Zac L. Lange

It’s that time of year again. The grocery list has been made, the headcount has been verified, and the dusted box with pilgrim decorations has been taken down from the top shelf of the storage closet. The table might not be set yet, but for the most part, we know who we will be eating turkey with next week on Thanksgiving Day. Aunt Cathy may or may not bring Cousin Lenny, but Cousin Lenny prefers ham and doesn’t even eat any cornbread stuffing or pumpkin pie, so we don’t need to worry about him!Traditionally, we have offered some suggestions on what not to talk about at the Thanksgiving dinner table. But this year, we decided to focus on something new. Who eats first, the family or the family business?There is no cookie-cutter recipe or fine-tuned formula one might use to answer this question. On the surface, it does not seem like a tough one. However, every family business operates differently, with different shareholder preferences, family dynamics, and investment decisions. So, before answering the most important question of who eats first on Thanksgiving Day, ponder these three topics to help guide you.The Meaning of the Family BusinessThe meaning of a family business is a function of both family and business characteristics. As shown above, the meaning of the family business, in turn, influences the company’s dividend policy, investing, and financing decisions.Family business directors must decide how to dispose of every dollar the business generates through its operations. At the most basic level, a dollar of operating cash flow can be returned to owners in the form of dividends and share redemptions or reinvested in the business.When the family business can access many investments offering high returns, reinvestment will be more attractive. However, if there aren’t many attractive investment options out there, retaining capital in a business that can’t use it well drives down returns and risks the future of the family enterprise.When discerning what the family needs, there is no substitute for asking.What are the liquidity needs of family shareholders?How much risk are family shareholders willing to bear in pursuit of capital appreciation?How important is the family’s legacy? Shareholder circumstances and attitudes are constantly evolving, so even if you had a good feel for what the family needed five years ago, you may not know what they need today. In our experience, the most successful family businesses balance the business needs with the family shareholders' needs.Dividend PolicyOnce the “meaning” has been embraced by the family, the distribution policy will more naturally follow. Answering the dividend policy question for your family business requires looking inward and outward. Looking inward, what does the business “mean” to the family? Looking outward, are attractive investment opportunities abundant or scarce?Some family businesses have shareholders who are highly dependent on distributions from the company to fund their lifestyle and are focused on the dividend-paying capacity of the family business. Other shareholders may fund their lifestyle needs from other sources and are more focused on the rate at which the value of their investment in the family business grows.Ultimately, family business directors need to remember their shareholders are just that: shareholders. While their equity may have been earned hereditarily, the family business directors owe a duty to the family shareholders — a focus on maximizing shareholder value through a mix of good reinvestment opportunities and distributions.Capital AllocationDividend policy decisions are not made in a vacuum. When operating cash flows are used to pay dividends, those cash flows cannot be reinvested to grow the business. Conversely, cash allocated for the future growth of the business is not available to provide for the liquidity needs of family shareholders.Click here to expand the image aboveSuccessful family business directors must balance the company’s needs with those of the family when making capital allocation decisions. Analyzing investment choices and understanding your family shareholder objectives is not easy, but going back to the meaning of your family business will help provide a backdrop for making these decisions.ConclusionA clear understanding of what the business means to the family is essential if decisions about dividend policy and capital allocation are to be made in a coordinated manner. Matching your family shareholders’ growth objectives with their relative risk tolerance is a key challenge for family business directors and one that is tied directly to what your family business means to you.Our professionals are eager to help your family discern what your family business currently means so that everyone has a seat at the Thanksgiving dinner table.

