Child support when a parent is self-employed

For a parent on a salary, income for child support usually starts with a pay stub. For a parent who runs a business, freelances or works on commission as an independent contractor, there is no pay stub, and the parent controls much of what the business reports. Child support guidelines handle this with a common starting point and several adjustments. This guide explains how self-employment income is usually counted, where disputes arise, and what records make a case go smoothly.

The starting point: receipts minus business expenses

Every state’s guideline counts self-employment income. The usual definition is gross receipts minus ordinary and necessary business expenses, which for a sole proprietor closely tracks the net profit reported on Schedule C of the federal return. Some states also spell out a deduction for the cost of goods sold, and many apply the same definition to rental, royalty and partnership income.

The tax return is only the starting point. Tax law lets a business deduct costs in ways designed to encourage investment or to simplify bookkeeping, and some of those deductions don’t reduce the money actually available to support a child. Federal rules require state guidelines to take into consideration all earnings and income of the paying parent (45 CFR 302.56), so courts look past the tax treatment to the economic reality. Our guide on what counts as income covers the full list of income types.

Expenses courts look at closely

The disputes in self-employment cases tend to cluster around a few kinds of expense.

Personal costs run through the business. A vehicle, phone, meals, travel or a home office can be legitimate business expenses, partly personal, or simply personal. Courts can add back the personal share. Many states also count perks from a business, such as a company car or free housing, as income when they reduce personal living costs; the income definitions of Kentucky and Louisiana, for example, name a company car.

Depreciation. Tax rules allow a business to deduct the cost of equipment quickly, sometimes all in the first year. For child support, several states limit this. The income definitions for District of Columbia, Idaho, Kentucky, Louisiana, Montana and Nebraska address depreciation directly, allowing straight-line depreciation or excluding accelerated methods, so the deduction is spread over the asset’s useful life rather than front-loaded.

Money left in the business. An owner of a corporation or partnership can choose not to pay out profits. Wisconsin counts undistributed income of a corporation or partnership the parent controls. Elsewhere, courts can still look at retained earnings when the parent can decide whether to distribute them.

Salaries to family members and unusual one-off costs. A sudden jump in wages paid to a relative, or a large expense in the year of the separation, will usually be examined for whether it serves the business.

Cash and unreported income. Income that never reaches a tax return still counts. South Carolina’s income definition, for example, includes unreported cash income that can be identified. When reported income looks too low, courts can compare it with the parent’s spending, deposits and lifestyle, and draw conclusions from the gap.

Self-employment tax

An employee and employer split Social Security and Medicare taxes. A self-employed parent pays both halves as self-employment tax, at a combined rate of 15.3%: 12.4% for Social Security and 2.9% for Medicare, according to the IRS. To put a self-employed parent on the same footing as an employee, many guidelines deduct the extra, employer-equivalent half. Among the states this site covers, the income definitions of Arizona, Hawaii, Idaho, Indiana, Oregon and Virginia say so explicitly. Oklahoma deducts 7.65% of self-employment income, the employer share of Social Security and Medicare tax, on its worksheet.

In states that work from net income, income taxes on self-employment earnings are estimated or entered along with the self-employment tax, and the same add-backs apply first. Our guide on child support and taxes explains how the gross and net approaches differ.

A worked example

Adjustments to business income move the guideline amount in a predictable way. Take a parent in Virginia whose business reports net profit of $90,000 a year, with two children living mainly with the other parent, who earns $45,000. On those figures, the guideline amount is $1,308.

Now suppose the court finds that $15,000 of the business’s expenses were personal, a family vehicle and travel, and adds them back. The paying parent’s income for support becomes $105,000, and the guideline amount becomes $1,488. The same logic works in reverse: an expense the court accepts as a real business cost lowers income and the amount. The child support calculator shows the guideline amount for any figures, so each side can see what a disputed expense is worth before arguing about it.

Uneven income and new or failing businesses

Self-employment income rarely arrives in a steady stream. Courts commonly average income over several years to smooth out unusually good or bad years. Where a business is clearly growing or shrinking, a court may weight recent years more heavily instead. Seasonal or irregular payments can be converted to a monthly figure with the income converter. Commissions and bonuses paid to employees are averaged in similar ways, as explained in overtime, bonuses and commissions in child support.

A parent who leaves a salaried job to start a business, or whose business income falls while the parent could earn more elsewhere, may face an argument that income should be imputed. Federal rules require states that allow imputation to consider the parent’s specific circumstances, including work history, skills, health and the local job market. Our guide on imputed income covers how courts approach it.

When income changes for real and stays changed, either parent can ask for a review. The modification calculator compares the current order with the guideline amount on the new income.

Documents that make a case go smoothly

Self-employment cases are won and lost on records. Expect to provide, or to ask the other parent for, several years of complete personal and business tax returns with every schedule, including depreciation schedules; year-to-date profit and loss statements and balance sheets; business and personal bank and credit card statements; records of owner draws and distributions; and payroll records if family members are on the payroll. Loan or lease applications are worth asking about, because income reported to a lender is sometimes higher than income reported for support.

State child support agencies have their own sources too. The federal Office of Child Support Enforcement notes that agencies can determine a parent’s income and assets from information received from many sources, and that a self-employed parent, who has no employer to withhold support, may be able to pay by electronic funds transfer. Whatever the source, the result is a guideline amount, an estimate under the state’s rules; courts can deviate from it when the guideline result would be unjust or inappropriate in a particular case.