In some cases, it can be difficult to determine which expenses should be considered as personal or business. There are business owners who are particularly sophisticated in their understanding of financial accounting methods and who may intentionally conceal personal expenses while claiming them as ordinary and necessary business expenses. For example, in a recent case in which I was the designated expert, in addition to many of the common perquisites described in our previous newsletter, I found:
Independent Contractors: The business owner coded more than $50,000 of expenses to independent contractors. Upon inspection, however, the expenses were for landscaping his personal residence, installation of cabinets in his personal residence, improvements at his personal residence, pool service for his personal residence, and maintenance of his personal residence.
Marketing: A review of the paid bills and general ledgers reflected that the alleged marketing expenses were actually Hallmark purchases and plumbing expenses for the party’s personal residence.
Dues & Subscriptions: This category included country club dues, which are no longer deductible as business expenses pursuant to the Internal Revenue Service’s rules.
Repairs & Maintenance: The client expensed more than $30,000 as repairs and maintenance, which, again, included costs for landscaping his personal residence, installation of water services at his personal residence, lawn care for the personal residence, installation of over 50 large trees and of windows at his personal residence, and other personal expenses unrelated to the operation of the business under examination.
In this particular case, the perquisites accounted for more than 32 percent of the total gross cash flow available for support. Had a thorough investigation into the nature of those expenses not been performed, that amount would not have been considered in the total gross cash flow available for support, significantly understating it.
Taxable or Non-taxable?
Once perquisites are uncovered, whether they should be treated as taxable or non-taxable depends upon the specific facts and circumstances of the case in question. Although case law exists that holds that the benefits should be included as taxable income, it is my opinion that the deductions from gross income for Federal and State income taxes should bear an accurate relationship to the tax status of the parties. Unless taxes are actually being paid on the perquisites, they should be considered as non-taxable.
An example of where a perquisite could be considered taxable would be dissolution-related legal fees. Once the dissolution has concluded, the expense would no longer exist and that portion of the business net income would be increased accordingly. The income would then be taxed as wages, or other business taxable income. This should be considered in any case where the category of the expense that is deemed a perquisite is non-recurring.
For most recurring perquisites utilized to reduce business income and provide a personal benefit for the operating spouse, it is appropriate to treat them as non-taxable. There are some benefits that have no specific direct economic benefit to the employee or business owner. Examples of such benefits would include:
- Accrued sick pay, which cannot be converted to cash
- Company-provided parking
- Employer-provided health club
- Ability to choose a flexible work schedule
To the extent that any of the aforementioned benefits reduces the party’s living expenses, they may be considered at the discretion of the court as additional income.
Perquisite testing is a complex issue, but the existence of perquisites can mean a significant adjustment to cash flow available for support. The practicing family law attorney should be familiar with the common types of perquisites and their affect on business valuation and gross cash flow available for support.