The Great Treasure Hunt: Hidden Income

Child support and alimony cases are based on the incomes of the parties so it is important to leave no stone unturned, even if one of you has no income. North Carolina law usually counts all kinds of compensation as income, although there are some exceptions.

What Are We Looking For?

Income is not defined by salary alone. Especially with large employers or self-employed individuals, there are “hidden” forms of compensation. There are two basic kinds of income in family law. Earned income is based on employment (salaries, wages, commissions, bonuses, dividends, severance pay, etc.) and unearned income includes everything else. Examples of unearned income include ownership or operation of a business, rents received from rental property, retirement or pensions, interest, trusts, annuities, capital gains, certain Social Security benefits, worker’s compensation benefits, unemployment insurance benefits, disability pay and insurance benefits, gifts, prizes and alimony or maintenance received from persons other than the parties to the instant action (from the NC Child Support Guidelines).

The Evidence: Tax Records

Courts first look at tax returns, which hold important clues about income. Most people know the W-2 statements include wages, tips and compensation as shown in box 1, which are taxed. But not everyone realizes box 3 of a W-2 statement reflects the social security wages, including income that isn’t taxed. If the amount of social security wages is larger, it should be used. Why? Because the larger amount includes tax deferred benefits. The most common example is an employee’s choice to make contributions to a 401(k) plan. Otherwise, several thousand dollars of income is easily missed. If someone has a 1099 tax statement, it means there is “miscellaneous income” such as money paid to that person for services as an independent contractor. A 1099-R statement is issued when a person collects retirement from pensions, annuities, retirement or profit-sharing plans, IRAs, insurance contracts, etc. Social security is shown on a SSA-1099 tax statement, which might be missed because sometimes it is taxed, and sometimes not. All of these tax statements, not just the tax returns themselves, indicate income for purposes of child support or alimony.

The Evidence: Pay Statements

While tax returns and tax statements give us a good starting point, they don’t tell the whole story. Certain benefits are disguised because they are voluntarily payroll “deducted” from someone’s pay. However, many of those deductions represent compensation the employee chooses to divert, so they are really income. This is because they are tax-free, tax-exempt or pre-tax benefits, so they won’t appear on the W-2 statement at all. One common example of a pre-tax payroll-deducted benefit is an employee’s payment for health, vision, and/or dental insurance. Those payments are made by the employee from his or her pay but because they are not taxed, they generally won’t be included on the W-2. Tax-exempt benefits include military disability payments and most military allowances, such as BAH and BAS, which usually aren’t even shown on the tax return. This is why it is a good idea to get the final pay statement or other statement that shows all compensation, taxed or not taxed, as of December 31st.

The Evidence: Self-Employment Business Expenses

The scope of this subject is too broad for this article but the general overview involves income disguised as business expenses. If these appear on the tax returns, most of the time they won’t be detailed enough to properly identify them without further investigation. Loans from the business to the business owner can be big-ticket forms of income even though they appear to be debts. Other “business expenses” include fringe benefits like free housing and company-payment of cell phones, health insurance, or credit cards. Some companies pay not only vehicle payments but gas and insurance. Typical travel expenses (or reimbursement of expenses) such as lodging, mileage and food also frequently masquerade as business expenses. While these expenses may be perfectly legitimate for IRS purposes, judges in family court will usually include them as income to the extent it is appropriate under the circumstances. The NC Child Support Guidelines count these benefits as income to the business owner by the company are considered income if they are significant and reduce personal living expenses.

Getting Attorney’s Fees in Family Law Cases

In North Carolina family law cases, a party may seek attorney’s fees in court cases involving child custody and support, and for temporary and permanent alimony, among other claims. With a couple of rare and unique exceptions to the rule, attorney’s fees aren’t usually available to be awarded by the court in equitable distribution cases for division of marital assets and debts.

Child Custody and Support Claims

The law permits parents to ask the court to award attorney’s fees in child custody and support cases, including cases when a parent files a motion to modify the order that is already in place. There are three requirements. First, the person asking for fees must be an “interested party” meaning he or she is someone entitled to exercise the legal right to participate in the lawsuit. Second, the person must be acting in good faith, not filing a frivolous claim. The third requirement for the court to address is whether the person “has insufficient means to defray the expense of the suit.” In other words, the person had to turn to the courts to get help, which has created a financial hardship.  If the claim was for child support there is a fourth requirement. The parent who should be paying support “has refused to provide support which is adequate under the circumstances.” If the parent files a frivolous claim, the court is also entitled to award fees to the other parent. NC Gen. Stat. §50-13.5