Back in the day when not all sporting events were shown on TV, reading the box score in the newspaper the next day was sometimes the only way to know the story of the game.A box score is a structured summary of results from a competition. The box score lists the game score as well as individual and team achievements. Here’s an example of a baseball box score—a savvy baseball fan might remember this game as it was especially memorable.As you see, the box score can tell the story of the game through key statistics—innings represent the primary measurement period, and runs, hits, and errors summarize the main takeaways from the game. Here's another example of a box score—personally, one of my favorites as I was born and raised in New Orleans.A question for you and your board, what is on your family business box score?When the lights are still on and things are stable, it can be easy to continue with business as usual and not look too closely at key return metrics. Creating a box score, and maybe more importantly, updating it consistently, can help prevent complacency. Establishing fundamental metrics important to your business and benchmarking your performance to peers or "opponents" can help quickly convey to you and your shareholders how the family business is doing.Consider these three metrics for your family business box score.Return on Invested CapitalReturn on Invested Capital—ROIC—is one of the best comprehensive measures of financial performance for family businesses. In its simplest form, ROIC is the ratio of NOPAT (net operating profit after tax) to invested capital (the sum of equity and debt capital invested in the business). It describes how much NOPAT the business generates per dollar of invested capital. ROIC depends on both the income generated by the business and the amount of capital invested. It is a great metric for the family business box score as it facilitates comparison to the performance of alternative investments that may be available to the family. As we have discussed previously, companies with higher ROIC display positive attributes for businesses: faster growth, more cash distributions, reduced risk, increased shareholder returns, and increased worth of the company as a whole. Paying attention to ROIC today is a reliable way to improve shareholder returns tomorrow. It is a powerful metric for evaluating how your family business has performed in the past and creating a strategy for future improvement.Shareholder ReturnsInvestment returns have two components: dividend yield and capital appreciation. The yield measures the current income a business generates, while capital appreciation measures the increase in value during the period. As depicted below, total return is the sum of yield and capital appreciation. These two components have an inherent tradeoff—greater current income limits future upside, and increased growth usually comes at the expense of current income. Investors choose from a menu of different investment alternatives, including short-term treasury notes, small-cap public stocks, private equity, and/or venture capital. Uniformly, investors desire higher returns; however, the greater the expected return correlates with the increased potential risk. Think of it like a football team: are we a run-first, ball-control offense, or do we sling the ball up and down the field? The two represent a tradeoff—but ultimately aim to achieve the same goal: a win. Or, in your family’s case: a return. Just like a team’s "identity" aims to play to its strengths, your total shareholder return profile likely reflects what your business means to you. Analyzing where the total return comes from (in the form of appreciation or yield) can help you see how you are doing relative to shareholder objectives and desired business meaning.Capital Structure & Financial LeverageUtilizing capital structure & financial leverage on your family business box score can lead to a plethora of important strategy discussions. Conversations with family shareholders that include: What is the appropriate mix of debt and equity? What is the current capital structure? How does the capital structure compare to our peers? What effect would different financing decisions have on the overall cost of capital? What is the target capital structure?Capital structure decisions are inevitably linked to family business meaning and shareholder objectives. Are you seeking to leverage current assets to achieve growth into the future (growth engine), heightening risk, or do you avoid debt to reduce volatility and shore up dividends? Financial leverage can be measured by comparing total debt to invested capital (book values of debt and equity), market values, or relative to cash flow. Ratios like debt-to-equity, debt-to-EBITDA, and debt-to-assets can be useful for your family business box score, especially when used to benchmark to peers in direct competition within your industry.ConclusionThe sports and business worlds are increasingly data-driven, and access to relevant data is essential to making the right decisions. The best performance metrics address not just “what” performance has been in the past, but reveal the “why” behind it and give direction for “how” to improve operations in the future. We believe that the individual statistics discussed above qualify as the best performance measures to help depict the “why” and guide the “how” in the future.Creating a process for your family business and understanding which key metrics to utilize for a box score can be challenging. But rather than stress about the exact measures, aim for consistent measurement and understand the drivers and outputs of your selected metrics. Our family business advisory professionals help family management teams develop their box score and align their perspectives on the financial realities, needs, and opportunities of the business.We’ll be taking next week off from the Family Business Director Blog. Enjoy the holiday, and we will see you in the new year!

