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How Should BONUS INCOME Be Treated for Child and Spousal Support Purposes In California?

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"Bonus" Income and Ostler & Smith Awards: Best Practices For How to Ensure Fair Child and Spousal Support Awards

It is not uncommon for parties to divorce or custody proceedings to be faced with the question of how to account for fluctuating income or commissions and bonuses when determining proper spousal and child support awards. Receipt of true "bonus" income is discretionary and is rarely guaranteed until it is actually paid to an employee (especially when it is based upon year-end profitability). As a supported spouse or unmarried parent, how can you ensure you are paid a "just" share of these earnings as additional support? As a support obligor, how do you avoid overpaying additional support and assure that the portions that represent alimony are tax deductible?

The problem arises because go-forward support obligations are usually derived by looking at the parties' past earnings history, typically by taking a snapshot of the prior calendar year's income (or the preceding twelve months), as the most reliable measure of future income streams. Judges may "gross up" a party's employment receipts, add in year-end bonuses, and then divide that amount by twelve and enter the information into the Xspouse or Dissomaster and punch the "enter" key. This treats the payor's monthly support obligation as though these future earnings have already been received in the coming year, because that is what happened in the prior. But if it doesn't, or the bonus decreases, this can create a severe financial hardship in terms of a supporting spouse's ability to pay their own living expenses - not to mention a windfall to other party. As it is, many of us effectively spend the first 107 days of each year to generate the earnings we need to pay just our annual tax bite (assuming an average 29% federal, state and local effective tax rate). If a spousal or child support award, and especially a support order that combines both, is based upon average monthly salaries (or commissions) PLUS end of the year bonuses that may or may not come at year-end, then a support payor may effectively have to work a half a year or more before they begin to accumulate the money needed to pay their basic costs of living. Until the bonus arrives the only way for such support obligors to survive economically is to borrow from credit cards or family members. If it never arrives they may have no opportunity to catch up. Judges are rarely willing to maintain any kind of retroactive jurisdiction to recalculate monies due under past support orders (i.e., to 'wait and see' and then give credits back if the bonus fails to materialize or is less than anticipated). Hence, if the expectations at the outset are later proven wrong, great hardship and material injustice can occur that as a practical matter won't get undone or remedied.

Paying Bonus Income Doesn't Allow a Support Obligor to Catch-Up

Small wonder that many support obligors feel antagonism and resentment towards the other party who seeks support based upon those cumulative income numbers - they view the potential bonus as their only hope for catching up with their own tax and personal expenses. It is therefore imperative that both parties, not to mention family court judges who have wide discretion over such matters, have a clear understanding and willingness to adopt or impose a predictable and fair mechanism for calculating "cash available for support" when an element of income fluctuates. Unfortunately, in my experience, some supported spouses resist a balanced approach that considers that the working parties (or higher earners) are themselves entitled to a life, inexperienced family law attorneys fail to comprehend some of the nuances concerning bonus income orders when they negotiate settlements or argue a client's position in court, and relatively inexperienced family law judges don't always think through the burdens that unbalanced support orders can create for payor spouses and registered domestic partners - and especially the tax ramifications and consequences.

This issue came to my attention again recently in a case I'd substituted into as the husband's third attorney. In the three years prior to separation, he earned between $185,000 and $225,000 each year as commissions that varied widely from year to year. The parties had two minor children, and the mother had not yet returned to the work-force. Husband worked in a commission based service business as a sale's representative. He signed clients up for his employer, and the employer asserted certain reimbursement claims on behalf of his 'customers' that could take up to a year to finally resolve. Husband's employer was entitled to a percentage of these reimbursements as his fee, and my client a percentage of that. My client did not receive his commissions until the claims on behalf of these customers were each paid, so that during any given month some claims were being finalized and paid out, and new business was being generated that would close at a later date. Because of this there was no way to know the total commissions that the husband had earned throughout the year until the books were closed on December 31st. Based upon prior years, however, certain assumptions could be made that permitted the employer to pay Husband a base salary of $10,000/month ($120,000) yearly, with the balance of what he was owed ("overages") at the end of the year becoming fixed at that time and paid over in January. Really these were not true "bonuses" - they were simply the excess commissions over the base salary that could not be distributed until the accounting period closed, since the $10,000 was set to ensure him a minimum dependable earnings' stream so that the family could budget from month to month.

