The other articles in this issue focus on big income, big executives, big executive benefit plans, and big companies. Yes, we want to have cases that involve these high-dollar executives and their benefits because there is usually a substantial amount of work for attorneys and related professionals to decipher what the benefits are and determine how to identify and monetize them as income or assets for child support, alimony, and property division proceedings.
But many of our cases involve smaller, if not small, businesses. In short, these businesses have benefits that won’t be found on a proxy statement or an SEC 10b-5 form because there isn’t one. Stated differently, the small business’s books are usually kept internally and are not subject to audit or a compliance review by general counsel. If accountants are involved at all with the small business, it is usually to receive the books of the business after the end of the year to prepare a tax return. The accountants really do not prepare even a “compilation,” much less a review, and certainly not an audit of the records furnished to them to do the tax returns. So the tax returns of this small business deserve scrutiny for “adjustments” to either income or to book value. That is what the business evaluator/appraiser does—he or she essentially “audits” the small business, looking for perks that are buried way down in the details, below the surface or under the radar.
Here is a simple example. Husband and Wife owned a small business. The business was refurbishing certain materials used in delivery of goods to client businesses. The couple owned a manufacturing company that hired one hundred workers and did not offer or pay for any health insurance or other benefits—in other words, a sweatshop. Then the couple operated a management company paid by the manufacturing company with—guess what—the husband and wife, and a couple of others, as the sole employees. (This model of several entities, of course, is used all the way up the scale of possible business sizes, but in this article, we’re not exactly worried about repatriation of foreign profits, i.e., about a company so large as to benefit from the new 2017 tax code.)
Wife had a credit card. When she would get her monthly credit card bill, she would go to the company office (there was only one), import the credit card statement into the company’s QuickBooks, and assign an expense account category to each charge. At the end of the year, the company presented the income and expense statement without the general ledger to the outside CPA to prepare the business tax returns, as well as the parties’ personal tax return.
In this case, it worked well for years—until the divorce. The business valuation team members did their job, adding back to income or to assets. Since both Husband and Wife had actively participated, neither could point the tax underreporting finger at the other. The net effect was that several business and personal tax returns were amended, as almost $650,000 in new or previously underreported income was recognized. (So much for being a small business!)
The company may state in its governing documents the importance of certain employees having access to a vehicle at all times to perform company business and that the company will pay all the expenses for such vehicles. In the pre-2018 tax world, the company may have leased vehicles from a captive leasing company that could depreciate the vehicle’s value much quicker if the vehicle was not subject to the full deduction in the year of acquisition (think big pickup truck). All insurance, maintenance, and operating expenses are paid by the company. Gasoline is paid by the company as well.
As lawyers, we know what marketing expenses generally look like: website, search engine optimization (SEO), print or media ads, newsletters, announcement and holiday cards, and entertainment (meals, game tickets, adult entertainment) of (exclusively, of course!) referral sources and clients. We need to inquire about the small business in our case to determine what portion of the expenses in this category provide a personal benefit. Do the business owners always go to the pro football games with family only?
Presumably all insurance is paid by the company. The question is, what, if anything, is charged back to the owner? Many times it takes a 1099 or 1095B form to encourage a business owner to “remember” such a perk. And is there a reimbursement “plan” for out-of-pocket health expenses that “operates” much like an informal health savings account? What is the cost of coverage for the whole family, and not just the employee-owner?
It is reasonable for the business to have key man life insurance and AD&D insurance, but ownership of the policies and ability to control designation of beneficiaries may be an overlooked benefit. And while 529b qualified tuition tax savings plans are technically for the benefit of those getting an education and should be totally outside the purview of the business, it may be worth a peek to confirm that such a plan, unused, will return to the benefit of the business owner.
Dues and Subscriptions
It used to be that one would look for newspapers and other periodicals delivered to the home address, but now there are a wide range of digital subscriptions that may be paid for by the company. These can quickly total up to amounts in the four-figure range.
Professional Meetings and Seminars
A.k.a. the travel club. Lawyers know well the importance of continuing legal education and how difficult it is to get without travel, which happens many times to be held at very nice places. But with the small business in your cases, see if expenses for kids, spouses, and others are included in the meeting expense. Does tuition for children of employees qualify as an education expense if papered in the company’s records with a stated business purpose?
Repairs and Maintenance
Many small business owners have a home office. Some even go through the hoops to deduct the home office as a business expense. But those who have a stand-alone workplace may forget to segregate maintenance and repair expenses actually performed at the home from those done at the business site. See the example of credit card use by Wife, above. The bill showed an expense; she assigned it to a category . . . .