The 2022 midterm elections are here, and, as usual, one of the most significant differences between Democrats and Republicans is tax policy. While voters are contemplating significant issues ranging from inflation, immigration, abortion, and gun control, the election outcome will also influence which tax priorities Democratic and Republican lawmakers will pursue over the next few years.These tax issues could involve tax deductions and other incentives that directly impact your finances. The party controlling the House and Senate will dictate which tax policies are proposed and potentially passed into law. In this post, we focus on three main tax dilemmas that will be most important to your family business this midterm election season.Individual Tax RatesThere are a number of tax provisions set to expire in 2025 that were passed as part of the Republican’s Tax Cuts and Jobs Act (TCJA). This 2017 legislation significantly reduced the corporate tax rate and temporarily cut individual rates. If Republicans take control of Congress, protecting previously passed policies will be among the party’s top priorities, despite the potential impact on inflation. One of the tax breaks set to revert to the pre-2017 levels if the TCJA is not extended is the individual income tax rate, which would return the top marginal rate to 39.6% from the current 37%.Below are the current single-filer and married filing jointly tax brackets, as well as the changes if the TCJA does expire in 2025. In an interview on C-Span, Nebraska Rep. Adrian Smith said that if the GOP regains Congress, advancing legislation for permanent individual tax rate cuts would be his first priority. However, many economists have debated that the GOP tax plan goes against the promise to combat inflation and reduce the federal deficit. Howard Gleckman, a senior fellow at the Tax Policy Center, states that extending these tax cuts promulgated from the TCJA may further fuel inflation by stimulating consumer spending. What if Congress remains Democrat-controlled? While Democrats campaigned on rolling back provisions from the TCJA, actually doing so has proven politically more difficult. Earlier this year, Democrats tried to increase the corporate tax rate and raise taxes on the wealthy to pay for the Inflation Reduction Act but failed. Meanwhile, President Biden’s 2023 Budget Proposal calls for reducing the federal deficit by $1 trillion over the next year in part by raising the corporate tax rate from 21% to 28%. The proposal also contains a new 20% minimum tax on households worth more than $100 million, which accounts for the top 0.01% of earners.Estate TaxesOn October 28, 2021, President Biden announced a framework for the Build Back Better Act. This Act invests in family care, health care, and combatting the climate crisis. It will also implement key reforms to make the tax system more equitable by ensuring that the wealthiest Americans and most profitable corporations shoulder a more significant portion of the overall tax burden. Specifically, these proposals included a reduction of the federal estate tax exemption (amount of assets that can transfer to an heir free of estate tax) to $3.5 million per person, as well as eliminating the tax basis step-up at death. These proposals were dropped from the legislation as the Build Back Better Act stalled in the Senate.Regardless of the fate of these specific proposals, effective January 1, 2026, under current law, the estate tax exemption will be reduced to $5 million per person or $10 million for a married couple – subject to inflation increases. Currently, each U.S. citizen has a $10 million exemption from estate taxes, and for a married couple, that amount is doubled. As the exemption is indexed for inflation, in 2022, the exemption is $12.06 million per person. Persons whose estates may be subject to estate tax under the projected 2026 exemption levels should consult with legal counsel and advisors to review their current estate plans and evaluate possible strategies for preserving their wealth and planning for future generations.Qualified Business Income (QBI) DeductionThe IRS defines Qualified Business Income (QBI) as the net amount of qualified income, gains, deductions, and loss from any qualified trade or business, including income from partnerships, S corporations, sole proprietorships, and certain trusts. The Tax Cuts and Jobs Act introduced a new deduction taking effect in 2018 for noncorporate taxpayers in respect of their qualified business income. This deduction is up to 20% of their QBI, plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. Income earned by a C corporation or from providing services as an employee is not eligible for the deduction.Prior to the TCJA, the corporate income tax rate was 35%, and dividends were taxed at a top rate of 23.8%, resulting in an aggregate tax rate of about 50% on distributed corporate business income. Contrast this to a pass-through entity, for which earnings are passed through and taxed in the hands of the owners. Before 2018 the top ordinary income tax rate was 39.6%, and thus, there was an approximate 10% tax rate advantage operating a pass-through entity rather than a corporation. The TCJA included a permanent reduction to the corporate tax rate from 35% to 21% and reduced the top individual rate to 37%. Without any further changes, the tax rate advantage in operating a business as a pass-through entity would have decreased from roughly 10% to less than 3%. The 20% QBI deduction was the TCJA’s answer, as only 80% of certain pass-through entity income is subject to tax for qualifying taxpayers.With the control of Congress up in the air and general gridlock in Washington, it is uncertain if the 20% QBI deduction will be a tax advantage for much longer, as the deduction would ultimately expire if the TCJA is not extended past 2025.ConclusionVoters are weighing many different policy questions at the ballot box this November, and the election results will set the stage for determining which major concerns are addressed first, as well as determine which tax priorities Democratic and Republican lawmakers will pursue over the subsequent few congressional sessions. The topics mentioned above highlight some of the most important individual, estate, and business owner tax implications that family business owners need to be aware of and evaluate as the election returns roll in.

