Child support when a parent owns (or sold) a business

The "phantom income" problem

Pass-through entities (S-corporations, partnerships, most LLCs) do not pay income tax themselves — the income flows through to the owners, who are taxed on their share whether or not it is actually distributed. An owner can owe tax on a K-1 figure they never received in cash because the business retained the money. That taxable-but-undistributed amount is what practitioners call "phantom income."

• S-corporations — 26 U.S.C. § 1366 (and 26 CFR § 1.1366-1) tax a shareholder on a pro-rata share of corporate income "whether or not distributed."
• Partnerships / LLCs — 26 U.S.C. §§ 702 & 704 and the IRS Schedule K-1 (Form 1065) instructions make a partner "liable for tax on [their] share of the partnership income, whether or not distributed."

The child-support question is whether that phantom income is also the parent's income available for support. The federal tax code creates the phantom income; it does not decide the support question — that is state law.

Federal analogue (conceptual only): the constructive-receipt regulation 26 CFR § 1.451-2 says income is not "constructively received" where the taxpayer's control of it "is subject to substantial limitations or restrictions." That mirrors the child-support idea that income must be available (controllable) to count — but § 1.451-2 is a tax-timing rule and does not itself govern K-1 pass-through income, which is taxed regardless of control. It is an analogy to the principle, not controlling authority.

Wisconsin's two-part test — Weis & Winters

In Wisconsin, a business's undistributed (retained) earnings are counted as the paying parent's income only if both parts of a conjunctive test are met:

1. the payer can individually control or access the undistributed earnings; and
2. there is no valid business reason for the company to retain them.

If either part fails, the retained earnings are excluded. Both conditions must be present (Winters ¶ 12).

Weis v. Weis, 215 Wis. 2d 135, 572 N.W.2d 123 (Ct. App. 1997), is the origin of the test. A partner who "does not have an ownership interest in the partnership sufficient for him to individually exercise control over the partnership's undistributed earnings" could not have those earnings counted — "it was error for the trial court to include [his] share of the undistributed earnings in his gross income." Caveat the other way: Weis held that employer- or partnership-paid health-insurance premiums are income. Its second condition traces to Lendman v. Lendman, 157 Wis. 2d 606 (Ct. App. 1990) (retained earnings as a "necessary adjunct of a well-managed business" versus a pretext).

Winters v. Winters, 2005 WI App 94, 281 Wis. 2d 798, 699 N.W.2d 229, restates and applies the test to an S-corporation minority (10%) shareholder. The official Wisconsin Legislature annotation to Wis. Stat. § 767.511(7) reproduces the two-factor formulation and attributes it to Winters.

Watch the citation: a separate Winters v. Winters, 2008 WI App 148, 757 N.W.2d 849, appears to be an unpublished disposition — non-citable as authority under Wis. Stat. § 809.23(3). The leading case is the 2005 published decision. [The 2008 status is flagged for confirmation, not relied upon here.]

Codified in DCF 150 — the two limbs live in different sections

Wisconsin's child-support income definition (Wis. Admin. Code ch. DCF 150, current as of Register November 2024 No. 827) splits the doctrine across two places — do not attribute the whole rule to one subsection:

• Control / access limb — § 150.02(13)(a)9. Gross income includes "undistributed income of a corporation, including a closely-held corporation, or any partnership, including a limited or limited liability partnership, in which the parent has an ownership interest sufficient to individually exercise control or to access the earnings of the business." Subd. 9.a. measures that "undistributed income" by federal taxable income of the entity, plus depreciation claimed on its federal return, less a reasonable allowance for economic depreciation.
• Valid-business-reason limb — § 150.03(2)(b) & § 150.02(16). Retained income is added to a parent's income only to the extent the court finds it "not reasonably necessary for the growth of the business," and "the parent shall have the burden of proof to show that any undistributed income is reasonably necessary for the growth of the business."

Practical upshot: the parent who wants to keep retained earnings out of the support calculation must prove the retention was reasonably necessary for the business — the burden is on them, not the other parent.

