Sustainable cash flow: A crucial component of calculating alimony and child support | Marcum LLP

When we hear the term “cash flow,” we generally think of the cash flow presented in the cash flow statements of publicly traded companies. Often, cash flow is confused with the income reported on the parties' tax returns. However, in marital accounting, “cash flow” refers to the actual cash flow generated in the past that thus provided the means to finance the expenses to support the lifestyle that the parties generally became accustomed to during the final years of the marriage. This includes the cost of accommodation, transportation, and personal needs including savings.

Individual tax returns (Form 1040) are the usual starting point for determining cash flow. However, these tax returns do not provide the reported taxable income in contrast to their actual economic income. Adjustments must then be made to the reported taxable income to convert it into the actual cash flow for the years analyzed. Depending on the complexity of the parties' financial circumstances, many different income components may be taken into account. These may include, but are not limited to, capital gains/losses, stock options, severance pay, signing bonuses, forgiven loans, accumulation of non-operating cash in the business, and other one-time items.

Likewise, fringe benefits and allowances must be identified and taken into account to convert reported taxable income into future sustainable cash flow. Appropriate adjustments to achieve sustainable cash flow can often be subjective and require professional judgment.

Adjustments are required for unusual and/or infrequently occurring items. Although they may have affected cash flow in the past, consideration must be given to whether they are likely to occur again and whether they should be considered as part of future sustainable cash flow. It is important to remember that these adjustments can result in a significant difference between historical cash flow and future sustainable cash flow.

Examples of non-recurring items include (but are not limited to) the following:

I) Severance packages

• Although severance payments are appropriately included in income and historical cash flow, they should be excluded from sustained cash flow due to their one-time nature.

II) Impacts of COVID-19 and other ‘storm of the century’ type events

• The associated impact on future sustainable cash flow must be considered if the business has been negatively or positively affected due to COVID-19, fire, flood, etc.

III) Stock options and other share-like compensation

• The various equity equivalents received (stock options, RSUs, awards, etc.) are components of income. However, subsequent increases or decreases in the price of the underlying stock after the grant date may have had a dramatic impact on historical cash flow, which would not necessarily be a representative recurring component of future or sustainable cash flow, as would be the case with capital gains or losses.

IV) Other factors to be taken into account

• Gains or losses from the disposal of a business
• Numerous factors impact business operations and future distributions:
  • Discontinuation or addition of product lines
  • New sales channels
  • Closure of a permanent establishment
  • Larger investments
  • Start-up losses for new companies
  • Lawsuits – positive or negative results

It is also important to consider that a person's ability to pay alimony will be affected once marital assets are divided, so the amount of past passive income may not necessarily reflect future sustainable cash flow.

Cash flow is a critical factor in determining the payor's ability to pay alimony and child support. It provides us with the information we need to understand the funds available to support the marital lifestyle during the years in question. While the importance of this information cannot be overstated, relying solely on historical cash flow without focusing on sustainable cash flow can lead to conclusions and positions that may be unfair to one or even both parties to the litigation.