"RECAPTURING" THE INCOME OF THE SELF-EMPLOYED SPOUSE OR PARENT
In determining spousal maintenance and/or child support in a family court case, the Court must determine the income of the parties. Typically, this is a fairly simple process of looking at paystubs, W2s, tax returns, etc. Sometimes there are small curveballs thrown in such as variable bonuses, commissions pay, and the like.
But what about the case of the person who is self-employed and is able to deduct all manner of expenses to reflect an income that is significantly lower than their gross receipts? Those deductions may be perfectly legal from a tax standpoint but may so significantly alter their actual income that it may become objectionable to use that figure as their income for determining a family support amount.
In cases such as this, the Court can “recapture” some of the deductions. The Court can add these “deductions” back into the spouse or parent’s income. This recapture is allowed pursuant to the Arizona Child Support Guidelines, which states that “for income from self-employment, rent, royalties, proprietorship of a business, or joint ownership of a partnership or closely held corporation, gross income means gross receipts minus ordinary and necessary expenses required to produce income.”
To go about the recapture process you will first need to obtain the tax returns of the self-employed party together with any and all Schedules. Many self-employed people will utilize a Schedule C as part of their personal tax return or will file a separate tax return for the business. Either way, there will be an accounting of what expenses are deducted from gross receipts.
Once you have this basic information and accounting, you can then start to see if the expenses are “ordinary and necessary expenses required to produce an income.” If not, you could argue that these expenses - or at least a partial amount of them- should be recaptured as income. Common examples of this are deductions for personal expenses, such as auto, phone, and travel/meal expenses. For instance, many people will deduct the entire amount of their phone plan and auto costs even though they use that same phone line and auto for personal use, as well as for business use. Another common expense to recapture is when there are large travel and meals expenses when their business is not the type of business that requires these type of expenses to produce business income.
In some cases, it may be prudent to issue discovery requests to obtain more detailed documentation of the expenses. For instance, Quickbook logs, bank statements, credit card statements, and invoices/receipts can all provide information that a Court would find useful in determining if the expenses are “ordinary and necessary expenses required to produce an income." However, the discovery process can be costly and time-consuming. Before embarking discovery, your attorney should advise you as to a cost/benefit analysis of this venture. If the recapture would only amount to a minimal or small increase in child support or spousal maintenance, it is not likely worth incurring thousands in legal fees to pursue the same.
If you would like to work with one of our experienced Attorneys, please call OWENS & PERKINS at (480) 630-2464 to schedule your free 30-minute consultation.