There are many reasons why divorce for W-2 earns are simpler than for business owners. Today I’m going to cover one of the more complex issues for business owners going through a divorce: determining income. More specifically, how can personal and business expenses be detangled.
When Business Income isn’t Really Income
The two primary accounting methodologies are accrual accounting and cash accounting. The basic difference is that cash accounting focuses on recording expenses or income when actually received, whereas accrual accounting focuses on recording expenses or income as such events naturally occur.
For instance, in accrual accounting you would record an electric bill the moment it is received, but in cash accounting you would only record it when you actually pay the invoice.
For business owners, what often appears as income may in fact be something else altogether. Perhaps the $20,000 ‘income’ this year has simply been held and earmarked for new equipment next year.
If you’re going through a divorce, the other side may then argue that the $20,000 ‘income’ be used in calculating alimony.
So instead, you purchase the equipment this year. And now the other side is arguing that you’re attempting to deflate your income to reduce your alimony exposure!
Divorce as a small business owner can often feel like a lose-lose proposition. Damned if you do, and damned if you don’t. And it’s not like you don’t still have a business to run.
And of course the $20,000 figure I used is completely arbitrary. Maybe it’s $40,000, or $100,000. To you it’s a necessary business expense, but to the other side it’s setting off red flags, and calls of divorce planning.
So what can be done?
Using Expert Witnesses in Business Divorce Cases
One thing that can be done is the retaining of expert(s) to provide business valuation reports. Perhaps they can speak to subjects such as expected expenditure in various categories, and what type of infrastructure, hiring, or upgrades is necessary for a business.
A written business plan can also be helpful in this scenario. Demonstrating that you have a plan, and that these decisions are not made in an arbitrary manner can go a long way in demonstrating good faith.
Another issue is separating personal expenses from business expenses. This is something both the Internal Revenue Service and your ex may have their eye on.
Separating Personal from Business Expenses
The car you lease, the restaurants you frequent, the vacations you take. The other side will be looking at these expenditures to analyze whether they are appropriate, or if you are attempting to reduce your business income. Remember, the other side is already skeptical, they know that many people attempt to reduce their income to pay less in taxes.
Now, with a divorce pending (or on the horizon), they believe you have every motivation to further reduce your income. Doing so can help in multiple ways: it can help reduce alimony and child support, and may also reduce the valuation of your business and thus reduce equitable distribution obligations.
Here, as with many parts of your divorce, is where keeping solid records will be helpful. If you can demonstrate that your leased car is actually a legitimate business expense, for instance, then that can help you reduce your alimony exposure.
Consistency of expenses may be helpful here as well. There may be an “appearance of impropriety” if there is a sudden increase in expenses leading up to a divorce with no legitimate reason for the increase.
Other times, you may be able to demonstrate that increased expenses are necessary to take advantage of limited opportunities, or to increase the infrastructure of your business.
Some businesses legitimately maintain multiple sets of books, and you may need to address this with your attorney to make sure your legitimate business practices do not come across as shady.
If a court believes that a business expense is really better classified as a personal expense, then they may add that back into your income. Family court judges have a great deal of latitude in this regard.
Conclusion
Divorce cases are always fact-sensitive, and even more so when a divorce involves a business owner. Whether you are a single member LLC, an S-Corp, or a simple independent contractor, your business records may be discoverable as part of a divorce litigation.
Finding the right attorney to work through the law and the facts specific to your case (and business) can make all the difference.
Partner with Carl Taylor, Esq.
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