Phone: 412-471-9000

Income Calculations

You are Here: Home » Income Calculations

Basics of Pennsylvania Law: Double Dip, Part IV

by bvertz on Jun 24, 2009 • Comments Closed • , , , , , , ,

This is the fourth in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

McFadden v. McFadden, 563 A.2d 180 (Pa.Super.1989).

            McFadden was a post-divorce alimony modification proceeding.  In this case, the husband’s pension annuity benefit was in pay status, and he was receiving the entire pension benefit. Yet, the court found that the husband’s pension had not been identified as marital property at the time of equitable distribution. Therefore, the Superior Court did not reverse the trial court’s calculation of the husband’s income, which included the pension benefit. Most troubling, in dicta, the Superior Court held (per Popovich, J.): “[I]t is equally clear that income from a pension is to be considered when fashioning an alimony award, even if the pension was previously subjected to equitable distribution. See 23 Pa.S.A. § 501(b)(3), (10), (13); Pacella v. Pacella, 342 Pa.Super. 178, 190, 2492 A.2d 707, 711-712 (1985)(court did not err in consideration earlier equitable distribution property in fashioning alimony); Braderman, 488 A.2d at 620 (pension subject to equitable distribution also may be used to calculate alimony award).”

Divorce Planning: Time to Defer Bonuses?

by bvertz on Jun 11, 2009 • Comments Closed • , , , , , , ,

Columnist Amy Feldman wrote an interesting article in this week’s Business Week entitled, “When to Take the Money.” June 30 is the deadline for executives to decide whether to defer this year’s performance bonuses to qualified plans. Ms. Feldman’s column suggests how to decide.

Take-home Pay Is Not the Measure of Child Support

by bvertz on Jun 8, 2009 • Comments Closed • , , , ,

In Pennsylvania, child support is based on the net incomes of the parents, so it shouldn’t be difficult to figure, right? Um, wrong.  It might seem as simple as looking at a W-2 or pay stub, or perhaps a tax return, to figure each parent’s net income, but child support is not based on take-home pay. The definition of income under the child support law includes more and less than taxable income. Here are some (but not all) of the differences between take-home pay and net income:

1. 401(k) contributions – On a pay stub, 401(k) contributions are deductions that reduce an employee’s net income. In divorce court, however, 401(k) contributions are added back to a parent’s income in most instances. In fact, if an employer makes unmatched contributions to the parent’s 401(k) plan, those contributions might be added to the parent’s income even though it is not take-home pay.

2. Disability insurance, life insurance, savings bonds – Some employees elect to pay for group disability or life insurance policies through pretax deductions, or defer part of their income into savings bonds and credit unions. These elections reduce their take-home pay, but the divorce court generally adds it back to net income.

3. Restricted stock – When restricted stock vests, it is generally reported as income on a pay stub or W-2. If the restricted stock was issued prior to separation, however, it might be marital property. The restricted stock can be considered as income for support purposes, or property for equitable distribution purposes, but not both. Therefore, restricted stock is excluded from net income in some cases.

4. Pass-through income – An owner of a business organized as a partnership or  Subchapter “S” corporation receives an annual K-1 form which reports his or her share of the business income. In reality, the business might not distribute the partner’s entire share of profits. Some businesses distribute just enough to enable the partner to pay his or her taxes. In divorce court, the retained earnings of a business may be excluded from the owner’s income if they were not actually distributed and the owner does not own a controlling interest.

Double Dipping … again

by bvertz on Jan 18, 2009 • Comments Closed • ,

At the Pennsylvania Bar Association Family Law Section Winter Meeting 2009, which took place at the William Penn Hotel in Pittsburgh this weekend, a panel of judges, lawyers and CPAs discussed hot topics in family law and business valuation. One of the hot topics, presented by Pittsburgh valuation professional Richard F. Brabender, was double dipping. Specifically, this seminar discussed the theoretical/academic argument (which I have advocated in this blog) that a double dip exists where capitalized income which has been divided between the spouses as marital property is also counted as income for child support or alimony purposes.

Clearly, if there is a pension in pay status which is valued on the date of trial, and the pension annuity benefit is counted as income for calculating post-divorce alimony, the court has divided the same stream of income twice – a “double dip.” This same problem exists where business profits have been capitalized as part of the valuation process and also included in the business owner’s net income for child support and alimony purposes.

The twist that Dick Brabender brought to light in his presentation was the double dip that may occur during the separation, where the owner’s compensation substantially exceeds a market salary. For instance, if a business owner is drawing $500,000 per year from the business, but could hired a newly-minted MBA (because we all know how they can improve any business) to do the owner’s job for $70,000 a year, then the owner is receiving excessive compensation of $430,000 per year. Why shouldn’t the business owner’s spouse get 50% of the excess compensation during the separation period as an advance against his or her share of the marital property (assuming the business is entirely marital), subject to re-allocation at the time of trial? (The excess compensation would then be excluded from both spouses’ incomes for support purposes.) This is the likely result if there were a marital pension in pay status, which could be divided 50/50 during the pendency of litigation as an advance of marital property.