Husband's first attorney argued at the wife's hearing on her request for temporary alimony and child support that husband's income should be inputted into the Xspouse at $10,000 month and that he should be ordered to pay 50% of whatever husband received in January each year for the year prior to equalize the wife/mother's share of husband's earnings. As discussed below, this was the first mistake and it reflected a complete ignorance about how percentage based support orders are customarily treated - he should never have conceded that the support obligations (spousal and child combined) ought include 50% of these commission overages, but instead he should have urged a lesser share. Second, husband's prior attorney failed to give any consideration to asking the court to allocate a portion of the January commissions to spousal support as opposed to child support, because the spousal support component would be tax deductible while the child support component would not be. When the Court made its orders no consideration was given to the tax implications of such a percentage support order; nor did the attorney ask the Court to reserve jurisdiction on that question so that it could be cleaned up later. As a result, husband was ordered to pay 50% of his gross January "bonus" to wife, and being taxed for that entire 50%. Given husband's income tax bracket, this resulted in the wife effectively receiving about 70% of these commissions relative to husband's share. The icing on the cake for this poor support payor was that the former attorney also didn't have a good understanding of the husband's base salary, so that wife's attorney successfully argued that husband's base salary should be inputted as $12,500 ($149,500/year), which wasn't in fact the case, and so husband's temporary SS and CS numbers were further inflated beyond what he actually received each month by $2,500. As a result, he was ordered to pay support based upon phantom income and then was not able to use the January bonus income to 'catch up' and so in a position to repay the money he had borrowed to enable him to pay for his own living expenses. When he retained our office, while earning about $200,000 a year gross on paper, he was renting a room in a friend's house because he was left with so little money. Needless to say, he resented that he worked 60 hour weeks and had less than nothing to show for it.

On the eve of trial we were able to clean this all up, along the lines of the Ostler & Smith percentages discussed below, but before we'd come on board these mistakes had cost the client about $80,000 and made it impossible for him to live at close to the level that wife was able to enjoy for the eighteen months from the start to finish of the case. It was a sad thing to observe the anger that the husband had towards both the former wife and their children as a result of the perceived unfairness of his economic situation (the mother repeatedly told the kids that their father was trying to cheat them all because given the Court's initial 50% of bonus order she had unreasonable expectations about what percentage she should continue to receive).

Please, if bonus income is an issue in your case, get it right at the outset.

Bonus Income and Child Support Statutes

There is no question but that bonuses are considered a component of "income" for purposes of child support awards, and that makes sense. Family Code section 4058 generically provides that "annual gross income ... means income from whatever source derived" and subsection (1) identifies bonuses within that definition. Family Code section 4064 expressly authorizes courts to adjust child support orders to reflect the effects of seasonal or fluctuating income of either parent. Such circumstances may include income from special compensation, in addition to salary, but obviously applies specifically to people who earn commissions. Section 4064 enables courts to base support orders on the totality of both parties' earnings' situations.

This rules make sense because, as a matter of public policy, "A parent's first and principal obligation is to support his or her minor children according to the parent's circumstances and station in life." Family Code section 4053(a). Few parents would dispute this sentiment, at least openly, although many might complain that it is the custodial parent and not the child who tends to benefit from child support, or child support in excess of some minimum threshold; our legislature has not prioritized the payment of alimony in quite the same terms. Such a possibly narcissistic view usually has more to do with unresolved resentments towards the other parent than it does with reality - although certainly there are parents who don't pass the support benefits onto their children but use child support for more selfish purposes.

What Are Ostler & Smith Awards - also known as Smith-Ostler's?

Family court treatment of bonus income for purposes of calculating spousal and child support orders is not new, but there aren't a lot of reported (i.e., published) decisions on the subject. The cases you might read are Marriage of Ostler & Smith (1990) 223 Cal.App.3d 33, Marriage of Mosley (2008) 165 Cal.App.4th 1375, and Marriage of Tong & Samson (2011) 197 Cal.App.4th 23; there aren't any other important cases in this area. Accordingly, given this dearth in case law authority there is only limited direction for how family court bench officers ought to exercise their discretion in ordering support to be paid from bonus earnings. Still, there are a couple of important rules you can pull from these decisions.

