Income - How to Calculate What you Earn or What you Should Earn

If a budget helps you think about money being spent every month (or the money going out of a household), then the income analysis is about the money coming in. In order to determine if you have sufficient money to meet your reasonable financial needs, you need to map out your income.  Income is money or other financial benefits that you receive in exchange for providing goods or services, or as a return on investments. It can be in the form of wages, salaries, tips, bonuses, commissions, rental income, interest, dividends, capital gains, and other sources. Income is often taxed by the government and the taxes need to be considered as part of this analysis.  

Steps to Calculate Income

Calculating income for a cash flow analysis in a divorce can be complex and depends on the jurisdiction you're in, as laws and guidelines can vary. However, here is a general outline of how income is typically calculated:

1. Gather Financial Documents

The first step is to collect financial documents outlining income, including tax returns, pay stubs, bank statements, and any other relevant financial records. For the income analysis, you want to establish all sources of regular income coming in and looking at documents is often the best way to gain a complete understanding of all income sources.  It is also important to have documentation to provide your spouse and/or to provide your attorney or mediator.

2. Determine Gross Income

‍Gross income is the total income before any deductions or taxes. This includes wages, salaries, bonuses, commissions, rental income, investment income, and any other sources of income.  If you are a salaried employee or work a regular job with a set income, this can be a fairly easy analysis. Your salary is your gross income.  If you are self-employed or have other business income, you should consider the total revenue received minus any expenses and use that for your gross income.

Variable income, like tips, bonuses or commissions, can be more challenging to establish moving forward.  If you and your spouse cannot agree upon an estimated variable income assumption, then it’s most common to look at 3-5 years of history of variable income and average them together to establish a variable income assumption moving forward.  This estimate can be revised moving forward if these assumptions turn out to be inaccurate.  

Another type of gross income to consider is interest/gains received on non-retirement cash and investments that you will have moving forward.  If you have investments or savings after divorce, then you will likely be earning some investment income or interest that could be used to help pay for your monthly needs.  So while you may not be expected to use the principal or spend the underlying assets to meet your need, you are often expected to use any growth/interest on these investments.  It is common to use 2%-5% as an estimated interest rate.  So, for example, if you have a $100,000 investment account moving forward after divorce, you could assume an additional $2,000-5,000 in income annually from this account.  

Other types of regular income in a cash flow analysis may include:

• Retirement distributions – if you withdrew retirement funds throughout the year. If you are under the age of 59.5 and don’t have an acceptable early withdraw reason, you may incur an additional tax penalty on these distributions.
• Pension payments – payments from a pension that is now in pay out status.
• Social Security income – income earned either through retirement Social Security or disability Social Security payments.
• Disability payments – if you are disabled, you should include any disability income from employer policies, private policies, or Social Security disability.
• Unemployment income – if you are not currently working, but receiving unemployment benefits, this would be included in your gross income.
• Severance payments – sometimes, when you lose a job or leave a job, you may receive some ongoing salary payments for a period of time.  These severance payments are included in your income.
• Dividend income – some investments earn interest and others earn dividends (and some earn both).  Dividend income is sometimes reinvested in the underlying investment and other dividends may be paid out to you directly. These dividends are included as income.

Gross income is used in some support calculations while others use net income (see below) – it depends on the laws in your jurisdiction.

Once you have a full picture of the total gross income you receive, now you should think about the deductions and what is actually available to you after paying taxes and other obligations.

3. Adjust for Deductions

Certain expenses may be deductible from gross income, such as taxes, health insurance premiums, and retirement contributions. Deductions come out of your gross income and the resulting number (known as net income) is what you typically use in the support analysis.  Taxes are a mandatory income deduction from your income.  Your medical and dental insurance premiums are also typically required deductions from gross income so should always be taken out before you land on a number for analyzing cash flow.

Other deductions are considered voluntary or optional, such as retirement contributions.  While you can make a retirement deduction from your pre-tax income which reduces the amount taxed this often isn’t a required deduction.  If you have sufficient income, you may choose to make a retirement contributions.  But if finances are tight and you cannot afford it, you may not contribute to retirement out of your income or you may contribute lower amounts.  Other deductions, like health savings account contributions or life insurance premiums, are considered variable/optional.  They are probably good to consider, but not required if you cannot afford them.

4. Calculate Net Income

Net income is the amount left after all deductions. Once you establish your gross income (#2 above) you subtract deductions (#3 above) and then result is your net income.  This is the income that is used for some support calculations.

5. Consider Imputed Income

Some people may be going through this exercise of outlining income moving forward before they actually have a job.  If you don’t have historical income or are currently unemployed, you will need to map out your financial situation based on your presumed income moving forward.  In most jurisdictions, unless the two parties agree on income assumptions, there will likely be some statutory minimum for an income assumption.  You often have an obligation to maximize your income and your imputed income should be in line with your potential to earn. If a spouse is voluntarily unemployed or underemployed (not earning to your full potential), the court may impute income based on their earning capacity, education, and work history.

An income analysis can be challenging if you have unusual financial considerations.  Ultimately, you want to land on a reasonable and predictable (as much as possible) amount for you to count on each month to determine other cash flow questions.  Once you know what’s coming in, the next step is to compare it against your budget, and work through the cash flow analysis.

The next module will help you answer the question “do I need support” or “do I potentially need to pay support”?