Fighting for Fairness: A Father’s Quest for Accurate Child Support

A Narrative Story of In re the Marriage of Haefele, 837 N.W.2d 703 (Minn. 2013)

Douglas Alan Haefele* had always believed in playing by the rules. When he and Kathy Lynn Haefele* divorced in 2000, he faithfully paid the $1,794 monthly child support ordered by the court for their three children. For ten years, he never missed a payment, even as he watched Kathy’s financial situation change dramatically through her ownership stake in Dura-Supreme, Inc., a successful cabinet manufacturing company.

By 2010, Douglas knew something wasn’t adding up. While he continued to pay substantial child support based on his epidemiologist salary of $178,056, Kathy was receiving massive distributions from Dura-Supreme – nearly $5 million between 2007 and 2009 alone. Yet when it came time to calculate child support, Kathy claimed her annual income was only $146,947, while Douglas’s calculations showed it should be over $1.7 million.

The disparity troubled Douglas deeply. As a scientist trained to analyze data objectively, he could see that the system was fundamentally unfair. Kathy owned 20% of a thriving business that was generating enormous profits, yet she was arguing that millions of dollars flowing through her hands shouldn’t count as income for child support purposes. Meanwhile, Douglas was shouldering the vast majority of their children’s financial support despite earning significantly less than what Kathy’s business ownership was actually worth.

Douglas understood the complexities of Kathy’s situation. As a passive investor in Dura-Supreme, she didn’t control day-to-day operations, and some of the distributions were being used to fund a new investment entity called TK Investments or to pay her income taxes on the business profits. But Douglas also understood a fundamental principle: income is income, regardless of how it’s ultimately used.

When Douglas filed his motion to modify child support in 2010, he felt he was simply asking for fairness and accuracy. The law should treat all parents equally, and if Kathy was benefiting financially from business ownership, that benefit should be properly reflected in child support calculations. His children deserved support that was proportionate to both parents’ actual financial resources.

The district court initially agreed with Douglas, finding that all $4.9 million in distributions constituted gross income and reducing his child support obligation to just $281 per month while ordering Kathy to contribute $395 monthly toward the children’s medical insurance. For the first time in years, Douglas felt the system was working fairly.

But then came the devastating reversal by the Court of Appeals. The appellate court ruled that most of the distributions shouldn’t count as Kathy’s income because they weren’t “available” to her or were used for business purposes. Douglas watched his hopes for fair treatment crumble as the court essentially allowed Kathy to benefit from millions in business income while avoiding the corresponding child support responsibilities.

Douglas knew he had to appeal to the Minnesota Supreme Court. This wasn’t just about his own case – it was about establishing a fair and consistent standard for how business income should be calculated in child support cases. Too many parents were gaming the system by claiming business income wasn’t “available” to them, while their former spouses continued paying support based on traditional employment income.

When the Supreme Court issued its decision in May 2013, Douglas felt a profound sense of vindication. The court had seen through the legal technicalities to understand the core issue: Minnesota’s child support statutes require a specific formula for calculating income from business ownership, regardless of whether funds are actually distributed or available to the parent.

The Supreme Court’s ruling was clear and decisive. Justice Dietzen wrote that income from joint ownership of a closely-held corporation must be calculated using the statutory formula in Minnesota Statutes § 518A.30 – gross receipts minus cost of goods sold minus ordinary and necessary expenses. The court explicitly rejected the Court of Appeals’ focus on whether funds were “available” to Kathy, noting that “the definition of income from self-employment or operation of a business under section 518A.30 does not turn on whether the corporation has ‘distributed’ the funds, or whether the funds are ‘available’ to the parent.”

Most importantly for Douglas, the Supreme Court recognized that allowing business owners to exclude income simply because it wasn’t distributed would create fundamental unfairness in the child support system. The court noted that “gross income is only the starting point” and that trial courts retain discretion to deviate from guidelines when appropriate, but that discretion must be exercised after properly calculating income according to the statutory formula.

