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Episode 75 Transcript: Organizing Your Finances - Income

For most people going through a divorce process, at some point in the process, usually, more toward the beginning, they will need to fill out some kind of financial disclosure form, be it a statement of net worth, a financial disclosure affidavit, or whatever it’s called in your particular jurisdiction. The gist of those documents, that kind of disclosure, is that it’s meant to help you disclose four key things: your income, your expenses, your assets, and your debts. Over the next four episodes, I want to go through each of those categories with you and give you some basic guidance for how to put together that information for your financial disclosure form and to help you expedite that process and make it as easy and clear as possible.

Let’s start with income. There are a couple of different things you want to think about when disclosing what your income is. The first thing you want to do is think about your different sources of income. You may have income from employment. That’s common for most people. Then there are many other potential sources of income. You may have income from a business that you own or that you own a part of. You may have income from a rental property, from investments, from your family. There are a host of different sources of income for people. The first thing you want to do is sit down and think about what your various sources of income are. It may be just one, which is employment income. That’s probably the most common. So basically, you want to start by identifying for yourself what your different sources of income are and if you only have one source of income, that’s totally normal.

Then, within the different subcategories of income sources, and in particular, for income from employment or from your work, you want to identify any different components of that income. Let me just take employment income, for instance. You may receive both a salary and a bonus from your employer. Both of those are income to you, but they are different in nature, and so it helps to distinguish them. How much is your salary and how much is your bonus? Then, with regard to your salary and with regard to your bonus, if they are composed of different things themselves, for instance, if your salary is in part guaranteed, but in part, it’s variable based on sales numbers, or if your bonus is in part cash and in part stock, you want to specify what’s what because each of those different components of compensation has different degrees of predictability, different tax treatments. So it’s really helpful. The more detail you can give about, “Well, this is my salary, and this is my bonus, and this much gets paid in cash,” or, “This much has historically been paid in cash and this much in stock.” That’s a good place to start.

Then the next thing you want to do is answer that question for the last, at least I would say, three years. You want to get clear on, “These have been my different sources of income over the last three to five years,” and then the same question for each of those different sources of income, are there different subcomponents of that source of income? For instance, employment income, do you have a salary and then a bonus? Is your bonus divided into part cash, part stock? Clarifying that not just for the present moment, but for the last three years. Specifically, it can be really helpful to base it on your most recently submitted last three tax returns.

What documentation would you be looking at specifically if you’re not sure where to go to figure out what your income amounts are, whether it be employment income or rental income? You really want to ground in your tax return, your 1040. And then, although the 1040 and its schedules are changing quite a lot starting for 2018 and going forward, really I’m going to be speaking about the old form, so this will have to be translated to what is accurate for the new form. Your 1040 and then Schedules A through E more or less are going to give you the most helpful information about what your income has been. Frankly, if you’re unclear, this is a question that your accountant should be able to answer for you very easily and quickly, which is, “Can you help me have a sense of what is my gross pre-tax income for the last three tax years?” They should be able to tell you that.

In addition to your 1040 and your Schedules A through E, documentation of your income that you would receive from another entity, like your employer, like a business you own, so W-2s, 1099s, K-1s. Those are also extremely helpful in terms of spelling out not just what your income is, but also different components of your income. So you want to try to gather both your 1040 and corresponding schedules for the last three tax years and then also your W-2s, 1099s, and K-1s for the same tax years. Then, what you want to understand, and I mentioned that you want to get a sense from your accountant of what your gross pre-tax income was, but you also want to understand, “How much did I pay in taxes on that income?” so that you can know what your post-tax income has been as well. Again, that’s not just for the present, but for the last three tax years. If that’s something that is not clear to you, this is the kind of thing that your CPA should be able to answer really, really easily for you.

Then I just wanted to say a final word about a special consideration if you are a business owner. Most businesses have their gross revenue, and then they have business expenses they report. Then if they have any income from the business, that’s the profit of their gross revenue reduced by their business expenses. It is not uncommon for business owners to include as business expenses, expenses that are really more personal in nature. People do that to varying degrees. What you want to do for purposes of your divorce is go back and look at, if a big source of your income is your business income, look at the business expenses that you have claimed, the different categories of expenses you’ve claimed for the three tax years that you’re reviewing.

You want to identify from those sources of expenses what are really more personal expenses in nature. A good trick for knowing that is, first of all, were these things required to run your business? Also, second of all, did paying for this expense through the business reduce a personal expense that you otherwise would have had to incur. For instance, you take a summer vacation with your family. It’s totally not related to or necessary for your business, but you claim it as a business expense. That’s a personal expense, and that should be added back to your gross pre-tax income. Another example would be you have a cellphone. Totally necessary that you have a cellphone to run your business. However, running that cellphone through your business does reduce a personal expenditure for you because if you didn’t pay for that cellphone from your business, you would still have a cellphone personally and you would still have a cellphone bill. So the amount that you are saving, you want to add back to your income. Now, don’t just throw it in there as income and not specify that this is the subcategory of business expenses that arguably are more personal expenses, but I run through my business. So, that’s a little bit of extra work that if you’re a business owner, you do have to engage in in order to more accurately be disclosing your income in a divorce process.

Those are a couple of pointers on how to pull together your income in the context of your divorce process. I hope it was helpful for you.

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Episode 76 Transcript: Organizing Your Finances - Expenses

Episode 74 Transcript: Assets You Can't Sell or Divide