Often cash flow is confused with taxable income reflected on the parties’ income tax returns. However, in matrimonial matters, it is essential to determine the actual cash flow that had historically been realized, thereby providing the wherewithal to support the lifestyle that the parties have generally become accustomed to. This includes the cost of housing, transportation, and personal needs, including savings, during the more recent years of the marriage.
While the individual tax returns (Form 1040) are the usual starting point in determining cash flow, these tax returns provide the reported taxable income of the parties (as opposed to their actual economic income). Adjustments must then be made to the reported taxable income in order to convert it to the actual cash flow during the years being analyzed.
Income Components That May Need to Be Addressed
Depending on the complexity of the parties’ financial circumstances, there can be many varied income components that must be addressed. These could include but are not limited to: capital gains/losses, stock options, severance payments, sign-on bonuses, forgivable loans, accumulation of non-operating cash within the business, various carry forward items such as capital losses, interest expense, real estate losses, and other non-recurring items.
Similarly, perquisites and benefits must be determined and addressed, as well as any bartering and “cash” income. Consequently, these types of factors must also be considered in order to convert the reported taxable income to arrive at actual cash flow, and the future sustainable cash flow. Appropriate adjustments necessary to arrive at sustainable cash flow can often be subjective requiring professional judgment.
Items that are unusual in nature, and/or infrequent in occurrence, require adjustments. While they may have had an impact on cash flow in the past, one must consider whether they are likely to recur and whether they should be considered to be a component of future sustainable cash flow. It is important to remember that these adjustments could result in a significant difference between the historical cash flow and the future sustainable cash flow.
Examples of non-recurring items
Severance packages
Severance package benefits are appropriately included in income and historical cash flow. However, this is a perfect example of an item that should be excluded from future sustainable cash flow due to its non-recurring nature.
Impact of “Hundred Year Storm” types of occurrences
In instances where the parties’ business was either negatively or positively impacted as a consequence of COVID-19 or a fire, flood, etc., the related impact on future sustainable cash flow must be considered.
Interest and dividends
Interest and dividends may be significantly affected by the current level of liquid assets rather than historical levels, as well as the level of liquid funds that each party will have available to them after their divorce.
Stock options and other equity type awards
The various equity equivalents received (stock options, RSUs, grants, etc.) are components of income, and cash flow. However, the subsequent increases or decreases in the price of the underlying stock after the grant date may have had a dramatic impact on historical income which would not necessarily be representative of a recurring component of future or sustainable cash flow, just as would be the case with any capital gains or losses.
Other factors
- Gains or losses from the sale of a business or other personal assets
- Items impacting business operations and future distributions such as:
- Discontinuation or addition of product lines
- New channels of distribution
- Closure of an operating facility
- Major capital expenditures
- Early starting losses relating to a new business
- Lawsuits – positive or negative results.
Consideration must also be given to the fact that once marital assets are divided, an individual’s ability to pay support will be impacted and, conversely, the level of support needed may also be impacted. Therefore, the level of prior passive income may not necessarily be reflective of future sustainable cash flow.
Cash flow is a critical factor in the determination of the level of alimony and child support. It provides the information needed to understand the resources that were available to support the marital lifestyle during the relevant years. While the importance of this information cannot be overemphasized, relying on historical cash flow without also focusing on the future sustainable cash flow can lead to conclusions and positions that may be unfair to one, if not to both litigants. The “ability to pay” is dependent on the sustainable cash flow and not solely based on the historical cash flow.
In conclusion, accurately determining cash flow rather than relying on tax returns is essential for fair and effective support calculations in matrimonial matters. By considering historical and future sustainable cash flow, parties can better understand their true financial resources and obligations. If you need assistance with cash flow analysis or support calculations, connect with CBIZ today for guidance tailored to your unique situation.
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