In many divorce cases, it is easy to determine income and identify assets and liabilities. In a run-of-the-mill case, income includes W-2 wages of the spouses and a few small items such as interest income and dividends. Assets and liabilities are obvious, as they often include houses, automobiles, and a bank account or two.
In other divorce cases, it is much more complicated. Divorces involving self-employed individuals, rental properties, income-producing assets, or high-level executives with special perks and benefits are more difficult to evaluate. These are the cases in which more documentation must be evaluated, including the laundry list of documents in Appendix B and possibly other documents depending on the unique factors in the family law case.
How does the financial expert evaluate the data and documents received during the discovery portion of a family law case? In general, the following procedures should be performed:
- Complete a document inventory (discussed in Chapter 5).
- Get a general overview of the case by reading the pleadings and answers to interrogatories. Discuss with the client the high points of the financial portion of the case to get an understanding of the potential issues.
- Perform a high-level review of the financial documents. This may include a brief analysis of income tax returns and financial statements to become familiar with the financial situation. It may also include searching for red flags that could point to fraud or the need for a lifestyle analysis.
- Analyze historical income, looking for changes and trends in the income and identifying explanations for them.
- Determine if an analysis of expenditures is necessary to the case. This may be necessary to prepare a budget, evaluate the need for support, or quantify the lifestyle of the parties before or after separation.
- Evaluate income and/or expenses using the procedures detailed throughout the rest of this book.
When attempting to calculate the income of the spouse or spouses, it is important to remember that income is not determined simply on the basis of historical earnings. It is necessary to also consider the future prospects for income and how the income scenario may change after the divorce. For example, one of the spouses may encounter a job change with a related change in earnings. Even if a change is not a result of a divorce, it still must be considered, as changes in earnings may change a spouse’s ability to pay support.
In evaluating historical income, it is necessary to consider whether historical income was abnormally high or low for some reason. For example, suppose a business run by the spouse had lower net income in the past because there was a substantial investment to increase the capacity of the business. The investment included operating expenses and depreciation of fixed assets, which lowered historical earnings but created an opportunity for the company to generate higher income in the future. Thus, the projection of future earnings must not rely solely on the historical earnings but must consider the future prospects for income.
Of course, it is also important to consider whether one or both of the spouses has intentionally manipulated or decreased income in anticipation of divorce. This is not the same thing as hiding income or assets. Instead, this refers to the manipulation of a known income stream. For example, a law firm partner may temporarily, purposely decrease his salary to manipulate his income for support calculations. The intention would likely be to restore the salary sometime after the family law case concludes. A salesperson may ask the employer to temporarily suspend commission payouts. A manager may ask to have a bonus delayed until after the divorce is over.
Also included in this chapter:
The Lifestyle Analysis
Specific Items Method
Bank Deposits Method
Net Worth Method
Lifestyle Analysis Software