The calculation of personal income for the purposes of support in the Commonwealth of Pennsylvania is both a mathematical calculation and an art containing both objective and subjective components. Matthews v. Matthews, 2013 Pa. Dist. & Cnty. Dec. LEXIS 490 (2013) is a good example of this objective and subjective calculation.
In the Commonwealth when calculating net income for support purposes, a trial court must go through a process of determination of gross income, then monthly gross income and finally from the monthly gross income calculation tackle the expenses and taxation which result in the monthly net income. Deductions and expenses may be deducted from the gross income to achieve the monthly net income and often this is done using a forensic CPA. The Court must look at the unreimbursed business expenses and then determine which shall be deducted from the monthly gross income. This involves an analysis utilizing the testimony of the parties and experts who proffer opinions on the whether the expenses are bona fide.
The Court does this by determining which specific expenses can be deducted from the gross income. The analysis generally involves a determination of whether the expenses are simply accounting fictions that do not have actual effects on income, such as depreciation and true business expenses, such as the cost for repair of a truck used by the business. Many deductions and expenses straddle the line between business expenses and personal expenses, such as the company paying for a cell phone or for a BMW. The Court must wade through the tax returns and books of the parties in order to determine which expenses are valid business expenses and which are simply personal expenses paid for by the business. Courts typically refer to whether a deduction or expense “reflect(s) an actual reduction in available cash.” Matthews, Supra.
As a result of the way Courts view determination of income, the defendant who owns their own business should come armed with evidence supporting the defendant’s perception of his or her own income. The numbers on the tax return must be defended by the business owner.
In Matthews, Supra. the husband owned several properties including a shore home and he deducted the mortgage payments on the shore home as a business expense on his taxes. The Court found that this mortgage deduction was a personal expense rather than a business expense and disallowed the expense for the purposes of income calculations. The moral of the story is that vacation home mortgages are not allowable business deductions.
In Matthews, Supra. the Court disallowed a large expense for professional services, which can include legal fees or accounting costs. In the matter at bar the personal services deduction was quite high, but more importantly the Defendant did not adequately justify the fact that the personal services were business related. Thus, the Court chose to lower the total amount allowable as a deduction in the calculation of gross income. Thus, be prepared to defend and explain the personal
The Court also covered automobile deductions which again were inadequately explained. Interestingly the Court did not simply disallow the expenses for personal use – but this was likely because the husband only deducted portions of the automobile expense. Nevertheless, he inadequately supported the deduction and the Court disallowed half of the expense. Likewise, he did not support his rental property income and the Court disallowed approximately half of it.
The bottom line is that if you include an expense on your business tax return, you must be prepared to defend the expense and support it with documentary evidence in Court.