How other states handle the same question

Wisconsin's approach lines up with leading sister-state authority (persuasive, not binding):

• Kansas — In re Marriage of Brand, 273 Kan. 346, 44 P.3d 321 (2002). "There can be no bright line rule" on undistributed S-corp earnings; a case-by-case analysis weighs past earnings history, ownership share, and the shareholder's ability to control distribution or retention. A controlling shareholder bears the burden of proving retention was necessary to preserve the business; a minority shareholder "has less ability to control" and, on the facts, the retained earnings were not counted.
• Pennsylvania — Fennell v. Fennell, 753 A.2d 866 (Pa. Super. 2000), the burden-of-proof source Brand relied on.
• Florida — McHugh v. McHugh, 702 So. 2d 639 (Fla. 4th DCA 1997). Retained S-corp K-1 income (~$247,000) of a 10% minority shareholder was excluded because the company retained it "for purposes of building the business" and the other parent "offered no proof that the husband … had any access to, or control over, these funds." Florida's access-and-control framework was later taken up by the state Supreme Court in Zold v. Zold, 905 So. 2d 1234 (Fla. 2005).

The former owner — sold or exited the business

A different fight arises when a parent sells or leaves a business and then reports a low W-2 salary. Here the question is not phantom income but whether the court should use actual income or earning capacity.

Wisconsin's "shirking" doctrine lets a court base support on what a parent could earn rather than what they report, when the income reduction is found to be voluntary and unreasonable. The leading statement is the Wisconsin Supreme Court's decision in Chen v. Warner, 2005 WI 55, 280 Wis. 2d 344, 695 N.W.2d 758 — shirking does not require bad faith, but the choice that reduced income must be both voluntary and unreasonable under the circumstances. It is a fact-intensive inquiry; reduced income after a genuine, reasonable business exit is not automatically "shirking."

So a former owner's order can turn on the gap between a sale-year flow-through figure and a later modest salary — the court decides which the support number rests on. This is the post-sale version of the same "what income counts" problem.

Other non-W-2 income to expect in the analysis

DCF 150 sweeps in more than wages. For a business-owner or self-employed parent, courts commonly look at:

• Self-employment / 1099 net earnings — gross receipts less ordinary and necessary business expenses.
• Depreciation add-backs — § 150.02(13)(a)9.a adds back federal depreciation and allows only a "reasonable allowance for economic depreciation," so accelerated/bonus depreciation and § 179 expensing that drive taxable income below cash flow can be partly added back.
• In-kind perks and "income modified for business expenses" (§ 150.02(16)) — a company car, paid personal expenses, and similar benefits can be counted.
• Distributions actually received, including cash distributed to cover the tax on pass-through income.

None of this is a verdict on any real case — the figures and findings are intensely fact-specific.

Sources & further reading

Weis v. Weis, 215 Wis. 2d 135 (Ct. App. 1997)·Winters v. Winters, 2005 WI App 94·In re Marriage of Brand, 273 Kan. 346 (2002)·McHugh v. McHugh, 702 So. 2d 639 (Fla. 4th DCA 1997)·Chen v. Warner, 2005 WI 55 (earning capacity / "shirking")·Wis. Stat. § 767.511 (with annotations)·Wis. Admin. Code ch. DCF 150 (PDF)·26 U.S.C. § 1366 (S-corp pass-through)·26 CFR § 1.451-2 (constructive receipt)·IRS Schedule K-1 (Form 1065) instructions

Verification note: the Weis/Winters two-part test, the DCF 150 sections, and the Brand/McHugh holdings were checked against primary sources (CourtListener opinions and the Wisconsin Legislature statute/administrative-code text); the federal pass-through mechanism was checked against the U.S. Code, Treasury regulations, and IRS instructions. Grohmann v. Grohmann is part of the Wisconsin predecessor line but its holding was not independently re-verified for this summary. Wis. Admin. Code ch. DCF 150 is current as of Register November 2024 No. 827 — confirm it has not been re-promulgated, and run a citator (Shepard's/KeyCite) check, before relying on any citation in a filing.

Informational summary, not legal advice. For the mechanics behind these doctrines, see Did You Know?, the multi-state child-support estimator, and the FYI hub. Consult a Wisconsin family-law attorney before relying on any of this.