For some, the American Dream involves “firing the boss,” opening up one’s own business and being one’s own boss. The freedom that accompanies running your own business can quickly turn into a headache during a divorce. That is because like any other asset, a business can be declared a “marital asset” and its value divided between the parties. Properly classifying a business as a marital or non-marital asset is only the beginning of the process; if the business is determined to be a marital asset, its value must be determined. Even where one spouse owns a portion of a company (say a majority or a minority share of a company), this must be determined to be a marital or non-marital asset and, if it is a marital asset, its value must be determined. What follows is meant to be an introduction to businesses in Florida and how they are valued as part of the property division in a divorce.
Types of Florida Businesses
In Florida, a business can exist in one of five main forms:
- Sole proprietorships are the simplest form of business organization. The defining characteristic of a sole proprietorship is that it is owned and operated by a single individual. Typically these businesses are service-oriented, such as a tax preparation business or auto repair garage. The earnings and losses of a sole proprietorship are included on the owner’s personal income tax return.
- Partnerships exist when two or more individuals agree and intend to carry on a business for profit. They can either be governed by complex written agreements or be held together by oral promises and understandings. Partnerships are one of the most common forms of business organizations.
- C corporations are a rare sight in Florida divorces. In this business form, shareholders experience double-taxation in that the profits of the corporation are taxed and then any dividends paid to the shareholders are included in the shareholders’ personal income tax returns and are taxed again. These businesses tend to be more complex and larger entities.
- S corporations share many of the same characteristics of C corporations except they are structured to avoid the “double-taxation” problem. Instead, all shareholders share in the profits, losses, and distributions of the corporation according to their percentage of ownership. Any profits or distributions are included only in the shareholder’s individual income tax return.
- LLCs are a relatively new form of business organization that protects owners from being held personally liable for the LLC’s obligations and debts. Like S corporations, earnings of LLCs are only included on the owner’s individual tax return and are thus only taxed once.
First Things First – Is the Business Marital Property?
Before a court will determine a business’s value, the court will first consider whether the business is separate or marital property. Separate property is generally property owned by one spouse prior to the marriage; marital property is that property which the spouses acquired during the marriage. So if Jake started his own personal training business right out of high school and then married Sarah several years later, his personal training business will likely be considered separate property. If Jake first married Sarah and then started his personal training business, it becomes much more likely that the business will be considered marital property.
Sometimes a business that might otherwise be considered separate property can be found to be marital property. If the proceeds or income derived from a separate business is used to support the marriage or is commingled with marital property, it may be considered marital property. If Jake uses the proceeds of his business to pay the couple’s bills during the marriage, or if he deposits his income in a joint checking account he has with Sarah, then his business may be considered marital property even if he started the business before he married Sarah.
Not only this, but even a separate business whose value increases during the marriage may be subject to division to the extent of the increase in value. Suppose that Jake’s business is only worth $40,000 when he marries Sarah. When the couple divorces several years later, the business is worth $100,000. The court may find that the increase in the business’s value is due to the combined efforts of John and Sarah and may therefore consider $60,000 of the business’s value as marital property, subject to division.
Valuing a Business
If a business is found to be marital property and subject to division, the court must then determine that business’s value. In order to do this, the court will employ a valuation expert to evaluate the business and assign a value to it. This “valuation expert” is typically a certified public accountant or similar person. The expert will review the business’s financial records, accounts payable and accounts receivable, and inspect any physical property, inventory, and/or real estate the business owns. A value will also be given to the “intangible” assets of the business, such as the business’s goodwill, its reputation, its client list, and the value of the owner spouse to the business.
The actual business valuation process begins with the expert determining the “standard of value” that will be used. The process used – and hence the value obtained – will depend how the expert is viewing the business. Is the expert determining the value of the business on the open market? Or is the value of the business to an investor with specialized knowledge and/or motivation to buy to be used? Jake’s business may be worth one value to an individual looking to buy the business outright and may be worth another value to another personal trainer looking to update Jake’s business and increase its efficiency. In most cases, experts will present the court with a variety of possible values and the court will choose a value based on these options.
The expert will follow one of three approaches when valuing a business. Again, it is common for experts to employ all three approaches and present the findings to the court.
- The income approach is the most widely used approach in valuing a business. This approach looks at the company’s present earnings and/or the future earnings the business is expected to produce. If the business is expected to produce far greater earnings in the future, the expert will employ formulas and make basic assumptions about the business in order to arrive at a “present value” for the business.
