The unique impacts of divorce on business owners
By arming themselves with knowledge of what to expect, they can devise a strategy to protect their interests
It’s no secret that divorce disrupts not just family and personal life, but also financial stability. In the case of small business owners, these effects are often felt even more acutely.
As a Certified Divorce Financial Advisor, I work with clients and their attorneys to evaluate the short- and long-term financial and tax implications of proposed settlement options. I see firsthand how divorce impacts business owners and their companies — and it’s not always pretty.
When faced with divorce, business owners often feel caught off guard by the myriad ways that the process stands to negatively impact their companies. Fortunately, by arming themselves with knowledge of what to expect, and working with experienced financial and legal professionals, they can approach the process with a strategy designed to protect their interests.
(Please note that the commentary below assumes that the couple will not continue to own the business together.)
Chances are that in addition to comprising the majority of the marital assets, a business is also the primary source of household income. This is daunting, because assets and income are usually two of the three main negotiating points in a divorce. (Children and the parenting plan are the third.) To make matters even more complicated, in many closely held companies, the line between personal and business assets is sometimes blurred. Similarly, separating earnings that are take-home pay from earnings that represent the owner’s return on capital can also be tricky.
A certified business appraiser will be needed to determine what the business is worth. Carving out business expenses that could also be classified as personal, determining the worth of the business to a third-party, and figuring what, if any, discount should be applied for minority interests or lack of marketability are just a few of the many calculations an expert appraiser might produce.
Under the microscope
If finding the cash for a lump sum to buy out the spouse is not an option, there are a number of ways that a payout can be accomplished, such as promissory notes and structuring spousal support within provisions of the Internal Revenue Code to avoid recapture of tax benefits.
The business owner’s income, along with other factors, will be used to determine spousal and child support. If the valuation effort described above used all of the earnings to assess the fair market price of the business, then counting them again to figure out support payments would be double-counting. In many businesses, some of that income must be kept on the balance sheet for working capital or used to repay debt. It’s important to both parties to fairly calculate the available income.
While the business is under the microscope as part of the legal proceedings, financial records, shareholder agreements, buy/sell agreements and tax returns all need to be kept confidential. Even if the business will be sold, making the inner workings of the business overly public can undermine the ultimate value to be realized by the separating spouses.
It is also imperative to consider both the current and future tax consequences of the settlement on both parties. Often, recapture of tax benefits can prove a point of contention, as the spouse who receives an asset initially owned by the business may be left to face recapture provisions.
For example, if a business owner purchases property, such as office furniture or a company car, claiming an expense deduction, and the property is then transferred to the spouse and used for non-business purposes, the spouse will be left to bear the recapture provisions.
It is also important for business owners to be cognizant of embedded taxes, as business interest is determined without regard to unrealized taxes intrinsic to its value and courts may divide property without providing the business owner with assets to offset future taxes.
Many complex tax, financial and valuation issues arise during any divorce. Those involving business owners require an added degree of expert help.
Monica Ann Ness is principal at Northeast Divorce Settlement Consultants, a wholly owned subsidiary of Portsmouth-based wealth management firm Seascape Capital Management. She can be reached at 603-812-0124 or email@example.com.