How Does Depreciation Affect Child Support in California Divorce Cases?

California requires its courts to calculate child support in divorce cases by looking at the number of children the couple have; the percentage of time each parent has responsibility for the children; and the income of each parent.  With computerization, the task seems pretty easy.

Not so fast.  What about a person who is self-employed?  How do you figure out how much he or she makes? Furthermore, can you just go off that person’s tax return, particularly a “Schedule C”, and calculate the income by simply taking receipts and subtracting out deductions.

The answer to this last question appears to be no, after yesterday’s published decision by the California Court of Appeal entitled Marriage of Hein.  In this case, the trial judge, over the objection of the wife, calculated the husband’s income by relying on the verbatim information contained in his income tax returns.  The judge, the Hon. Stephan D. Schuett of Kern County, consistent with his reliance on the tax returns, said it was the wife’s duty to show that the returns were false or incorrect and that it was not the husband’s job to show that the return was true.

However, in a 3-0 decision, the California Court of Appeal reversed the judge on both counts.  The problem was that the tax return included an adjustment for depreciation for the husband’s equipment and assets.  That may be perfectly fine as far as the Government is concerned, but it was not fine for purposes of calculating child support.  Accordingly, as noted below, Hein became the third California case in the past 13 years or so to reject the argument that depreciation matters in child support.

In the Hein case, the appeals panel noted that previous cases had rejected depreciation for rental property (Asfaw v. Woldberham (2007) 147 Cal.App.4th 1407 and motor vehicles (Marriage of Rodriguez (2018) 23 Cal.App.5th 625), and there really was nothing about equipment and assets that differed enough from rental units or cars to deviate from the rule of not counting these accounting procedures.  In the words of the authoring justice, the Hon. Justice Donald R. Franson, “we continue to interpret ‘expenditure’ as used in subdivision (a)(2) of section 4058, to mean the actual outlaying of cash or other consideration.  In addition, we continue in the view that depreciating an asset on a company’s books and claiming a depreciation deduction on federal income tax returns does not involve an outlaying of cash with a corresponding reduction of cash available for child support”.  Family Code section 4058, in turn, defines income for a self-employed person as “[i]ncome from the proprietorship of a business, such as gross receipts from the business reduced by expenditures required for the operation of the business”.

As mentioned above, this case also established the precedent that the burden is on the self-employed person to show the veracity of the data in her or his tax returns, not the other way around.  Whether that burden of proof will always be allocated that way is not clear.  In the Hein matter, the Court noted that previous cases “did not involve a self-employed parent who had organized his or her business or businesses into multiple wholly owned entities”.  Thus, there was no California precedent that addressed the burden of proof in this particular type of case.  In the end, however, the justices considered three factors that led to their conclusion:  one, the superior knowledge of the person who prepared the tax returns (or on whose behalf the tax returns were prepared); two, the superior ability to gather information about finances regarding the corporate setup on the part of the person with the tax returns; and the importance of child support (and the possibility that someone could manipulate their finances to the detriment of minor children).

If you want to know how much difference in child support dollars the trial judge’s methodology and that ordered by the appeals court totaled, hire an accountant and read this entire 33 page opinion.  The appeals court did not calculate child support, but the trial judge will have a chance to use the correct process when he gets the case back in his chambers.  This is not to say that the appeals court did not mention some of the figures inserted in various parts of the multiple tax returns at issue, but there is no way to give a quick answer as to the sum total all of this made with respect to child support.

The cases on child support and depreciation do not outright apply to spousal support cases.