- The market approach arrives at a business’s value by comparing the target business to other comparable businesses. In essence, the expert finds businesses that are in a similar industry and situation to the business at issue in the divorce that have been recently purchased. These values then help the expert come to a value for the business at issue in the divorce. This approach presents a danger of being inaccurate if the expert does not find comparable
- The cost approach is sometimes referred to as the asset-based approach. This approach is based on the assumption that a buyer of a business would not pay a single cent more than is necessary to purchase all of the business’s assets while considering its liabilities.
It is common for the parties to dispute the value of a business. It is important that a business be properly valued so that both parties can be treated fairly during the property division process. If a business is valued too high, the spouse who owns the business will receive less-than-fair portion of the marital property. Conversely, if the business is valued too low, the non-owner spouse will receive a less-than-fair portion of the marital estate. For example, if Jake and Sarah have $1,000,000 in assets and Jake’s business is found to be worth $100,000, he should expect to receive an additional $400,000 worth of assets; if his business is found to be worth $400,000, he will likely receive only an additional $100,000 worth of assets.
A court is likely to rely heavily on an expert’s opinion as to the value of the business, but the expert’s opinion is not infallible. Although the expert should be a neutral third party, not favoring either side in the divorce, an expert’s opinion is only as good as the methods he or she employs and the information he or she uses. Before a court decides on a business’s value, both parties are typically able to present information and evidence that challenges the expert’s value. Sometimes a party will hire their own expert to conduct another valuation; other times a party will present evidence or testimony that suggests the expert’s methods were somehow flawed.
A court is given considerable discretion in deciding a business’s value. A court may rely solely on the expert’s opinion or it may take the various values presented and arrive at some “middle ground.” If the court assigns a value to a business that has no basis in fact, however, that value can be challenged. In other words, a court cannot simply pick a value for a business out of thin air.
How Will My Business Be Divided in My Divorce?
Business owners may fear that a court is going to make their ex-spouse a business partner, or award him or her some share in the business. This rarely happens, however. Instead, the court considers the value of the business along with the value of all other marital assets when it divides the marital estate. Typically the spouse who owns the business will be awarded the business, but may not receive many other assets depending on the value of the other marital assets. In this way, the court is able to treat the parties fairly.
Alternatively, the parties can always agree as to how the business should be treated, either through a premarital or antenuptial agreement or through negotiations during the divorce. For example, John and Sarah can agree as part of the divorce that John will keep his business in return for Sarah keeping some other asset (like the marital home). Or John and Sarah could have agreed before or shortly after their marriage that John’s business would remain his. In any event, so long as the parties are acting fairly and one party is not obviously taking advantage of the other, any such agreement is likely to be honored by the court.
When a business is owned wholly or partly by one of the spouses in a Florida divorce, that business’s valuation is sure to be at issue. Determining that business’s true value is an essential part of ensuring that the marital estate is fairly divided between the divorcing parties. Before determining its value, however, a court must determine if the business is actually separate or marital property. It is separate property if it was owned or started by one of the parties prior to the marriage; however, if it was started after the marriage, if it was used to support the marriage, or if its profits were commingled with marital property, then the business is likely to be considered marital property.
If a business is marital property, then its value will be determined by an expert. A court can appoint an expert or order one or both parties to submit expert valuations. Any expert is likely to use a variety of approaches in valuing the business and will present several possible values to the court for consideration. These values can then be further supported or challenged through additional evidence or testimony presented by the parties. The court is then free to arrive at a value for the business for purposes of the divorce by any reasonable method, so long as the ultimate value arrived at has some basis in fact.
Because of the importance of a business’s value, it is important to hire an attorney with experience in business valuations if you are going through a divorce. An inexperienced attorney or one who is unfamiliar with valuation experts may end up costing you significant assets to which you would otherwise be entitled.
Divorce, Business and IRS Taxes
Another side of this issue is federal income tax. This is a key area to check when analyzing a business. Depending on the tax situation, $50,000 may be worth only $10,000 to the spouse who receives the business. Or that same $50,000 may be worth $100,000 if the potential tax treatment is beneficial.
When a family business is caught up in a divorce, it seems a universal rule that the spouse who owns the business presents that the business is going downhill two years before the divorce. The other spouse presents the picture that the business has reached the size of IBM. The actual truth is somewhere in between. It takes a business mind to uncover the truth. Businesses are extremely complex and have many opportunities to manipulate assets.
Bottom Line: If a business is at stake, your potential settlement can vary by hundreds of thousands of dollars. Don’t do it yourself. Get a qualified professional.
