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May 06, 2024 Feature

Earning Capacity: A Necessary Consideration When Support Is at Issue

Cynthia J. Ponce

Spousal support and child support are usually hotly contested issues, and rightfully so. The amount of support ordered affects both the paying party’s and the receiving party’s monthly budget and may affect their lifestyle. Central to determining the amount of spousal support and child support is the income of each party. Usually, the income used to calculate support is the actual earnings of the parties. But what if one of the parties is unemployed or underemployed? Or they are purposely cutting back their work hours or flatly refusing to work? Or the party is living well beyond their actual earnings? Under certain circumstances, it may not be appropriate to use the party’s actual earnings to calculate the amount of support, and it becomes necessary to consider a party’s earning capacity.

In most states, the court is authorized to impute income to a party based on their earning capacity in ordering support. In other words, a court can attribute the amount of income to a party they are reasonably capable of earning even if they are not currently making that amount. Earning capacity can be based on age, health, education, marketable skills, employment history, availability of employment opportunities, and prior earnings. Earning capacity is not only limited to what the party can earn with their labor but can include what they can earn from investment returns on their capital at full capacity. Imputing earning capacity versus actual earnings ensures that the proper amount of support is awarded. The use of earning capacity in child support cases furthers the public policy that a parent should pay support consistent with their ability to pay. Imputing income is not automatic and must be proven by the party who seeks to impute income. The other party will then have the burden to show why income should not be imputed to them. Notably, income can be imputed to both the party who will pay support and the party who will receive support. Earning capacity can be applied to the paying party’s ability to pay and the receiving party’s ability to support themself.

Income imputation cases can be complex, but anytime there is support at issue, you should consider whether the actual earnings reflect the income that should be used to calculate support under the circumstances of your case. Experts can assist with deciding to pursue income imputation and determining earning capacity.

When Is It Appropriate to Request Income Imputation?

It is appropriate to request income imputation when a party’s actual earnings are below their earning capacity. This could happen when a party is unemployed or underemployed, either because they were laid off or terminated, they refuse to work, they work at a low-paying job, or their hours have been cut. This could also happen when a party is underutilizing their income-producing assets. However, the Court can consider why the party is unemployed or underemployed in deciding to impute income. For example, if the party’s health has declined and necessitates them to cut their work hours or completely stop working, then it might not be reasonable to impute income. As a further example, if the party was working an extraordinary number of hours to pay the unusual costs related to litigation, they may not be expected to continue keeping up with such a demanding schedule and income may not be imputed. It is unnecessary to show that the party is intentionally depressing their income to avoid payment of support, although evidence of that intention may be relevant in certain jurisdictions. The timing of the decrease in income is certainly a factor that should be presented when intent matters.

What Evidence Should Be Presented in an Earning Capacity Case?

Where a party is unemployed or underemployed, evidence that demonstrates that the party has the ability to work and that there is an opportunity to work should be presented. To demonstrate this, counsel will need to ascertain the circumstances under which the party left their prior employment; what efforts the party has made to obtain employment; what job skills, licenses, and certifications the party has; what education and career training the party completed; whether the party’s age and health affect their ability to work; the party’s employment and earnings history; what employment opportunities are available for a person with similar skills as the party; and what the pay is for said opportunities. To complete this analysis, counsel should propound discovery requests for copies of separation agreements or memoranda, severance packages, resumes, job applications, correspondence with potential employers and headhunters, their LinkedIn profile, offers of employment, five years of tax returns and tax forms, and bank records. Additionally, counsel can subpoena the party’s past employer(s) for copies of any files maintained related to the employment of the party, including earnings records, memoranda regarding employment and separation from the employer, offers of assistance with job placements, referrals to headhunters or job agencies, and any correspondence with the party regarding their separation from the company. Depending on what documents are provided by the employer, counsel should consider deposing the employer for additional information, such as whether or not the party accepted any job placement assistance. Most importantly, a vocational expert should be retained in these matters to assist with calculating a party’s reasonable earning capacity. A vocational evaluator can assist counsel with determining what documents and information could help determine earning capacity. They interview the unemployed or underemployed party and have them complete questionnaires and vocational tests. Based on the interviews and tests, the vocational evaluator can testify regarding the party’s work aptitude and employability; the party’s marketable skills; whether efforts by the party to obtain replacement employment were reasonable; the type of occupation the party can perform based on their skills, age, health, and past work experience; the job market; employment opportunities available; and the appropriate potential salary for the party. Vocational evaluators can also provide a timeline for retraining or reeducation needed for the party to obtain employment or earn a higher salary. The vocational evaluator’s testimony can be crucial in cases with an underemployed or unemployed party.

