This is not legal advice. If you require legal advice, contact a lawyer.
Calculating The Income Of Self-Employed Individuals For Child Or Spousal Support
When calculating the income of a self-employed individual, there are many factors that one must consider. They will need to determine what they consider personal expenses and business income. Unfortunately, it is not this simple. Do you also have other area of employment? Is your business operating as a corporation or as a sole proprietor? If you are operating as a corporation, are you earning an income as a shareholder or an employee? These are just a few questions that are a part of a complex structure in determining your income.
How Is The Calculation Of A Self-Employed Different Than A Salaried Employee?
The starting point for determining a non-self-employed person’s annual income is to look at their tax returns. Line 15000 (previously line 150) is what most individuals consider their pre-tax income. This is the number typically used when calculating child or spousal support in Alberta.
We cannot only use Line 15000 for self-employed individuals . This is because these individuals are legally able to pay themselves whatever amount they wish through either dividends from the company or as an employee of the company. The owner can keep additional income or profit within the company as a “retained earning”. Examples of why individuals can do this vary from keeping money in the company in anticipation of upcoming operational expenses, to future capital purchases for the company, or to simply save money for a rainy day or retirement purposes and not pay personal taxes on the corporate money at that point in time.
Generally, any money the company keeps for non-business operational purposes is actually ‘available’ to the owner of the company. As such, it must be a part of the individual’s income for support calculations.
What Are The Two Components For Determining A Self-Employed’s Income?
For the above reasons, a self-employed individual’s personal tax return often does not reflect the money they have available to pay child or spousal support; the analysis has to go further and really evaluate the financial statements of the company. We need information from both the tax return and the company. The two numbers together determine the entire income that a self-employed party should be paying support on. The main formula will be:
Line 15000 income will include both payroll and dividend payments. (Note: we need to adjust dividends to ensure they are taxed at the appropriate rate);
Any available corporate income which was earned by the company during that year and could have been paid out to the owner and reflected on their personal tax return, but was not. This is the “additional business income”
What Documents Do I Need To Review To Determine Business Income?
A judge will typically begin by reviewing two documents that companies must fill out each corporate year. These documents are the balance sheet and the income statement. Both documents appear in either a company’s financial statements or within their corporate tax returns. If a business owner is not operating as a corporation, this information will be in their actual personal tax return under “Business Operations”.
How Do I Determine The Additional Business Income?
An individual’s additional business income for the purposes of calculating child and spousal support is most often calculating by taking their corporate revenue and subtracting business related expenses.
The income statement shows a company’s annual revenue. This number represents the amount of money the company generates and deposits into the corporate bank account every year.
Next, we make an inquiry regarding what expenses are business related. True business-related expenses will be deducted from the corporate revenue. As part of this review, there is an inquiry about which expenses, that the business pays for, are actually of a personal nature and benefit to the owner. Expenses which are of a personal nature are not typically allowed to be deducted from corporate income for the purposes of support calculations; even though CRA permits the deduction for the purposes of tax filing. Any expenses which are of a personal nature will also consist a portion of the corporate income available for support purposes.
As part of the analysis, we consider what sort of expenses are common depending on the type of company. A company that builds houses is will likely have significant expenses for the purchase of materials necessary for construction. An investment company is likely to have mostly office expenses. It is often important to understand the details of what staff a company regularly employs, its day to day operations and future plans for growth or downsizing, as that will help in the analysis of determining legitimate business expenses.
During an initial review of the financial statements, there is a review of each expense the company pays. The main questions being:
1) Are they solely business related?
2) Are they of a personal nature / benefit to the owner?
3) Are they reasonable?
Lastly, we subtract from the revenue the expenses we believe are reasonable and are in relation to the business. This results in a final pre-tax number that is often referred to as the company profit. The profit is most often the amount of money that as self-employed individual has access to, and therefore it is typically an addition to their line 15000 income for the purposes of calculating child or spousal support.
What Are Examples Of Personal Expenses?
We typically “add back” some of these expenses when calculating a self-employed individual’s income, here are a few examples:
- If a person has significant expenses related to travel, meals, or entertainment; we “add back” some of those expenses by taking a percentage of them and adding them back into the profit;
- If a person has a cell phone or vehicle that they use for both personal and business purposes; they will often claim the entire expense. For that reason, we often “add back” a portion of vehicle and phone expenses.
- Sometimes you’ll see self-employed individuals expensing their personal legal fees or life insurance. These should be added back to their profit.
Cunningham v Seveny Disclosure
Cunningham v Seveny is a case from the Alberta Court of Appeal. The case said that a self-employed individual must provide all the necessary information to determine if an expense is purely business related.
This can be a burdensome process. The self-employed individual has to provide receipts, invoices, bank statements, and explanations for each expense. This is to make a proper determination that each expense is truly for the business.
Hiring An Expert Accountant
Your lawyer can provide a very rough estimate of what they think a self-employed person’s income may be from looking at a financial statement. However, it is best to engage the help of an expert accountant or request further financial disclosure.
Your lawyer will be able to suggest an appropriate expert based on your budget. They can also help that expert get the information they need to determine a self-employed individual’s income. If you have more questions, please do not hesitate to contact our excellent team of family lawyers through email or call us at 403-255-8810.