Many working people are employed in a traditional employer/employee relationship and are issued W2’s at the end of the year. However, others work in some form of self-employment, either as their only earned income or to supplement their income from a traditional job.
Self-employment is common for health care providers, attorneys, electricians, plumbers and consultants in various disciplines. Many self-employed individuals manage their finances in such a way to benefit from various tax codes and to continuously reinvest in the business. This can create challenges in a divorce.
Categories of self-employment
- Sole proprietorship: An individual business owner operates a business on their own. Their business income is reported on their personal income taxes.
- Partnership: Two or more individuals operate a business based on a partnership agreement. Income and expenses are divided between the partners as agreed. The income and expenses are reported as part of their personal income taxes.
- Limited Liability Corporation (LLC): Generally treated as a partnership. There are benefits to this type of entity for tax purposes that may not receive the same treatment in a divorce.
The impact of self-employment during a divorce
Self-employment does not inherently have an adverse impact on the outcome of divorce proceedings. The challenge is to properly evaluate income and expenses associated with a business. Determining streams of income and the allocation of expenses can be much more complicated than simply using the net income as determined for tax purposes.
Divorce can also have a significant impact on the business itself. This varies based on the type of entity the business operates under. Some business assets are accessible in a divorce, and therefore the impact of the divorce can reduce the assets available to continue the business. This includes:
- Physical assets transferred to the other marital partner
- Reduction of cash flow to maintain the desired level of business enterprise
- The business being divided by the marital partners
Home-based businesses are particularly susceptible
Some married couples are in business together. They may have operated as sole proprietors because they completed joint tax returns and the income was immediately accessible to both of them. The difficulty then becomes determining how the business will be divided. This complex decision will be based on the ongoing survivability of the business as well as the type of business in question.
Process of evaluating business assets
Marital partners involved in self-employment will need to have fully prepared financial documents including all tax returns and applicable Financial Affidavits for review. All information needs to be up to date, accurate and include all personal and business-related income and expenses to conduct a proper evaluation of assets and liabilities.