Determining self-employment income for child support purposes: the Massachusetts view compared with the national view.

• Author: Owens, Jason V.

1. INTRODUCTION II. THE EVOLUTION OF THE MASSACHUSETTS CHILD SUPPORT GUIDELINES A. Ordering and Enforcement Prior to 2009 B. Self-Employment Income Prior to 2009 C. The 2009 Child Support Guidelines: Self-Employment Definition Receives Initial Appellate Review III. ORDINARY AND NECESSARY BUSINESS EXPENSES: WHERE THE GUIDELINES AND TAX CODE OVERLAP A. Ordinary and Necessary as Defined by Tax Law B. Understanding Ordinary or Necessary: Capital Expenses IV. WHERE THE OVERLAP STOPS: EXPENSES REQUIRED TO PRODUCE INCOME V. CALCULATING SELF-EMPLOYMENT INCOME: A PRACTICAL LIST OF DEFINITIONS FOR COMMONLY SEEN DEDUCTIBLE BUSINESS EXPENSES A. Capital Expenditures and Section 179 Expenses B. Depreciation, Amortization and Depletion C. Meals and Entertainment D. Equipment, Repairs, and Betterments with a Useful Life or Value Exceeding One Year E. Charitable Contributions, Political Contributions and Club/Membership Fees F. Supplies and Materials Not Consumed During a Tax Year G. Taxes Paid by a Business H. Retained Earnings and Pass-Through Income I. Cost of Goods Sold, Rent, Employee Pay, Advertising, Insurance, Dues and Publications and Other Common Business Expenses J. In-Kind and Personal Benefits, Including Auto, Travel, Home Office, Medical Insurance and Retirement Benefits IV. CONCLUSION I. INTRODUCTION

   Since 1988, the Massachusetts Child Support Guidelines ("Guidelines") have presumptively applied to all child support orders entered by Probate and Family Courts ("probate court") throughout the Commonwealth, including cases involving self-employed parents. (1) From 1988 to 2008, these Guidelines largely remained unchanged, defining income earned by small business-owning parents as simply "income from self-employment." (2) As a result, the proper approach to determining self-employment income principally fell on individual probate court judges during this period. (3) Under the Guidelines, probate court judges have considerable discretion, and Massachusetts statutory law defers to the Guidelines in all respects. (4) Because probate court findings in cases involving Guidelines issues have long been subject to review under the abuse of discretion standard, which requires significant deference to trial court findings, the Massachusetts Appeals Court and Supreme Judicial Court ("SJC") found little space to clarify the definition of self-employment income prior to 2009. (5)

   In 2006, a task force, appointed by Chief Justice for Administration and Management Robert Mulligan, undertook a comprehensive review of the Guidelines and made substantial revisions. (6) Effective January 1, 2009, these revised Guidelines ("2009 Guidelines") provided a clear definition of self-employment income, describing it as "gross receipts minus ordinary and necessary expenses required to produce income." (7) The 2009 Guidelines definitively stated that self-employment income for child support purposes "[i]n many cases ... will differ from a determination of business income for tax purposes." (8) The 2009 Guidelines also provided new guidance on the types of tax deductible business expenses not applicable in the child support context. (9)

   Following the release of the 2009 Guidelines, Massachusetts courts announced decisions in several cases that applied and interpreted the Guidelines, thereby providing probate court judges with new guideposts when setting child support orders in cases involving self-employed individuals. (10) Despite the clarification provided by the 2009 Guidelines and subsequent case law reviewing self-employment income in child support cases, significant questions remain regarding the best approach and methodology for determining self-employment income. This Article seeks to provide judges, practitioners and litigants with guidance by identifying, organizing, and presenting state and federal law affecting self-employment income in child support cases from a broad range of jurisdictions. (11)

   Part II of this Article examines the evolution of the Massachusetts Child Support Guidelines, including recent appellate decisions involving the 2009 Guidelines. (12) Part III.A details the critical "ordinary and necessary" test, which determines the deductibility of claimed business expenses from income through the lens of federal tax law. (13) Part III.B provides a primer on "deductible" versus "capital" expenses under the tax code. (14) Part IV analyzes the phrase "expenses required to produce income" included in the 2009 Guidelines, examining how other states define similar language by statute, rules of court and case law. (15) Part V concludes with a comprehensive list of common business expenses to provide judges, practitioners and litigants with a reference guide to the deductibility of specific business expenses from income for child support purposes. (16)

