Phantom income and child support in Wisconsin

The short version

• Tax law and child-support law measure income differently. A tax return is where the analysis starts, not the answer.
• Wisconsin counts undistributed business income only if the parent can individually control or access it. If the parent can, the parent must prove that earnings kept in the business are reasonably necessary for its growth.
• Cash the parent actually received counts, but only once. A distribution paid out of K-1 income is not extra income on top of that K-1.
• A balance-sheet total of retained earnings is years of past income, not this year's. Gain on installment payments not yet received is not this year's income either.
• In our fictional example, a report of $670,000 corrects to $195,000. See it line by line.

What phantom income is

S corporations, partnerships and most LLCs don't pay income tax themselves. Their income "passes through" to the owners, who pay tax on their share whether the business hands them the cash or keeps it. Federal rules say so in so many words. An S-corporation shareholder takes into account their pro rata share of the company's items "whether or not distributed" (26 C.F.R. § 1.1366-1(a)(1)). A partner takes into account their distributive share "whether or not distributed" (26 C.F.R. § 1.702-1(a)).

So an owner can report $150,000 on a K-1 and receive $60,000. The other $90,000 is "phantom": taxed, but never in the owner's hands. Other items work the same way on a return. Depreciation recapture reverses deductions from earlier years. A § 1231 gain comes from a one-time sale of business equipment. Some sales are taxed before the money arrives. The tax rules are right about tax. The question for support is different: what income is actually available to support the child?

What Wisconsin counts

Wisconsin sets child support with a percentage standard (Wis. Stat. § 767.511(1j)). It is applied to "monthly income available for child support," defined in the Department of Children and Families rule, Wis. Admin. Code ch. DCF 150. The pieces that matter for business owners:

Monthly income available for child support — DCF 150.02(21)

calculated by adding the parent's annual gross income or, if applicable, the parent's annual income modified for business expenses; the parent's annual income imputed based on earning capacity; the parent's annual income imputed when no or little information is known; and the parent's annual income imputed from assets, and dividing that total by 12. DCF 150.03(1) gives the court the same instruction.

Gross income — DCF 150.02(13)(a)

Salary and wages (1.); interest and investment income (2.); voluntary deferred compensation and employee retirement contributions (7.); and all other income, whether taxable or not, apart from listed exclusions such as child support and public assistance (10.).

Undistributed business income — DCF 150.02(13)(a)9.

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, unless the income included is an asset under s. DCF 150.03 (4). It is measured as federal taxable income of the closely held corporation, partnership, or other entity plus depreciation claimed on the entity's federal income tax return less a reasonable allowance for economic depreciation (9.a.). The allowance is depreciation on assets computed using the straight line method and useful lives as determined under federal income tax laws and regulations (9.b.).

Income modified for business expenses — DCF 150.02(16) and 150.03(2)

The court may add wages paid to dependent household members (150.03(2)(a)). It may add undistributed income that meets the criteria in s. DCF 150.02 (13) (a) 9. and that the court determines is not reasonably necessary for the growth of the business. The parent shall have the burden of proof to show that any undistributed income is reasonably necessary for the growth of the business. (150.03(2)(b)). And it may reduce income by business expenses it finds reasonably necessary for the production of that income or operation of the business and that may differ from the determination of allowable business expenses for tax purposes (150.03(2)(c)).

Income imputed from assets — DCF 150.03(4)

A court may give assets a reasonable earning potential only if the parent has ownership and control of them, and the assets are underproductive, and either income was diverted into them to avoid support or their income is needed to keep the child's standard of living. That reach includes cash and corporate income in a corporation in which the parent has an ownership interest sufficient to individually exercise control that is not already counted as gross income. The imputed income is the assets' net value times the six-month Treasury bill rate, or another reasonable rate, less the actual income they produce (150.03(4)(b)).

Quotations are from Wis. Admin. Code ch. DCF 150 as published in Register November 2024 No. 827, and Wis. Stat. ch. 767 as updated through 2025 Wis. Act 247.

