I recently blogged on the issue of how to treat unreported income, perks and other personal expenses paid through the business and the treatment of same for support purposes. As noted in that post, the issue comes up both for support and business valuation purposes.
In order to value a business, the experts come up with an income stream that gets capitalized. That income stream is tax affected. That is where the issue gets interesting. More often than not, the experts tax affect the entire income, after adding back the perks, personal expenses, non-operating expenses, unreported income, etc.
I have asked several of the forensic accountants why this is being done if this is note the economic reality for the business owner in that case. More often than not, I have been told that you cannot assume that a buyer of the business would not declare all of the income and/or would improperly pay expenses through the business. From a pure business valuation perspective, this seems correct and reasonable.
For purposes of equitable distribution, that remains questionable. In the seminal case on business valuation in divorce in NJ, Brown v. Brown, discounts for lack of marketability and lack of control were not considered because the business was not really being sold. Some have argued that Brown means a value to the holder standard is to be applied. While I am not sure that that is the case, if discounts are not applied because there is no sale, then why are these excess perks and personal expenses tax affected when doing so artificially reduces the value of the business? Put another way, if the business owner is not paying taxes on these things, why should there be this fictional tax be applied, which only serves to reduce value? At some point, I am sure this issue will be litigated further. Until then, we will continue making the arguments on both sides.