Standing in his home that evening, reading the Supreme Court’s decision, Douglas felt a weight lift from his shoulders. After thirteen years of marriage and three years of legal battles, the highest court in Minnesota had affirmed a principle he’d always believed in: that child support should be based on accurate financial information and that all parents should be held to the same standards. His children would finally receive support that reflected both parents’ true financial capacity, and the legal system had proven it could deliver justice even in complex business cases.

*This story is based on the true facts of the Supreme Court’s decision, but the personal experiences and emotions described are a fictional representation to bring the case to life.

Question: How does a Minnesota court figure out my real income for child support and spousal maintenance if I’m self-employed or own an S-corp/LLC? 

Answer: Self-employed people and business owners have special rules for calculating income because they can write off expenses and control their income differently than regular employees. Courts use a specific formula to determine their true income for support purposes.

The income of self-employed persons poses special challenges because the self-employed person is typically responsible for keeping track of income and expenses. Special tax rules available to the self-employed person, such as the ability to write off equipment as a current expense and deduct quasi-personal expenses, also make it more difficult to determine the self-employed person’s true economic income. In light of these difficulties, the current child support statute contains a specific section related to income for self-employed individuals.

What formula do courts use to calculate income for self-employed people?

Courts calculate income by taking all money the business brings in, subtracting the cost of goods sold, and then subtracting only ordinary and necessary business expenses. Some tax write-offs that help reduce taxes aren’t allowed when calculating support.

Minnesota Statutes section 518A.30 states that to determine income from self-employment or operation of a business, including joint ownership of a partnership or closely held corporation, “gross income” is defined as gross receipts, minus cost of goods sold, minus ordinary and necessary expenses required for self-employment or business operation. Specifically excluded from “ordinary and necessary” expenses are amounts allowable by the Internal Revenue Service (IRS) for the accelerated component of depreciation expenses, investment tax credits, or any other business expenses determined by the court to be inappropriate or excessive for determining gross income for purposes of calculating child support. The person seeking to deduct the expense has the burden of proving, if challenged, that the expense is ordinary and necessary.

What did the Haefele case decide about business income and child support?

The Minnesota Supreme Court ruled that business owners must count their share of business income for child support purposes, even if they didn’t actually receive the money. Courts can’t ignore business income just because it wasn’t distributed to the owner.

There have been a number of court cases in recent years that have dealt with the income of business owners. In Haefele v. Haefele, 837 N.W.2d 703 (Minn. 2013), the Minnesota Supreme Court clarified the definition of a parent’s income from self-employment or operation of a business for child support purposes. The opinion in Haefele clarified that to determine a parent’s income under section 518A.30, a parent’s share of income from joint ownership of a closely held S corporation (a “pass-through” entity where the income of the corporation is reported on the individual’s tax return) must be taken into account. The calculation must be made of the pass-through entity’s gross receipts, cost of goods sold, and ordinary and necessary business expenses regardless of whether corporate funds have been distributed or are available to the parent.

Can courts adjust child support if business income isn’t actually available?

Yes, after calculating support using the business income formula, courts can consider whether the money is actually available and may lower the support amount if the business owner truly can’t access the funds.

The Haefele opinion goes on to say that after calculating the presumptive child support obligation, the district court must, pursuant to Minnesota Statutes section 518A.43, subdivision 1, consider all of the circumstances and resources of each parent in setting the final child support obligation. The unavailability of funds included in gross income may be taken into account in departing from the presumptive child support guideline amount. See section 3.7, infra.

Does the Haefele rule apply to spousal maintenance too?

It’s unclear whether the same business income calculation rules apply to spousal maintenance cases. The Haefele case specifically dealt with child support, which has different legal requirements than spousal maintenance.

The Haefele court specified that this methodology applies to the calculation of income for child support purposes. It remains uncertain as to whether the methodology also applies to income for spousal maintenance purposes. Income for child support could be the same as income for spousal maintenance purposes per Haefele and Lee. The difference is that child support has a statutory presumption.

How have recent tax law changes affected business expense deductions for support calculations?

Recent tax law changes have modified what business expenses can be deducted, particularly for meals and entertainment. Some expenses that aren’t allowed for taxes might still be considered necessary business expenses for support purposes, and vice versa.

