One of the biggest problems in divorce is determining the actual income of a sole proprietor. This person owns a small business, and takes draws from the business rather than W-2 income. Usually, this person also pays for their car and other expenses through their business. All of this can get very messy if there is a divorce because the other spouse will usually claim the self-employed sole proprietor is “hiding cash,” and “paying for everything through the business.” This can lead to a long and expensive discovery process, including but not limited to depositions, subpoenas and the hiring of forensic accountants and financial investigators. So, how do you avoid this? A little preventive medicine is the answer, whether or not you ever get divorced. The following are some suggestions for the self-employed sole proprietor. These are only suggestions and should not be considered legal advice. Further, I make no representations that these suggestions will work, because the old saying in the world of computer programers applies here: “Garbage in, garbage out.” You should always work with a CPA and/or tax attorney to make sure you avoid putting in “garbage.” With that in mind, here are some tips:
1. Hire an elite CPA. You need to make sure your business is set up properly, and that your taxes are prepared properly.
2. Hire a bookkeeper and get everything into QuickBooks or some other accounting software with back ups. You want to do this for reasons that I will explain, below.
3. Don’t “shuffle” or “shift” your income. Depositing money into a personal account and then transferring the same money into a business account does not pass the smell test. YOU NEED TO HAVE A SINGLE BUSINESS ACCOUNT WHERE YOU DEPOSIT ALL OF YOUR INCOME! You take your draws from your business account after you pay your expenses. Further, there is an accounting presumption that any checks you write from your business account are for expenses, unless they are draws. This is a rebuttable presumption. In my experience, having a single business account makes everything clean and tidy, provided you keep it that way.
4. You may find that your business account is low on funds. When that happens, avoid the temptation to simply pay business expenses from your personal account. Take the extra step of writing your business an advance and when you get more funds into your business account, then you need to repay yourself.
5. You need to hire a bookkeeper. YOU DO NOT WANT TO DO THIS YOURSELF. Why? Because if the other side takes your deposition, you don’t have to defend each and every entry and withdrawal. All you need to say is: “I give everything to my bookkeeper and she/he reconciles my books, etc.” This forces the other side to take the deposition of your bookkeeper as well, and assuming your books are in order, the other side won’t get anywhere.
6. Stop being cheap. Seriously, you’ve got to become financially sophisticated and buckle down and pay for professional services like an elite CPA and a bookkeeper. It is not that expensive and it provides you with a clean record if you ever end up in court.
7. You never want to be in the position of explaining your deposits. Only your earnings/income go into your business account. If your parents give you a gift of money that should be placed into your personal checking or savings account. If your parents or other parties lend you money for your business, discuss how to deal with that with your CPA and/or tax attorney.
8. If you are getting divorced, make sure your CPA adds back your perquisites and that you account for those perquisites on your QuickBooks or other accounting software profit and loss statement so YOU can tell the Court what you believe your perquisite add backs are, rather than let the other side take the high ground on this.