Child Support When a Parent Is Self-Employed or Owns a Company

For an employee, finding income for child support usually starts and ends with a T4 and a tax return. For a self-employed parent or a business owner, the picture is rarely that simple.

The Child Support Guidelines give courts specific tools to look past the tax return when it does not show the money really available to pay support. This article explains those tools, what you will need to disclose, and the common points of disagreement.

The starting point: the Child Support Guidelines

Under section 150 of BC's Family Law Act, a court ordering child support must generally use the child support guidelines. BC adopts the Federal Child Support Guidelines for this purpose, with some modifications, through the Family Law Act Regulation. The table amount of support depends mainly on the paying parent's income and the number of children. Our article on how child support is calculated in BC explains the basics.

For a business owner, the hard part is not the table. It is working out what the income figure should be.

The tax return is only the beginning

Section 16 of the Guidelines starts with the "total income" on the parent's T1 tax return, then adjusts it under Schedule III. Several of those adjustments matter to self-employed parents:

• Dividends are counted at the actual amount received, not the grossed-up taxable amount shown on the return.
• Payments to family members that reduce self-employment income, such as a salary paid to a new partner, are added back unless the parent shows they were necessary to earn the income and reasonable.
• Capital cost allowance on real property is added back.
• Capitalization: for a sole proprietorship or partnership, money properly needed to be kept in the business for capital purposes can be deducted.

If income goes up and down, section 17 lets the court look at the last three years and choose a fair figure based on the pattern, rather than relying on one unusually good or bad year.

Business expenses: deductible for tax is not the same as fair for support

A common dispute is whether expenses the business deducts for tax purposes should also reduce income for child support. Section 19 lets the court impute income where a parent unreasonably deducts expenses, and it says expressly that an expense is not reasonable just because the Income Tax Act permits it.

Vehicle costs, home office expenses, meals, travel, and personal items paid through the business are frequent examples. The question is whether the expense is genuinely needed to earn the income, or whether it is a personal benefit that should be counted as money available to the parent.

If you own a company: section 18

Many owner-managers pay themselves a modest salary or dividends and leave the rest in the corporation. That can make sense for tax, but it means the personal tax return may understate the money available for support.

Section 18 lets the court, where a parent is a shareholder, director or officer and their personal income does not fairly reflect all the money available for child support, include:

• all or part of the corporation's pre-tax income for the most recent taxation year, including that of related corporations, or
• an amount that reflects the value of the services the parent provides to the corporation, up to the corporation's pre-tax income.

When calculating pre-tax income for this purpose, salaries, management fees and other payments to non-arm's-length people are added back unless the parent shows they were reasonable.

This does not mean all retained earnings automatically count as income. Businesses have real needs for working capital, debt repayment, equipment and reserves, and other shareholders may have a say in what the company does with its money. Showing why money stays in the company, often with an accountant's help, is usually central to these cases.

Imputing income

Beyond expenses, section 19 lists other situations where a court may impute income, including where a parent is intentionally under-employed, has diverted income in a way that affects support, has not provided required income information, or earns a significant part of their income from sources taxed at lower rates, such as dividends or capital gains. In that last situation, the court can impute additional income to account for the lower tax rate.

What you will need to disclose

Section 21 of the Guidelines sets out income information a parent must provide when support is at issue. In addition to three years of personal tax returns and notices of assessment:

• A self-employed parent must provide three years of financial statements for the business or practice, and a breakdown of payments to non-arm's-length people.
• A parent who controls a corporation must provide three years of financial statements for the corporation and its subsidiaries, and a similar breakdown of non-arm's-length payments by the corporation and related corporations.
• A partner must provide confirmation of income, draws and capital in the partnership for three years.

Incomplete disclosure is one of the circumstances in which a court can impute income, so it rarely helps the person holding back. Our article on financial disclosure after separation covers the wider disclosure picture.

Getting the number right

In business-owner cases, each side often needs a clear analysis of the financial statements, and sometimes an income report from a chartered business valuator or accountant. Whether you own the business or are the parent receiving support, early legal advice helps you know which documents to ask for, which adjustments are likely to be argued, and when an accountant's report is worth the cost.

Business income in a child support case? Get the figure reviewed early

Our family lawyers can review the tax returns and financial statements, identify the Guidelines adjustments likely to matter, and work with your accountant on income for child support.

Call 604-259-2844 or send us a message to arrange a consultation at our Vancouver office.