The essential facts of Ostler & Smith were these: Clyde (husband) and Vicki (wife) had a lengthy marriage of twenty-one years. They married when they were seventeen. They raised four children together, two of whom were minors at the time of their divorce. By the parties' agreement, Vicki had always been a stay-at-home Mom, sacrificing her own education and career opportunities as she served in that role while Clyde obtained a master's degree in banking. He became an increasingly successful banking auditor, who was still enjoying an upward trajectory when the parties separated and instituted legal proceedings and by the time of the hearing that lead to the appeal he was an executive vice-president and chief financial officer of an unnamed major bank.

The parties amicably resolved the division of their community property. They could not agree upon spousal support, child support or attorney fees and underwent a contested trial on those subjects. While Ostler Smith awards are commonly seen today at the temporary spousal support stage of the proceedings, the case itself did not involve a pendete lite hearing (i.e., seeking temporary orders pending the final division of the community estate) but was instead at the judgment phase. At least as to child support, however, Family Code section 4058 today makes clear that bonuses may be treated as it was ultimately here at the initial hearing phases of a family law proceeding involving kids. No appellate decision has explicitly extended Ostler-Smith to temporary spousal support applications although it clearly happens regularly.

By the way, if you are preparing for a spousal support trial and want suggestions on how to present that evidence, Ostler & Smith contains a great discussion of how to analyze and present the marital standard of living and other Family Code section 4320 factors.

Clyde started receiving significant bonuses each year which continued up to the time of trial. On the question of how to treat this income for purposes of support, the trial judge found "No future bonus is guaranteed. It would therefore not be appropriate to base a support order on Husband's bonus income and then require him to file motions to modify at such times as the bonus is reduced. It would be more fair to all parties to base the support order on Husband's income from salary and dividends, and to allocate a portion of the future bonus income to the children and to Wife by way of a percentage interest so that future litigation will not be necessary as the bonus income changes." 223 Cal.App.3d at 41-42.

Therefore, the trial court was interested in developing a formula that would take this income into account for support purposes without forcing the parties to re-litigate the issue at the end year once the amounts were known for sure (or the husband to seek a downward modification if his bonuses decreased from the prior period). The judge decided to charge ten percent (10%) for each minor child, and fifteen percent (15%) for the wife as spousal support, for a total of 35% of the gross bonus income. This approach was upheld on appeal.

Marriage of Mosley

Marriage of Mosley also involved judgment spousal support (and child support). There the trial Court had previously ordered the husband to pay fifteen percent (15%) of his gross bonus income in excess of a base amount ($447,100/year) and twenty-one percent (21%) of the excess was characterized and ordered as additional child support. This was not the order appealed from, so we cannot say from the reported decision itself whether, under circumstances like Ostler-Smith (spouse and two minors), a combined amount of 36% is acceptable or not - although we certainly can say that given the total combined amount of 35% as in Ostler-Smith that 36% would not have been an abuse of discretion - the Mosley court in no way implied that the 36% had been excessive. But it did recognize that Smith-Ostlers can become excessive if they leave the supporting spouse with nothing left for paying their own expenses, especially if a trial court merely assumes that the support obligor will be made whole with a year-end bonus that may never materialize. Again, there was no discussion of whether it is fair to charge these percentages off of gross verses net income although in Mosley the trial court had evidently ordered the husband to pay the percentages off of gross income, so that presumably the wife would have been charged for the spousal component as deductible alimony.

Marriage of Tong and Samson - Temporary Support Orders

Tong & Samson involved an appeal from a temporary spousal support order that had been based upon variable monthly commissions, where an Ostler-Smith award had previously been ordered but then later the payor husband lost his job and the wife felt his severance pay should be treated like a bonus. There were no children or child support issues. As with Mosley, Tong & Samson dealt with the downstream consequences of a percentage award and not on the original establishment of the award. The trial court had originally ordered him to pay 35% as spousal support of all his gross income in excess of $45,000/month. Upon being terminated the wife sought to impose the Ostler-Smith percentage against the husband's lump sum severance payment. The trial court agreed with the wife and called the severance pay a "bonus" but that determination was deemed to be in error, and accordingly the ruling was reversed. The Court did not comment on the 35% for additional spousal support alone because it did not need to reach that issue, since the 35% award had not been appealed. I would not read this case as meaning that 35% is appropriate at the temporary spousal support phase, since the Tong & Samson trial court was not required to look at the judgment support section 4320 factors which had been specifically addressed in Ostler & Smith.