The Tax Cuts and Jobs Act of 2017 (TCJA) changed the rules regarding the deductibility of meals and entertainment expenses for business purposes. Taxpayers could still deduct 50 percent of the food and beverage expenses associated with operating their business (i.e., meals consumed by employees on work travel). However, no deduction was allowed for purchasing meals for customers or for any entertainment expenses. The American Rescue Plan Act of 2021 changed the rules again regarding business deductibility of meals and entertainment expenses—allowing a 100-percent deduction for tax years 2021 and 2022. This change was an effort to stimulate consumer spending in the restaurant industry, hard hit during the COVID-19 pandemic. In addition, the TCJA suspended all miscellaneous itemized deductions that were typically subject to the two-percent floor, including unreimbursed business expenses incurred by an employee, through December 31, 2025 for federal tax purposes. These miscellaneous itemized deductions are still allowed as a deduction for Minnesota taxes. There may be instances where the types of expenses described above are not allowable for tax purposes but could be considered ordinary and necessary by the court in computing net income from self-employment—or vice-versa, expenses allowable for tax purposes may be considered excessive or not ordinary and necessary by the court for support purposes.

How do S corporation tax payments affect income calculations for support?

S corporation owners can now pay their personal income taxes through the business, which shows up as a business expense. However, this tax payment should be added back to the owner’s income when calculating support because it’s really the owner’s personal tax obligation.

Changes to the law now permit the owners of S corporations to pay and deduct Minnesota personal income taxes at the corporate level. The amount of tax paid is shown as an expense on the business return; the owner is given credit for the payment when the personal return is prepared. The amount of tax paid by the corporation should be added to the income of the owner in determining income for support purposes.

What documents should self-employed people provide for support calculations?

Self-employed people need to provide detailed business records including tax returns, financial statements, bank statements, and detailed expense records. Courts need enough information to accurately determine true business income and expenses.

Parties should include enough detail with the information presented to the court on a timely basis, so that accurate determinations can be made. This applies even more so to self-employed individuals who do not always keep good records. The IRS has several publications that are good resources when analyzing the income of the self-employed that can be found at <www.irs.gov>, including Publication 504, Divorced or Separated Individuals; Publication 535, Business Expenses; Publication 583, Starting a Business and Keeping Records; Publication 587, Business Use of Your Home; Publication 225, Farmers Tax Guide; Publication 334, Tax Guide for Small Businesses (for Individuals Who Use Schedule C or C-EZ); and Publication 463, Travel, Gift & Car Expenses.

How do different business structures report income differently?

Different types of businesses (sole proprietorships, partnerships, S corporations, C corporations) report income on different tax forms and schedules. Each structure has different rules for how income flows through to the individual owner for support calculation purposes.

The income of self-employed persons is reported on different schedules depending on whether the self-employed person is a sole proprietor, partner, or S corporation shareholder. Sole proprietors or single member LLCs report their income and expenses on Schedule C of their individual income tax return. Schedule C does not include a balance sheet and typically only contains skeletal information regarding equipment and other fixed assets used in the business, if at all. Farmers report their income and expenses on Schedule F of their individual tax return. Schedule F does not include a balance sheet and only skeletal information regarding equipment and other fixed assets used in the farming operation. Partners report their income and expenses on the federal Form 1065 and receive a separate Form K-1 listing their respective shares of income, deductions, distributions, and other pass-through items. K-1 items can be reported on various parts of an individual’s income tax return. S corporation shareholders report their income and expenses on the federal Form 1120S and receive a separate Form K-1 listing their respective shares of income, deductions, distributions, and other pass-through items. K-1 items can be reported on various parts of an individual’s income tax return. C corporation shareholders report their income and expenses on the federal Form 1120. There is no K-1 form issued by a C corporation because it is not a pass-through entity. Owners receive their income in the form of W-2 wages (paychecks, bonuses) and less commonly via dividend payments.

How do business distributions and loans affect support calculations?