The Wall Street Journal recently published an article on the life of entrepreneur Clarene Law. Clarene was a mother and a hotel bookkeeper in Wyoming’s Jackson Hole valley in the 1960s. Which led to a problem – who would take care of the kids? This question led her down the path of starting a family business. After hearing the Antler Motel was for sale, she borrowed money from her parents and put a down payment on the $125,000 asking price. Problem solved – Clarene switched hats from hotel bookkeeper to motel owner and innkeeper, and her family could live at the motel.Fast forward some years later and what started as a little-known town blossomed into a luxurious year-round hiking and skiing destination for visitors all over the country. While right place, right time played a part, it does not tell the whole story of how Clarene Law became one of the best-known entrepreneurs in Jackson Hole. Clarene expanded her reputation further as she served n the Wyoming House of Representatives for 14 years. Inspired by her story and the family business she built, we highlight three themes that can help build your family business: growth, diversification, and family business leverage.GrowthSteady, natural growth is a long-term commitment. Clarene realized early on there was no get-rich-quick formula – how could there be when rooms cost less than $10 a night? She understood that growth could be individually affected through her own efforts. Her energy was infectious, and her personal interactions with customers made them feel special. This feeling grew into loyalty, creating 30+ year relationships with customers as well as hotel employees. Clarene’s daughter, Teresa, shared why they kept coming back, “because mom’s here…just to be with her.” In 1973 Clarene married Creed Law, and while finding the right business partner doesn’t normally start with “I do,” Mr. Law helped Clarene take a step forward in growth. Mr. Law was a great builder, and together, they expanded the family business to include several more properties with a total of 477 rooms, now known as the Elk Country Inn.Growth in your family business may seem distant and slow-paced, but consistent, day-to-day efforts play a huge part in long-term growth. Clarene presents an example of someone who steadily influenced growth through her personality, decision making, and reliable hard work.DiversificationWe have written on asset diversification in the past, but Clarene’s story teaches us a good lesson on how the degree of diversification matters. Diversification is simply investing in multiple assets as a means of reducing risk. Warren Buffett states, “Diversification may preserve wealth, but concentration builds wealth.” As far as concentration goes, Clarene doubled down on hospitality, buying several inns around the area to add to the growing family business. Later, Clarene began to transition from building wealth to preserving it. She diversified into non-hospitality investments with a couple of farms and a dude ranch. Unfortunately, her other investments reportedly did not work out. Regardless of why the investments failed to deliver, we question whether Clarene’s approach to diversification was radical enough. Investing in multiple assets yields diversification benefits only if the assets behave differently; if the correlation between the assets is high, the diversification benefits will be negligible. We suspect that the correlation between Jackson Hole motels and other real estate investments in the same area was too high to generate significant diversification benefits.Diversification is simply investing in multiple assets as a means of reducing riskThis illustration is an important reminder for family businesses that diversification is important, but how you diversify your assets matters just as much. Understanding the degree of correlation among assets in the family business portfolio is essential to achieving real diversification.Leverage the Benefit of Being a Family BusinessHad it not been for family, Clarene might never have purchased the Antler Motel. Our colleague Atticus Frank reminded readers in a post earlier this year to distinguish a family business from a business family. Clarene involved her family in the business early on and gradually began passing the management of the business to her children as they grew older. Until earlier this year, she still came to work and was the first person customers would see. Clarene told The Jackson Hole News, “Whatever success I have, I owe to my family – my hardworking children, my husband, and a very loyal staff.” Loyalty, hard work, and focus on the best service are common hallmarks of successful family businesses.ConclusionClarene knew when to have the talk with her children so that when the day came, they would be ready to continue the business in her honor. Her concentration on steady, long-term growth allowed the business to develop naturally as a family business. While her diversification efforts may have fallen short of the ideal, her legacy of success is a valuable example to other enterprising families.