Suggestions for Dealing With Bonus Income Issues

Given that there are only three reported decisions in California that discuss these types of percentage support awards, it is very difficult to know where to draw the lines. Here are some thoughts if you face a fluctuating commission or bonus type situation:

  • Percentage awards in child support cases will be upheld on appeal whether at the temporary or judgment (including post-judgment) phases of the case. There is express statutory authority for these types of child support awards. These percentages will be applied to gross income. Obviously there is no tax deduction for child support in any event.
  • Ten percent (10%) per child, and twenty-percent (20%) in the aggregate, certainly passes muster. But what happens if a family includes three or more children? Would it matter if there is, or is not, a spousal support obligation as well? Probably not!
  • Percentage awards in spousal support awards will be upheld at least up to sixteen percent (16%). The Court has discretion to apply those percentages to gross income or net income, but will likely apply them to gross earnings - especially if the trial court renders a statement of decision that shows that all the 4320 factors were considered. At the same time, argue per Mosley that the supporting spouse at some point has insufficient funds to live on. This argument may be more successful with lower earners. All the Smith & Ostler cases involve very high earnings.
  • It is essential that a self-represented payor, or their attorney, ask the Court at the time the additional spousal support award is made to specify that it is taxable income to the recipient, and deductible by the supporting party. If the court declines and you are at the pendente lite stage request the Court to retain jurisdiction to revisit the issue at time of trial if you are at the pre-judgment phase of the case.
  • You likely won't gain traction in arguing that there is no authority for Ostler-Smith orders at a pendente lite spousal support hearing. But you can try: the Smith-Ostler decision included a detailed analysis of both the legislative history of the predecessor statute to Family Code section 4320 and the trial court findings over what we now call the "4320 factors". You could also use this information to advocate for a percentage that is less than fifteen or sixteen. If the bonuses only begin to be received after the parties' separation or after a Judgment, argue that they should not be considered at all for purposes of spousal support because they cannot be part of their parties' living standards.
  • Always fix a monthly income floor so that the percentages apply only to the excess to avoid double-dips, i.e., a percentage of commissions or bonuses in excess of $X/month and ensure that the $X/month is the number that is inputted into the guideline support program.
  • If you are the payor, you may want to argue for a cap, especially where the percentage of bonus income if paid out will exceed the marital standard of living. For instance, with a base salary of $!0,000/month and bonuses ranging between $0 and some number (that depends upon your facts) like $25,000/month, that the first $25,000 is subject but that nothing after $25,000 will be included. Commissions and fluctuating income are confusing to payors and their spouses, because it sometimes seems that the employee is playing games with the income, and that he or she and not the employer controls whether they are paid out and when. This creates the possibility that the Court will input too high a number as the base salary. If a person receives a fixed amount per month and the balance due them is turned over to them at the end of the year, if a higher is used that accurately reflects what they receive their base spousal and child support obligation will also be skewed higher.
  • Always consider submitting a declaration from the party's employer describing how bonus income is decided and to establish that the employee is not pulling his employer's strings or misrepresenting the facts, since the party themselves may not be believed without corroboration.
  • If you represent or are the support obligor and are self-employed, be sure to factor in and deduct business expenses before the bonus income is calculated.
  • Consider whether, if you are a payor, you might be better off requesting that the Court take your prior year's income - including whatever bonus was then received, and then inputting that entire number into the support calculator (if the issue is child support or temporary alimony). If your next bonus is less than the year used, this will hurt you but if it is more and so long as there are no percentages, this will help you. Understand that courts typically apply Ostler-Smith percentages only when it is specifically requested by one of the parties; otherwise, the Court usually just looks to the information at page 2 on your FL-150 or at your prior year's tax return. It may behoove you not to bring the bonus question to the attention of your family court bench officer.
  • If you do wind up overpaying support at the temporary phase of the proceedings because bonus assumptions turned out to be wrong, consider arguing that the Court should equalize this overpayment as on the of Family Code "4320 factors" whether as a 'hardship' or additional equitable factor.

And, as always, good luck out there!

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Thurman W. Arnold III, CFLS