My rich uncle always said, “No one ever got rich unless they walked into a bank and asked for a loan.” Smart businesspeople borrow money. Smart businesspeople sometimes spend that money on a non-business-related purpose. Does that mean the loan will be considered income in an Illinois divorce?
Business owners almost always have a variety of loans and liabilities that balance out their hard assets. These loans keep the business owner liquid and provide them with the flexibility needed to maintain their business and their personal life.
When the business owner gets divorced, the loans will look a lot like income to the other spouse….especially if the business owner is borrowing from their own company.
The other spouse can try to characterize the loans as income for the purposes of determining maintenance (formerly known as alimony) and child support.
What Is Income In An Illinois Divorce?
The spouse’s incomes are what determines child support and maintenance amounts.
To order child support, Illinois divorce courts must “determine each [spouse/]parent’s monthly net income” 750 ILCS 505(a)(1.5)(A)
Determining income for the purpose of ordering maintenance works exactly the same as the child support income determination.
“Net income. As used in this [maintenance] Section, “net income” has the meaning provided in Section 505 of this Act, except maintenance payments in the pending proceedings shall not be included.” 750 ILCS 5/504(b-3)
For most people whose income is received as regular paycheck, the net income amount is a simple calculation: Gross income less the standardized tax deduction.
““[N]et income” means gross income minus either the standardized tax amount” 750 ILCS 5050(a)(3)(B)
“[G}ross income” means the total of all income from all sources” 750 ILCS 5050(a)(3)(A)
“[S]tandardized tax amount” means the total of federal and state income taxes for a single person claiming the standard tax deduction, one personal exemption, and the applicable number of dependency exemptions for the minor child or children of the parties, and Social Security and Medicare tax calculated at the Federal Insurance Contributions Act rate.” 750 ILCS 5050(a)(3)(C)
Business owners do not just get a paycheck every two weeks. Business owners’ incomes are also the gross receipts less the legitimate expenses.
“Business income. For purposes of calculating child support, net business income from the operation of a business means gross receipts minus ordinary and necessary expenses required to carry on the trade or business. As used in this paragraph, “business” includes, but is not limited to, sole proprietorships, closely held corporations, partnerships, other flow-through business entities, and self-employment.” 750 ILCS 5/505(a)(3.1)
Business owners have big swings in their income. That is why business owners take out loans to bridge the gaps during a slow season or a downturn. Illinois courts account for this variability of income by requiring a consideration of“[a]t least the three prior years…to obtain an accurate income picture.” In re Marriage of Freesen, 275 Ill. App. 3d 97, 103 (1995)
Illinois divorce courts have a lot of wiggle room in determining a spouse’s income.
“Th[e Illinois Marriage And Dissolution of Marriage] Act shall be liberally construed and applied to promote its underlying purposes… make reasonable provision for support during and after an underlying dissolution of marriage, legal separation, parentage, or parental responsibility allocation action” 750 ILCS 5/102(8)
An Illinois divorce court’s flexibility to determine income is important when one spouse is moving a lot of money around. The court must make a decision as to the divorcing party’s incomes.
“[T]he circuit court has a duty to make its own calculation of a parties’ income.” In re Marriage of Evanoff, 2016 IL App (1st) 150017
A divorce lawyer must accurately communicate what their client’s income truly is…and is not.
Are Loans Income In An Illinois Divorce?
It is common for small business owners to both borrow and lend sums to their own businesses. One can imagine a small business owner paying themselves $ 1000 a week while taking loans liberally from the business’s operating account. At the end of the year, when the total proceeds of the business are tabulated, the loan is considered “repaid” when the business owner’s dividend is reduced by the total amount of the loans taken over the year.
It is okay to rob Peter to pay Paul…so long as Peter gets paid back eventually.
Why would a business owner take a loan from the business instead of just withdrawing the money as pay? Because withdrawn money is income. Income gets taxed by income tax at up to 37%. Money loaned is not taxed. The remaining money after the loan is repaid will be issued and taxed as a dividend at 0%, 15% or 20%. These business owners are not dumb!
The business owner may call it a loan. The other spouse will see it as money from the company deposited into the business owner’s personal account and then spent on personal matters. If it looks like a duck, it walks like a duck and it quacks like a duck…it’s a duck.
Whether a loan is really a loan depends on whether the loan gets paid back.
Often loans are “loans in name only. [If the borrower] had never been required to repay any part of the substantial “loans” given to him each year..[and the loans]…represent a steady source of dependable annual income…he has received each year over the course of his adult life….[then] the money the [borrower] received…was no less “income” than…gifts…or [a] salary.” In re Marriage of Rogers, 820 NE 2d 386 – Ill: Supreme Court 2004
If a loan is paid back (or will credibly be paid back) then the loan is not income for the purposes of calculating child support and/or maintenance.
“[I]n general, loans should not be considered income.” In re Marriage of Tegeler, 848 NE 2d 173 – Ill: Appellate Court, 2nd Dist. 2006
Loans shouldn’t be considered income in an Illinois divorce because loans do not add to wealth.
“`Income’ represents a gain or profit and is ordinarily understood to be a return on the investment of labor or capital, thereby increasing the wealth of the recipient.” In re Marriage of Worrall, 778 NE 2d 397 – Ill: Appellate Court, 2nd Dist. 2002 (citations and quotations omitted)
“More significantly, loans typically should not be counted as income because they usually do not directly increase an individual’s wealth.” In re Marriage of Tegeler, 848 NE 2d 173 – Ill: Appellate Court, 2nd Dist. 2006
Considering loans income (even when they really look like income) creates a slippery slope of absurd results.
“[I]f a merchant borrows $500,000 to buy equipment for his business and is to repay the loan over a 10-year period, even a three-year income averaging approach would attribute much more “net income” to the merchant than the funds he actually possesses. Other scenarios create even more nonsensical results. Should a parent who takes out tens of thousands of dollars in student loans for graduate school be credited with an equal amount of “income” for those years? Should a parent who borrows hundreds of thousands of dollars for a mortgage to buy a house be considered to have that much additional “income” that year? In the mortgage example, even the comparatively small monthly mortgage payments could not be deducted from the inflated income, for a home mortgage is not an expense that produces income” In re Marriage of Tegeler, 848 NE 2d 173 – Ill: Appellate Court, 2nd Dist. 2006
The non-business owning spouse never understands how the business owner’s business really works. Divorce judges do not understand the financial mechanics of a business either. It is the duty of the business owner’s divorce lawyer to educate both the spouse and the judge as to what is income and what is NOT income for the purposes of determining child support and maintenance.
Furthermore, the non-business owning spouse needs to realize that the loans must be paid back…and they will be partly responsible for paying those loans back.
Illinois divorce courts “shall divide the marital property without regard to marital misconduct in just proportions” 750 ILCS 503(d)
“”marital property” means all property, including debts and other obligations, acquired by either spouse subsequent to the marriage” 750 ILCS 503(a) (emphasis mine)
If you would like to discuss your business, its loans and your divorce with an experienced Illinois divorce attorney, contact my Chicago, Illinois family law firm today.