Why is my income for support purposes so much higher than my total self-employment income?

The process of calculating the support obligations in Ontario for someone who is self-employed is much more complicated than it is to calculate support obligations for someone who is a salaried employee. Self-employed individuals have some ability to manipulate their income, or at least how it appears on their tax return. They can structure their affairs to pay significantly less tax than their employee counterparts. That reality led the courts to consider the fairest way to calculate income for support purposes.

One of the reasons the Child Support Guidelines, and subsequently the Spousal Support Advisory Guidelines, were implemented was to create uniformity in the way that support is calculated for separated parents and spouses. Ideally, people of the same financial means should be paying the same amount of support. However, people who are self-employed have a wide range of tools available to them so that they pay less tax, and thereby have more money in their pocket than their salaried colleagues being paid the same amount. The courts decided that the fairest approach to determining support was to figure out a way to ensure that people with the same amount of money in their pockets every month paid the same amount of support, regardless of how they earned that money.

There are a few ways that the court may adjust the self-employed person’s income to adjust for tax savings and other advantages of being self-employed:

• Some self-employed individuals create a corporation and are paid through that corporation. This allows them to pay themselves by way of dividends, which are taxed at a much lower rate than a salary. The Child Support Guidelines provide for a specific mechanism by which the person’s income is adjusted to take into account the tax benefits of dividends. That adjustment results in a higher income appearing in the support calculations than appears on that person’s tax return.

• Self-employed individuals, who have a corporation, can leave some of the money they earn in the corporation, which means that income never shows up on the business owner’s tax return. Business owners can thereby keep savings in the corporation and invest the entire amount, whereas a salaried employee has to create savings from his or her after-tax income. The Guidelines make things fairer by requiring that any money that the business earns, which is not required for the ongoing operation of the business, be added to the owner’s income for child support purposes.

• Some business owners reduce their amount of tax for the family by dividing the income between several family members, such as a spouse, children, or the owner’s parents. The amount that these family members receive may not reflect the work that they do for the business. These payments may be designed to divide the income due to the owner across several tax returns so that it is taxed at a lower rate. The Guidelines take into consideration payments that the business makes to non-arms length individuals when calculating the business owner’s income for support purposes.

• Business owners can also write off many expenses in the business, some of which may also have a personal benefit to the business owner. An obvious example is a cellular phone. The business owner likely requires a cellular phone for business purposes, which makes it a legitimate deduction for tax purposes, but as a result, the business owner does not need a personal cell phone and avoids that expense. Some expenses can have quite a large personal component and the business owner can receive significant benefits without reporting additional income on his or her tax return. The Guidelines require that the personal component of business expenses be added back to the business owner’s income for support purposes.

As it is evident from above, many of these strategies have significant tax advantages for the business owner that allow him or her to pay less tax than a salaried employee. The law requires that an additional adjustment be made to take into account the tax savings that business owners can enjoy but salaried employees cannot. To accomplish this, the law does not just add back the amount of personal expenses or other amounts that do not appear on the business owner’s tax return but also adds back the tax savings as well. This is called “grossing up” the support payers’ income for tax. For higher-income individuals, this additional amount can be significant. The highest tax bracket is around 43%. This means that the law requires that for every dollar of income that the business owner is able to take off his or her tax return, $1.43 is added back to that reported income for support purposes. This is fair because the adjustments look at how much money the business owner gets to put in his or her pocket and then base support on how much a salaried employee would have to earn to have that same amount of money in his or her pocket.

The above are just some of the examples of adjustments to reported income that the law makes when determining income for support purposes. Income for support can be much higher than the “total income” as reported on a tax return. In any support case, it is important for both the support payor and the support recipient to speak to a Toronto family lawyer to make sure that the level of support is appropriate.