Being an entrepreneur usually requires you to work long hours, deplete personal finances, and spend a lot of time away from home. These factors may assist you in succeeding as an entrepreneur but cause your marital relationship to fail. Any number of things related to your entrepreneurship can contribute to the dissolution of your marriage. While you are working hard, your spouse may turn to someone else for romance. Money may become an issue, or your spouse might not be supportive of taking on the risks involved with starting a business. Because of these possible issues, divorce can be common among entrepreneurs.
Due to the unique nature of entrepreneurship, many face complex issues that most divorcing couples don’t face. Custody issues are complicated because many entrepreneurs don’t have a consistent time to spend with their children. Property division is difficult because it is hard to place a value on the business. Support issues are also complex because it is hard to verify an entrepreneur’s income. Monthly income may vary based on profits and the actual needs of the entrepreneur. Even the most successful entrepreneurs may end up having very little cash on hand because all of their wealth may be tied up in their business. For example, an entrepreneur working with a technology start-up may not see a profit for years as opposed to a local coffee shop owner who has already started generating a regular profit. Calculating income in these two scenarios will be very different.
North Carolina General Statute 50-16.3 gives the court a wide range of discretion in calculating alimony. Alimony is defined spousal support paid by the supporting spouse to the dependent spouse. Typically, the dependent spouse is the spouse who makes less money. An award for alimony must be equitable considering all relevant factors. Some factors the court may consider are the parties’ standards of living; the earnings and earning capacities of the spouses; the contribution of one spouse as a homemaker; and other factors relating to the economic circumstances of the parties.
In determining alimony with regard to an entrepreneur spouse, the nature of the business venture involved will be a major factor in calculating income. Documents such as tax returns, balance sheets, income statements, and statements of equity will help attorneys to determine an entrepreneur’s true income. One thing to avoid in looking at tax returns specifically is phantom income. Phantom income occurs when income from the business winds up on a personal tax return and will then show a much higher income than the business owner actually retained. In order to know what you can truly afford to pay in spousal support (or to know what you are truly entitled to in spousal support), it is essential to prepare a detailed cash flow statement and to predict what your future cash flow may be. Otherwise, your company could be in jeopardy if your alimony obligations exceed your free cash flow.
To avoid miscalculating your income, you should hire an expert to help you muddle through your financial documents. Your attorney should hire a forensic accountant with experience in calculating and predicting cash flow. You may end up with a “battle of the experts” if your spouse hires their own expert. Typically the entrepreneur claims to earn less income than the non-entrepreneur spouse claims he or she makes. The best way to convince the court that your income is what you report it to be is by not hiding income! Many business owners are tempted to do this once divorce proceedings are under way. The less the business is worth, the less the entrepreneur will have to pay his spouse in a division of property. The less income the entrepreneur appears to make, the less he will owe in child and spousal support.
Entrepreneurs may also have unreported income. Cash-intensive businesses and earnings from offshore accounts can generate unreported income. An entrepreneur might also consider overstating expenses to make it look like his earnings are less than they actually are. However, the penalties for hiding income can be severe. Tax fraud is a federal crime with serious consequences. Anyone can report possible fraud to the IRS by filling out IRS form 3949-A. If the IRS discovers fraud, you could face massive fines or even jail time.
Find peace of mind in knowing that an award for alimony set forth by court order can be modified. An award for alimony set forth in a private separation agreement is not modifiable, so it may be in your best interest as an entrepreneur with an uncertain financial future to obtain an order from the court. In obtaining a modification, you must be able to show a substantial change in circumstances has occurred since the original order was entered (your business is suddenly and expectantly less profitable). You will have to provide evidence that shows the facts have changed since the original order enough to warrant a substantial change in circumstances. You will need a record of the circumstances at the time of the original order, including findings of fact as to the spouses’ financial circumstances so you can show that things have changed.
Also, there are various tax implications associated with alimony. Alimony payments are taxable as income for the dependent spouse and deductible for the paying spouse. However, the parties can request that the legal instrument (the court order or separation agreement) state that the payments are not taxable/deductible in order to avoid these tax implications. There are, however, more tax implications regarding alimony of which you and your spouse need to be aware.
The recapture rule is a tax implication that applies when the alimony payments decrease substantially or end during the first three calendar years. This is a difficult concept that an attorney or tax expert should assist you with, but put simply: there are two situations where the recapture rule comes into play. When the amount paid in the third year plus $15,000 is less than the amount paid in the second year, or when the payments in the second and third years are averaged and this average plus $15,000 is less than the payments in the first year. If the above defined substantial decrease occurs, the paying spouse must “recapture” excess alimony over the first and second years. The payments that were previously deducted will have to be reported and recaptured in the third year post-separation. On the other hand, the receiving spouse may deduct that portion of the alimony payments previously included and taxed as income.
Overall, there are several moving parts to determining alimony, especially when one of the spouses is an entrepreneur. It’s important to take note of the tips provided in this article, but also to seek guidance from an expert so that you avoid paying more alimony than you can afford.