What Winters v. Winters holds — and doesn't

Winters v. Winters, 2005 WI App 94, 281 Wis. 2d 798, 699 N.W.2d 229 (review denied), is the Wisconsin Court of Appeals' leading published decision on S-corporation income and child support. The payer owned 10%, a minority interest, in an S corporation that kept its earnings and paid out only enough cash for shareholders to pay their tax. The majority shareholder decided whether to distribute (¶¶3, 10).

“When undistributed company earnings are at issue, the court must: 1) ascertain whether the child support payer has the ability to individually control or access the undistributed earnings; and 2) determine whether there is a valid business reason for the company’s decision to retain the earnings. If the payer has the ability to individually control or access earnings and the company has no valid reason for retaining its earnings, the undistributed income can be considered when calculating the payer’s child support obligation.”

From the opinion itself:

• The two conditions (¶9, at 804–05). Following Weis v. Weis, 215 Wis. 2d 135, 141–42 (Ct. App. 1997), the court first asks whether the payer has the ability to individually control or access the undistributed earnings. Second, it asks whether there is a valid business reason for the company's decision to retain the earnings. Only if the payer has control or access and there is no valid reason can the undistributed income be counted.
• Selling your shares is not control (¶10, at 805). The argument that the payer could sell his stock erroneously equates [his] ability to control undistributed earnings with his ability to sell his stock.
• The second condition is about manipulation (¶11). It addresses whether the payer is using the company as a pretext to manipulate income.
• Both conditions must be present (¶12, at 805–06). Because the minority owner lacked control, the court did not need to reach business purpose.
• Tax distributions were not decided (¶13, at 806–07). The court declined to consider whether tax distributions count, because the argument was undeveloped and unsupported by authority. The conclusion (¶21) says they were appropriately excluded, but that rests on the forfeited argument. It is not a ruling that tax distributions never count. See the business-owner guide for a later unpublished decision reading Winters that way.
• Discovery can be limited (¶¶18–20). The court upheld limiting a sweeping request for nearly every financial record to what was relevant to the business income at issue. Targeted requests work better than broad ones.

Know which side of the fork you are on. Winters protects owners who cannot reach the earnings. Most small-business owners can. For them the first condition is met. DCF 150.03(2)(b) then puts the burden on the owner to prove that retained earnings are reasonably necessary for the business's growth. For a controlling owner, the defense is accurate arithmetic and documented business need, not Winters.

Five kinds of phantom income — and the correct treatment

1. Undistributed K-1 income

The error: the report adds the whole K-1 (1120-S box 1 or 1065 box 1) and then adds the distributions too.
The rule: without individual control or access, count only the distributions actually received (DCF 150.02(13)(a)9.; Winters ¶12). With control, count the entity's taxable income plus depreciation above straight-line, minus what the owner proves is reasonably necessary for growth (DCF 150.02(13)(a)9.a.; 150.03(2)(b)). The distributions are part of that amount, not an addition to it.

2. Depreciation recapture and § 1231 / Form 4797 gains

When a business sells equipment it has depreciated, the gain up to the depreciation taken is "recaptured" as ordinary income (26 U.S.C. § 1245). It flows through Form 4797 into K-1 box 1. Any further gain is § 1231 gain (1120-S K-1 box 9; 1065 K-1 box 10).
The error: the report treats the sale as ordinary, recurring income, and often adds back all depreciation as well.
The rule: for an owner without control, both are part of undistributed income and are not counted. For an owner with control, only depreciation above straight-line is added back (9.a.–b.), and the gain is a one-time event that should not be built into an ongoing order without the court addressing it.
Argument, not settled: if earlier years' support already added back the accelerated depreciation, counting the recapture now counts the same depreciation twice. We found no Wisconsin appellate decision on this point.

