Self-employed Parent’s Income Determination for Child Support in Tennessee

Determining a Self-emloyed Business Owner's True Income for Setting Tennessee Child Support Can Be Challenging

Determining a Self-employed Business Owner’s True Income for Setting Tennessee Child Support Can Be Challenging

Determining a business owner parent’s income for setting Tennessee child support requires obtaining and reviewing detailed financial statements, tax returns, other supporting business records and knowledge of the TN Guidelines’ specific requirements for calculation.

Determining a Business Owner’s Income

A child support case involving a self-employed parent who pays child support is going to be more difficult – every time – than a paycheck-collecting employee.

In Tennessee, the child support computation begins with a determination of a parent’s “gross income,” a phrase which is defined to include income from “all sources,” including self-employment income. “Self-employment income” is also defined within the Tennessee Child Support Guidelines, and it means “…income from, but not limited to, business operations, work as an independent contractor or consultant, sales of goods or services, and rental properties, etc., less ordinary and reasonable expenses necessary to produce such income.”

It is helpful to cover this topic, using federal income tax return documents. A person can be characterized as “self-employed” based upon the type of income tax returns they file and year-end income documents they receive from the business.

A Tennessee Business Owning Parent’s Income Determination Normally Starts with Business Income Tax Records

A “sole proprietor” annually files a “Schedule C” to the IRS Form 1040. This tax return may even be completed by hand, using a shoebox of receipts and some bank statements. Simply because a sole proprietor had a tax preparer complete and file the returns does not mean that the accountant has reviewed any records or confirmed any figures; such is the role of an auditor. A sole proprietor might not have any annual income statement issued by the business. But a sole proprietor may have Form 1099s from persons or businesses that hired him to perform work and paid him at or over $600 during the year.

“Partners” are also self-employed. At year’s end, each receives a federal Form K-1 to quantify their portion of the income, loss, and deductions of the partnership. This information flows onto a person’s individual income tax return, much in the way that an employee W-2 Wage and Benefit Information flows onto a different line of the federal Form 1040. The partnership’s tax return is assembled on Form 1065.

A person who owns a corporation are also considered “self-employed.” You might learn it is a “C-corp,” or an “S-corp,” “LLC,” “PC,” or other variation of a “corporation.” These variations have to do with the annual earnings of the business and the owner’s financial liability. The corporate business owner also receives a Form K-1. These annual statements issued from a business go to the owner, as well as to federal and state tax authorities.

And, one additional category of self-employment that routinely arises is that of a rental property owner, where income-related information is found on IRS Schedule E.

While an employee receives periodic paychecks from his employer, the self-employed person might receive a paycheck, but also take a “draw” of moneys, defer income, or receive income disguised as company perks. Any benefits that are in excess of reasonable and customary business expenses might be excluded from deductions for the computation of child support.

Not All of a Business Owner’s Deductions Are Allowed for Tennessee Child Support Income Determination

Reading Financial Statements Carefully is Important to Correctly Determine a Self-employed Business Owner’s Income for Setting Child Support

Note should also be taken of any depreciation deductions taken on business tax returns because these deductions are not allowed as part of business expenses for purposes of child support calculations. Any amount taken on an income tax return as a depreciation deduction is added back into income for child support calculations although there are certain exceptions to this provision as reflected in Tennessee appellate opinions.

As you can see just from this brief overview of tax documents related to self-employment, it is important to know what to ask for and how to carefully read the financial documents, otherwise the child support calculation will be incorrect.

When a primary residential parent fears or can demonstrate that the parent paying child support has underreported income for tax purposes or otherwise hidden income, it may be time to involve an expert witness, a forensic accountant, in the review of the financial records of the self-employed parent. In rare cases, courts can even appoint an independent auditor to review the financial records of a company. In the most extreme cases, a receiver might even be appointed to take over the financial transactions of the company, literally receiving the moneys paid by clients and remitting expenses.

The real key to self-employment child support cases is whether a parent is forthcoming with financial records to permit a reasonably accurate income and expense analysis. Whenever there is resistance to laying out the books and the supporting documentation, one can essentially assume there is a problem with the bookkeeping and its accuracy or completeness.

Once the records are in hand, headlight focus should be put on the “gross receipts” of the business. These are the revenues received by the business, and whether it is accurately reported to the government on tax returns is a threshold question in a child support case. If you can prove that gross receipts were under-reported, you will have gone a long way to making the argument that child support should be calculated at an amount higher than a strict computation using income tax returns.

Examples Under Tennessee Child Support Guidelines Cases

One case that helps us to understand these principals is Gina Scarlett Ferrari Pace vs. Ward Redden Pace, No. M2009-01037-COA-R3-CV (Tenn. Ct. App. 2010). The father was an automobile broker and a partial owner of Global Motor Sports. He sold that ownership interest and became partial owner of a different company, Dixie Motors. The father provided income tax records for 2005-2007, showing income of over $200,000 per year. Even though he claimed his income went down in 2008 to $32,750, the father failed to provide any proof of 2008 income, whether in the form of paystubs, tax returns, or other. Without any documentation of recent, decreased income, the court discredited the father’s testimony and used the earlier income figures from his filed tax returns.

Another illustration from a self-employment child support case is Irina N. Parris vs. Jerral D. Parris, No. M2006-02068-COA-R3-CV (Tenn. Ct. App. 2007). The father claimed he was a poet and construction company owner; he also owned rental properties. He claimed that his income from Harmony Industries for three years from 2004-2006 was “negative zero.” It turned out that bank deposits during the period April 2005 to April 2006 were $237,692.76 of which $191,109.87 was business income. The father claimed the money was spent. The court determined that there were only expenses of $41,880.91. The court attributed a “net income” to the father of $149,228.96 and computed his child support obligation to be $1,646 per month.

For many more examples and income determination case law summaries, see the Income Determination category in the Child Support Section of our Tennessee Family Law Blog.

Finally, it is worth mentioning that there is yet another approach to a determination of the income of the self-employed parent, and it is particularly useful when documents are not forthcoming called the “lifestyle audit” or the “net worth method.” Developed by the IRS, the lifestyle audit takes into consideration what one can see and value, e.g., the house, the cars, the motorized toys, the trips, the household help. The argument is then made that the only way to afford this level of assets was to earn a certain amount of money per year over so many years.