Very often, we are confronted with situations where on spouse is self employed and the business pays certain personal expenses on behalf of one or both of the parties. Often times, these expenses are wholly appropriate and would withstand IRS scrutiny. Other times, there are excess perks or other personal expenses paid through the business that have no business purpose. The practical effect is that these expenses are deducted as business expenses, and essentially taken as tax free income. For purposes of the determination of the proper income to use for support purposes, as well as for business valuation calculations, these expenses are added back to income. While obviously inappropriate, some times we even encounter unreported income which also has to be added back for support and valuation purposes.
A bigger question/debate is once added back, should taxes being considered? Put another way, if the person was not paying taxes on this aspect of his/her income. should the income be reduced by taxes or should it be grossed up. As an example, a person whose W-2 income is $300,000 per year, has far less spending power then someone who earns $300,000 but only pays taxes on $200,000 because of appropriately deducting an expense that is part personal and part business and/or inappropriately taking excess business deductions for personal expenses paid through the business. To exemplify this point, I have often asked the forensic accountant at a deposition or trial, "What would a taxpaying W-2 wage earner have to earn to have the same spending power (net after tax income), as this person?"
This issue seemingly came up in an unreported (non-precedential) decision in the matter of Tuman v. Tuman released January 11, 2011. In that case, the ex-husband’s forensic accountant, during cross examination, was challenged on the methodology used by the accountant. Utilizing the figures contained
on defendant’s Case Information Statement (CIS), counsel elicited an estimate of defendant’s 2008 income based upon defendant’s CIS when considered with the business records. The questioning was as follows:
Q: . . . If there was an after tax expense of approximately $105,000 and a working
person had to pay taxes above that in order to afford to pay that expense, approximately
how much would have to be added to it to pay the expenses plus those categories of taxes?
A: Can I use my calculator?
THE COURT: Oh, certainly.
A: Around $131,000.
In his written opinion, the judge noted he relied more heavily on the accountant’s cross-examination, stating that "a more accurate and credible amount would be $130,000, as established by Plaintiff’s attorney during cross examination of the expert." It was that amount that the court used for support purposes in this case. The Appellate Division affirmed this ruling.
In short, the court appeared to go with economic reality.