Divorce, Taxes, and the Family Business
An issue frequently overlooked is how tax liability can be used as a divorce tool. If improperly used, tax liability can destroy all of the marital assets. In the worst case, tax liability can seriously impact the future financial security of either spouse.
Divorce and Family Business
The most common situation where taxes become an issue is in a divorce with a family business or professional practice. The owner – spouse may have hidden cash receipts or recorded inflated expenses in an effort to minimize the profits of the business. The other spouse is often aware of and approves of this practice. During the marriage, minimization of income results in higher household income and a better lifestyle for the couple.
Tax Liability and Blackmail
This practice is illegal or borders on illegal. But during a divorce each spouse usually tries to use past tax behavior to gain an advantage. The owner – spouse wants to minimize past income in an effort to lower child support, alimony, or division of marital property. Of course the other spouse wants to prove the opposite.
The result is a game of chicken – with one spouse threatening to turn the other spouse in to the IRS. This is a dangerous game for all involved. Do it yourselfers will find the situation blowing up in their face. People with attorneys may find the attorney reluctant to deal with the situation.
The Potential Problems in a Divorce Court:
- Your Attorney cannot assist the owner – spouse commit the crime of tax evasion.
- The non-owner spouse may end up liable for half of the back taxes, penalties, and fines.
- The Judge may decide to turn everyone in.
- In an extreme situation, everyone can go to jail.
The Potential Solution in Tax Court:
- The IRS has a provision called Innocent Spouse Relief. This provision gives complete or partial tax forgiveness to an innocent spouse. But be aware – the definition of “innocent” is technical, elusive, and difficult to understand.
The Bottom Line:
Good, in-depth advice is essential where there is a potential tax issue. Your attorney should discuss this problem with you, give you alternatives, and discuss potential risks. Don’t throw out allegations of tax issues until you know the potential risks and rewards.
Valuation Issues With a Family Business
The definition of business value:
The price that a willing buyer would pay a willing seller, each having full knowledge of all facts, and neither party is under any compulsion to sell or buy.
There are three main methods to use in valuing a business:
|Income||A business appraiser using the income method looks at only one thing – money the company can produce. This is the best method for professional practices, brokerages, advertising companies, and other companies that have few hard assets. The appraiser calculates income for the past few years, or the next few years. The resulting figure is put through a mathematical calculation to arrive at a final value.|
|Asset||A business appraiser using the asset method looks at the hard assets a company owns. This method is good for a business that owns lots of expensive things. Things like real estate, trucks, buildings, trademarks, machinery, or anything else that is highly valued. Some companies falling into this category are real estate investment firms, apartment complexes, construction firms, technology companies, etc. This method is unreliable for service oriented companies like doctors, dentists, lawyers, delivery firms, or other service providers.|
|Market||A business appraiser using the market method tries to find similar businesses that have been sold in the last couple of years. The businesses selected must be in the same type of business as the one to be valued. The best match would be a business offering the identical type of product or service, located in the same area. This is the most common sense of approaches because it shows what a real world buyer would pay the seller. Unfortunately, there may not be past sales information available for more than a few businesses. This method is excellent and very accurate if many comparable businesses have been recently sold and the sale prices are available.|
A business appraiser usually uses one or more methods and then averages them according to a selected formula. In a divorce proceeding, there are many ways to challenge or defend the calculated value.