Alimony and Temporary Alimony

If the court awards alimony or temporary alimony, called postseparation support, the judge has the authority to award attorney’s fees if the financially dependent spouse doesn’t have sufficient means to subsist during the pending case. That means the dependent spouse can’t meet living expenses until the judge enters an order for alimony. As is the case with children’s claims, the court must rule on whether the dependent spouse “has insufficient means to defray the expense of the suit.” These requirements also apply when the dependent spouse files a motion to modify the alimony. NC Gen. Stat. §50-16.4. At the trial, the attorney submits an affidavit about the fees, along with billing statements to show what has been paid. The judge generally confirms the fee is reasonable, considering the attorney’s skills and qualifications, and the type of work the attorney performed. Customarily, the client has to pay the attorney at the beginning of the case. If the fees are awarded, they are either reimbursed to the client or applied to any outstanding balance the client owes to the attorney. As is the case in so many family law cases in North Carolina, the judge has broad discretion when ruling on fees. A judge is free to order some, none or part of the fees requested.

Can I Give Up My Rights as a Parent?

Especially when child support is pending, some people mistakenly think they can avoid paying support, or avoid the other parent seeking visitation, if one parent surrenders parental rights. Because parents have legal duties to their children, and because various rights as next of kin flow from parents, there are very few occasions when “giving up” parental rights is legally possible. Courts are extremely hesitant to legally erase a parent from a child’s life unless there is another adult stepping up to legally assume that role. Making sure the parent is in fact the parent (maternity and/or paternity and/or legitimation) is a legal determination, and this article assumes these designations have been made.

Duties and Rights of Parents

Parents naturally have constitutionally protected rights to the care and custody of their children. So long as they meet their basic responsibilities as parents, the state has little say about their parenting so long as the children are adequately cared for and safe. Parents have a legal obligation to support children or pay child support but there are other legal benefits to which children are entitled. Children, both natural and adopted, have rights such as social security death benefits, military benefits rights, and legal claims for wrongful death of parents in appropriate cases, and inheritance rights, to name a few. Children have legal benefits from a parent even if that parent fails to pay child support or is a parent in name only.

How Are Rights Given Up?

Choosing not to pursue visitation with your child is quite different from surrendering your legal rights as a parent.  One example of surrendering parental rights is found in North Carolina’s safe surrender laws, for infants seven days old or younger. Parents who would otherwise abandon an infant are given legal protection from criminal prosecution if they leave the infant with an appropriate agency or individual, such as a social worker, law enforcement officer, or an emergency medical service worker. NC Gen. Stat. 7B-500 et seq.

A parent can give legal consent to allow the NC Department of Social Services (DSS) to facilitate an adoption by a step-parent if the other parent has remarried and he or she desires to adopt, or adoption by a third-party. The state then assigns new parents who legally assume the rights and duties of parents. If only one parent consents to an adoption, it becomes a complicated legal matter beyond the scope of this article.

When a parent is unable or unwilling to appropriately parent a child, DSS will independently initiate legal proceedings to protect a child. When DSS becomes the legal custodian of a child, parents are typically given access to resources to assist them, such as substance abuse treatment. If the assistance is not accepted or the parents cannot or will not parent the child, the state (or a third-party) may initiate legal action called “termination of parental rights.” If the parental rights are terminated, DSS will often clear the child for adoption.

Taking Care of Business: Child Support When a Parent is Self-Employed or Owns a Business

Our state’s child support guidelines calculate child support obligations based on gross incomes of parents, any work-related childcare, health insurance and several other factors. When a parent has a salary and W-2 statement, it is usually easier to determine that parent’s gross income. A parent who is self-employed and/or owns a business has at least some control over his or her gross income. For this article, assume a self-employed person is the same as a business owner with 100% ownership.

NC guidelines define gross income for a self-employed parent as “gross receipts [of the business] minus ordinary and necessary expenses required for self-employment or business operation.” That means the court would calculate a disputed income by first looking at the total income generated by the business, then subtracting the business expenses. Business expenses claimed on tax returns may be perfectly acceptable to the IRS, but the court may or may not deduct them when determining income for child support. That is the tricky part.

But there are a few things that are clearly not subtracted from gross receipts, such as the accelerated component of depreciation expenses. The court considers each of the claimed business expenses and decides which will or will not be subtracted from the gross receipts generated by the business. Fringe benefits paid for by the business “are counted as income if they are significant and reduce personal living expenses.” Examples of these types of expenses that are considered income to the parent who is self-employed include use of a company car or free housing.