3. One-time sale gains

Be careful here: Wisconsin does not exclude a gain just because it is a one-off. The Court of Appeals has held there is no "windfall" exception, so income actually received in a year is generally gross income. The official annotation to Winkler v. Winkler, 2005 WI App 100, 282 Wis. 2d 746, 699 N.W.2d 652, reads: A lump sum payment as the result of a pension plan enhancement was gross income subject to the child support standards. There is no windfall exception to the application of child support to gross income. Expect the other side to cite it. Winkler is about a lump sum actually paid. It does not address retained earnings or money not yet received. What you can challenge:

• gain that has not been received (see 4, below);
• counting the same gain twice (for example as a K-1 item and again as a separate "sale" line);
• counting an asset twice across the case. The annotation to State v. Maley, 186 Wis. 2d 125, 519 N.W.2d 717 (Ct. App. 1994), reads: An asset and its income stream may not be counted both as an asset in the property division and as part of the payer’s income from which support is paid. Note the exception recognized in Cook v. Cook, 208 Wis. 2d 166, 560 N.W.2d 246 (1997), for some assets such as military retirement pay;
• turning a single year's gain into a permanent monthly figure. If using the percentage standard on it would be unfair, ask the court to deviate under Wis. Stat. § 767.511(1m). The court must then make the findings § 767.511(1n) requires.

4. Installment notes and receivables not yet received

Under the installment method, gain is taxed as payments arrive: the gain recognized each year is that proportion of the payments received in that year which the gross profit … bears to the total contract price (26 U.S.C. § 453(c)).
The error: the report counts the gain on every future payment now, as if the note had been paid off.
The rule: count the gain on the payments received this year, and the interest actually received. Next year's payment brings its own gain into next year's income. Two traps:

• Depreciation recapture on an installment sale is taxed in the year of sale no matter when the money comes (§ 453(i)). A seller who elects out of the installment method reports the whole gain at once (§ 453(d)). In both cases the return shows income the seller has not been paid. Point that out.
• A note receivable is an asset. At most it can bring in imputed asset income under DCF 150.03(4), if that rule's conditions are met.

5. Retained earnings the parent cannot reach

The error: the report takes "retained earnings" from the company's balance sheet (Schedule L, or the M-2 accumulated adjustments account) and adds the owner's share to this year's income.
The rule: that balance is the total of earlier years' income, already reported on earlier K-1s. It is not a year's income. DCF 150.02(21) builds support from annual income. Undistributed income is measured from this year's federal taxable income (9.a.). Accumulated earnings can reach support only through the asset rule, DCF 150.03(4). That requires ownership and control, underproductive assets, and diversion or a standard-of-living need. Even then, it produces a modest imputed return, not the balance itself.

If you own the whole business: single-member LLCs, sole-shareholder S corporations, salary and distributions

Most small-business parents own the whole thing. How the business files its taxes changes where the numbers appear. It does not change the principle: count each dollar of real income once.

Single-member LLC (Schedule C)

By default, a domestic LLC with one owner is disregarded as an entity separate from its owner (26 C.F.R. § 301.7701-3(b)(1)(ii)). Unless it elects to be taxed as a corporation, its profit goes on the owner's Schedule C. For support, the Schedule C profit is the starting point. The court can adjust expenses it finds unnecessary, or allow necessary ones the tax rules don't (DCF 150.03(2)(c)), and add back wages paid to dependent household members (150.03(2)(a)). The trap: money the owner moves to a personal account — a "draw" — is that same profit. It is not extra income on top of Schedule C.

Sole-shareholder S corporation (Form 1120-S → K-1 → your 1040)

The owner usually receives three things: a W-2 salary, a K-1 showing the company's profit after that salary, and distributions of cash. A sole owner controls distributions, so undistributed income counts (DCF 150.02(13)(a)9.), less what the owner proves is reasonably necessary for growth (150.03(2)(b)). Health-insurance premiums the company pays for a more-than-2% shareholder appear in W-2 box 1 but not box 5 (IRS guidance). The official annotation to Weis reads: Health insurance premiums paid by a partnership are included in the partners’ income available for child support. Expect the same argument for S-corporation-paid premiums. The same dollar can show up twice in two places:

• W-2 salary plus the salary added back. The company deducts the owner's salary (Form 1120-S line 7) before computing K-1 income. W-2 plus K-1 is therefore not a double count. It becomes one if a report "normalizes" by adding the salary back to the company's income while also counting the W-2.
• K-1 income plus distributions. A distribution is paid out of the income on the K-1. It is not a second income stream. Count the K-1 measure once. The distributions are inside it.

