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?"