Courts look at how much money business owners actually take out of their businesses through wages, distributions, or loans. Sometimes owners could take more money out but choose not to, which is important for determining their true ability to pay support.

In the past, C corporation owners generally paid out all of the income as wages each year, if cash is available, due to the high corporate tax structure. With the 2017 changes to the federal tax law that significantly lower C corporation tax rates, this may no longer hold true. S corporations and partnerships generally pay only a portion of the income as compensation. The rest is withdrawn from the entity as cash distributions or loans from the corporation. It is important to compare the amount of residual net income to the amount of distributions taken each year. Income can be high, and distributions low, leaving a lot of cash in the business at year’s end. The argument could be made that more cash could have been taken out of the business. After Haefele, this information is relevant as to the calculation of income for a self-employed person. See also Hill v. Hill, No. A14-1752, 2015 WL 5511444 (Minn. Ct. App. Sept. 21, 2015); Patock v. Patock, No. A14-0658, 2015 WL 134068 (Minn. Ct. App. Jan. 12, 2015); Stier v. Peterson, No. A17-0024, 2017 Minn. App. Unpub. LEXIS 838 (Minn. Ct. App. Sept. 18, 2017).

What additional documents might be needed beyond tax returns?

Besides tax returns, courts might need financial statements, bank records, detailed transaction records, and other business documents. Sometimes financial statements prepared by outside accountants aren’t necessarily more accurate than those prepared by the business owner.

In addition to tax returns, a business may have financial statements available. These may be prepared internally or by an outside accountant. It should not be assumed that financial statements or tax returns prepared by an outside accountant are more accurate than those prepared internally by the business owner.

What specific documents should self-employed people gather for support cases?

Self-employed people should provide complete business tax returns, financial statements, bank statements, detailed transaction records, depreciation schedules, and forms showing payments from customers. Additional documents like invoices and loan applications might also be needed.

For self-employed persons, in addition to the basic documents listed in section 3.3.A.1, supra, request the following information for the past two to five years: complete business tax returns, including Form K-1; business financial statements (i.e., balance sheets and income statements), if available; monthly and/or year-end business bank statements; general ledger detail reports including dates, amounts, and descriptions for all transactions; business check registers; credit card statements for charges paid by the business; detailed depreciation schedules, including those for Schedule C businesses; and annual 1099 forms issued by merchant account payors, Venmo, PayPal, and other such account transaction information, if relevant.

Depending on the initial analysis of the above, the following documents may also be requested: invoices sent to customers; invoices for business expenses; personal bank statements and credit card statements; loan applications; and personal financial statements provided to lenders or mortgage brokers.

What sources of cash flow do courts look for in business owner cases?

Courts examine all ways business owners get money from their businesses, including wages, business profits, cash distributions, loans from the business, personal expenses paid by the business, and benefits received through the business.

For self-employed individuals, including owners of closely held businesses, a thorough analysis of the information could reveal cash flow from the following sources: wages, guaranteed payments, or net income of a proprietor, as reflected on Form 1040, Schedule C; actual or potential cash distributions from an S corporation or partnership; net loans to or from the business to an owner for the year; personal expenses paid by the business; or fringe benefits received.

How do courts analyze business financial information for support cases?

Courts look at patterns over several years, compare income and expenses across time periods, check if bank deposits match reported income, and determine whether personal expenses were improperly deducted as business expenses.