K-1 income versus cash, basis, and retained earnings

K-1 income increases the owner's stock basis. Distributions reduce it (26 U.S.C. § 1367(a)). A distribution from an S corporation with no accumulated earnings and profits shall not be included in gross income to the extent that it does not exceed the adjusted basis of the stock (§ 1368(b)(1)). That is why a distribution isn't taxed a second time: it is income that was already taxed on a K-1. The same logic applies to support. Retained earnings are what the company kept from past years' K-1 income. They are not a new year's income.

The business's reasonable working-capital needs

A business needs cash to operate: inventory, receivables, payroll timing, loan payments, and reserves for equipment it will have to replace. DCF 150.03(2)(b) frames the question as whether retained income is reasonably necessary for the growth of the business, with the burden on the owner. Winters and Weis frame the second condition as whether there is a valid business reason to retain earnings. Either way, the owner has to prove it with contemporaneous documents: a capital plan, lender covenants, a reserve policy, and cash-flow history. "The company needed it" is not proof.

All names and numbers are invented. Load this example in the worksheet to see every line explained.

How to answer an inflated report, step by step

1. Get the whole report, including the workpapers. Ask for the schedules, the source documents the expert relied on, and any spreadsheets. An expert's opinion is admissible only if its proponent shows it is based upon sufficient facts or data, is the product of reliable principles and methods, and reflects a reliable application of them to the facts (Wis. Stat. § 907.02(1)).
2. Map every line to a form and a box. Write the form, the box and the dollar amount next to each line. Mark every line where the same dollars appear twice: salary and a salary add-back, K-1 and distributions, Schedule C and draws, a sale gain on the K-1 and again as a separate line.
3. Settle the control question with documents. Collect the ownership percentage, the operating or shareholder agreement, voting rules for distributions, and any buy-sell agreement. Remember that the ability to sell is not control (Winters ¶10).
4. Prove what was actually received. Build a distribution ledger from bank statements: date, amount, and purpose (tax distribution or other). Match it to K-1 box 16D or 19A.
5. Subpoena or request the right records, narrowly. Discovery reaches matter relevant to a claim or defense and proportional to the needs of the case (Wis. Stat. § 804.01(2)(a)). A subpoena may command production of books, papers, documents, electronically stored information (§ 805.07(2)(a)), with notice to the other parties at least 10 days ahead for a third-party subpoena (§ 805.07(2)(b)). Winters shows that narrow requests hold up better than broad ones (¶¶18–20). Typical list:
   • the entity's returns (1120-S or 1065) with all K-1s, Form 4562 (depreciation) and Form 4797 (asset sales);
   • Schedule L balance sheets and the M-2 accounts; the general ledger and trial balance;
   • the distribution ledger and business bank statements;
   • the operating or shareholder agreement, minutes and resolutions on distributions;
   • loan agreements and covenants, the capital or equipment plan, reserve policy;
   • for a sale: the purchase agreement, the note, the payment history, Form 6252.
   Both parents also have their own disclosure duties. In an action affecting the family, each party files a financial disclosure. The form must warn that deliberate failure to disclose fully is perjury. The court must require the past two years' tax returns if either party asks (Wis. Stat. § 767.127(1)). Under a support order, parties exchange tax returns with all W-2s and 1099s every year (§ 767.54).
6. Depose or cross-examine the expert. Questions that tend to matter:
   • "Which of these lines did the parent actually receive in cash? Show me where in the bank records."
   • "Line 6 distributions — were they paid out of the income on line 4? Then why are both in the total?"
   • "Did the parent have the individual power to make the company distribute? What document says so?"
   • "What is the difference between retained earnings on Schedule L and this year's taxable income? Which years' income makes up that balance? Were those years already counted?"
   • "How did you compute the depreciation add-back? Did you subtract straight-line depreciation, as DCF 150.02(13)(a)9.b. requires?"
   • "Has any of the gain on line 10 been received? When will it be taxed under § 453?"
   • "Is the equipment sale on lines 4 and 5 expected to recur? Is the recapture included in line 4?"
   • "Did you review the company's capital plan, loan covenants or reserve needs before concluding no earnings were needed?"
   • "Which Wisconsin rule or case supports adding each line? Did you apply DCF 150, or a general 'cash flow' method?"
7. Know the burdens. For a controlling owner, the owner proves business necessity for retained income (DCF 150.03(2)(b)). A party asking the court to depart from the percentage standard must show unfairness by the greater weight of the credible evidence, and the court must state its reasons on the record (§ 767.511(1m)–(1n)). The party offering the expert must meet § 907.02(1).
8. Offer a corrected worksheet. Present your own line-by-line calculation with a source and an authority for every line. The worksheet prints one. Concede the lines that are right; it makes the rest more credible. For complex businesses, consider your own qualified expert.
9. Ask for findings. Ask the court to state which lines it counts and why: control, business necessity, and any deviation. That record matters for a later motion or appeal.