“Ohana” means family…family means nobody gets left behind or forgotten. Lilo & Stitch, the Disney film about a family and an alien, taught us this just over 20 years ago. This is especially true in a family business as family business directors need to work together to ensure they are moving forward together, as a business and more importantly, as a family. As seen on the big screen with Lilo & Stitch, in family business meetings, and maybe even at the dinner table, Ohana is easier said than done. Sometimes your family does, in fact, act alien to you. But at the end of the day, family is vital to who we are and what we do.What Should We Do About Estate Taxes?Most family business owners desire to provide financially for their family. Due to this, one of the widespread concerns of these owners is the ability to transfer ownership of the family business to the next generation in the most tax-efficient way.The Estate Tax is a tax on your right to transfer property at your death. The tax is calculated based on the "decedent’s gross estate," less the taxpayer’s remaining gift and estate tax deduction, which in 2022 is $12.06 million per individual ($24.12 million per couple), as well as other specific deductions. A unique issue for family business owners is that a substantial portion of their estate often consists of illiquid interests in private company stock. If this is the case, liquidating assets to pay the estate tax may prove more difficult as estate taxes are payable only in cash. Family businesses may have to be sold or forced to borrow money to fund the payment of a decedent’s estate tax liability.Keep in Mind Fair Market Value and the Level of ValueThe concept of fair market value is essential to understanding and evaluating any estate planning strategy. For brevity’s sake, fair market value, or “FMV,” is defined by the IRS as the price at which the property would change hands between a willing buyer and seller, not under compulsion to buy or sell, and both having reasonable knowledge regarding specific facts and circumstances regarding the transaction. The IRS is clear, per Revenue Ruling 59-60, that appropriate discounts, or reductions in value, are allowed to account for the fact that the shares in the family business are privately held rather than publicly traded.How does FMV, or the standard of value, intersect with the “level of value”? For example, if an estate owns a controlling interest in a family business (more than 50% of the stock), the FMV of those shares will reflect the estate’s ability to sell the business. In contrast, the owner of a small minority block of the outstanding shares in the family business cannot force the business to change strategy, seek a sale, or unilaterally compel any action. The level of value chart captures two common-sense notions: investors prefer control rather than not, and they prefer liquidity to illiquidity. The magnitude of a lack of control and lack of marketability adjustment depends on specific factors of the subject interest being transferred, but unsurprisingly investors prefer to have control and a ready market for their shares.It’s Not All TaxesMinimizing taxes is one possible objective of an estate planning process, along with asset protection, business continuity, and providing for loved ones. Families should be careful not to let the tax tail wag the business dog; families should consult legal, accounting, and valuation advisors who understand their business needs and family dynamics to ensure that their estate plan accomplishes the desired goals.Families should be careful not to let the tax tail wag the business dogAs an example, one objective of most estate planning techniques is to ensure that no individual owns a controlling interest in the family business at his or her death. However, is the patriarch/matriarch ready to hand the reigns to the next generation? Is the next generation ready? Management and business concerns may need to prioritize the tax/liability side of the equation based on the family and its dynamics.What Now?Some potential next steps include:Review the current shareholder list & ownership table: Based on the current shareholder list, are there any shareholders that – were the unexpected to happen – would be facing a significant estate tax liability?Identifying current estate tax exposures: Will shareholders have to look to the family business to redeem shares or make special distributions to fund estate tax obligations?Identify tax & non-tax goals of the estate planning process: If there was no estate tax, what evolution would be the most desirable for your family and business?Obtain a current opinion of the fair market value of the business at each level of value (control, marketable minority, and nonmarketable minority). We are just a phone call or an email away.