1. THE EVOLUTION OF THE MASSACHUSETTS CHILD SUPPORT GUIDELINES

   1. Ordering and Enforcement Prior to 2009

      Massachusetts law states: "Upon a judgment for divorce, the court may make such judgment as it considers expedient relative to the care, custody and maintenance of the minor children of the parties...." (17) Similarly, Massachusetts law provides that when "parents of minor children live apart from each other, not being divorced, the probate court ... shall have the same power to make judgments relative to their care, custody, education and maintenance." (18) In all child support cases in Massachusetts, there is a rebuttable presumption that the amount of child support calculated by the Guidelines formula is the appropriate amount to be ordered. (19)

      Prior to 1984, each state enforced child support through a considerable hodgepodge of laws under loose federal oversight, which led to the need for improved consistency and "greater fairness to families." (20) In 1984, Congress amended Title IV-D of the Social Security Act to resolve the child support crisis, mandating uniform state enforcement standards for child support orders throughout the country. (21) In response to this federal mandate, Massachusetts enacted the Child Support Enforcement Act of 1986. (22) In 1988, Massachusetts promulgated its first Child Support Guidelines ("1988 Guidelines"), which provided, in pertinent part:

      The child support guidelines are formulated for justices of the Trial Court's use, whether the parents of the children are married or unmarried, in setting temporary, permanent or final orders for current child support, in deciding whether to approve agreements for child support, and in deciding cases that are before the court to modify existing orders. (23) The 1988 Guidelines defined income as "gross income from whatever source," and provided an enumerated list of income sources that included self-employment income. (24) The 1988 Guidelines also introduced a worksheet in which the respective gross weekly incomes of parents were used to calculate baseline weekly support, with adjustments for the number of children covered by the order and the age of the oldest child. (25)

      The Massachusetts Chief Justice for Administration and Management then promulgated revised versions of the Child Support Guidelines in 1989, 1994, 2002 and 2006. (26) Somewhat strikingly, revisions to the Guidelines during this period principally worked at the margins, with modest adjustments to baseline orders focusing on certain expenses, such as medical insurance and child care, while mostly leaving the core formula for determining basic support intact. (27)

   2. Self-Employment Income Prior to 2009

      Since their adoption, the Guidelines have maintained presumptive application in all cases seeking a child support order, but appellate review of probate court decisions affecting the child support obligations of self-employed parents was limited before 2009. Statutory and case law vested probate court judges with considerable discretion in matters affecting the care and custody of children, and the exercise of this discretion unsurprisingly resulted "in a range of proposed support orders" in child support cases involving self-employment income, where the Guidelines provided limited guidance to the presiding judge. (28) This discretion was largely a result of Massachusetts' abuse of discretion standard--the standard of review applicable to decisions in child support cases prohibiting appellate courts from disturbing lower court findings unless they are "clearly erroneous"--combined with the absence of a clear definition of self-employment income under the pre-2009 Guidelines. (29)

      Lacking this clear definition, the Massachusetts Appeals Court was limited in its review of child support cases involving self-employment income because probate court judges possessed both considerable discretion and broad deference due to the abuse of discretion standard. (30) The Massachusetts Appeals Court repeatedly signaled its approval by affirming lower court decisions finding that the tax deductibility of a particular business expense did not guarantee that the same expense was deductible from a parent's income for child support purposes. (31) For example, in 1998 the Massachusetts Appeals Court in Smith-Clarke v. Clarke (32) held a "husband's lack of records substantiating claimed business expenditures and his commingling of business and personal expenditures made it reasonable for the judge to disregard certain claimed items ... or to substitute a reasonable figure for others." (33) The court held, "[a]bsent substantiation of 1995 income, the judge could properly assume it approximated 1994 income." (34)

      In 2005 in Maillet v. Maillet (35) the Massachusetts Appeals Court remanded the case for review on issues similar to those found in Smith-Clarke (36) In Maillet, the financial statement of a business-owning husband set forth gross income of just $800 per week, but the husband's corporation had much more substantial income reduced by questionable depreciation deductions. (37) The court held that the wife's access to her husband's...