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.

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