Alimony Or Child Support: Self-Employed vs Salaried
Determining alimony or child support when a spouse is self-employed is more complicated than for a traditional employee. With a normal, salaried employee, all employment compensation on a W-2 counts, and it typically consists of salary (or an hourly wage), with the possibility of bonuses or commissions.
With a business owner, the income situation is murkier;. For the self-employed, child support or maintenance income includes both salary, plus earnings based upon the profitability of the business. Sometimes such earnings are paid out in draws, but often they are kept in the company and reinvested, or used to create a “float” in the company accounts.
Self-Employed Child Support Or Alimony Includes Business Income
Colorado law provides that when a parent owns a business, for the purposes of both alimony and child support, his “gross income” includes:
Income from general partnerships, limited partnerships, closely held corporations, or limited liability companies. However, if a parent is a passive investor, has a minority interest in the company, and does not have any managerial duties or input, then the income to be recognized may be limited to actual cash distributions received.C.R.S. 14-10-115(5)(a)(I)(W) (Child support) or C.R.S. 14-10-114(8)(c)(I)(W) (Maintenance) (Emphasis added)
The emphasized language is the topic of this post. Over the years, courts have struggled with how to treat income from a self-employed business owner, especially under the previous version of this statute, which simply provided that “taxable distributions” counted as income. But in 2013, the Colorado Assembly made several changes to the self-employment portions of the statute with HB 13-1209, included clarifying the section above.
The statute is now clear that for child support (and maintenance), the court needs to consider all business income reported on a Schedule K-1 as the self-employed owner’s share of the business earnings, not simply the funds which the owner takes out in draws or distributions. The only exception is that a court may exclude undistributed income from a company where the party basically has no involvement or control other than being a passive investor.
A business owner has a unique ability to control her flow of income by choosing what to take in draws, and this statute is aimed at preventing manipulation of income for purposes of child support or maintenance. When a person owns shares in a corporation, or is a passive minority shareholder in a smaller business, the statute recognizes that the potential for manipulation of income is slim, so in that case normally only funds actually distributed will count as income.
For more information, see our article on business & self-employment income in a Colorado divorce in the Colorado Family Law Guide.
Business Earnings vs Draws vs Alimony
A self-employed person who is a majority shareholder or otherwise controls the business, however, will have included in her income all earnings of the business attributable to her on a Schedule K-1, even funds not distributed. Without this rule, it would be too easy to artificially reduce one’s income by just leaving profits in the company bank account.
For that reason, the concept of a “draw” has little meaning in a Colorado domestic relations proceeding. By way of example, a business owner may take out a $20,000 business loan, and in the same time frame, take a “draw” of $5000 from his business. That draw is not actually earnings, but simply spending funds which the business borrowed. Or money may have been earned in a prior year (and counted as income in that year), but this year the owner takes the distribution – same principle – it was not just earned, he just decided to spend money previously earned.
Undistributed Business Earnings Must Be Included As Income
The Colorado Court of Appeals recently reversed a trial court which had determined a husband’s alimony based only upon his draws, and not upon the actual earnings of the business.
In Karsten,1In re: Marriage of Karsten (Colo.App. No. 19CA0558, June 25, 2020) (Unpublished decision). the husband owned and controlled a business and had discretion how much to pay employees, and how much to draw in earnings. His profit & loss statement reflected earnings of almost $29,000/mo, but the trial court counted as his income less than half that amount, or $13,500, counting only the salary he actually paid himself, plus a couple of other add-backs. The judge found it was reasonable to withhold earnings in the company to reinvest in material, vehicles, real estate, etc.
But the standard for determination of a business owner’s income is whether the company had earnings, not whether it was reasonable to leave the earnings in the company for legitimate business purposes. And for that reason, the Court of Appeals reversed:
Because husband is self-employed and his income is derived from his business, of which he is the only owner, his income is not automatically limited to the salary that he chooses to pay himself. Rather, the court was required to calculate husband’s income from self-employment by using his business’s “gross receipts minus ordinary and necessary expenses… That formula recognizes the fact that a self-employed spouse can manipulate his or her own compensation to avoid paying maintenance.Karsten.2In re: Marriage of Karsten, ¶¶ 16-17 (Colo.App. No. 19CA0558, June 25, 2020) (Unpublished decision) (Emphasis added).
FAQ – Self-Employed Business Income & Family Support
How do I pay child support if self-employed?
In Colorado, child support and alimony are both based upon total business earnings, including undistributed funds not withdrawn by the business owner. For a closely-held company managed by the party, if the earnings are on a Schedule K-1, they count as income.
How does child support work for business owners in Colorado?
For purposes of child support and alimony, a self-employed business owner’s income is the gross business earnings minus reasonable expenses. And if the business is paying any personal expenses, those amounts are added back to the income.
Can I deduct all of my business expenses from my income for purposes of alimony?
No – accelerated depreciation is disallowed by statute, and a court will add-back expenses paid by the business which have the effect of reducing the party’s living costs.
Do I have to pay child support based upon money I never paid myself?
Yes – as long as the child support payor owns or manages a business, all business earnings reflected on a Schedule K-1 will count as income, even if the money is legitimately left behind in company accounts.
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