Determining income is the first step toward determining child support and spousal support. This is easy to do for employees. The challenge is determining the income for people who are self-employed.
Self-employed people often write-off expenses from their income to minimize taxes. The purpose of writing off as many expenses as possible is to minimize their profit, as self-employed people pay income tax based on their profit. The more in expenses they write-off, the less the profit and the less they pay in personal income taxes. It makes sense and cents.
When it comes to determining income for support purposes, some of the soft expenses may be considered unacceptable and will be brought back into income. Typical soft expenses are cell phones, home offices, car, entertainment, restaurant meals and home office expenses. Typical hard expenses are advertising, rent for office space outside of the home, advertising and employees.
The self-employed person needs to prove that the expense is necessary to generate an income and is solely related to the operation of the business. The support recipient wants to have the expense disallowed and needs to prove that the expense is not related to the operation of the business, but rather is a personal benefit bestowed on the self-employed. This requires an examination of the business financial statements.
For example, let’s say that the self-employed person writes off his cell phone as a business expense yet he uses the cell phone 50% of the time for personal calls and the annual cost of the cell phone is $2,000. Fifty percent of the cell phone cost could be added to his income, but that’s not the end of the story.
There will be an additional amount assigned to the self-employed to account for income taxes an employee would have to pay in order to have $1,000 left over for his cell phone expense. This is called “imputed income”. So, if the self-employed person’s tax bracket is 40%, then $1,667 would be added his income (imputed) to take into account an employee would have to earn that amount to net after taxes $1,000.
This sort of determination won’t affect the self-employed person’s income taxes in any way. Canadian tax-collectors don’t come to family court or look at privately negotiated separation agreements.
Once income for support purposes has been determined, the amount of spousal support and child support can be determined. Also, the new income amount will be used if any child-related expenses are shared in proportion to income.
A private way to resolve such issues is through the Collaborative Process of divorce. It is a private and effective negotiation process when compared to Family Court, where all of your records will become available to the public.
The determination of income of self-employed people can be a difficult process. Every case is unique. Sometimes, we hire a chartered accountant to assist with the analysis. Our lawyers have experience looking at financial statements and working with accountants. We can help you.