Consider More Than Just Your 1040 for Accurate Income Determination

What is an individual’s annual income? An income tax return, specifically the individual federal income tax return (Form 1040), is the most heavily relied upon document that attorneys and the courts gravitate to in order to answer this question. This is a mistake that could have a significant and detrimental financial impact, especially in matrimonial litigation.

The word “income” is overly broad; its application results in differing definitions and usages of the word itself, examples, of which, include, “taxable income,” “gross income,” and “net income” to name a few. All these types of income can be substantially different simply based upon definition alone.

Line 1 of Form 1040 reports wages, salaries, tips, etc., and these amounts are derived from a W2 Wage and Tax Statement; this statement has four (4) different reported wage amounts. The different wage amounts reflect differences in the tax treatment of specific components of wages. All these reported wage amounts can be significantly different, and Box 1 is generally the lowest wage amount. Would you be surprised to learn that this is the figure that receives most attention? It is this figure that is reflected on that line 1 of Form 1040. At the very least, “actual” wages are best reflected by utilizing Box #5, “Medicare wages and tips.” However, this too may understate an individual’s actual wages. Non-taxable benefits may not appear on Form W-2, such as retirement contributions, health savings accounts, pre-tax deductions, employee perquisites, stock options, etc., and they certainly are not observable simply by reviewing an individual’s federal tax return. To determine an individual’s “actual” income from wages, a detailed analysis must be performed utilizing not only tax returns, but also W-2s, payroll earnings statements and pertinent employer records.

A tax return reports taxable income and, depending on the specifics, some of the reported taxable income may be further reduced by allowable deductions. While Form 1040 is a great source of information, it is only the beginning of understanding and computing an individual’s income and not the end.

The more complex an individual’s tax return and/or compensation plan is, the more imperative it is to have a professional who has extensive knowledge and experience in performing an income analysis, so that all income components can be accurately determined, considering the purpose of which it will be used.

If you have any questions about income determination, tax returns, or W-2 statements, give us a call at (401)-921-2000, or fill out our online contact us form.