By Jamie R. Walker
and Matthew Taylor
It is frequently challenging in divorce or family law matters to deal with business income when seeking or defending against a motion for temporary orders, given page limits and time constraints. Business owners may underestimate the amount of income available to them, whereas the non-business owner may fail to distinguish between business and personal income. The first places to look in attempting to determine what constitutes business income are the statutes and case law governing income.
In the context of child support, the important thing to know is that income is defined very broadly in RCW § 26.19.971(3), which directs the court to consider income “from any source.” This includes salaries, wages, commissions, deferred compensation, dividends and bonuses, as well as “income from self-employment, rent, royalties, contracts, proprietorship of a business, or joint ownership of a partnership or closely held corporation.”
Likewise, in the context of spousal maintenance, income is broadly defined. The court generally considers the same resources it uses in setting child support to award maintenance, although the court has greater discretion with maintenance.
If we represent the business owner, we may have to convince them, as well as the court, as to what their available income actually is on a temporary basis. Nearly all business owners start by saying they don’t make a profit, which, of course, for tax purposes is usually the case. If we represent the non-business owner, we may hear about expenses that have always been run through a business and a lifestyle that far exceeds what is shown on tax returns and business records as traditional income that shows up on a W-2. Some small-business owners can be relatively informal with their accounting practices; treating business income as if it is personal income.
On a motion docket, all of this can create a substantial disconnect between the resources of the households and what a tax return shows as “income” or resources to the parties. While we rely on our experts and CPAs for valuations or specific findings as to income, we do not always have the luxury of time to go this route before a temporary orders hearing.
Although a statement from an expert or CPA is always best, there are a few key places where we can look when determining (or defending) our preliminary positions on business income for purposes of setting child support, spousal maintenance or debt payments on a temporary basis if an expert or CPA statement is not available.
Few businesses show income as profits or wages to the business owner. While profits and wages are a part of the equation, it is rarely the extent of the business owner’s financial picture or benefits received as a business owner. In other words, there is probably a reason a business owner chooses to be an entrepreneur as opposed to an employee.
There are three common business structures that we deal with in family law: sole proprietor, limited liability companies and S-corporations (closely held businesses).
In a sole proprietorship structure, you can look to the individual tax return where both business income/profit and personal income are reflected on the same return. You may also want to compare the expenses listed with those on the financial declaration to see if expenses that are listed as monthly expenses out of the party’s income are actually coming out as a business expense.
Home offices, cell phones, cars, entertainment, food, travel, timeshares or other expenses may be encompassed in business expenses, but may also find their way onto a financial declaration, reducing the amount of money available to pay spousal maintenance or temporary debts. This can easily be demonstrated to the court by comparing the tax return and the financial declaration, and creating a chart within a client declaration for the court to review.
For limited liability companies or S-corporations, you can start by referring to Schedule K-1 of the business tax return. This section will reflect ordinary business income (profit), interest income, dividends, gains and “other income,” which may be resources in addition to what shows up as wages to a business owner. Arguably, all of these sources can be characterized as income by the court when determining child support, spousal maintenance or temporary debt payment allocation.
A full review of the tax return may show loans to shareholders, which you may argue are a cash resource for purposes of temporary orders. You may also include a shareholder’s pro rata distributions as income and look for retained cash assets and retained earnings to list as available resources to the business owner. If the individual is a shareholder, you can disclose their pro rata share of retained earnings.
Retained cash assets within the business are one of the most common ways to reduce income to the business owner. This is money available for distribution that has been withheld, sometimes for tax liability purposes, or for legitimate business planning or the need for available capital. These are all arguments that can be made based upon a review of the tax return or statement from the business bookkeeper, CPA or expert.
If you are in the mid-year, you may also have the benefit of a profit/loss balance sheet. Look for draws on income to the business owner or shareholder loans as a cash source to be disclosed.
In sum, in the context of temporary orders hearings on family law motion dockets, practitioners usually do not have the time to obtain opinions from CPAs or other experts for business valuations or other specific findings on business income. The above-described documents are an attorney’s best bet for supporting an argument on temporary orders and achieving a good result for the client pending final resolution of the case.
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