Where a party’s lifestyle cannot be paid for with their actual earnings, counsel should inquire into how it is being paid for. In other words, when expenses exceed claimed income, the inconsistency must be examined. The disparity between the claimed income and expenses should be highlighted to the court. The use of financial declarations made throughout the course of the case can assist with showing the party’s expenses. In addition to obtaining the information outlined for underemployed and unemployed parties, counsel should request copies of credit card statements, bank statements, brokerage account statements, loan documents including applications and promissory notes, transaction histories for person-to-person mobile payment systems such as Venmo, PayPal, Cash App, and Zelle, and documents that reflect expenses paid for by non-parties including their employer. A loan application, signed under penalty of perjury, can reveal other income sources and income-producing assets. Bank statements and transaction histories from Venmo or PayPal, for example, can reveal recurring gifts from family members or friends that, in some states, can be considered income. Credit card statements and loan statements may reveal that the lifestyle is funded through debt and not hidden income, assets, or third-party payments. Where a party is a business owner, business records such as general ledgers, financial statements, credit card statements, bank statements, and tax returns should also be requested. These records can reveal any payment by the business of the party’s personal expenses, such as travel, entertainment, meals, vehicles, and housing. The personal expenses paid by the business, also known as perquisites, are considered income and can be included to calculate support. Some business structures can be so complex and used to disguise income. Counsel should consider deposing the accountant for the business to obtain information about the business finances, how the business owner’s salary was determined, and what personal expenses are paid by the business. A forensic accountant can assist with analyzing the party’s income and business records to help identify any potential income to impute to the party and what expenses paid by the business can be considered perquisites. They also can testify as to the appropriate amount of income that should be imputed to a party.

Where a party has assets that are income-producing but underutilized, the court can impute a reasonable rate of return. Likewise, when a party has a non-income-producing investment, the court can impute a reasonable rate of return. Counsel should request copies of documents related to any investments, such as brokerage account statements, stock certificates, agreements for rental properties, rental value appraisals for rental properties, sale agreements, and investment agreements.

Fair market rental value can be imputed on rental properties that are losing money because they are rented below market value. Reasonable interest income can be imputed on sale proceeds from the liquidation of an asset. A reasonable rate of return can be imputed on a stock portfolio that is composed of stocks purchased for long-term growth rather than stocks that could produce dividend income now. A forensic accountant can assist counsel with reviewing financial records and determining what additional records are needed to impute income on investments. In addition, a forensic accountant can testify as to the value of the assets and the reasonable amount of income that could be generated from the assets that should be imputed as income. A real estate appraiser can inspect rental properties and testify as to the fair market value that should be imputed as income.

This is not an exhaustive list of evidence necessary to support the imputation of income, as the sufficiency of evidence needed is dependent on a case-to-case basis and the jurisdiction in which the case is filed.

How Much Income Can Be Imputed?

Income imputation is discretionary. If the evidence supports income imputation, the amount of income imputed must also be based on the evidence presented. The amount can be based on previous earnings, the specific amount of income for a profession in which the party has the opportunity to be employed, a reasonable rate of return on investments, the amount of recurring gifts, the amount claimed in a loan application, the amount of perks received from their business or employer, etc. so long as the specific amount is supported by evidence.

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Cynthia J. Ponce

Walzer Melcher & Yoda LLP

Cynthia J. Ponce is an associate with Walzer Melcher & Yoda LLP in Woodland Hills, California. She has exclusively practiced family law since being admitted to the bar and focuses on complex family law litigation. She has been recognized as a “Rising Star” by Super Lawyers magazine. Cynthia is a graduate of Mount St. Mary’s College and Southwestern Law School.