Michigan Court of Appeals Reverses Child Support Determination

On October 23rd, 2014, the Michigan Court of Appeals held in a family law case that the trial court erred in calculating child support.  At an evidentiary hearing, the trial court erred in relying on an expert witness's calculation of the father's income that incorporated the witness's own assumptions about how the father's business should run, as opposed to using the company's own historical practices to calculate the father's actual income.

In Diez v. Cloma Davey, Docket No. 318910, the Michigan Court of Appeals addressed the issue of how to calculate a business owner's income when determining child support.  

The Court first recited the facts of the case.

Plaintiff is the president and sole shareholder of Supreme Gear Company (“SGC”), a small business manufacturer of precision gears used in the aerospace industry. SGC is organized as a corporation and it has elected to be an S Corporation for tax purposes under 26 USC § 1362(a)(1). The parties in this case met in 1994 and became romantically involved. They never married, but, over the course of a 16 year relationship, they had three children together.

After their relationship ended, plaintiff filed the present lawsuit in April 2010, seeking sole legal and physical custody of the three minor children. Following more than three years of litigation, on July 2, 2013, the trial court issued an opinion and order addressing the issues of (1) custody and parenting time, (2) child support, and (3) defendant’s request for attorney fees. First, regarding custody and parenting time, the trial court awarded the parties joint legal and joint physical custody. The parenting time schedule provided defendant with approximately 122 overnights per year, consisting of alternate weekends from Friday to Monday morning, alternate weeks in the summer, parenting time during spring break, and holiday parenting time pursuant to the 16th Circuit Judicial Reasonable Parenting Time Schedule.

On the issue of child support, the trial court credited the testimony of an expert, CPA Justin Cherfoli, who opined that plaintiff had an average income of $723,000 over the course of three years, from 2009 through 2011. Included within this calculation of income were plaintiff’s wages, distributions from SGC, “perks” such as car expenses paid by SGC, and a portion of “excess working capital” retained in SCG, meaning those amounts that, in Cherfoli’s judgment, plaintiff could withdraw from the S-Corporation while maintaining a viable business. Based on this, and accounting for defendant’s income and plaintiff’s award of 122 overnights, the trial court set plaintiff’s monthly child support at $7,062 . . .

The Court's analysis of whether the trial court erred in awarding the amount of child support that it did award followed.

On appeal, plaintiff challenges the child support order entered by the trial court. In particular, plaintiff disputes whether the trial court erred in relying on an expert’s determination of “excess working capital” in the S-Corporation as a basis for attributing income to plaintiff. He also contends that the trial court erred by including within its calculation of plaintiff’s income funds distributed to plaintiff by SGC for purposes of paying the tax burden attributable to SGC’s corporate income.

Relevant to plaintiff’s arguments, the FOC referee held an evidentiary hearing on the topic of child support. The hearing took place over the course of three days, and it involved testimony from both parties and three certified public accountants who testified as experts. The experts reached various conclusions regarding plaintiff’s actual income available for the payment of child support in the years 2008 through 2011, but, ultimately, the referee and trial court both relied on the opinion of Justin Cherfoli when determining plaintiff’s income . . .

Plaintiff objected to the FOC’s recommendation, and the matter was considered by the trial court. The trial court acknowledged that it must conduct a de novo review, but framed the matter as whether the referee “erred in crediting Cherfoli’s expert testimony” and ultimately found no error in the referee’s reliance on Cherfoli’s testimony. Specifically, the trial court concluded that “Michigan law treats the income of an S corporation as the income of the S Corporation’s shareholders” and, for this reason, “Cherfoli properly treated the income of plaintiff’s S corporation as plaintiff’s income.” Indeed, the trial court concluded that Cherfoli’s analysis “worked to plaintiff’s advantage” because Cherfoli considered only “excess working capital” rather than all of SGC’s income as income available for distribution. Agreeing with the referee that Cherfoli was the most credible expert, the trial court accepted Cherfoli’s calculation of “excess working capital” and his conclusion that 60 to 65 percent of “excess working capital” was available for distribution. In accepting Cherfoli’s annual figures, the trial court made no findings regarding whether these figures included amounts dispersed for payment of SGC’s taxes. Unlike the referee, the trial court used the average of three years, rather than a two year average used by the FOC, resulting in a gross income of $723,000, and ultimately, a net monthly income of $35,712. Based on this, and accounting for defendant’s income and plaintiff’s award of 122 overnights, the trial court set plaintiff’s child support at $7,062 per month . . .

Thus, turning to the particular facts of the present case, problematic in Cherfoli’s opinion is his substitution of his own judgment for that of plaintiff’s in terms of how SGC could be appropriately managed and, as a related matter, Cherfoli’s general disregard of the corporation’s historical practices. That is, rather than focus on SGC’s historical business practices and its historical distribution of profits to plaintiff, which would afford plaintiff continued control in the management of the corporation while at the same time ascertaining what monies should be available for child support under the MCSF, Cherfoli focused on how the business could be run by comparing its practices to that of an industry standard and offering his own personal opinion regarding what percentage of profit could be distributed under his alternative model. Central to our decision is the fact that Cherfoli did not opine that plaintiff’s management of his corporation or his retention of profits in the corporate coffers was outside the range of how business owners could reasonably be expected to conduct their business. Cherfoli did not focus his analysis on whether the profits retained by SGC were used or intended for unnecessary or illegitimate business expenses, whether the retention of funds was at odds with plaintiff’s historical practices, or whether plaintiff retained those funds in the corporation in order to avoid child support. Instead, in substituting his own judgment for that of plaintiff’s, Cherfoli freely acknowledged that his estimation was his own “personal” opinion, and, beyond his own personal feelings on the subject, he offered no basis to conclude that 60 to 65 percent of “excess working capital” was actually available to plaintiff or should be distributed by SGC to plaintiff. See 2013 MCSF 2.01(B), (E)(2). Accordingly, we conclude that the trial court erred by adopting the opinion of an expert who evaluated plaintiff, not based on how plaintiff historically ran the business, but based on, in essence, the substitution of his own business judgment for that of plaintiff’s in terms of how much income the business could relinquish.