What the other side will argue — and how it is answered

A fair analysis expects the counter-arguments. These are the common ones.

"The owner is shirking — impute a higher income."

A court may impute income based on earning capacity if a parent is voluntarily unemployed or underemployed without good cause, weighing factors such as work history, prior earnings, skills and education (DCF 150.03(3)). In shirking cases the court applies a test of reasonableness under the circumstances, balancing the needs of the parents and the needs of the child, both financial and otherwise (official annotation to Chen v. Warner, 2005 WI 55, 280 Wis. 2d 344, 695 N.W.2d 758; see also Sellers v. Sellers, 201 Wis. 2d 578, 549 N.W.2d 481 (Ct. App. 1996): earning capacity may be used if the job choice is voluntary and unreasonable). Answer: show the business's real history, market conditions, the hours you work, and why your pay is reasonable for the work. Show that the income didn't change when the case started.

"The owner controls the company and is keeping the money inside to hide it."

This is the second Weis condition: whether the company is being used as a pretext to manipulate income (Winters ¶11). For a controlling owner, the owner carries the burden of proving business necessity (DCF 150.03(2)(b)). Answer: contemporaneous documents — a capital plan, lender covenants, reserve history — that were created before the dispute and actually followed.

"Look past the labels — the business pays the owner's personal expenses."

Courts can. No matter how corporate income is labeled, a family court may pierce the corporate shield if it is convinced the obligor’s intent is to avoid financial obligations (official annotation to Evjen v. Evjen, 171 Wis. 2d 677, 492 N.W.2d 361 (Ct. App. 1992)). Personal expenses run through the business can be added back. The court may disallow expenses that are not reasonably necessary to produce the income (DCF 150.03(2)(c)). Answer: clean books (see below). Where some personal use exists, concede it and quantify it yourself.

"The tax distributions are real cash — count them."

Often correct. Cash actually received is generally counted. Winters did not decide whether tax distributions are excluded (¶13). Treat excluding them as an argument, not a rule.

"The sale proceeds are income."

Gain actually received is generally income for that year (Winkler, above). Answer: separate what was received from what wasn't. Separate return of basis from gain. Ask the court to address whether a one-time amount belongs in an ongoing monthly order.

Building a better structure for your family

This is about transparency and accuracy, not about lowering support. The goal is a record that shows the court your real income, so the order is right the first time. Concealing or manipulating income to reduce child support is improper, and it tends to backfire. Courts can look past the arrangement and impute income (DCF 150.03(3)). Deliberately incomplete disclosure is perjury under the statement the disclosure form must carry (Wis. Stat. § 767.127(1)). If a party fails to file a complete disclosure, the court may accept the other party's information as accurate (§ 767.127(4)). A party who by deliberate conduct, frustrates an accurate calculation of income does not stop the court from finding income on the available evidence (annotation to Lellman v. Mott, 204 Wis. 2d 166, 554 N.W.2d 525 (Ct. App. 1996)). Where a payer had a substantial potential to manipulate the amount of support, a minimum fixed amount based on potential income was upheld (annotation to Doerr v. Doerr, 189 Wis. 2d 112, 525 N.W.2d 745 (Ct. App. 1994)).

