In determining income available for support from self-employment, the court does not simply use the net taxable income from the tax returns. The general rule is that Income from a business is gross receipts less reasonably ordinary and necessary business expenses.
Ordinary and necessary business expenses do not include all claimed business expenses. For example, some self-employed individuals deduct 100% of vehicle expenses, cell phone, and a large amount for meals and entertainment. Personal mileage, including the commute from home to the office, is not a business expense. When the business pays the entire amount of cell phone service, a reasonable amount for personal use should be added back as income. Season tickets to Lakers games will not be considered a legitimate business expense, when the tickets are used primarily for family and friends.
Another business deduction that is frequently added back as income is depreciation of real property. Some businesses significantly reduce their taxable income by depreciating commercial or residential real property. Because the value of property over time generally appreciates, such deductions are not a business expense. IRMO Asfaw (2007) 147 Cal.App.4th 1407.
Two issues involving business profits that can be problematic are retained earnings and reinvestment of business profits. Retained earnings could be considered necessary if the business is undercapitalized or has anticipated retooling of equipment, such as machinery, computers, vehicles, etc.
Reinvested business profits to expand the business have generally been considered income if such expansion was not part of the status quo during the marriage. This has typically been looked as discretionary expenses by the owner spouse to reduce his/her obligation to pay spousal support. However, the case discussed below upheld reinvestment of business profits in order to adapt to changing market conditions.
Marriage of Blazer (2009) held that income reinvested in the company was properly excluded for spousal support purposes. Blazer involved a produce brokerage company that bought and sold produce, mostly strawberries and other berries. During the marriage, the company made a significant profit acting solely as a middleman between growers and distributors. Two years after the parties separated, the Court valued the community interest in the business which was awarded to husband at $5.6 million. Wife was awarded one-half of the community interest and temporary spousal support was set at $52,000 per month pending trial on permanent spousal support. The stipulation of the parties permitted retroactive modification of spousal support to August 15, 2004.
In 2006, at the trial on cash flow and spousal support, Husband and his expert testified that the business was undercapitalized and that he needed to expand his business to handle the entire process, from growing berries to distribution, in order to compete. Otherwise, the business would not survive. Wife argued that it was husband’s choice to use business profits to expand the business and that such expenses should not reduce husband’s income available for support.
The trial court found that these were reasonable expenses which should be excluded from husband’s income for the purposes of support. Based on this finding, the Court modified the temporary spousal support from $52,000 to $30,000 retroactive to August 15, 2004 and set permanent support at $20,000 per month. Wife appealed, and the Court of Appeal affirmed.
Blazer provides authority that earnings can be set aside to maintain a business. How much and for what purpose will be a case by case determination.