment in a given year all in the effort to demonstrate that he/she has much less income that the court may consider when setting or modifying support. Some other practices, for a party that is willingly and intentionally making an effort to improperly reflect IAFS is to buy excessive inventory for their business, loan money to a third party or prepay or accelerate payments to their vendors, or simply build up large cash reserves on their books, all in order to make the balance sheet reflect far less income than what has been accrued.
In order to represent your client effectively in the circumstance where the client would be receiving support, a family law practitioner must be prepared to argue and defeat this accounting technique so your client can get the support to which he/she is entitled. The global way to combat this practice as a family law practitioner is to ask the court to focus on the income from the perspective of recurring annual revenue, not from a single year’s skewed results as provided by the opposing party. If the court reviews the level of income based on several years of IAFS and determines that the income for the year that the divorce or modification was filed is not an accurate picture of the IAFS that a party typically has, then the court can decide that other years, taken in combination, are more reflective of anticipated income than the individual year when the action was filed.
On a more micro level, in order to represent your client effectively, you should point out to the court the nature of various expenditures and expenses that may be on a given year’s balance sheet and explain why those transactions would not take place on a recurring basis but were merely one-time and convenient payouts from by the opposing party. Opposing counsel will most likely argue that any and all such expenditures are legitimate business expenses and that the timing is coincidental to the pending litigation. However, a poignant way to present your side of this argument is to flip the situation on its head. If a party is holding large cash reserves one year in order to lower IAFS, then the following year, if the reserves are released then the balance ought to reflect cash flow to the party greater than the income for that given year because of the built-up, unnecessary reserves. Pose the question to the court, Would it be fair to assess IAFS based on an overstatement of cash flow in that second year? Then it would be equally unfair to assess IAFS based on the first year when the reserves were held, or the loan was prepaid, or the excessive inventory was purchased, whatever the non-recurring expenditure happened to be. This argument is effective even in the absence of any intentional manipulation by the opposing party since opposing counsel would most certainly object if IAFS was assessed based on income in a given year from a loan repayment or the sale of equipment.
In order to present this to the court in an effective and coherent manner, demonstrating industry norms as well as historical spending and income trends for the type of business in question may be necessary. In addition to the expertise of a forensic accountant who can make the necessary adjustments to the income calculations, employing an expert in the given industry may be necessary for both the court and the party seeking support to be educated properly in how that business operates, what expenditures are routine and necessary, and other particulars that explain the information on the balance sheet. Not only would an industry expert help to educate the court about these nuances, but they can be used to rebut the arguments of opposing counsel as to why potential negative trends in an industry will impact IAFS going forward and that it is unfair to take the present income as the norm for the future.
When considering how to prove your case in court, insisting on the most current and continuing discovery regarding the financials of the business is a necessity particularly since manipulation can take place in a short period of time. For the party who is unintentionally affecting IAFS, but more particularly for the party who is intentionally manipulating IAFS, the most current financials are required to get an accurate picture of what is truly going on with the business in question.
Though it is not the subject of this article, it should be noted that all of the tactics discussed above as well as others that are more complex and not covered can also be used by a party when attempting to reduce the valuation of his/her business before and during a divorce. The family law practitioner should be aware that the same manipulation and more can be employed when a party seeks to show that their company is really worth less during a division of the marital assets.
When dealing in cases where there are high-value assets held in the form of a closely held company, the expenses for effectively pursuing a true and accurate number for IAFS can be high, but the rewards can also be great. The information presented by the opposing party as to value and the legitimacy of the transactions on their balance sheet requires close scrutiny and should not necessarily be accepted at face value. Close evaluation of this information with the assistance of qualified professionals will reap significant benefits for your client when determining IAFS.
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