Analyzing the information includes: determining the amount of cash distributions or guaranteed payments paid to the owner by reviewing the tax returns, with these amounts found on the owner’s Form K-1 and relevant to the issue of possible deviations from the guideline level of support, and assessing whether additional distributions were possible but not paid; determining the amount of loans to or from the owner from the business by reviewing the tax return, with this information relevant to the issue of possible deviations from the guideline level of support and reported on the balance sheet of both a corporation’s and a partnership’s tax returns, and, if there are multiple corporate owners or partners, asking for the detailed information; summarizing the income and expenses over several periods and looking for trends, with gross profit percentages and percentages of income to revenue computed and compared over several periods, as such an analysis usually reveals transactions that will require further investigation; determining whether the business reports on the cash basis (where income is reported when received and expenses when paid) or on the accrual basis (where income is reported when earned (accounts receivable) and expense when incurred (accounts payable)), with the accounting method listed on the tax return and the use of the cash method of accounting resulting in greater manipulation of income and expenses; comparing the deposits per the bank statements to the income per the tax returns, and, to discern trends in seasonal income, summarizing deposits by month over several years or seeing whether there is an effort by a cash basis taxpayer to push deposits into the next tax year, lowering income for the current year; reviewing the general ledger detail, check registers, credit card statements, and invoices to see whether living expenses have been paid by the business, and, if that is the case, determining whether they have been deducted as business expenses or classified as distributions or loans to the owner, and, if they are properly classified as distributions or loans, noting that no addition back to income is necessary; reviewing the invoices sent to customers to determine if all billed work is included in the revenues of the business, with this analysis also revealing information as to the overall work efforts, i.e., whether the business owner is working full- or part-time; and, if living or “mixed use” (both business and personal, such as a car) expenses have been paid and deducted by the business, adding back the personal portion to net income to compute income for support, with common expenses including vehicles, including but not limited to lease or financed purchase payments costs, gas, insurance, and other operating expenses; cell phone, including for family; meals, travel, and entertainment; rent (personal); utilities (personal); legal fees (especially those related to the divorce); insurance; and credit card interest. Reviewing the fixed asset records of the business to determine whether accelerated depreciation has been taken for tax purposes is also necessary, and if so, depreciation will need to be adjusted, with depreciation generally recalculated over the estimated useful lives of the assets on a straight-line basis and realistic asset lives used.

How do courts determine appropriate income when business income varies year to year?

Courts look at income over several years to find a fair average or trend. Sometimes the most recent year is most accurate, sometimes an average works better, and courts often give more weight to recent years when income is increasing.

Once all the pieces of income from self-employment are calculated, it is necessary to review the information over a period of years to determine an appropriate measure of income as the income will most likely vary from year to year. Sometimes income is increasing and the latest year is a reliable measure of income. Sometimes an average is more appropriate. Consider giving more weight to recent years.

Where incomplete information (or none at all) is available for a self-employed individual, the court may consider the person’s lifestyle, cash flow, and earnings capacity in measuring net income.

Once all the pieces of income from self-employment are calculated, it is necessary to review the information over a period of years to determine an appropriate measure of income as the income will most likely vary from year to year. Sometimes income is increasing and the latest year is a reliable measure of income. Sometimes an average is more appropriate. Consider giving more weight to recent years.

What happens when business owners don’t provide complete financial information?

When business owners don’t provide adequate financial records, courts can look at their lifestyle, spending patterns, and earning capacity to estimate their income for support purposes. Where incomplete information (or none at all) is available for a self-employed individual, the court may consider the person’s lifestyle, cash flow, and earnings capacity in measuring net income.

How do partnership and S corporation distributions affect support calculations?

Courts must consider the relationship between business income and actual cash distributions, including how loans and owner investments affect the owner’s basis in the business. The timing and amount of distributions compared to business profits is important for determining support.

Partnerships and S corporations often encounter the situation where cash distributions exceed the owner’s cumulative “basis” in the entity. Increases or decreases to owner loans and receivables should be considered when calculating the annual net distributions to an owner. Basis is a function of the cumulative net income or losses incurred by the business, reduced by distributions, and adjusted for other items as required by taxing authorities. S corporations are required to make distributions pro rata to the owners; partnerships are not required to make such distributions.

What should non-business-owning spouses know about business expense claims?

Non-business-owning spouses often worry that their ex-spouse is hiding income by having the business pay personal expenses. However, if these expenses are properly recorded as distributions to the owner rather than business deductions, they don’t reduce the owner’s income for support purposes.

The non-business-owning spouse often reports that the business is paying for the couple’s living expenses. This often contributes to suspicion of the activities of the other spouse. Upon review of the records, one can often demonstrate to the non-business-owning spouse that, while the business may be paying the expenses, they are properly accounted for as distributions to the owner as opposed to deductible business expenses.