The Advantages Structuring Personal Injury Settlements for Clients Concerned About Child Support Obligations

Most people do not normally focus on family law issues in personal injury matters, but believe it or not, such issues can make a difference for clients with child support obligations, or even potential future child support obligations. Now, at the outset, let me state clearly that it is every parent’s obligation to properly and responsibly care for their children. That being said, divorced parent’s manipulating child support for other purposes is certainly not unheard of and many commentators believe that child support should be based upon earned “wage” income, not passive income from investments or the like.

On that note, one of the issues that is not yet decided in Arizona is whether passive income from separate property can be considered income for the purposes of calculating child support. As a result, it may make sense to structure all or part of a large award into an annuity to avoid any imputation of income affecting child support calculations.

So, still do not see how this might affect you?

Imagine that you are divorced with minor children and you obtain a $500,000 personal injury award. Is your ex entitled to the award? No, that’s an easy one. What if you buy a house with the money and the house increases in value. Is your ex entitled to attribute the increase in value as income for the purpose of calculating child support? No, that’s also an easy one.

But what if you invest the award in a money market account earning 5% — i.e., $25,000 a year. Should the court consider the additional $25,000 as income to calculate child support? That question has not been answered.

The closest any Arizona court has come to addressing this issue is the recent case of Jenkins v. Jenkins. Jenkins involved a farmer making about $75,000 a year, who also inherited an interest in land worth about $7,000,000. The trial court awarded child support without any consideration of the separate property, but commented that, if the property was sold, “it may be appropriate for the Court to impute income to [Father] from the investment of [those] funds . . . .”

The father eventually did a 1031 exchange whereby his $7,000,000 worth of real property was, under the federal tax code, converted into $7,000,000 of other real property without any taxable event.

The mother claimed that the father should be “imputed with income” from the sale based upon what he “would have earned” had the money been invested in something else, like a 5% money market, and relied upon a case where a court was reversed for failing to consider the value of vested stock options granted by an employer.

In my view, it was a pretty easy decision that the mother was wrong. Stock options granted as part of an employment package are reasonably part of one’s compensation in connection with employment. In addition, there is clear case law that says “an increase in the value of [separate or investment] property over time does not constitute income . . . for purposes of calculating child support.”

Unfortunately, the Court of Appeals expressly did not decide the bigger issue, the one we already discussed. That is, whether the “Child Support Guidelines should attribute income to the parties based on the value of their sole and separate property in calculating child support.” The court stated that, “[a]ssuming, without deciding, that had Father chosen to transmute his real estate into income or an income-producing property and that the income would be attributable to him for purposes of calculating his child support obligation, Father nevertheless did not do so here.”

So, would such “income . . . be attributable to him for purposes of calculating his child support obligation”? What will the courts do with respect to divorced parents who acquire “income or an income-producing property”? If a parent saves their money after a divorce and puts it in an income-producing money-market or the like, would or should such income from that investment be attributable for the purposes of calculating child support? Why should buying a non-income producing asset not affect such calculations as opposed to an asset that produces passive income?

Although there’s no answer to this question at this time, one obvious way to avoid the issue (that was tacitly endorsed in Jenkins) is to structure all or part of any settlement in an annuity. Structured settlements essentially do not create any income until the annuity “pays out” as scheduled. So in cases with large settlements it makes sense for clients to consider the consequences in the event of child support issues.