For anyone, a pending divorce is a trying time. Aside from all the emotional aspects, there are financial and tax consequences. For a business owner or executive, the financial worries can be quite complex.
If it appears that divorce is a strong possibility, carefully evaluate these concerns in advance. Know your tax consequences before any settlement is proposed. Early on, consult with your attorney and your CPA to help minimize surprises and to craft the best possible solution for all involved.
From a business owner’s standpoint, there are really three broad groups of issues: tax treatment of the items specified in the divorce decree, valuation of income sources and property and the ability to make the cash flow work on a monthly basis.
For starters, recognize that many payments specified in a divorce decree – child support, a large portion of your legal fees and property settlements, whereby you split the interests in your home, investment and retirement accounts and businesses – are not deductible. Mortgage interest paid for a home you don’t live in is generally not deductible, either.
Alimony, however, is deductible for the paying spouse and must be included in the income of the receiving spouse. Therefore, rather than pay other expenses separately, you may want to increase alimony and specify what it is intended to cover, such as an ex-spouse’s mortgage payment. But you need to balance the deductibility of alimony against the possibility that it can be paid indefinitely.
Dependency exemptions may be dictated in the settlement, but for high-income earners, these are generally phased out and may not offer any tax benefit, even if you are paying child support. Getting your legal and tax planning fees separately billed by your attorney and CPA can allow that portion to be considered an itemized deduction. Your tax filing status will change from married filing jointly to single or head-of-household. Your CPA can project the tax consequences of these changes.
Finally, there are estate tax planning implications to divorce. Ask your CPA and attorney to review your wills, insurance policies and other planning trusts to ensure any needed changes are anticipated in the planned decree.
By far the most disputed items in any divorce are the total income amounts and the valuation of the various properties to be divided. For income items, expect careful scrutiny of your tax returns and pay records. Most problematic are S corporations and partnerships and the determination of how much income you really receive each year.
For valuations, broker and retirement accounts can usually be valued easily and then split tax-free using a qualified domestic relations order, or QDRO. But for real estate or closely held business interests, expect a valuation fight. Any business valuations or appraisals you have had conducted probably will be subpoenaed, as will the tax returns of most businesses you own.
Any personal financial statements you’ve submitted to a bank in the last five years will be reviewed. Talk with your attorney about the advisability of retaining a valuation expert, or possibly preparing your CPA to testify about the values.
Cash flow issues
Given that divorce settlements may take months or up to two years, there is the expense of simply carrying on the negotiations. Legal and tax planning are only part – potential distraction from attention to your business could cost you thousands.
Your CPA can be helpful in analyzing your monthly cash flow before and after a proposed settlement to ensure that you know what you must do to make your settlement workable for you.
Everyone knows that divorce is a last resort step with tremendous consequences on your life. But if you are a business owner and must take that step, do so with your eyes wide open to the financial and tax consequences and do the best job you can to make it a decision you can live with.