May 18, 2021

Income Determination for Self-Employed Payer Parents

Richmond Tymchuk Family Law

A common challenge we face is determining what is a reasonable amount of child support or spousal support when the payer spouse is self-employed?  Whether the payer parent is self-employed through a proprietorship or corporation, we discuss the relevant considerations below.

 

When the payer parent is self-employed through a proprietorship 

In the payer parent’s tax return, line 150 shows the total income before deductions. However, many self-employed individuals will try to keep their line 150 income as low as possible to reduce the amount of taxes that they pay and if we simply use their line 150 number as their income to determine payments, that parent may be paying less than their fair share to support their child(ren) or their former spouse. 

The important consideration to determine what income should be used to calculate support payments is to look at the expenses which have been deducted from the proprietorship or corporation, to determine if any of these expenses are something that the payer parent derives a personal benefit from. 

Under Section 19(G) of the Federal Child Support Guidelines (FCSG), these expenses can be imputed into the payer parents income (and grossed up for taxes) where the expenses have been unreasonably deducted. 

Here, the onus will be on the payer parent to show that the expenses are reasonable.

Looking at the statement of business activities will give us an idea of the expenses, and whether any of these could be considered to be “accounting fiction” – expenses to reduce taxable income or if they are expenses for which the payor parent derives a personal benefit, which is not strictly for business operations. 

Common examples can include expenses like: 

  • Telephone expenses
  • Motor vehicle expenses
  • Business use of home expenses
  • Amortization

What proportion of that expense is a personal expense and what is business? The personal expense portion will be added back into the total income. Importantly, the add backs will be added back as gross value. 

Laurie Tymchuk says “If this person had to use their after tax dollars to pay this expense, what amount would they have to earn in gross value as a T4 employee in order to get that net amount?” 

 

When the payer parent is self-employed through a corporation 

In this case we want to look at the income statements as a starting point and perhaps general ledgers as well. Generally, the types of expense categories we’ll be looking at are the same as above – motor vehicle, phone and could also include promotions and entertaining expenses like meals. 

Where there’s a personal benefit to the shareholder from that expense, we want to work out what percentage of that benefits the shareholder personally, then add it back into the income. Again, as above, grossing it up on a pre-tax basis. 

Often what shareholders will do is only draw an amount of income that they need to live. They use the corporation as a personal or retirement savings account so as to keep a lot of value in the corporation (which is otherwise available to pay support). 

Section 18 ensures that that value gets added back into a payer’s income so that the support recipient or children are benefiting from the total amount available to pay support. 

Section 18(1) says: 

18.(1) Where a spouse is a shareholder, director or officer of a corporation and the court is of the opinion that the amount of the spouse’s annual income as determined under section 16 does not fairly reflect all the money available to the spouse for the payment of child support, the court may consider the situations described in section 17 and determine the spouse’s annual income to include

    • all or part of the pre tax income of the corporation, and of any corporation that is related to that corporation, for the most recent taxation year…

Some questions which were asked in our recent webinar included: 

 

Is it common for people to get income valuation done professionally each year? Or do you rely on the information provided during the divorce proceedings? 

Professional income determination doesn’t need to be done each year IF you have a plan in place that you can replicate on your own each year, provided there are no material changes to how income is reported on the Statement of Business Activities of Income Statement. It is a common approach to rely on a reasonable formula which can be used going forward. Such formulas are typically put into place by consent rather than judicial or arbitral decision, and the formula may continue to be used provided there are no material changes. 

To create this formula you could look at the methodology the business valuator used and see if you can identify themes which could help you create an ongoing formula. You will want to work on this income determination formula with your family law lawyer and your accountant or business valuator. 

 

What happens if the other party refuses to have income determination done? 

The Notice to Disclose Application is the starting point. If that information is not sufficient for analysis purposes, you have 3 options: 

File a Notice to Reply to Written Interrogatories Application. This can only be used if there is a pending application before the court and the payer needs to reply to the list of 30 or less questions by way of Affidavit which must be filed with the Court.

By questioning. The availability of this will depend on where you are in the process. You can ask for information or documents to be provided at a later date by undertaking and conduct further questioning on undertakings if necessary.

Or, take a strategic approach. If you do nothing, you can rely on the case law that says the obligation rests with the spouse who operates the business to prove the legitimacy of the expenses. If they don’t, the court can draw an adverse inference. 

 

Am I or my ex-spouse required to provide formal disclosure every year? 

In any order for child support, there is a mandatory disclosure clause that says by June 30 each year the party shall provide a tax return and notice of assessment. This clause has recently been expanded to include disclosure of corporations. 

Only the financial statements have to be produced under the mandatory disclosure clause, not general ledgers. 

Once per each 12 months you have the right to file and serve a notice to disclose.

This is a complex area of family law and this post should not be taken as legal advice. If you want advice specific to your situation, please contact us to arrange a consultation. 

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