Written by Chris Walton, JDYour client owns an S corporation. The K-1 reports $300,000 of pass-through income. The company distributed $100,000 in cash and retained $200,000 for equipment purchases, working capital, and debt service. Your client’s ex-spouse’s attorney argues that the $300,000 on the K-1 is “income” for support purposes. Your client says only the $100,000 he actually received should count. Who’s right?
The answer depends on where you are. In Roberts v. Roberts (Miss. Ct. App. February 25, 2025), the Mississippi Court of Appeals examined this question in the context of an S corporation appraisal business and emphasized that the analysis requires close attention to three variables: the shareholder’s control over distributions, the distinction between pass-through income and actual cash available, and whether the retained earnings were genuinely necessary for business operations. The court didn’t set a bright-line rule. It stressed that the treatment of retained earnings for support purposes is a fact-intensive inquiry that depends on the economic reality of the shareholder’s relationship with the business.
For family law attorneys and valuation professionals, Roberts addresses a problem that surfaces in every divorce involving an S corporation, LLC, or partnership: pass-through entities create phantom income — taxable income that the shareholder reports on their personal return but may never receive as cash. When that phantom income becomes the basis for child support or alimony calculations, the owner-spouse pays support on money that’s still sitting inside the company. Getting this wrong can produce support obligations the owner-spouse literally cannot fund.
The S corporation retained earnings trap exists because of a structural mismatch between tax law and family law. Under Subchapter S, the corporation’s income, deductions, and credits pass through to the shareholders’ personal tax returns regardless of whether the income is actually distributed. A shareholder who owns 100% of an S corp that earns $500,000 reports $500,000 on their K-1 even if the company distributes only enough cash to cover the shareholder’s tax liability and retains the rest for operations.
Family law support calculations, however, generally start with “income.” The question is what “income” means. If the court uses the K-1 figure, the support obligation is based on money the shareholder never received. If the court uses only cash distributions, the owner-spouse may have an incentive to suppress distributions to reduce support — particularly if they control the company and can decide how much to retain versus distribute.
Both approaches create distortions. Using K-1 income without adjustment overstates the shareholder’s available cash. Using only distributions without scrutiny creates an incentive to manipulate the timing and amount of distributions. The correct approach — and the approach Roberts points toward — requires analyzing the economic substance of what’s happening inside the company.
The Roberts court emphasized three variables that determine whether retained earnings should be treated as income for support purposes:
Control over distributions. This is the threshold question. If the shareholder is also the sole or controlling owner of the S corp and has the unilateral ability to declare distributions, the court is far more likely to treat retained earnings as available income. The reasoning: a shareholder who chooses not to distribute earnings is making a voluntary decision that shouldn’t reduce their support obligation. Conversely, if the shareholder is a minority owner who cannot control whether the corporation distributes earnings — the fact pattern in the well-known South Dakota Roberts v. Roberts (2003) case — the retained earnings genuinely aren’t available to them, and imputing the income is unfair.
Pass-through income versus actual cash available. The K-1 reports taxable income. It doesn’t report cash available for personal use. The two figures can diverge significantly. Depreciation reduces taxable income without consuming cash (but the equipment it represents does require capital expenditure). Debt principal payments consume cash without reducing taxable income. Revenue recognition timing can create taxable income before the cash is collected. A valuation professional who simply takes the K-1 number without analyzing the company’s cash flow statement is measuring the wrong thing.
Whether retained earnings are necessary for business operations. This is where the analysis gets company-specific. A construction company that retains earnings to fund equipment replacement, bond requirements, and working capital for seasonal revenue fluctuations has a legitimate business reason for not distributing the income. A professional services firm with minimal capital needs that accumulates cash beyond any reasonable operating requirement is harder to defend. The expert must analyze the company’s actual capital needs — equipment replacement schedules, debt service requirements, bonding capacity, working capital cycles — and determine whether the level of retained earnings is consistent with those needs or exceeds them.
Roberts also reinforces Mississippi’s distinctive approach to business valuation in divorce. Mississippi law requires an asset-based approach to business valuations and does not permit the division of goodwill as a marital asset. The Mississippi Supreme Court has stated that “goodwill is simply not property” and “cannot be deemed a divisible marital asset.” This framework — articulated in Singley, Watson, and Gutierrez v. Gutierrez — means that valuing a Mississippi business by capitalizing its earnings necessarily includes goodwill and is impermissible.
