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  • Retained Earnings

    Hi there,

    I will be headed into a settlement conference soon and was wondering if anyone knew how retained earnings works?

    In short my ex claims to make 80K. After over a year she has shared some of her financials (not all). At the end of the day her corporation makes $160 - $180.

    she has about 100K in retained earnings. She says she needs to keep it there in case she loses her job. She has no employees and works off-site with clients, not sure why it needs to be there. Can this be added back to her income? why can't this be counted as part of child support?

    anyone have experience with ex's who own a corporation?

    thank you.

  • #2
    My understanding is - it depends.

    a - it depends on what the industry standard is for retained earnings. If a corporation has high overhead, it makes sense to retain more capital in case of lean years. If it is a low overhead industry, than it doesn't need the capital in the accounts.

    b - what has the corporation historically done. When you were together, did the ex routinely keep a large amount in the corporation (if they were doing that business when you were together)? If so, than that is likely the norm. You still could get it imputed into their income if their industry doesn't require the capital to be retained, but you may need some sort of expert to testify to that. You may be able to argue it yourself if the ex's financials are fairly clear and they don't have many expenditures. But whether you are successful would depend on how well you can articulate it and how much you educate yourself on her industry.

    Comment


    • #3
      The reason she gave answers the question 'why don't you spend that $100k'. It does NOT answer the question 'why is it being kept within the corp as retained earnings instead of being paid out as your wages.'

      Comment


      • #4
        Her argument in her response was that she is required to keep the funds in the account while she is in between contracts. However, she has never been out of work as long as I have known her. She consults, no office space other than her house and has no employees. So I don't see a reason that money cannot be used for child support purposes. I wonder if the judge will buy that argument.

        Comment


        • #5
          Assuming this isn't her first year of work, you need to get at least 3 years of financials from her corporation (or more if the income is highly variable). As others have stated unless she has a history of maintaining this level of retained earnings it's worth exploring imputing the income to her.

          Comment


          • #6
            The last 3 years it looks like she has kept between 80 - 100K in retained earnings. So does that mean I am SOL in trying to add this to child support calculations. I can understand if she had employees or large office space or capital purchases. But she has none of these so why not pay yourself out. It looks like she was smart to do it this way I suppose, now she can withhold 100K instead of using that to pay child support all because according to her it is her cushion in between contracts. Seems unfair if it is just sitting there for no reason other than to avoid increasing child support payments.

            Comment


            • #7
              Does that mean her company is gaining between 80-100k every year?

              Comment


              • #8
                I believe the onus would be on your ex to prove that she needs the 100k slush-fund for business purposes. A one-woman real estate person (assuming that is her occupation or something similar) with little business expenses and no employees? She may have had the luxury of having this little rainy-day fund when the marriage was intact but now that you are not together it is entirely something else. Hope you also look at adding non-essential business expenses that she has likely claimed on income tax return, to her income for purpose of determining income for child support.

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                • #9
                  It doesn't look like a gain every year. It looks like it just sits there every year as per Arabian her "little rainy day fund".

                  Comment


                  • #10
                    Originally posted by mcj2012 View Post
                    It doesn't look like a gain every year. It looks like it just sits there every year as per Arabian her "little rainy day fund".
                    Retained earnings on a balance sheet does not mean that the sum is sitting in an account somewhere untouched. Retained earnings is the money the corporation has earned in previous fiscal years. It has been disclosed on the corporation tax return, and income taxes for the business have been paid on those earnings. As with people, businesses tend to spend some of what they earn in order to increase operations, update operations, hire staff. Retained Earnings is a balance sheet item, not a cash account. The cash account should be the first item on the balance sheet. That represents the liquid money available to the company at any given time. Without retained earnings, the balance sheet would never balance.

                    If the business is in fact a corporation, the only way to take funds from it is through payroll (then personally taxed) or through a shareholder draw. Otherwise, the retained earnings belong to the corporation, not the owner of it.

                    Comment


                    • #11
                      Yes, so when a parent has control over a corporation, they can choose to leave their earnings withing the corp (instead of paying out as salary) as a mechanism for lowering their income for support calculations. That is why parents are required to disclose financials for any corporation they control (either as outright owner or via a controlling/directing membership on the board). So the question is - what is a reasonable level of retained earnings for that particular business?

                      http://www.justice.gc.ca/eng/rp-pr/f...ep5-etap5.html
                      Last edited by dinkyface; 10-23-2015, 12:30 PM.

