Why Are You Covering The Business Matters Of A Divorce?
The calculation of spousal support or maintenance and the division of the assets in the marital estate such as cash, the house, bank accounts, retirement accounts, pensions, and businesses are complicated when one or both parties own a business. The reason for that complication is twofold. The first reason is that the stream of income from a business is not as easily defined as a stream of income that comes through a W2 or working for another company. When it comes from your own business, the business owner has a lot of leeway on how they take income. Most usually take it in multiple forms. They take income through a W2, through distributions that show up on a K1, and perks from the business paying for personal expenses that they would otherwise have had to pay if they weren’t a business owner like cars, cellphones, meals, and entertainment. The value of a business is not a finite thing. If I look at your bank account, it’s easy for me to identify its value. Still, looking at your business, to value a business in the state of Illinois, we have to have an agreement between the parties or have a qualified financial expert value the business.
The value of the business affects a number of things. It involves the division of assets, how much money the business is worth what goes into the balance sheet, and how it is balanced against the other asset. It has to have value. The business also complicates the matter by changing how support or maintenance is calculated. Suppose you’re receiving support or maintenance based on a stream of income from the business, and you’re receiving a division of assets based on one party or the other getting the business. In that case, it seems like you’re double-dipping because you’re going to receive the equivalent of half of the business, and then you’re also going to receive maintenance of the income derived from the business.
Depending on what side of the business you’re on, your attorney would argue that if you’re going to divide the marital asset, which is the business, you shouldn’t then also receive income benefits in the form of maintenance off of the whole business because you’ve already been paid your half of it and received the benefit.
If the business is marital, then it is considered part of the marital assets. It’s calculated into the division of assets, affecting the balance sheet directly. Suppose the business is non-marital, meaning it was a business that the party had before the marriage or acquired through gifts or inheritance, making it non-marital. In that case, it still affects maintenance and the division of assets because one factor in determining the appropriate division of marital assets is whether either party has a non-marital estate. So, even if the business is non-marital, it will affect the division of assets within the marriage. The income that flows from it to the party paying maintenance is used to calculate the amount paid.
Suppose we’re going to value the business, which, in almost all cases, you must. In that case, you must hire a financial expert with the necessary qualifications to value a business. In Illinois, there are numerous methods of calculating a business’s value. One choice is to look at the income stream from the business and value it based on its income. Another form of valuing a business is to look at the assets held by the business, and value based on the assets held. A third way to value the business is a bit of a hybrid where they consider both stream of income and assets that are owned by the business. The final way is fair market value; if it were to be sold, the judge would use a fair market value of the business at the time of the trial.
Many times, we get a business valuation, which allows the case to settle meaning that you get the business valuation, and both parties agree that the expert has determined that the business is worth $10 million. Then that $10 million is used by both sides to calculate the division of assets and calculate the different factors that they needed that value to determine.
The other thing that an expert does is determine the stream of income from the business to an owner. A business often gives a business owner tax draws or tax distributions to cover the corporate taxes that flow through to the owner’s taxes. As you decide what income is, some parties have determined that those tax draws are not actual income to the party. In calculating the gross income of the party, those tax draws are included. There is a seminal case in Illinois called In Re: The Marriage of Rogers where the Supreme Court has defined income as income from all sources, including financial benefit to one of the parties. So, it’s a very, very broad definition of income. That means that the courts have found that a car payment paid by a company is income to the person who drives the car. that paying for a cellphone by the company benefits the person who uses the cellphone.
Many people would argue that the company is paying for the car or paying for the cellphone so that you can use it for business use. The court nods and says, “Yes, that’s true, but it also allows you to use the car for personal use and it makes it so that you don’t have a car expense and therefore, it is a benefit to the person receiving it and therefore, its income.” The same type of decisions have been made regarding other perks such as meals and entertainment for the person who receives them, especially if there’s no well-documented proof that the only person you took to those meals and entertainment was a client. Many times, when there’s no clear proof, it just says “Dinner with client” but doesn’t say who or doesn’t say what it was about, the court finds that that meal or entertainment was a personal benefit and charges it as income.
Looking at the business’s value, we create an asset debt spreadsheet in the division of assets, especially in high-net-worth cases. It lists all the marital estate assets, the houses, bank accounts, investment accounts, and the business as assets. It then lists any debts attached to those assets, such as a mortgage or a line of credit that went with the business. Then, all the other family debts that are not directly attached to an asset, such as a credit card or a student loan. The qualified assets, things such as retirement accounts, pensions, IRAs, 401(k)s, and other assets that have a different tax implication than that first set. The assets in the first set are called non-qualified assets because their tax importation is that of cash. The retirement accounts are called qualified assets because most of them have not yet had the income tax on them. When you take them out, a tax consequence will be different from when you take money out from your bank account. When you prepare that spreadsheet, the business does not always go on as it’s value. It has other things taken out of it, and it’s a net number. So, if the business is worth $5 million, but there’s $1 million of debt on that business, it is listed for $4 million on that spreadsheet.
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