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Determining self-employed business income in a divorce?

Updated: Nov 13, 2021

What income? Self-employed Income concerns?

Updated 2/9/2020

A study conducted by Harris Poll found that two in five Americans with combined finances have admitted to committing financial infidelity against their partners. Lets's me honest that was just the percent of the population that was willing to admit it. The real ratio is likely higher, and add in an impending divorce, and that ratio only increases as the likelihood that financial deception will occur also increases.

Self-employed Income Concern

I have met quite of few folks looking to divorce, with a self-employed spouse that shows little to no income on their tax return.  Or there are profitable businesses’ and the spouse refuses to have a business evaluation done, properties appraised, documents are hidden or lost.

... there are profitable businesses’ and the spouse refuses to have a business evaluation done, properties appraised, documents are hidden or lost.

Most times, the other spouse has little resources to hire a forensic accountant or have business valuations performed as they are not in control of the family finances. It is not uncommon that these folks are the spouses that stayed home, may have given up a career, raised the children and have not been in the workforce for some time.  There is fear and uncertainty, and these spouses are in an emotionally vulnerable position unsure what their next step should be.

Hiring a Financial Professional

This baby step approach can help keep costs down and determine if further analysis needed.

It may make sense to hire a Financial Professional (FP) with an engagement for limited scope analysis work; perhaps a lifestyle analysis, cash flow analysis,  or to identify changes in net worth that are incongruent with the tax return.

This baby step approach can help keep costs down and determine if further analysis needed. The FP can begin by examining the individual  Financial Affidavits, tax returns (personal & business), bank statements and the credit cards to identify undisclosed/hidden assets, funds used for non-marital expenses, personal expenses hidden as business expenses that reduced the profit of the business, over-payment of taxes (to reduce income), even double dipping on expenses etc. An example of double-dipping would be deducting  cell phone and car expenses  on the business return (reducing profits) and then listing these same expenses on the Financial Affidavit as personal expenses to show less available income.

Financial Tools

The more information that you can gather without your attorney issuing subpoenas, requesting additional documentation during discovery from opposing counsel (or your uncooperative spouse)and conducting deragatories the better. Divorce can be expensive, believe me very expensive. This will help to keep the costs down.

The identification of red flags can also help

Many times the income on a tax return does not actually reflect the cash-flow available from a business to support a family’s needs. Perhaps as a first step, an “income determination” can be explored as an alternative to a business valuation. Adjustments like depreciation and prepaid expenses may need to be added back to get a better sense of the business’ income. An example if this is real estate rental properties which typically produce little taxable income.

The identification of red flags can also help. A cash flow analysis of deposits received, perks, fringe benefits etc. can be created and combined with a review of operation expenses to create a basis of business income versus what was stated on the tax return. For example, a red flag may be: if a historical data review shows that appointments in a radiology office are consistent for the last 3 years, expenses for x-rays services are still up (and correspond to consistent appointments), but the business revenue is down, there may be intentional understating of income.

Another tool known as “lifestyle analysis” can be used to challenge an income claim of a spouse. The process involves identifying the spending during the marriage as a basis for calculating the income needed to fund that lifestyle and determine if it was supported by debt or unreported/undisclosed income during the marriage. Thus helping to establish a level of income circumstantially and a basis for support even if the tax return or the Business profit/loss statements show otherwise.

A trained Financial Professional in Divorce Planning and a background in taxes can help with these tasks.

This information is not meant to be construed as financial, tax, or law advice. Always speak with a professional in the applicable area of expertise to address you specific situation and concerns

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