FAMILY LAW ARTICLES
Divorce and Business Ownership: Preserve Your Rights To Future Income
Are you getting a divorce and wondering how to account for the family business? Can decisions you’ve made about not taking a wage affect your future income?
Do you have a family business—whether it’s a contracting business, a professional medical business, a dentist’s office, almost anything if it is supporting your family—and you and your spouse are both working in the business? In this video, managing partner Carla Hartley discusses what is the best way to preserve your rights to future income from that business.
If you have any questions or would like to speak with an experienced family law attorney, contact Hartley, Lamas, Et Al today at (833) 647-2377.
So you have a family business. It can be a contracting business, a professional medical business, a dentist’s office, can be almost anything if it is supporting your family. And you and your spouse are both working in the business, what is the best way to preserve your rights to future income from that business?
My name is Carla Hartley. I’m an attorney licensed to practice in California and Texas, and for most of my career, I have practiced in both the family law and probate spaces. I had a brief stint as a bankruptcy attorney, and I know just enough about bankruptcy to know how it can impact you, but I do not practice that area anymore. It is good information to have, not always what we want to use.
Divorce And A Family Business
I am not a tax attorney. This is not tax advice. This is advice about how the decisions you make on your taxes can impact your future, especially in the event of a divorce between the parties who are operating the business, or between the party who is operating the business and the one who doesn’t work in the business.
Either way, we want to make sure that you know the potential consequences of decisions you’re making today that may affect you two years from now, five years from now, ten years from now. It depends on a future we can’t see for you.
So let’s start with the impact that we often see when we have two people working at a family business. One is taking a wage and reporting a wage, and the other one is working in the business for free. Not taking a wage. No wages are reported.
You guys are making a good living and you’re declaring a lot of deductions, but you have no wage from the business. This is a tragedy in the making. In the event of a divorce. The short term decision to not report all your income, the short term decision to take a lot of deductions that are really legitimate deductions can affect you hugely over time, starting with not taking a paycheck from the business.
First of all, if you can take a paycheck from the business, you should take a paycheck from the business. This report, this has taxes coming out of your paycheck. Yes, you do have to pay employment taxes and certain other taxes, depending on what state you’re in. Obviously, more taxes if you’re in California than if you’re in Texas.
However, the fact that you’re paying those taxes means it’s reported to the Social Security Administration. Upon retirement, under current law, a spouse is entitled to either a derivative portion of their higher wage earning spouse’s income, provided if they divorce, the lower wage earning spouse does not remarry before age 55. So that’s one scenario.
The other scenario is that you’re going to be entitled to Social Security solely on what you and your income contributed, reported and contributed to the Social Security Administration. We have seen this just work out tragically for some clients and for some opposing parties. It depends on which side of the fence you’re on. But either way, this is a tragedy in the making if you are permitting this to happen.
If you have not been reporting income and you have been working in the business, that’s going to just mean you get no return for it from the Social Security Administration. If you divorced and remarried before age 55, because that remarriage, which may be something you truly desire, cuts you off under current law from the derivative benefits that you have coming to you under the Social Security Administration.
Now, you’re thinking, I can manage not to remarry by 55. Well, that depends on how old you are. Truly, it does. And you might want to be thinking about this, but that is not the only reason.
New Employment Considerations
The fact that you have not been working outside the family means that you don’t have a wage or salary history to show when you’re looking for a new employment and it just prejudices you in so many ways. The Social Security aspect of it is one aspect and it’s an important aspect that we’ve seen really impact a lot of people over time. For the most part, this impacts the wives in the event of a divorce.
There’s a lot of literature out there on the feminization of poverty after divorce, and I think this is one of the contributing factors. It’s the desire to save money in the short term, by not paying or reporting all of your income, by taking deductions you really shouldn’t be taking, in order to minimize the taxes you’re going to be paying.
I run a business. I am not in love with the taxes I pay. But everyone who works in this business gets a paycheck. And that means that in the event something happens to me, in the event that there is some sort of catastrophe in my life, everyone has a safety net that has been legally provided for them because that’s how we run this business.
I would encourage you, if you’ve got someone who’s telling you to take every deduction you possibly can and warning you that in the event of an audit, it’s all going to go away. You really need to look at someone else to do your taxes and you really should consider paying both of you, both of the spouses in the business, a good wage.
