Business owners and their ex-spouses face distinct challenges when calculating child support due to fluctuating income, business expenses, and the potential to manipulate financial records.
This article will discuss how child support is generally calculated for business owners, considering various factors and providing legal insights.
How Is Self-Employment Income Calculated For Child Support
While every state’s law will differ, there are some general guidelines courts use when calculating child support.
In general, income from self-employment is defined as gross receipts minus ordinary and necessary expenses required to produce income.
Tim’s Legal Tip: In every child support case with a business owner, income and expenses from self-employment should be carefully reviewed to determine the appropriate level of gross income available to the parent to satisfy a child support obligation. In most cases, this amount will be different than what is shown on the business tax returns.
The Court Will Examine All Business Expenses When Calculating Child Support
While every business has expenses, it has been my experience that business expenses can be manipulated to reduce apparent income for child support purposes.
Separating legitimate business expenses from personal ones is crucial in arriving at a fair child support calculation.
When calculating child support, a judge will examine the parent’s claimed business expenses. The goal is to ensure that both parents contribute appropriately to the financial needs of their children.
In general, a judge must determine whether claimed business deductions are ordinary and necessary to the production of income without regard to whether those deductions may be claimed for Federal or State income tax purposes.
Here are the steps a court will take when examining business expenses to calculate child support:
Step 1: Are The Expenses Ordinary and Necessary Business Expenses?
The judge will assess whether the claimed business expenses are ordinary, necessary, and reasonable for the operation of the business.
If the expenses are deemed excessive or unrelated to the business’s legitimate operation, they will not be included or may be adjusted.
The following is a list of business expenses that a judge will scrutinize:
- Extravagant Entertainment: Expenses for lavish entertainment, such as frequent high-end dining, luxury vacations, or extravagant parties, might be deemed excessive and unrelated to the essential operations of the business.
- Personal Travel: If a parent tries to claim personal travel expenses as business expenses without proper justification, such as claiming family vacations as business trips. The judge will question these expenses.
- Non-Business Vehicles: Expenses related to personal vehicles not used for legitimate business purposes, such as luxury or sports cars, may not be considered necessary for the business and could be disallowed.
- Excessive Charitable Contributions: While charitable contributions are valid business expenses in some cases, they will be scrutinized if the contributions are unreasonably high and not directly related to the business’s mission or industry.
- Non-Business-Related Memberships: Expenses for memberships to exclusive clubs, social organizations, or other groups that don’t have a clear business purpose might be challenged as unnecessary.
- Luxury Office Space: Renting upscale office space that exceeds the practical needs of the business and the industry norm might be viewed as an attempt to inflate expenses.
- Non-essential Staff or Contractors: If a parent employs family members or friends for roles that aren’t essential to the business’s operations, the judge will question the expenses related to their salaries or fees.
- Excessive Marketing or Advertising Costs: While marketing is essential, extravagant spending on marketing campaigns that don’t yield reasonable returns might be considered non-essential.
- Personal Expenses Mixed with Business Expenses: Mixing personal and business expenses, such as charging personal meals or family expenses to the company, can lead to scrutiny of the claimed expenses.
- Overly Luxurious Office Furnishings: If the parent invests in opulent office furnishings, artwork, or decorations that far exceed typical business needs, the judge may consider these expenses extravagant.
- Non-Business-Related Training or Education: Costs for personal development or education that aren’t directly related to the business’s operations might not be considered necessary.
- Supplies and Materials Not Consumed During a Tax Year: While ordinary and necessary supplies and materials are generally deductible, such deductions should be limited to materials and supplies actually consumed and used during the tax year.
- Taxes Paid by a Business: The I.R.S. permits the deduction of “various federal, state, local, and foreign taxes directly attributable to [the parent’s] trade or business,” but not federal income tax. A few states permit the deduction of self-employment taxes for purposes of child support. Arizona is one example wherein its child support guidelines expressly prohibit deductions for self-employment taxes paid.
Step 2: Is This a Business Expense, or is it a Capital Expenditure?
I have frequently seen business owners try to pass off capital expenditures as ordinary business expenses to reduce the amount of child support owed.
Capital expenditures are generally not considered ordinary business expenses for the purpose of calculating child support.
Capital expenditures are investments made by a business in acquiring, upgrading, or improving assets expected to provide benefits over an extended period, typically more than one year.
These expenditures are usually intended to enhance the business’s long-term value or efficiency rather than cover day-to-day operational costs.
While capital expenditures can indirectly impact a business’s financial health and, consequently, a parent’s income, they are not typically factored into child support calculations in the same way as regular operational expenses.
Step 3: Is The Parent Claiming Depreciation as a Business Expense to Reduce Net Earnings?
Business depreciation can impact child support calculations in various ways, although it’s important to note that the exact treatment can vary based on your state and the specifics of the case.
Depreciation is a non-cash expense that reflects the decrease in the value of assets over time. While it doesn’t directly impact cash flow, it can reduce the reported income of a business on financial statements.
In some cases, parents might attempt to use depreciation to lower their reported income for child support purposes.
However, many courts will add back a portion or all of the depreciation to the parent’s reported income, as it is a non-cash deduction.
Step 4: Did The Business Have Any Retained Earnings?
Retained earnings refer to the cumulative profits a business has retained rather than distributed to its owners (shareholders or partners) as dividends.
Retained earnings are typically reinvested in the business to support growth, fund operations, or pay off debts.
When calculating child support, retained earnings impact the parent’s reported income in the following ways:
- Retained Earnings to Maintain The Business: Earnings retained to maintain the business as currently operated are not typically included in gross income.
- Retained Earnings to Expand The Business: Earnings retained to expand the business, on the other hand, have the potential of increasing the business’ value and thus the shareholder’s net worth and will likely be viewed as income available for child support.
Step 5: Did The Business Pay any In-Kind and Personal Benefits, Including Auto, Travel, Home Office, Medical Insurance and Retirement Benefits
In general, most state child support guidelines address in-kind benefits and expenses resulting in a personal benefit to a parent. In-kind and personal benefits are typically added back into a parent’s earned income.
Most child support guidelines include numerous business expense deductions categories from which a self-employed parent can enjoy a personal benefit:
- auto expenses,
- medical insurance,
- retirement/employee benefits,
- and home office and utilities.
If a business-owning parent fails to assign a reasonable sum of additional gross income in consideration of the personal benefit the parent received from a business expenditure, a court will likely be justified in attributing a reasonable sum of money for those benefits back to the parent’s income.
Legal Considerations and Expert Assistance
Child support calculations for business owners often require legal expertise and financial analysis.
I recommend collaborating with an experienced family law attorney and financial professional specializing in such cases to help ensure a fair and accurate assessment of child support obligations.
Navigating the child support calculations as a business owner can be challenging. The interplay between income, business expenses, and legal considerations demands careful attention and accurate representation of financial records.
Remember that child support is ultimately about ensuring the well-being of children, and fair calculations contribute to their stable and secure future.