Examining business deductions and income determination for child support
When a payor of support owns a business, a contentious issue that might arise is the determination of the payor’s income. The Child Support Guidelines recognize that the income that a payor of support takes home, under line 150 on their tax return, might not be equal to the amount of income available to the payor from their business. In other words, the court recognizes that there may be business deductions legitimate for the purposes of income tax but not for the purposes of child support. Section 18-20 of the CSG provides guidance on the matter.
If there are unreasonable business expenses, the court can impute income to the payor parent to boost their income to where it would have been. Like most other subjects in family law, the court does a contextual analysis and decides based upon the unique factors of each case.
For example, Szitas v Szitas, 2012 ONSC 1548, provides several examples where business deductions were added back to the payor’s income for the purposes of child support:
By way of examples:
1. In Lemmon v. Lemmon, notional deductions for home office and promotional expenses that had personal overtones were added back into the payor's income.
2. In R. (P.C.J.) v. R. (D.C.), the British Columbia Court of Appeal imputed income back to the payor father on account of claimed food, motor vehicle and telephone expenses because there was an element of personal benefit to these expenses.
3. In Manchester v. Zajac, the court imputed a number of claimed business expenses for home office expenses, car expenses, utilities and capital cost allowance back to the payor as income because of the personal use aspects of the expenses.
4. In Cook v. Cook, the court imputed claimed expenses for a home office into the payor's income on the basis that these expenses were payable by the payor whether she operated her business from the home or not, and that the payor had not adduced any evidence to establish that the cost of operating her business from the home materially increased the cost of operating her household.
5. In Osmar v. Osmar, the court imputed home office and automobile expenses back into income as a result of the personal benefit which the party derived from the expenses.
6. In Wilson v. Wilson, the court added business expenses for meals and entertainment, and a portion of the expenses claimed for cell phone, computer and internet back into the payor parent's income based on the personal nature of the expenses. The court also added the amount claimed for work-space-in-the-home expenses back into the party's income, since the party did not adduce any evidence showing that he needed a larger home to carry out his work as a commissioned salesman. The court concluded that the party would have likely incurred these same household expenses even if he did not require a home office.
Another, perhaps more cumbersome, consideration is for a capital cost allowance for a business asset. In other words, consideration into the deduction of depreciation of an asset, such as a car, from the payor’s business income. Obviously, depreciation occurs over time, and likewise, the deduction occurs over time, affecting income into the future. This type of deduction is particularly problematic because it may not have any upfront cost to the business owner, unlike other expenses such as having to pay an employee. Szitas v Szitas continues on the subject:
The court concluded that the following factors may be relevant in any given case in determining whether the deduction claimed is reasonable in the context of the child support analysis:
1. Was the capital cost allowance deduction an actual expense in the year in question?
2. Was the capital cost allowance deduction greater than or less than the cost of acquisitions during the same period?
3. Was the capital cost allowance deduction greater than or less than the repayments of principal with respect to the chattels in question?
4. Was the capital cost allowance deduction the maximum allowable capital cost allowance deduction?
5. Was it necessary to take the capital cost allowance deduction in that year?
6. How much of a loss in a business year resulted in that year?
7. Are the chattels for which the capital cost allowance deduction claimed truly needed for business purposes?
8. Do the chattels for which the capital cost allowance deduction was claimed truly depreciate?
9. Is it foreseeable that future chattel purchases will not be required?
10. Is there a pattern of spending that establishes a greater real income than income tax returns indicate?
11. If the children were living with the party, would they benefit from the actual income earned by the spouse?
12. Is there a dire need for child support?
Cases decided since Cornelius v. Andres have established the following additional factors which may be relevant to the analysis:
1. Whether the capital cost allowance deduction claimed in the year in question corresponds generally with the actual depreciation of the property for which it was claimed.
2. Is there an intention to replace the chattel(s) in relation to which the deduction is claimed? If there is an intention to replace it, what is the cost of replacement and when will it need to be replaced?
3. Does the chattel continue to serve a useful function for the business?
4. Did the party claiming the capital cost allowance deduction set aside funds during the years in which the deduction is claimed for the purchase of new equipment?
5. Is the capital cost allowance deduction a real expense or a book entry to simply reduce income? Is it reasonable and necessary?
6. What capital acquisitions are needed in the foreseeable future to sustain or expand the business?
If it is determined that business expenses claimed by a party should be added back into that party's income, the amount added to income should be grossed up by the party's marginal tax rate to place the party's real income on par with what it would be for a person with a salaried income who would be taxed on the amount in question.
In the case, the court says that the party refuting the deduction as an obligation to raise this concern, but the party seeking the deduction has the onus of presenting the evidence for why it is a reasonable expense. In the case, the father was seeking a capital cost deduction of over $11,000.00 for his vehicle for one year alone. However, the court refused to allow any of the deduction, and imputed it all back to the payor’s income. Most significantly, the payor did not present any evidence whatsoever that the depreciation was an actual expense to the payor or that the amount claimed was reasonable for the specific year in question.
Obvious takeaways? The court understands that business owners’ personal income may not reflect the amount of income available to them. When it comes to child support, courts are loathe to allow business owners to avoid part of their child support obligation by incurring unreasonable business expenses and deductions.