How to Find Money in Your Spouse's Profit and Loss Statement

As a special master for add-backs in California family law cases, I have witnessed countless situations where self-employed spouses attempt to minimize their income available for support by writing off personal expenses through their business. Many fail to understand that the rules governing business deductions for family law purposes fundamentally differ from Internal Revenue Service regulations.

There is a Critical Distinction: IRS Rules vs. Family Law Add-Backs

I have been in court where opposing counsel will argue that meals and entertainment expenses are legitimate write-offs for IRS purposes, completely missing that what constitutes a valid tax deduction may be subject to an add-back when a court determines income available for support. This fundamental misunderstanding can cost clients significantly in support calculations.

Under California law, when calculating income for support purposes, courts examine income from business proprietorship as gross receipts reduced by expenditures required for business operation. The key phrase here is "required for the operation of the business" – not merely expenses the IRS allows as deductions.

What Expenses Should an Attorney Scrutinize?

California courts apply a stricter standard when evaluating business expenses in family law proceedings. The court will scrutinize profit and loss statements to identify personal expenses improperly classified as business deductions. Personal expenses such as income tax payments, lunches, entertainment, home office rent, health insurance for the spouse, a car if used for personal, personal cell phone runs through the business, depreciation, and other expense categories are not legitimate business expenses for support calculation purposes and are “added back” to the bottom line for income available for support.

A reasonable attorney should analyze a profit and loss statement regardless of which spouse they represent to ensure they can justify the expenses or request that the court “add back” expenses. Constantly scrutinize a profit and loss statement.

Common Red Flags in Profit and Loss Statements

When examining a self-employed spouse's profit and loss statement, I look for several telltale signs of personal expenses masquerading as business deductions:

• Meals and Entertainment: The IRS permits meal and entertainment deductions, but family courts will be more skeptical. Unless these expenses are directly connected to client meetings or business development activities that can be well documented, they will likely be added back.

• Vehicle Expenses: Personal transportation costs, including commuting to and from a regular workplace, are personal expenses regardless of IRS treatment. Only vehicle expenses related to business operations should be considered legitimate business deductions.

• Home Office Deductions: Courts will carefully examine whether claimed home office expenses represent additional costs or merely a reallocation of existing household expenses.

• Travel and Lodging: Personal vacation expenses disguised as business travel are common targets for add-back analysis.

• Monthly Expenses Not Related to the Business: Cell phone bills, utilities, health insurance premiums, staff gifts, staff meals (especially if the spouse is the only employee), and miscellaneous expenses.
  

The Add-Back Process

When courts identify personal expenses improperly deducted from business income, these amounts are "added back" to determine the actual income available for support. This process can significantly increase the calculated support obligation.

Courts can examine more extended periods when dealing with self-employed individuals with significant income fluctuations. This prevents manipulation through the timing of income and expenses and provides a more accurate picture of actual earning capacity.

The classification of expenses as personal or business depends on whether the expense was incurred in connection with genuine profit-seeking activities. For example, legal expenses related to dissolution or separation are considered personal expenses rather than legitimate business costs, regardless of how they are treated for tax purposes.

Conclusion

While tax law seeks to determine taxable income according to federal guidelines, family law seeks to determine the economic resources available to support children and spouses.

The difference between a legitimate business expense and a personal expense disguised as a business deduction can mean thousands of dollars in support calculations.

Contact Livingstone Law for a free 20-minute San Diego Family Law Consultation.