Business Owners’ Divorce
Automatic Orders that Come with Business Owners' Divorce
After being served with divorce papers, a business owner’s first step should be to retain an attorney who is experienced with business owners' divorce and complex divorce cases.
In New York, when divorce papers are served, the defendant is notified of the existence of certain “automatic orders,” which impose certain restrictions for the purpose of maintaining and preserving the status quo of marital property. They include prohibitions against the transfer, removal, and/or withdrawal of any property owned by the parties, either individually or jointly, including bank and retirement account. However, there are exceptions, including hiring an attorney and paying normal business and personal expenses.
Additionally, automatic orders require that all insurance, including medical, life, homeowner’s, and automobile insurance, must remain in place during the divorce.
Once the business owner has retained an attorney, the attorney will discuss the possibility of requesting the court to modify one or more or the automatic orders, if and when necessary.
The Family Business: Additional Spousal Maintenance or Buyout?
Although it might seem like a smart plan from a tax perspective, it is not wise for a business owner to pay additional spousal maintenance in lieu of buying out their spouse’s interest in a family business.
In essence, it disguises the distribution of an asset as spousal support, or, what is now called “spousal maintenance,” or “maintenance” under New York law. On federal income tax returns, however, the term is still referred to as “alimony.”
In some instances, divorcing couples can consider doing an income tax rate arbitrage to have the IRS pay some of the maintenance disguised as equitable distribution. Tax rate arbitrage is the practice of profiting from the differences in the way transactions are treated for tax purposes. The complexity of tax codes often allows for many incentives, which drive individuals to restructure their transactions in the most advantageous way in an effort to pay the least amount of tax. Some forms of tax arbitrage are legal, while others are not; this is where a good tax attorney is useful.
Although we always work towards structuring our clients’ transactions in a manner most favorable to them, namely, where they are obligated to pay the least amount of tax as possible, we work with highly experienced tax attorneys to be absolutely certain that this structure is in fact legal.
More often than not, it is imprudent for divorcing spouses to continue joint ownership in a family business post-divorce, due to the likelihood of future disputes. In fact, such disputes could bring them back into court, the difference being, to dismantle a business relationship instead of a marital one.
There are many ways to buy out a spouse’s interest in a business that should be considered instead of paying additional maintenance.
When a Couple’s Children “Worked At” the Family Business
Company cell phones, cars, and paychecks for the children are non-essential business expenses that would be considered by a Fair Market Value (“FMV”) buyer and FMV seller in a hypothetical sale. A forensic accountant would add them back to cash flow in the Normalization Process.
The Normalization Process refers to adjustments made in business valuation methodology, the goal of which is to estimate future expected cash flow that a potential buyer can reasonably expect to receive in return for his or her investment and to present information that is on a basis similar to that of other companies in its peer group.
There are various categories of “normalization” adjustments that could be made, depending on the facts and circumstances of a case. For example, excess or deficient officers’ compensation or benefits, excess or below-market rent paid to a shareholder, or personal travel and entertainment expenses.
The Normalization Process allows a valuator to use normalized income to better reflect the true economic income of a particular business, and in turn, generate a more accurate comparison with other similar businesses and their respective values.
