In a divorce, the court attempts to divide property fairly between the separating spouses. In order to do so, the property must first be valuated. The value of the property is its market value minus any financial encumbrances. Ideally, all property will be given a determined value, and any property that is not valuated may be assigned a value of zero by the court.
One item of property that the court must determine the value of is a family-owned business. When businesses are valuated, the following concerns are taken into account:
- Tangible assets possessed by the business
- The personal goodwill at stake in the business
- If the business was acquired before or after the marriage
- How much the business would be worth if sold
- How the marriage has invested in or held back the growth of the business
- Debts, taxes, and other obligations
One area of business valuation that is less obvious involves independent contractors. If you or your spouse is an independent contractor, is this considered a business? And if so, how will it be valuated?
An independent contractor is someone who is technically self-employed and receives IRS Form 1099 income from third parties, and is considered to own a sole proprietorship. The issue of who is an independent contractor is governed by the IRS. Many individuals contract out their services to various others and are not considered employees. Their business may not have the same features of a larger business, and therefore the business as its own entity may not be seen as valuable in the same ways to a court.
The contractor’s self-employment income will be considered an income stream available for the payment of spousal support or for the payment of expenses and child support. However, because their income must be used to service the expenses of their “business,” the expenses they incur in order to conduct their work must also be considered, and will lower the net value of their business. Falsifying or exaggerating business expenses is considered tax fraud if filed with the Internal Revenue Service, but not uncommon during a divorce. These expenses should be investigated carefully, especially if they have been paid for with community funds. The other side of the coin is that the tax return may have to be amended to reflect only reasonable business expenses, resulting in increased tax liability to the spouses.
The business of an independent contractor may have little to no tangible assets, and the business itself may not be salable. Where the success of the business depends upon the personal skill, work ethic, reputation, and habits of the individual contractor it may be difficult to sell to a third party, especially if that independent contractor is in a highly competitive market.
The bulk of the value in a sole proprietorship is in the goodwill of the business — in other words, the reputation it has that is likely to generate future business. With an independent contractor as with any business, the goodwill may be valued as part of the business.
Ultimately, determining the value of the business of an independent contractor will depend on the specific characteristics of their business, and how it is valuated and presented to the court. It is important to have a professional evaluate your family’s business in order to have it represented fairly in a divorce case. For a personal consultation, call us today.