TCJA and DivorcePosted on July 11th, 2018
A recent question was posed as to how family law attorneys should interpret the new tax code for purposes of dissolution and settlement. I recently returned from my annual valuation conference and took a course titled, “Tax Cuts and Jobs Act of 2017 (TCJA) – Impact on Divorce” presented by Sharyn Maggio, which dove into this very topic.
The following is a brief list of considerations I gathered from the course with which family law attorneys should take into account and be prepared to address at their next settlement hearing:
Alimony recapture is no longer recalculated
Modification to divorce decrees or parenting plans must now explicitly state in the decree or the parenting plan whether or not the TCJA rules will be used moving forward. If the new decree is silent to the effect of which tax rules apply, it defaults to the old tax rules that were in place at the time the original decree or plan was filed.
The deduction for personal exemptions have been suspended for tax years 2018-2025. The personal exemption is relevant in determining the child tax credit, which is an important consideration of clients with children. This is a temporary change to the code which will expire in 2025. It was recommended that adding explicit language to the documents to revisit or revise the personal exemption upon the expiration of the TCJA be included in the filings.
Additionally, it was mentioned that when writing settlement offers, language such as, “If there is a change in the tax law, the following items may be modified at a later date” should be written into the decree or parenting plan. Because there are still so many unknowns, contingency wording is important in these first few years to secure at least the option to revise down the road if tax rules change.
One last takeaway relates to settlement offers revolved around alimony and what alternatives are available to incentivize equitable distribution of monetary assets without alimony, now that it’s no longer deductible to the spouse paying the alimony. The following are possible suggestions:
1. IRA distributions can be annuitized under IRC Section 72(t) to avoid a 10% penalty now
2. QDRO’s no longer have a 10% early withdrawal penalty on distributions.
3. Business owners may assign non-voting, assignee, or income-only interest in business interest in lieu of alimony. There could be an agreement to pay out dividends for a number of years (i.e. 3 years, like alimony), and then the non-voting stock is purchased back from the ex-spouse at a pre-determined rate (or reverts back to the ex-spouse).
Key Employee RetentionPosted on June 11th, 2018
With a strong economy, low unemployment, and the Baby Boomer generation retiring, the transaction environment is ripe with sales of privately held businesses.
However, along with a strong economy and low unemployment come opportunities for employees to find better career opportunities. Whether it’s an increase or pay, flexible working hours, or more benefits, employees are keeping their eyes open for greener pastures.
If you’re a business owner who is thinking of selling your business in the next few years, consider the incentives you have in place in keeping your management team intact. Potential buyers purchase companies based on cash flow – and they pay premiums for cash flow that they expect to increase after they buy the company. In order to keep cash flow figures stable, you need your key employees to drive revenue and profits forward.
The following incentives are considerations for retaining the top talent in your business:
1) Stay bonus – When a business is sold, a certain amount of the purchase price can be held in Escrow, which the key employees will become vested in over a period of years, so long as they stay employed with the Company. After their vesting period had commenced, they received their pro rata portion of the proceeds as a bonus for staying on with the Company post sale.
2) Equity bonuses – You may consider offering a small minority equity stake in the company to your top employees (<5%). This creates a sense of ownership and responsibility in business performance and incentivizes the employees to stay on board and growth their interests. The better the Company performs, the better return they receive on their interest.
3) Promotion – Do you have or two employees who could easily step into a C-suite level role? If so, you may want to consider promoting your top talent to executive roles within the Company. Leadership opportunities are a powerful incentive in any sector. Promotions lead to new skills, new challenges, and new opportunities that will keep employees wanting more.
Please don’t think of employee incentives as a one-time exercise. Consider these options, among others, as incremental steps in the development your top management team.
Case Law Corner – July 2018Posted on June 11th, 2018
This month, we’re commenting on a Washington State case published in June 2017 titled, In re Marriage of Vandal. One of the key arguments in this case revolved around community labor and community property.
A court’s characterization of property as separate or community is a question of law reviewed from the beginning of that asset’s life. However, substantial evidence (of sufficient quantity) can sway the characteristics of what was once a separate asset to a community asset. This is exactly what happened to the business in this case. Husband had started a CPA practice prior to the marriage, but over the course of the marriage, had comingled business and personal funds to pay for various household and business expenses. No reconciliation had been performed to separate these expenses at the end of the year. According to state law, where separate property is commingled with community property with no effort to keep the two separate, it becomes community property. Additionally, Husband had testified that he used an equity line of credit secured by the family residence for business purposes. This testimony further supported the act of comingling and solidified the business as “community property.”
The important takeaways from this case should encourage business owners to respect the tried and true recommendation of “keep business and personal separate”. Had the husband directed his Accountant to reconcile the personal expenses at the end of the year (with a clear and definite trail of documentation) and had applied for a line of credit (LOC) through the business, not the couple’s home, there may have been an argument that this asset had, in its entirety, retained its separate property characteristics.
In Washington State, courts recognize professional goodwill as an intangible property subject to division in a dissolution (See In re Marriage of Brooks (1988). If business owners do not calculate the value of professional goodwill at the time of marriage, its almost impossible to distinguish between professional goodwill earned before, during, and after the marriage. Because the husband did not present any evidence of the value of the business’s goodwill prior to the marriage, nor did he attempt to present evidence to calculate any separation between personal or enterprise goodwill, the entire intangible value of the Company resulted in community property.
Again, an important takeaway from this case should also encourage business owners to conduct the proper due diligence at the proper times. A business valuation should be done at the time of marriage to calculate the tangible and intangible values of the business. This valuation can then be used as evidence at the time of dissolution to allocate any potential separate property that may remain.
It may seem that divorce is never in the cards, but understanding the nuances of case law and planning for the worst may be the best decision our clients can make.