                      Comment


                      • #12
                        Mcj, so it is 90k accumulated over 3 years?
                        I.e. her income was underreported by 30k in each of those years?
                        If you were to accept that, then in future she has no need to accumulate more retained earnings, so her income going forward should be imputed as 30k + her last-3-year-average.
                        Assuming those numbers are all pre-tax. If they are post tax, then gross up by 33% (for 25% tax) or more.

                        Comment


                        • #13
                          Originally posted by dinkyface View Post
                          Yes, so when a parent has control over a corporation, they can choose to leave their earnings withing the corp (instead of paying out as salary) as a mechanism for lowering their income for support calculations. That is why parents are required to disclose financials for any corporation they control (either as outright owner or via a controlling/directing membership on the board). So the question is - what is a reasonable level of retained earnings for that particular business?

                          Step 5: Calculate annual income - The Federal Child Support Guidelines: Step-by-Step
                          Well, yes and no. They can pay it out to themselves in salary, if the cash is available. As I said, its a balance sheet item and is on the balance sheet to make the balance sheet balance.

                          The physical cash may have been used up in a Capital Item purchase or other expenses.

                          The $80000 in retained earnings may now be represented by the computer system upgrade, the new vehicle purchase, legal expenses (for the business), etc, etc.

                          If you think about it from a personal perspective.....your T4 says you made $100000 last year. How is that $100000 represented this year? $35000in taxes and deductions, $15000 in mortgage payments, $10000 deposit on a car, and the list goes on. You still made that $100000 even if you don't have any of it left in cash.

                          There really isn't a typical amount for retained earnings. And it doesn't have to ever come out of the company unless the company dissolves.

                          When judges want corporation balance sheets, etc. they're looking for personal expenses filtered through the business. For instance, is the business paying your home phone, insurance, car payments?? If so, the judge will consider that income to the person despite the retained earnings of the corporation.

                          As an example, the retained earnings of the company I work for is substantially higher than $80000. However, the retained earnings amount is not what's available to me in liquid funds. It's what's available to me if I sold assets.

                          You are better off looking for those filtered personal expenses, comparing the wage she pays herself to others that are traditionally employed doing similar work, or finding personal assets that also appear on the company balance sheet - like the new Mercedes that the company makes a monthly payment on, but her mother (who isn't employed by the company) drives.

                          Comment


                          • #14
                            In this case, the parent indicated it hasn't been spent, but is being kept to fund possible future gaps in her personal income. There are no other employees/contractors.
                            Agree on the personal vs business expenses search.

                            Interesting read here. https://www.google.ca/url?sa=t&sourc...EjxwRXpZlV8KZw

                            "... the Court of Appeal’s decisions of Hausmann v. Klukas, [2009] B.C.J. No. 121 and Teja v. Dhanda, 2009 BCCA 198. These cases, particularly Teja, make it clear that an incorporated professional or the controlling shareholder of a business bears a heavy onus to show why all of the pre-tax income of the corporation should not be included in the calculation of Guidelines income."
                            Last edited by dinkyface; 10-23-2015, 01:15 PM.

                            Comment


                            • #15
                              A good indicator that someone is shovelling personal expenses through their corporation is the lack of increase in retained earnings year to year. If the company made $80000 since incorporation (say 4 years), they've averaged a profit of $20000/a over those 4 years. And, if the profit all of a sudden isn't being generated, I'd ask myself why? Where are the profits going then? In small corporations, owned by one person, it is highly probable that the retained earnings account is only augmented at fiscal year end - when the profits (or losses) are realized. It could be that the business model is no longer profitable, or that the industry has changed, etc. but if the business historically generated profit from Year 1....it will take some explaining to state why they are no longer profitable.

                              If she's living a million dollar a year lifestyle, yet only pays herself $25000/a - then she is funneling expenses through the business that should be personal.

                              If you have the company's financial documents for 3 years, you should do a year over year comparison of the income account and the expense accounts. You may see income went down while expenses increased.

                              Comment

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