Divorce can be the single most important event in your life. Make sure you gather lots of information so you can make informed decisions. Many people can benefit from the advice of one of our good, honest, loyal divorce attorneys.
Common Strategies when there is a Business in a Divorce
Owners or spouses of owners have must consider all the issues that can happen during a divorce. Florida law specifies a 50/50 split of property in a divorce. But the question is” 50/50 of what? No where is there more opportunity to fudge the numbers than there is in a business.
In most divorces, the owner/spouse usually says the business is going down the drain. The other spouse usually claims the business is the next Apple Computer. The actual truth is somewhere in between, and shrouded in mystery.
The strategy you would use in a divorce depends if you are the owner, or spouse of the owner. Be aware, this is one of the most complex areas of divorce law. It would be next to impossible for you to represent yourself and come out ahead in this situation.
If you are the spouse of the owner: The first place to start is a complete analysis of the corporate income tax return. There are many places to hide income. A few examples are excessive salary to family members, and personal expenses run through the books.
If you are the owner: Your job is to show the realistic financial picture and how the business depends on your personal involvement.
Either party may desire to have a professional business appraisal. Appraisals are typically done by professionals holding a certification in business valuation.
Strategies for the Spouse of a Business Owner in a Divorce
In a divorce where there is a business or professional practice, there are two competing strategies. The idea behind the two strategies is simple: One spouse wants the business to look as big as IBM. The other spouse wants the business to look like it is going under. There are many ways each spouse can prove their point. We will discuss this subject from the viewpoint of the non-owner spouse.
The problem is that a business or practice owner can hide money a gazillion different ways (the word “gazillion” means a lot!). The business owner has almost complete control over the finances and how they are written up on the business books and IRS tax return.
The first place to start is by getting the last five years of the business tax return. This can be done through a legal mechanism called a “request for production.” The courts ultimately will force a spouse to turn these documents over to the other spouse.
One technique we like to use – that has the most potential for success. We like to graph all major expenses – as they are listed on the tax return. If you do this, you will see some amazing things. For example, for a business that uses vehicles, maintenance expenses may be steady for 4 years and then double in the last year. Or payroll, going up one year in a very suspicious way. The fact is: business expenses should be fairly steady from year to year. They don’t tend to double or triple in one year. That is a technique some business owners use to hide or purposefully reduce profits.
Look on the tax returns for:
- “Dummied Up” expenses
- Phantom employees that don’t exist
- Business property leased from an “Uncle Joe” or other such person
- An unusual imbalance between earnings and assets.
For example, it is very unlikely that a business which owns $300,000 in assets is only earning $10,000 a year.
If you have the money, there are professionals called Forensic Accountants. These people are trained as accountants but have chosen to specialize in uncovering financial fraud. A Forensic Accountant looks through the books, looks at the physical premises, and looks at the lifestyle of the owner. The Forensic Accountant then looks at the flow of money and tracks money that disappears during business operations. All observations are weighed against each other and a judgment is made whether the owner is hiding money. The advantage of a Forensic Accountant is their ability to testify in court.
The Bottom Line:
Don’t give up. Hire the best professional help you possibly can. Nowhere is there more potential for a spouse to recover money in a divorce. Unfortunately, many spouses go without rightful property division, child support, or alimony because the business owner-spouse has hidden assets. Be persistent, stubborn, and hard working in your efforts to uncover assets. Your effort will pay for itself.
Valuation Strategy for the Business Owner in a Divorce
The spouse that owns a business during the divorce will benefit if the business value is low. Please keep in mind that hiding or destroying business value is a fraudulent activity and will be severely punished by the court. But you are still allowed to run the business in a normal manner during the divorce and your decisions are valid if they have legitimate business purposes.
Here are some basic strategies for the business owners to minimize valuation:
- Accelerate taxable activities to the current year or the prior year. Do not defer taxes
- Section 179 large asset purchases this year instead of depreciating assets
- Make long term business investments that will pay off in the future but absorb cash flow and profits in the short term
- Hire adequate or ample amounts of staff
- Do not compensate for short staffing by working huge amounts of uncompensated overtime
- Compensate family members at industry rates
- Do not defer maintenance on your facility or large assets
- Catch up on any deferred maintenance now, even if it hurts profitability.
Do not roll out any new ideas or services that have large profit potential
The Bottom Line
Decisions that minimize present value are legitimate as long as that are done for future profit and growth. Now is the time to make those kinds of decisions.