Beware: the CARES Act may distort business cash flows from 2020.
Almost every business faced an unusual year in 2020. When the pandemic hit, work slowed dramatically then came the whiplash effect. In particular the sweeping Coronavirus Aid, Relief, and Economic Security (CARES) Act provided short term help for many businesses.
While the hospitality and entertainment sectors tanked, some businesses soared. (Did you need cardboard boxes?) As the business books and records are studied during a pending divorce and support litigation, the CARES Act impact on the business will distort the usual balance sheet entries. There will be changes in the treatment of business income expenses and losses.
Those changes may be unfamiliar and in some cases misleading. Why?
- When Payroll Protection Program (PPP) loans were awarded, business expenses (payroll, taxes, rent, and qualified expense) were paid from these federal funds. Now, many and possibly most PPP loans are being forgiven. The forgiven loans that paid certain expenses will result in deductions for those expenses. Loans over Two Million ($2,000,000) Dollars are routinely being audited by the federal government. Spot audits are possible. Inquiries by divorce courts and the litigants should include a review of all loan applications and loan forgiveness paperwork. In the event a business received COVID-19 related loan money, the 2020 business cash flow may be artificially high.
- Employers can delay payment of payroll and self-employment taxes for 2020. Fifty percent are due in December, 2021 and fifty percent are due in December, 2022. The delayed payment will be made without interest charges. In the meantime, the liability entry will remain on the books.
- The 2020 legislation reversed restrictions on loss carrybacks. A business owner can now amend tax returns for 2018 and 2019 to allow five years loss carryback. The losses in 2020 also benefit from the five year carryback.
In cases when a business is owned by someone in the midst of divorce proceedings or litigation for payment of child support or dependent spouse support, the changes in the typical business cash flow may appear unusual. The law may create a change in the way company income (revenue and expenses) is recorded and the loss carryback could cause confusion and possibly suspicion or financial mistrust. While a federal government or bank audit of a PPP loan may find mistreatment, the business owner may decide bending the rules is possible because the chance of audit is remote.
Yet in the context of divorce and support litigation, the forensic accountant and advocate for the non-employed spouse will look closely at the books and records.
Some of the topics based on the three changes in the law follow:
- The business owner who received a PPP loan, later forgiven, may argue the 2020 revenue and cash flow cannot be replicated in 2021 or thereafter. 2020 cannot be treated as a typical year for the purposes of income available for support in 2021 or business valuation based on past performance.
- The non-owner spouse who is desperate for spousal and child support may ask that the deferred payroll taxes, albeit a liability on the books, allows current cash flow to fund payment of reasonable support.
- If 2020 is a post-separation year for a divorcing couple the business owner will need the cooperation of the estranged spouse to file amended tax returns to get tax refunds for the pre-separation years. While the amended returns will trigger tax refunds, if the loss occurred post-separation, in this case during 2020, should the carryback loss during the marital years trigger a refund that belongs to the marital estate? It could be argued that the 2020 loss creates a refund that is post-separation and non-marital. On the other hand, the non-owner spouse will seek to share in the benefit of the refunds which are dependent on that person’s cooperation with filing amended returns.
Experienced family lawyers and forensic accountants net income available for support (NIAS) calculations will be difficult to project in the future based on 2020 data. Will the NIAS for 2021 mirror 2020? Can 2019 be considered more typical after the upheaval of 2020? Will the business promptly return to 2019 circumstances?
In divorce cases where a business is valued, it is typically based in part on the economic performance for the past three to five years. The business valuation will consider normalized revenue based on typical income and expenses. Arguably very few businesses operated according to past norms in 2020, therefore can the 2020 books be considered typical? What adjustments are warranted?
Some business owners will argue the terrific year, for example manufacturing cardboard, in 2020 will never be repeated. Other business owners that suffered in 2020 will ask that the review to earlier stable years are inappropriate and therefore the business value should be modest for their struggling companies. Will litigation about a cash-strapped business owner be affordable by the divorcing couple considering the in-depth analysis required? Collecting the data from 2020 will be important and the insights of the attorney and forensic advisors will be critical.