Every marriage has its share of difficulties, but a marriage involving an entrepreneur is more likely to end in divorce than a marriage involving those in a traditional occupation. Many duties of being an entrepreneur can lead a marriage to end in divorce. While entrepreneurs spend long hours trying to build their business, their relationship with their spouse may suffer and serious debt may be incurred, the stress of which can cause the end of the marriage.
When an entrepreneur does have to go through a divorce, there are many different issues that must be considered. Custody, property division and support issues can be very complicated and even more so when an entrepreneur is involved. Custody can be hard because of the long hours away from the home. Property can be hard to divide because an entrepreneur’s business can be difficult to value. Alimony and child support are almost always more difficult because of the complexity of figuring out income for the business owner.
North Carolina provides child support guidelines, which usually make child support easy to calculate. Courts use a formula based on each parent’s income, childcare expenses, the child’s health insurance expenses and any extraordinary expenses to come up with a number to plug into a worksheet to figure the obligation owed. This is usually a pretty cut and dry process, but it is much more complicated when an entrepreneur is involved because it can be difficult to calculate income.
So how do you go about calculating an entrepreneur’s income when they sometimes don’t pay themselves or if they do pay themselves, it can be sporadic and varied? Trying to answer this question can lead to a very contentious divorce because usually, the non-entrepreneur spouse believes the entrepreneur spouse makes much more than claimed.
Sometimes the business owner isn’t trying to hide income, they just can’t be sure how much they actually make or will make in the future. Business leading up to the divorce usually suffers because of the emotional strain and time spent trying to deal with the strain. Once the divorce process has started there can be even more strain if the entrepreneur begins a relationship with someone new, which can lead to less time spent working and less income. The entrepreneur must take a hard look at what the business is actually doing and why, then come up with the most honest income calculation possible.
A business owner must realize that there are different types of businesses. Some businesses turn a profit quickly, some won’t be profitable for years, and some have imports or exports and a variable cash flow. The type of business one runs is important to figuring how income is calculated. Generally, income can include a salary, commission, bonuses, tips, rental income, royalties, interest, in-kind and fringe benefits, lottery winnings and stock options. Beyond these types of income, the way a business is organized and the accounting method used are also important factors to consider. Whether a business is run as a sole proprietorship, corporation, partnership or LLC will determine the type of tax ramifications on the business. Each type of business files a different tax return and must be evaluated differently. Also important is the method of accounting, whether it be the cash method, the accrual method or a hybrid method will impact the respective tax records. Additionally, the entrepreneur must also consider their balance sheet, income statement, statement of cash flows and the statement of equity to determine their actual income as compared to what is reflected on their tax return.
Once the type of business and accounting method have been decided, there are a few methods that are used to come up with a number to input on the child support worksheet. The “Average Historic Income” theory uses the previous year’s information to see what the entrepreneur paid himself over the course of the year to come up with an average monthly income, which can then be plugged into the worksheet. This method can be efficient, but also problematic because of the inconsistency of profitability from one year to the next as well as the previously mentioned usual downturn in business in the year leading up to divorce. Another method used to figure out an entrepreneur’s income is to predict future income by evaluating past performance, a business plan, and market trends. Because this method is highly speculative and there are many unforeseen factors that may come into play, this method can be more complicated and may require an expert.
Business Valuation Tricks
Both the entrepreneur and the non-entrepreneur spouse need to be aware that it is easy to hide income and assets when there is a business involved. The business owner may be tempted to lower the value of the business so they don’t have to pay the non-business-owner spouse as much. The business owner may also be tempted to show less income made so less is owed in support obligations. Income can be hidden by depreciation and expensing for tax purposes, pass through entity distributions, false lease of office space or rental equipment, and loans given to friends or family members. Additionally, the entrepreneur can under-report their income or overstate expenses to make it look like earnings are much less than they actually are.
If you are an entrepreneur and are tempted to use one of the tricks in the hopes of saving money, think again. It is very easy for a family law attorney to discover deception by simple analysis of your lifestyle, expenses, and general inconsistencies. If an attorney feels you are hiding something but is unable to find the proof, a forensic accountant can be brought in to find it. The consequences of hiding income are much greater than the savings you may have for lowering your reported income. Tax fraud is a federal offense, punishable by fines or even jail time. It just isn’t worth the time and effort to try to hide income, so don’t do it.
Even if the entrepreneur is on the up and up with the business valuation and income, there is still very likely going to be disagreement between the spouses. It is not uncommon for both the entrepreneur and the non-entrepreneur spouse to hire forensic experts to come up with a business value or income. It is more likely that a fight will happen when arguing over the value of the business, but it often happens when trying to figure out income for support obligations, so be prepared for an argument.
Finally, an entrepreneur should consider the amount of time they can spend with their child. If the child is primarily with the non-entrepreneur spouse, the child support obligation will be higher than if custody is shared equally. It can be difficult to grow a business and still have equal custody of a child, but if the entrepreneur wants to lower child support obligations, they need to consider an equal custody situation.