Matrimonial Case Study Shows Importance of Full Analysis

October 11, 2012

A real-life case can provide valuable insights into litigation and valuation issues and how to resolve them. Each case requires thoughtful analysis and the creation of a work program designed specifically for the situation at hand. This matrimonial case was handled by CPA Laura Ewart and other CPAs at CPAmerica International member Cowan & Gunteski, & Co., in New Jersey.

The Situation

In most matrimonial litigation cases in which an accounting expert is retained, one spouse is a business owner.

The expert retained in the case must analyze and report on two issues. The first issue is the value of the business owner’s interest in the company, and the second is the amount of cash flow the business owner is receiving from the company.

The value of the business owner’s interest in the company is necessary to determine the distribution of assets between the spouses. The cash flow analysis is necessary to determine the amount available for alimony and child support.

In accordance with state case law for matrimonial cases, a business interest gifted to the owning spouse is exempt from equitable distribution. However, the non-owning spouse may be entitled to a share of any increase in equity that occurred during the marriage.

Our firm was recently retained by the wife in a matrimonial matter. In this particular case, the interest in the business was gifted to the husband by his parents. The parents also kept an interest in the business and continued to operate it.

An analysis of the financial history concluded that the company had lost its largest vendor several years before, which had caused a significant downturn in the gross revenues. Although the company survived the revenue loss and successfully restructured to recover, its value had severely decreased from the time of the gifting.

Therefore, it was concluded early in the case there was no equity in this company that would be subject to distribution.

A cash flow analysis still had to be performed to calculate the husband’s true earnings to determine an adequate amount of support for the wife. The starting point for a cash flow analysis is the salary and distributions the business owner is taking from the company. An analysis is also made of the owner/shareholder’s loan account to determine if the business owner is taking additional funds from the company, and there is no history of repayment of the loan.

The next step is an analysis of the company’s general ledgers to determine if there are any personal items or perquisites being paid by the company that should be included in the business owne’s cash flow. Any payment of items that are for the personal benefit of the business owner or his family is considered cash flow to him.

Examples of these payments for personal items include automobile expenses, travel and entertainment, mortgage or other personal loan obligation payments, personal insurances and home utilities. The key phrase to remember in this analysis is “personal benefit.” If the item is for the personal benefit of the owner or his family, and not for the benefit of the business, it is considered additional cash flow to that owner.

The Findings

At our initial interview of the wife, we were advised that the husband’s parents retained complete control of the operations of the company. The husband received wages from the company and all of his and his wife’s personal credit card expenses were paid by the business. He received no other distributions, loans or perquisites. The wife provided the couple’s personal credit card statements for the past three years. The charges totaled over $100,000 per year in personal marital lifestyle expenses.

The husband’s parents were interviewed next and were allowed access to the company records at the time. The parents agreed the wife was correct that the parents controlled the operations of the company.

They also advised that the husband received wages and did not receive any material distributions, loans or perquisites other than the payment of personal credit cards. However, the parents had a significant difference in the accounting for the personal credit cards. They said they personally paid for credit cards of the husband and his family, not the company.

The two scenarios yielded dramatically different results in the cash flow analysis. If the wife’s explanation was correct and the business was paying the personal credit cards, the payments made by the company were for the personal benefit of the husband and his family and are considered to be cash flow to him.

However, if the parents’ explanation is correct, and they are paying the personal credit cards, the payments would be considered a gift from family members and not cash flow to the husband. (In some jurisdictions, however, recurring gifts from family members have been determined to be additional cash flow. But that is beyond the scope of the case at hand.)

As in every case, it is important that experts always reconcile what they are told by all parties with the supporting documentation they are provided. In this case, the documents supported what both sides of the litigation told us.

The general ledgers and other supporting documentation provided showed that the company was paying the personal credit cards of the husband and his family. However, the payments were being posted to the parents’ shareholder loan account, and the parents were depositing personal funds into the company to repay the loans. Therefore, we concluded the payments of marital lifestyle expenses on the personal credit cards were gifts from family members and not recurring cash flow from the business to the husband.

Each case has nuances that require the keen analytical skills of the expert. Careful planning and procedures can help assure that you have captured all the pertinent data needed to issue relevant reports to the matter you’re involved in.