Separation of the Person and Business in Divorce
Divorce is not easy. Separating assets and debts is not easy. Delineating cash flow and creating a new budget that reflects separate households is not easy. But what if a business is involved? Well, it makes everything more complicated. If you are enduring the divorce process and a business is involved, here are a few items to consider moving forward:
1. When was the business incorporated or when did either spouse obtain the business interest?
Even if the business or the business interest existed prior to the date of marriage, the business will be addressed in the divorce proceedings. Absent a premarital agreement or “prenup” stating otherwise, the operation of the business or the increase in the value of the business interest due to active efforts by either spouse during the marriage creates a marital property interest that is subject to distribution in a divorce. How does that look?
If a business or a business interest is owned by either or both spouses as of the date of separation, then the business or business interest contains a marital interest that must be identified, valued, and distributed as part of the Equitable Distribution process. That business or business interest will be assigned a fair market value for distribution purposes by the Court based on the evidence presented by either or both spouses, unless the parties stipulated by agreement as to its value prior to the date of trial. If the business or business interest existed as of the date of marriage by one of the spouses, then the Court will also need to identify the fair market value as of the date of marriage. Why? Because the value increase between the date of marriage and the date of separation reflects a marital interest, in whole or in part depending on several other factors.
2. How is a business valued?
Although the age-old response of an attorney to most legal questions is uninteresting and straight-up frustrating, the reality is – It depends! Does the business hold assets? Or is the business primarily involved in a service-related industry? Can anyone provide said service? It is one thing if you are providing maid services and an entirely different situation if you are providing medical services. Beyond the business’s specific characteristics or industry, there are business aspects that are difficult to value. Over time and with public acceptance, there is a value attached to the reputation and recognition of a business or enterprise. For example: You will find the “golden arches” around world and know you are going to get pretty tasty fries as a consumer. There is a value to that. How about the red bullseye? Not only will you find laundry detergent and groceries, but you may even find a cute outfit along with the nerf gun you needed to purchase for a child’s birthday party…all in one spot. There is value to that. And although the business involved in your divorce may not have such a popular profile, the business may still have a prominent reputation and recognition in your specific community. There is value to that!
When a business is involved in a divorce, these reasons reflect the importance to have the right experts on your side. This includes a family law attorney experienced with businesses in the Equitable Distribution process as well as a business valuator and financial advisor or analyst.
3. How is business revenue spent? More importantly, how is the income of a business owner determined?
If you own a business, then you know. You are not necessarily “only” a W-2 income earner, even if you have set up your business to pay you W-2 income. Why? Because the reality is that business owners can and do legally pay themselves via owner distributions. Go one step further, some “combined” personal and business expenses may be covered by a business. The classic example is a business owner’s cell phone. If the business owner primarily uses their cell phone for business purposes, the business owner can pay the cell phone bill via the business revenue (versus from a personal account or income). But clearly, we all know the business owner has taken a personal call on that same cell phone. As such, it is possible that a Judge, when looking at a business owner’s expenses, will adjust some “business expenses” to “personal expenses” at least for income purposes when calculating child support or spousal support.
What can help a business owner from succumbing to the reality that a Judge can impute more business expenses to the personal expense column? Keep your business and personal expenses separate. How does that look?
- Do not pay personal expenses from your business account, and do not pay business expenses from your personal account. This applies regardless if the account is a bank account or a credit card account. Do not pay your personal rent or mortgage from the business bank account. Do not charge your family vacation to the business credit card. If you have a question as to the line between business and personal expenses, a great guide could be your tax accountant. The Internal Revenue Service has a number of guidelines on what can be classified as a business or personal expense for tax purposes. Although a Judge in a divorce proceeding is not bound by IRS codes in this regard, it is a strong guiding principal. For example: the amount paid for office space is a legitimate business expense for tax purposes, and a Judge will likely find the same.
- Keep records. Keep clear records. Keep very clear records. If you cannot show clear records that show the separation of your personal and business expenses, then we cannot expect a Judge to look at an account statement and clearly know the difference between personal and business expenses. I see it all the time: a receipt from a restaurant. Anyone can eat at a restaurant. This could be your friend, your children, or a prospective client for your business. Go one step further…when your family attorney asks you about the restaurant charge from two years ago, do you honestly believe you will remember if it was for a prospective client or your teenage son on his way to a basketball game? It is crucial for you to keep ongoing records of both business and personal expenses. I have found one of the easiest ways to keep clear and separate records is to establish separate bank and credit card accounts. Treat your business essentially as a separate person. For example: if your business pays for your personal haircut (because your personal credit card was unimaginably declined, you have no cash in your pocket, your haircut is already complete and the hair dresser is giving you the death stare), then literally write a check from your personal account to your business. The business covered a personal expense, and you “personally owe” your business the reimbursement. This can work in reverse as well.
- Recognize the Gray area, but do not live there. A lot of business versus personal expense determinations depend on the honesty and integrity of the business owner and its employees. At times, any business owner or employee may recognize that a certain expense can “technically” qualify as a business expense. But should it? It is one thing if the business owner hosts a company holiday dinner to support and improve employe morale. Yes, that is likely a business expense. However, if you are out to drinks watching a basketball game with a friend that just happens to work at the same company as you but you never discuss business…well that bill should likely be classified as a personal expense. Simply saying the word “business” while you are sharing drinks with your friend does not suddenly reclassify the personal expense to a business expense.
In the absence of implementing some of the above parameters, you may be creating more obstacles that simply cannot be overcome even by the best legal counsel and hired experts when a Judge is addressing the business during the divorce proceedings. The business will be addressed in terms of asset and debt distribution or cash flow purposes in child support and spousal support matters. Be prepared.
If you have a business and are enduring a divorce, our Modern Legal Team is here to help.
Please note: these educational materials are based on North Carolina law where my legal practice is based. While the insights may have wide applicability, readers should consult with an attorney regarding the specific laws in their state or country.
Written by: Theresa E. Viera
