How is bonus income treated in support situations in California?

It’s a common issue for parties in divorce or custody proceedings to encounter fluctuating income or commissions and bonuses when determining spousal and child support. True bonus income is discretionary, and rarely guaranteed until actually paid to an employee. This is especially true when it is based on end of year profitability for the employer. As a supported spouse or single parent, how can you ensure you are paid a correct share of these earnings as additional support? As a supporting spouse, how do you avoid overpaying additional support and assure that the support representing alimony is tax deductible?

The problem arises because future support obligations are usually determined by looking at past earnings history, usually by examining the prior calendar year’s income as the measure to project future earnings. Judges may round up a party’s employment W2 forms, add in year-end bonuses, and then divide by twelve. The result is entered into the X-spouse or Dissomaster support-calculating programs, which treat the supporting spouse’s monthly support obligation as though future earnings have already been received in the coming year. But if the future year ends up being less, or the bonus decreases, this can create a major hardship in terms of a supporting spouse’s ability to pay their own living expenses – not to mention the supported spouse.

It’s no surprise that many supporting spouses hold resentment toward the other party who seeks support based upon those cumulative income numbers. Supporting spouses often view the potential bonus as their only hope for catching up with their own financial obligations. It is very important that both parties, including family court judges who have wide discretion over such matters, have a clear understanding and the ability to adopt or integrate a predictable and fair policy for calculating support, especially when an element of income fluctuates. Unfortunately, some supported spouses resist an approach that considers that the other party (or higher earner) is entitled to a life. We have found that Inexperienced family law attorneys sometimes fail to understand some of the aspects concerning bonus income orders when they negotiate settlements or argue a client’s position in court. Additionally, inexperienced family law judges don’t always anticipate burdens that unbalanced support orders can create for supporting spouses and registered domestic partners.

Bonus income and child support

Bonuses are considered a component of income for purposes of child support awards. Family Code section 4058 generally states that annual gross income means income from whatever source derived, and subsection one identifies bonuses within that definition. Family Code specifically allows courts to adjust child support orders to account for the effects of seasonal or fluctuating income of either parent. These circumstances may include income from special compensation (in addition to salary) but applies specifically to people who earn commissions.

Including bonus income is logical, as a parent’s top priority should be the welfare of their child (or children). Few parents would argue against this, although many might complain that it is the custodial parent, and not the child, who usually benefits from child support. This view usually has more to do with unresolved resentment toward the other parent, although in some cases there are parents who use child support for themselves instead of the child.

Ostler & Smith Awards

Family law treatment of bonus income for purposes of calculating spousal and child support orders is not new, but there aren’t a lot of reported decisions on the subject. There are a few commonly referred to cases, including 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. Given the rarity of published decisions in case law authority, there are a couple of important rules you can pull from these outcomes.

The basics of Ostler & Smith: Clyde and Vicki had a long marriage of twenty-one years. They married when they were both seventeen, and raised four children together, two of whom were minors at the time of their divorce. By their agreement, Vicki had always been a homemaker, sacrificing education and career opportunities as she filled that role. Clyde obtained a master’s degree in banking, became a successful auditor, and was enjoying an upward climb when they separated and instituted legal proceedings. By the time of the hearing that lead to the appeal, he was an executive VP and CFO of a major bank.

Clyde began 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 judge concluded that future bonuses aren’t guaranteed.  Instead, it would be better for base the support on his income from salary, while including a percentage of future income in the event that future bonus totals changed.  This would prevent the need for future litigation in the event that Clyde’s future bonuses were significantly different than what the order was based upon.

The trial court was interested in creating a formula that would take this income into account for support purposes without forcing the parties to re-litigate once the  bonus amounts were known for sure (or Clyde sought 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 also involved judgment spousal and child support. 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 a combined amount of 36% is acceptable or not .  Given the total combined amount of 35% as in Ostler-Smith, 36% would not have been unacceptable – the Mosley court did not imply 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 to pay their own expenses, especially if a court simply assumes that the supporting spouse will be stable 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 (versus net income). 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 tax deductible alimony.

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 the 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 in this case. As with Mosley, Tong & Samson dealt with the downstream consequences of a percentage award and not on the original establishment of the award. The 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 court agreed with the wife and called the severance pay a “bonus”, but that determination was deemed to be in error and the ruling was reversed. The court did not comment on the 35% for additional spousal support alone because it did not need to escalate to that issue, since the 35% award had not been appealed.

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 main points if you’re in 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) phase. These percentages will be applied to gross income, and there is no tax deduction for child support in any event.
• Ten percent (10%) per child, and twenty-percent (20%) in the aggregate is common. But what happens if a family includes three or more minor children? Would it matter if there is also a spousal support obligation as well? Not likely.
• 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 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, as the Smith & Ostler cases involve very high earnings.
• It is important that a self-represented supporting spouse, 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 supported spouse, and deductible by the supporting party. If the court declines and you are at the pendente lite (pre judgment) stage, request the court to retain jurisdiction to revisit the issue at time of trial.
• You likely won’t have sufficient grounds in arguing that there is no authority for Ostler-Smith orders at a pendente lite spousal support hearing. But, it may be worth a shot: 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 is now referred to as “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 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 living standards.
• Always choose a monthly income floor so that the percentages apply only to the excess to avoid coming from the base.
• If you are the supporting spouse, 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 $10,000/month and bonuses ranging between $0 and some number 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 both parties, because it sometimes seems that the employee is playing games with the income, and that he or she 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, it’s important to use the base so the support order isn’t skewed high.
• Always consider submitting a declaration from the party’s employer describing how bonus income is decided and to establish that the employee is not attempting to deceit or misrepresent the facts (they may not be believed without corroboration).
• If you represent, or are the supporting spouse, and are self-employed, be sure to factor in and deduct business expenses before the bonus income is determined.
• Consider whether 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 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 form FL-150 (or your prior year’s tax return). It may hurt you not to bring the bonus question to the attention of your family court officer.
• If you do wind up overpaying support at the temporary phase of the proceedings because bonus assumptions turned out to be incorrect, consider arguing that the court should equalize this overpayment per Family Code “4320 factors” as a hardship.