Computers and Telephones
The entire network of computers, printers, scanners, routers, NADs, monitors, etc. at both the workplace and home is many times taken as direct expenses by the company and/or deducted under I.R.C. § 179. Is the justification for expensing the Xbox and the 75-inch smart TV at home that it was needed to view training and/or YouTube videos (about needed work expertise) after hours? (You know some small business owners work all the time . . . .) It is now more difficult to discern even clearly leisure—game—software purchases from software for businesses because a substantial amount of both types of content is available from the Apple App store, iTunes, and the Google Play store, as well as from the traditional vendors such as Microsoft, Adobe, Intuit, Amazon, and others. Is the full Adobe Photoshop suite really necessary to run the company? Does the company even have any use for it? And were the computers and iPads expensed? Who has them?
VoIP phones and telephone lines make the virtual office seamless with cell phones. In fact, many professional businesses are choosing to have virtual or as-needed offices (such as those provided by IWG plc, formerly known as Regus) instead of physical offices. How many cell phones and voice and data (for iPads, etc.) lines in the family plan are paid for by the company? Are the “home” phone lines expensed?
Can you discern by looking at the general ledger where the sheetrock and painting or installation of a new electric circuit occurred? And with the relaxed depreciation and expanded § 179 new tax rules, and with the lack of an IRS-issued technical corrections set of regulations, it would seem that there’s going to be a lot more expensing, rather than capitalizing, of improvements in the small business.
It is quite reasonable for many companies to ensure the safety of its key employees at all times. But what is a reasonable home security system and monitoring system? Does security include having chauffeurs drive management to the professional football games to sit in the company’s seats?
In the age of obesity and diabetes, emphasis on health incentives should not be dismissed, and furnishing memberships to health clubs has proven to be a valuable tool to ensure the health of the company’s workforce. But is it necessary to have a gym with a Peleton bike and subscription at both home and office? What about a note from an executive’s doctor that it is necessary/recommended for the owner to fly business class because of stress/back/whatever issues, or to take two weeks off at a spa in Arizona or Hawaii because of job-related stress? Or to attend week-long quit-smoking seminars three times a year?
Is a several-hundred-dollars-per-month storage building full of business records and equipment or full of excess furniture and keepsakes from the house reasonable?
Hopefully, a category like this is small, but flash drives, SSDs, monitors, and cameras, as well as the usual supply of printers, toners, and paper, can push the dollar value way up.
Plant Services/Yard Care
It may be appropriate for an office to have regular plant care, but are all the services performed at the business site? If not, what is the justification for the off-site expense? Is there just one invoice submitted to the business for what may also include the home?
Utilities; Internet Service
Internet service is becoming as much a utility as electricity, water, and natural gas. But are the services at sites paid for by the business all business locations?
Operating Company versus Management Company Benefits
The sweat of the operating company, after paying the hard expenses of that business, produces profit. In many cases, that profit seems to be used by the operating company to ensure as much benefit as possible to the business owner while minimizing the income recognized by the owner or by the company. See the above list. And also, look at all the affiliated companies, including those that may not even be owned by the parties. Is there an actual or promised after-the-divorce benefit from one of these entities?
And then there is the business with at least some cash aspects. This type of business is quite troubling because generally there are limited, if any, reliable records, such as credit card statements. It is hard to even quantify expenses unless your client has active knowledge of occurrences. Such active knowledge is problematic. This perk may actually be an asset known to the parties—it may be referred to as the suitcase in the closet. See innocent spouse rules for underreporting of income. See ethical edicts for lawyers to determine their duties to cease representation of a client with the credit card—or suitcase—who refuses to amend the tax returns.
The issue in many of these perk areas is not the concept of the perk itself; rather it is the level of reasonableness or excessiveness that may be present in the smaller business that operates without an accounting department and without audit of income and expense. Your audit as a lawyer would be you in an hour discussion with your client with the general ledger (and, in the example here, the credit card statements) to determine what you and the client need to do. Hopefully, it will be a simple, straightforward task. But know when your ethical duties outweigh the client’s desires. fa
Benefits that Fly Under the Radar
A Starter List
So what type of benefits may fly under the radar unless there is a full-blown business evaluation, an evaluation performed with complete access to all the records of the business, and a substantial budget for doing so? (This is typically the case: The one “losing” the benefit of the company in the divorce wants the value he or she is “selling” it for to be maximized. But how much does one want to “invest” in the evaluation to find out the answer?)
Here is a starter list of what to look for:
- automobile expense
- marketing expense
- insurance—AD&D and life
- dues and subscriptions
- professional meetings and seminars
- repairs and maintenance for computers and telephones
- leasehold improvements
- security systems
- health incentives
- other benefits available to the management company but not the operating company
- rent, storage facility, or home office
- office supplies
- plant services
- janitorial/yard maintenance services
- business with at least some cash aspects
- repairs to equipment and other household repairs done by business employees.
The above benefits are mostly in the nature of income, not assets. (Those valuable benefits such as benefit or retirement plans that have objective third-party plan documents and records are not addressed here, as these are covered elsewhere in this issue.)