Now, the other impact this is going to have for you, if you are not the spouse that comes away with the business, is going to be in terms of cash flow available for support. It’s going to affect your spousal support, your child support if you have children, and it’s going to affect the valuation of the business, the dollar value of the business that you’re going to receive in the distribution of property.
So let’s start with how this is going to affect spousal support for you. Let’s just say, as a pure example, that your wife is a dentist and that you are working a little bit on the books on the weekends and stuff like that. But for the most part, you’ve been taking the kids to soccer practice and football practice and making sure that you’re the person at PTA, while your wife is running the dental practice. And again, this is an example.
We’ve already discussed if you’re receiving a paycheck, you’re accumulating Social Security income over time. If you’re not receiving the paycheck for the work that you’re doing, then what you are doing is providing a situation where the other side, especially if you are deducting everything you can deduct. So you guys can put it into your houses and your cars and your vacations and so on and so forth. If you’re deducting all of that, not counting it as income for the family. Yes, you’re saving on taxes, you’re the bookkeeper. You know this.
But what is happening is you’re reducing the income available for support. You’re reducing the cash flow of the business. In the case where you’re the bookkeeper, you’re particularly on the hook because if there is an audit, there’s no innocent spouse. So that is probably one of the worst examples I can give you for, wow, you’re making a mistake here.
It’s going to drive down the support you can get because you’ve driven down the deductions you can claim, you’ve driven down the income available for support by maximizing the deductions you can claim. That’s all problematic. And if you’re not reporting all your income, it’s just worse and worse.
In this case, you’re the bookkeeper. How do you challenge that? Yes, you can get a forensic accountant. Yes, you can undo it. But there is a clean hands doctrine, or sometimes depending on the state you’re in, called the doctrine of unclean hands, or the disentitlement doctrine. You can’t go all the way to the bank taking advantage of your deceitfulness and your willingness to cut corners in order to cheat the government and then claim that you have more money coming in. That’s creating problems, not just with your cash flow available for support. It’s creating problems with the IRS.
All right. Now the next example I have for you, or the next place that this is going to be a problem, is if we’re valuing the business. Now, if you have a community property business and one of you is going to walk away with the business, the business is probably going to have a value. Let’s say this dental practice was established during marriage and it’s been going for 15 years and it’s been doing very well.
Capital Investments In The Business
And then, you know, things are starting to get rough. So the spouse who is the managing spouse for the business starts to make investments in the business. This is driving down the income available for support. This is also driving down the cash flow for the business and this is driving down the value of the business.
All right. It looks like it’s something that should be reasonably done. Oh, we need all new dental chairs. We need all new X-rays. We need the state of the art, you know, computer stuff that we replaced two years ago. We have to replace it again this year. We just do. This is a time to begin questioning and start asking what is happening and what is on your horizon.
Now, one thing, if you are receiving a paycheck from the business, because I’m really advocating you should be receiving a paycheck from the family business. If you are receiving that paycheck, then that is a deduction on the taxes. Yes, you’re paying employment taxes, but it’s a deduction from the taxes.
Then in the event of a valuation of the business, that money can be thrown back into the business as a value point if you weren’t actually contributing to the business. If you were contributing to the business, you have a good idea of what a replacement wage would be for the person who’s going to have to take your place, because it’s very unlikely both of you are working in the business after the divorce gets started.
So I hope I have given you a few examples, at least some food for thought when you’re looking at doing your tax returns as married people who are self-employed, when one of you is self-employed, but particularly when both of you are self-employed.
If you’re both in the family business, this is just a minefield, in the event that you are taking shortcuts on those taxes, you’re not making sure that you’re getting a paycheck or you’re not making sure your spouse is getting a paycheck. And then you’re ending up with this series of disasters that are really hard to get out of. It’s not impossible. We’ve done it a number of times, but it’s expensive.
You can save yourself and your spouse an awful lot of money paying a little bit more in taxes over the years and just avoiding the need for that forensic accountant to go through every bank statement you guys have in all of your various bank accounts for the past 3 to 5 years.
Forensic accountants are very valuable, they’re very worthwhile, but they are expensive. And the easier you make their job, the better you’re going to come out of this in terms of Social Security, in terms of the valuation of the business, and in terms of cash flow available for support.
Legal Help With Your Divorce Involving a Family Business
My name is Carla Hartley, and I hope this has been helpful.