Families have experienced significant changes in 2020 in how they work, learn, shop, visit friends and family, and even get divorced. Studies show that divorce filings are up 34% so far in 2020 compared to the same time period last year. With continued uncertainty looming, the trend is expected to continue as added stresses are placed on families. Adding fuel to the fire, several new tax acts were passed in 2020 that have significantly impacted businesses and households at every economic level.
This summary will help equip family law professionals with the tools to identify current financial risks and tax impacts when negotiating settlements, which are crucial to avoiding post-settlement surprises or burdens. We will discuss the various 2020 tax acts, how they impact family law cases, and provide actionable tips and alternative settlement strategies to utilize these provisions to your advantage and to ensure settlements remain fair and equitable.
Business Valuation Considerations in the COVID Era
Business valuations are date sensitive. The timing of the divorce and the date of the valuation make a difference. As experts, we are tasked with valuing a business as of a certain date, but only the facts and circumstances that were “known and knowable” as of that valuation date are considered in the valuation. With market data and economic forecasts changing constantly since the pandemic hit, it is important to rely only on the economic data that was available at the time of the valuation date.
In light of the volatility in 2020 financial performance, valuation professionals, business owners, and family law attorneys are asking many questions, such as:
“How much weight can be placed on historical financial performance?”
“Is a single-period valuation method such as a Capitalized Cash Flow “CCF” method appropriate?”
“Have the uncertain times created justification for the use of a multi-period forecasting method such as the Discounted Cash Flow “DCF” method?”
Historically, concerns have been raised when using the DCF method for divorce purposes arguing that it takes into consideration post-marital efforts.
Examining the industry in which a company operates provides an important point of view to understand the structure, current performance, and outlook for the industry. Not all industries are created equal. Some industries, and correspondingly individual companies, have been able to pivot their strategies and drive business value, other industries have experienced significant declines in value.
In determining the long-term health of a company, valuation professionals will assess whether the subject company is experiencing structural, and likely permanent, changes or encountering a temporary “bump in the road.”
Settlement Strategies: Approaches to Valuation Issues and Uncertainty
We encounter three primary settlement strategies that address various valuation considerations:
- Wait and See: This approach puts the business valuation on hold until an agreed upon date but settles all other matters of the case.
- Share and Delay: This approach allows the parties to share in the economic benefits/determinants from the business until an agreed upon date. It could also include a partial settlement amount now, with a “true-up” determination at a later date.
- Best Case, Worse Case: This approach involves determining the business value based on multiple scenarios.
Considerations Related to Payroll Protection Program Loans and 2020 Retirement Account Changes
Payroll Protection Program (PPP) loans could have significant business valuation and tax implications. On one hand, the funds represent a non-recurring source of cash flow. On the other hand, expenses associated with any portion of a PPP loan that is forgiven are not tax deductible.
We expect to see normalizing adjustments for both business valuation and income determination purposes. Obtaining a copy of the PPP loan forgiveness application will be necessary to help determine if there is adequate consideration given for next year’s tax obligation.
Along with introducing the PPP, the 2020 CARES Act brought about multiple changes to the rules related to retirement account contributions and distributions. Notably:
- Allows traditional IRA contributions beyond age 70 ½
- Required minimum distributions (RMDs) moved to age 72 instead of age 70 ½
- Allows penalty-free retirement withdrawals for birth/adoption
- Increases limits on retirement plan loan amounts
- Provides for Coronavirus-related distributions from retirement accounts
- Suspends retirement RMDs for 2020
- Waives 10% surtax on early distributions for COVID reasons
- Permits 3-year delayed income recognition and 3-year repayment
With these tax changes, additional settlement strategies have opened up to counter the 2018 tax change that eliminated alimony as a deductible expense.
Alimony Alternatives in a Post-TCJA Era
The 2018 Tax Cut and Jobs Act (TCJA) eliminated the alimony deduction for divorces entered into after December 31, 2018 which was a significant tax savings strategy used for decades. The ability to deduct alimony allowed the primary income-producing spouse in a higher tax bracket to shift tax liability to the lower income-producing spouse. The overall shared tax savings allowed more money to be left over at the end of the day to be shared between the couple. Without this tax advantage, the ability to replicate the tax savings becomes more complex, but it can be accomplished.
Family law attorneys and their clients may consider the following alternative income-shifting settlement solutions and strategies:
- Transfer additional retirement assets at pre-tax values as part of the property settlement. This strategy can be particularly helpful for business owners that have the ability to make significant tax-deductible contributions to replenish their retirement account, such as a cash balance plan.
- Transfer additional low basis investment assets
- The recipient will receive the asset with carryover basis and will pay taxes when sold at potentially lower tax rates.
- Assign a non-voting, assignee, or income-only interest in real estate or business interests
- Preferred stocks and stripped dividend strategies
- C-Corp stock redemption alternatives
Tax planning for post-settlement filing is complex and nuance-filled, but there are many effective ways to accomplish your goals, if you are prepared and informed.
If you want to learn more on these topics, Michelle Gallagher and Kaylee Simerson will be hosting a webinar on Tuesday, November 10th to discuss these topics in more in depth.
Join us at 10:00 AM ET on November 10th by registering here.
Please also contact one of us directly if we can be of any assistance as you navigate this challenging process.
Exit Planning Series
WH and Adamy Valuation began a series called “Tactical Tuesdays” in 2020 in response to the impact of the COVID-19 pandemic on our clients and business partners. The goal of “Tactical Tuesdays” was to provide up-to-date information that would allow leaders to make tactical decisions to run their business. As COVID (hopefully) winds down, the Tactical Tuesdays focus is shifting to address longer-term issues. Over the next several weeks, DWH and Adamy will be publishing a series of blog posts around exit planning for business owners.