In California, a business or professional practice owned by one or both spouses should be valued to determine the community property interest which is then divided between the spouses upon a divorce. Although the business or professional practice does not need to be dissolved, both spouse should have their interests established in order to avoid future complications.
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The family business or professional practice may be community property that needs to be divided when spouses get divorced.
Community or Separate Property
The first step is to determine when the family business or professional practice was started. If it was created during the marriage it will be classified as community property. However, if one spouse used their own separate funds, it may be classified as separate property. If the family business was created before the marriage is will be classified as separate property, but the other spouse may still have an interest for the increase in value gained by the business during the marriage. This increase in value will be classified as community property which is divided by the spouses upon divorce.
Valuing the Family Business
California courts rely on a variety of factors to determine the value of a family business or professional practice. Any value is typically done as of the date of separation. The assets to be valued include:
- Fixed assets: The fair market value of all cash accounts, furniture, equipment, and supplies. Fair market value is the price at which the property would change hands between a willing buyer and seller, both who have reasonable knowledge of the relevant facts.
- Other assets: Accounts receivable, costs advances, partially-billed work in progress, and work completed but not billed.
- Goodwill: The expectation of continued public patronage determined by the Excess Earnings Method. The appraiser compares the professional’s annual net earnings to those of a similarly situated professionals. First deducting a fair return for the business, the appraiser then subtracts the earnings of the similarly situated professional from those of the professional spouse in the case. Finally, the appraiser capitalizes those excess earnings over a period of years.
- Liabilities: Debts or other amounts related to the business owed by the business or practitioner.
Remember, that although a valuation is done, the court is not obliged to rely completely on the appraiser’s opinion. A court can also take into account other factors, such as:
- The location of the business.
- Duration of the business.
- Expected future earnings.
- Patronage of the business.
- Customers’ habits.
- The personality of the owners.
- The owner’s demonstrated earning capacity.
- Owner’s reputation for judgment and skill.
- Owner’s age and health.
Additionally, a California court can rely on IRS methodology to determine the value of a family business or professional practice. The IRS uses eight factors:
- The nature of the business and the history of the enterprise from its inception.
- The economic outlook in general and the condition of the specific industry in particular.
- The book value of the stock and the financial condition of the business.
- The earning capacity of the company.
- The dividend-paying capacity.
- Whether or not the enterprise has goodwill or other intangible value.
- Sales of the stock and the size of the block of stock to be valued.
- The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market either on an exchange or over-the –counter.
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