In order to accomplish this interim division of the business income stream, the court would have to conduct a hearing to determine that the owner’s compensation were excessive, something the court is unlikely to decide in motions court. Moreover, the excess compensation hearing would have to occur prior to the support or maintenance hearing so that there were no inconsistencies between the support order and the property advance. One of the panelists, eastern Pennsylvania lawyer Mark Ashton, suggested that the court would also have to look at whether the rents being paid by the business to the owner were consistent with market levels, whether the owner were working more than 40 hours a week, etc. Suddenly a simple hearing to determine a property advance has become a multi-day trial with multiple expert witnesses!

Another panelist, Jay Blechman, suggested an alternative: a lookback at the time of the final property division trial. In other words, if it were proven at the end of the case that the owner’s compensation during the pendency of litigation was above-market, then the court could re-designate the excessive income as marital property and award an incremental amount to the owner’s spouse. In Pennsylvania, a business owner’s spouse without children would receive 40% of the income stream as support or maintenance, but if the excess compensation were marital property, the spouse might 50%, 55% or more. So, Jay Blechman suggested that the business owner’s spouse could get 40% during the pendency of the case, and an additional 10%, 15% or more of the excessive compensation at the end of the case.

No case law supports this idea yet.

No Silver Lining for Divorcing Spouse

by bvertz on Oct 28, 2007 • Comments Closed •

In Silver v. Silver, a 2007 decision of the Ohio Court of Appeals, Second Division, the court discussed a business owner’s income for support purposes in conjunction with a business valuation for equitable distribution purposes. The husband was the sole shareholder of a marketing business, which was marital property subject to equitable distribution. Both spouses offered expert reports and testimony as to income and business valuation. While husband’s expert averaged his net income over a period of three years, wife’s expert used his most recent year’s net income, which was greater than the average of the prior three years. The appellate court endorsed the trial court’s finding on this issue, noting that income had been growing constantly throughout the period. Since husband was a sole shareholder but failed to present evidence of capital expenditures, the trial court declined his request to reduce income for capital needs.

This case is consistent with decisions of the Pennsylvania appellate courts, which have held that retained earnings and undistributed income of a business controlled or owned solely by a spouse will be presumed to be income for support purposes unless there is strong evidence of a need for capital expenditures. On the other hand, if the business owner is a minority shareholder, lacking the ability to manipulate income and expenditures, the burden shifts to the non-owner spouse to show that the retention of earnings is not justified.

Depreciation Not Always an “Addback” in Child Support Calculations

by bvertz on Nov 2, 2006 • Comments Closed •

The National Litigation Consultants’ Review this month contains a terrific article about depreciation addbacks in the context of income calculations for child support. Since the goal of a child support calculation is to allocate available cash flow (rather than taxable income) between the child’s parents, business depreciation expenses are usually added back to the net income. Depreciation expense is also added back when normalization is performed on the income statement of a company in a business valuation. In both instances, depreciation is regarded as a non-cash expense.

This article reminds us that depreciation is nothing more than a method of allocating the cost of capital assets over a number of years. Depreciation often reflects an underlying expense that really does affect cash flow, but recurs less frequently than every year. We should not blindly add back depreciation if there is an underlying capital expense that can be expected to recur in the future. At the same time, we must avoid “double counting” by deducting depreciation annually and capital expenses as they are incurred.

Perhaps one of the reasons why this principle is overlooked, the article suggests, is the implementation in 1986 of the MACRS depreciation method under the Internal Revenue Code. This method represented a shift from “estimated useful life” to “cost recovery.” The MACRS depreciation method allowed businesses to write off capital expenditures more rapidly than the useful life of the capital assets.

An even more rapid method of depreciation is the “Section 179″ expense, which allows a business to write off a capital expense (up to $108,000 in 2006) immediately if the company does not exceed a limit (currently $430,000) of capital acquisitions in a single year.

Consider the difference between two examples of capital assets: real estate and automobiles. Automobiles wear out over time, usually cannot be resold for their purchase price, and must be replaced eventually. Real estate, on the other hand, does not wear out, usually increases in value over time, and need not be replaced. Depreciation expense related to automobiles probably should not be added back in child support calculations, but depreciation expense related to real estate probably should.

In Pennsylvania, we have the Labar case to guide our courts. In Labar, the Pennsylvania Supreme Court held that depreciatino should be added back to the business owner’s income if (1) the income tax savings created by depreciation deductions was distributed to the business owner and not reinvested in the business, or (2) the underlying capital outlays (such as inventory build-ups) were unnecessary or represented an attempt to shelter income from child support obligations. Absent specific evidence of intent to shelter income, it must be presumed that business expenditures were legitimate and necessary.

The National Litigation Consultants Review is available to business valuation experts who subscribe to KeyValueData and through the Litigation Consultants LLC’s website.