In Roberts, the trial court valued the husband’s appraisal business by calculating average income from the prior four years. The appellate court reversed, finding that this approach “necessarily included goodwill.” The correct approach under Mississippi law is to value the business’s tangible and identifiable intangible assets without capitalizing the owner’s earnings stream.
This creates an important interaction with the retained earnings question. If the business is valued on an asset basis (not on earnings), then retained earnings that have accumulated as cash or tangible assets on the balance sheet are already captured in the equitable distribution. Double-counting the same retained earnings as both (a) an asset in the equitable distribution and (b) income for support purposes would be inequitable. The valuation professional must trace the retained earnings to determine whether they’ve been invested in assets (already captured in the asset-based valuation) or are sitting as excess cash (potentially available as distributable income).
The retained earnings question is genuinely unsettled across jurisdictions:
Retained earnings as income when the shareholder has control. Several jurisdictions impute retained earnings as income when the shareholder controls distributions. Massachusetts (J.S. v. C.C., 2009) held that retained earnings “have the potential of increasing the business’s value and the owner’s net worth, and might properly be viewed as income available for child support.” Illinois reached a similar result when the shareholder controlled the corporation (In re Marriage of Lundahl, 2009).
Retained earnings excluded when the shareholder lacks control. South Dakota’s Roberts v. Roberts (2003) — a different case from the Mississippi Roberts — held that pass-through income from an S corp should not be included in gross income for child support when the shareholder “did not actually receive the corporate income and had no control over its distribution.” The shareholder “faced the worst of all possibilities: retained corporate income he could not spend combined with a distributed federal income tax liability he was obligated to pay.”
Retained earnings excluded when necessary for operations. Illinois (In re Marriage of Steel, 2011) found retained earnings were not income because the company relied on them for future operating expenses, the shareholder didn’t control distributions, and the company reimbursed the shareholder’s tax liability on the pass-through income.
The through-line: control and necessity are the two axes of the analysis. If the shareholder controls distributions and the retained earnings exceed what the business needs to operate, courts are more likely to treat them as income. If the shareholder lacks control or the business has a demonstrated need for the capital, courts are more likely to exclude them.
If you’re retaining a valuation expert or forensic accountant to address retained earnings in a support case, the analysis needs to go beyond the K-1:
Cash flow analysis, not just income analysis. The expert should prepare a cash flow statement that reconciles K-1 income to actual cash available for distribution. This means adding back non-cash charges (depreciation, amortization), subtracting capital expenditures, debt service, and working capital requirements, and identifying the free cash flow that could have been distributed to the shareholder without impairing the business’s operations.
Historical distribution patterns. What has the company actually distributed in prior years? If the company historically distributed 80% of earnings and suddenly drops to 30% in the year support is being calculated, that change needs an explanation. A shift in distribution patterns coinciding with a divorce filing is exactly the kind of fact that will draw judicial scrutiny.
Capital needs analysis. The expert should document the company’s specific capital requirements: equipment replacement schedules, lease obligations, bonding requirements (for construction or government contracting), working capital for seasonal operations, and debt covenants that require minimum cash balances. Retained earnings that fund these documented needs are defensibly excluded from support income. Retained earnings that accumulate as excess cash without a documented business purpose are harder to defend.
Double-counting check. If the business is also being valued for equitable distribution, make sure retained earnings aren’t counted twice — once as an asset in the business value and again as income for support. This is particularly important in Mississippi, where the required asset-based valuation already captures accumulated retained earnings to the extent they’ve been invested in identifiable assets.
Roberts v. Roberts doesn’t resolve the retained earnings question with a bright-line rule — and it shouldn’t, because the answer depends on the specific facts of each case. What it does is identify the three variables that matter: control over distributions, the gap between pass-through income and available cash, and whether the retained earnings are genuinely needed for business operations. For family law attorneys: build the record on all three before the support hearing. For valuation professionals: the K-1 is a starting point, not an answer. The analysis the court needs is a cash flow reconciliation that shows what was actually available for distribution and why the company retained what it retained. Without that analysis, the court will either impute income the shareholder can’t access or exclude income the shareholder chose not to distribute — and neither outcome reflects economic reality.
If you need a cash flow analysis distinguishing pass-through income from distributable cash for a support calculation involving an S corporation or other pass-through entity, happy to talk through the approach. The reconciliation between K-1 income and available cash is often the most important exhibit in the support hearing.
Schedule a free consultation meeting to discuss your valuation needs.
