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While the rules used in a legal separation, paternity or divorce or different from the IRS, it is important to understand how true income is calculated by the IRS. When a taxpayer has insufficient records or the records are inadequate, the IRS has authority to compute income under whatever method will reflect most accurately and clearly the income of the taxpayer. In this procedure, it is not unlike family law courts which will often do the same. Generally, one of three methods are used and these depend upon the records, facts and circumstances. These three methods include:
Both the expenditures and bank deposit and net work methods have application in family law cases and are explained in more detail below.WHAT IS THE BANK DEPOSITS AND EXPENDITURES METHOD?
The IRS will first reconstruct the gross receipts of the taxpayer by adding total bank deposits, cash accumulations not deposited in any bank account and business expenses paid in cash. This total is then reduced by nontaxable deposits: loan repayments and nontaxable cash used for any of the purchases which are considered business expenses. When this method is used to determine true income, each item of expense and income is scrutinized as to the source of funds and what the funds were used for. The cash expenditures method of reconstructing income will take into account that the expenditures of the tax payer [during a tax period over reported income for that period] equals taxable income. Once the IRS makes this determination, the burden of proof to overcome is on the taxpayer.WHAT IS THE NET WORTH INCREASE METHOD?
The IRS can look to the increase in the taxpayer's net worth over the tax year. This can be determined to be taxable income if no other explanation of the income is presented. The IRS may add to this amount the taxpayer's estimated living expenses: presumption to have been paid from income. The net worth method analyzes the tax basis of the assets rather than fluctuating fair market value. The taxpayer may meet their burden of proof by demonstrating that the excess income was from nontaxable sources: gifts; loans; inheritances or capital. Included, but not limited to, below are some of the records analyzed in reconstructing a taxpayer's net worth are the following:
In family law cases in San Diego including divorce, legal separation and paternity, often, the bank deposits method is the easiest to use. This method can also be highly probative of the true income. Similar to the IRS method, the burden is on the party to establish the sources of the income. Unlike the IRS method, whether the income is taxable is not the test as nontaxable income is also available for support as family law may have “add backs” to the income for support purposes.WHAT IS THE CASH FLOW METHOD FOR DETERMINING TRUE INCOME IN A FAMILY LAW CASE?
Another family law method [akin to the IRS expenditures method] is used in family law cases. This has bee referred to as the "cash flow" method. If a parent or spouse has undisclosed income, then it may not be able to be proved what the party earns. In this case, it is often easier to established what the expenses are. Once total expenses over a given period are established, the burden of proof is on the party to prove that the funds used were from sources which should not be counted as income: credit card advances; loans;, sale of assets; etc.HOW CAN A LOCAL SAN DIEGO FAMILY LAW FIRM HELP YOU TO DETERMINE THE TRUE INCOME OF THE OTHER PARENT OR SPOUSE?
The law firm of Doppelt and Forney, APLC has experience in calculating true income for support purposes. This can be an extremely complicated area of the law and legal representation is often needed. Feel free to contact their law office for a virtual consultation which is confidential and at no charge for up to 30 minutes.