1. Pay yourself a documented, reasonable salary. For an S corporation, the IRS says the company must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made. A salary set by a written rationale (the market rate for your role and hours) makes the W-2 a clean, credible figure.
2. Adopt a written distribution policy, and record decisions in minutes. Board or member minutes that approve each distribution, and state why any earnings are kept, turn "the company needed it" into evidence.
3. Document why earnings are retained. Keep a capital plan (equipment replacement, expansion), debt-service schedules and loan covenants, and a reserve policy (for example, a set number of months of operating expenses). Update them every year, before any dispute. The owner carries this burden (DCF 150.03(2)(b)).
4. Keep separate books, and don't commingle. Use separate business bank and card accounts. Pay personal expenses personally. Record any personal use of business property. Commingling invites the argument that business expenses are really personal income (DCF 150.03(2)(c)).
5. Keep the paper trail organized. Keep K-1s, entity returns (with Forms 4562 and 4797), a distribution ledger tied to bank statements, and loan documents, by year. You will exchange returns every year under a support order (§ 767.54).
6. Have a tax professional review the entity choice. Sole proprietorship, single-member LLC, partnership and S corporation each change where income appears and how it is taxed. The right choice depends on your business. Make it for business and tax reasons, documented at the time, and disclose it fully in the support case.

None of this changes what counts as income. It makes the income easy to see. A parent who is receiving support can ask for the same documents to understand the other parent's business.

Questions

Related Wisconsin cases: the official annotations to § 767.511

For attorneys and anyone researching further: every case annotation the Wisconsin Legislature publishes under Wis. Stat. § 767.511, in the official order. Each line is the annotation's own text, not our summary. Annotations are research aids: read the opinion before relying on it.

Source: Wis. Stat. § 767.511 annotations, 2023-24 Wis. Stats. updated through 2025 Wis. Act 247 (published Sept. 4, 2026). Annotations to other sections (for example Chen v. Warner under § 767.59) are cited where used above.

Sources

• Wis. Admin. Code ch. DCF 150 (Register Nov. 2024 No. 827)
• Wis. Stat. § 767.511
• Wis. Stat. § 767.127 (financial disclosure)
• Wis. Stat. § 767.54 (annual exchange)
• Wis. Stat. § 907.02 (expert testimony)
• Wis. Stat. § 804.01 (discovery)
• Wis. Stat. § 805.07 (subpoenas)
• Winters v. Winters, 2005 WI App 94, 281 Wis. 2d 798, 699 N.W.2d 229
• Weis v. Weis, 215 Wis. 2d 135, 572 N.W.2d 123 (Ct. App. 1997)
• Official annotations to Wis. Stat. ch. 767 (PDF)
• 26 U.S.C. § 453 (installment method)
• 26 U.S.C. § 1245 (depreciation recapture)
• 26 U.S.C. §§ 1367–1368 (S-corp basis & distributions)
• 26 C.F.R. § 1.1366-1 (S-corp items "whether or not distributed")
• 26 C.F.R. § 1.702-1 (partner’s share "whether or not distributed")
• 26 C.F.R. § 301.7701-3 (single-member LLC default)
• IRS: S corporation compensation (reasonable compensation)

Checked against primary sources: the text of Wis. Admin. Code ch. DCF 150 and Wis. Stat. chs. 767, 804, 805 and 907 on docs.legis.wisconsin.gov; the opinions themselves; the U.S. Code and Treasury regulations; and the IRS page on S-corporation compensation. Paragraph (¶) and page citations to Winters are to the published opinion. Law changes: confirm the current rule and run a citator check before relying on any citation in a filing.

Related: business owners and former owners · the flawed report, corrected · income worksheet · Wisconsin support estimator · court prep for self-represented parents