This is the third of the three-part series where we focus on key areas to assist family lawyers and divorcing parties. Part III concentrates on Schedule K-1 (Form 1065 or Form 11-20-S) and additional business-related schedules which can be useful in divorce proceedings. Part I discusses Form 1040 and can be found here, and Part II discusses Schedule A (Itemized Deductions) and can be found here.Entities taxed as general partnerships, limited partnerships, limited liability partnerships, limited liability corporations, and S corporations prepare a Schedule K-1 (“K-1”) for each of its owners. The Schedule K-1 identifies the owners of the business and specifies the percentage of equity, profits, and losses that will be attributed to each for tax purposes, among other information. K-1s must be distributed to each owner and filed with the entity’s tax return. Owners then utilize the K-1 when preparing their personal tax returns to substantiate the profits and/or losses they are claiming.Why Would Schedule K-1 Be Important in Divorce Proceedings?Schedule K-1 provides information regarding the business, the individual partner (or member or shareholder), as well as the portion of taxable income or loss that is attributable to each owner. A business owner may not receive a salary and therefore, might not get a Form W-2 Wage and Tax Statement. Schedule K-1 provides the details on profit and loss allocated to the individual from the business. Sometimes other agreements are in place for bonus sharing, etc. and the K-1 reflects each business owner’s proportionate share of taxable income or loss.The K-1 provides evidence of ownership in a business, details the percentage of ownership, and shows business gains and losses for the year allocated to the specific owner, among other information. The business ownership (whether 100% or an interest in the business) may be divisible within the marital estate. If multiple business interests exist, each entity would generate a separate K-1 per owner. The Schedule K-1 can also be used in conjunction with other documents for income determination purposes.Key Areas of Focus for Family Law Attorneys and Divorcing PartiesPart II of Schedule K-1, Information about the Partner –provides details on each individual partner such as the type of entity, partner’s share (beginning and ending) of profit, loss, capital and liabilities, and the beginning and ending capital account of the individual. Box G will indicate if the taxpayer is a general, limited, or other type of partner. Another item to pay close attention to is Box J which is the line that states: “Check if decrease is due to sale or exchange of partnership interest.” If checked, more information may need to be requested to understand the transaction, amended agreement, or other type of sale or exchange.While the K-1 offers helpful information on business ownership percentages and annual profit or loss, additional documentation of the business entity should be requested when performing a business evaluation and/or in conjunction with other forensic services such as income determination.Box L – titled Partner’s Capital Account Analysis presents the ending capital account for the individual partner by showing the following: the beginning capital account, plus capital contributed and current year net income (loss) for the year, less withdrawals and distributions, if any.One should pay attention to the information presented on the Partner’s Capital Account Analysis because it may be a starting point for evidencing distributions (which may or may not be included in W-2 salary), and investments into a business such as a capital call.Part III of Schedule K-1 – is Partner’s share of current year income, deductions, credits, and other income. A few of the individual boxes are explained below.Box 1 – represents the taxpayer’s share of Ordinary Business Income, or Loss, from the corporation. The individual’s income amount is further categorized within Form 1040 depending on whether the income is deemed active or passive. Passive income includes money earned from interest, dividends, and rental property. Active income includes pass-through income or loss, wages and salaries (these may also be included on an individual W-2) or supplemental income. Refer to Schedule E – Supplemental Income and Loss for information on the income; specifically Line 28, which includes column (H) for passive income and column (K) for active or nonpassive income.Box 12 – Section 179 Deduction – is an immediate expense deduction that business owners have the option to utilize for purchases of depreciable business equipment rather than capitalizing and depreciating the asset over a period of time (referred to as straight-line depreciation). This allows businesses to lower their current-year tax liability rather than capitalizing an asset and depreciating it over time in future tax years, i.e., the tax reduction is taken in full versus in smaller amounts over a period of time. The Section 179 deduction is offered as an incentive for small business owners to grow their business with the purchase of new equipment. To qualify, the property is limited to items such as cars, office equipment, business machinery, and computers; this property also must be used for business purposes more than 50% of the time to qualify. This deduction election will also be reported for the individual taxpayer on Form 4562 – Depreciation and Amortization.Information on the K-1 can guide questions to ask and subsequent documents to request in order to understand and evaluate business interest(s).Additional Relevant Business-Related Schedules and Why Each Could Be Important in Divorce ProceedingsForm 4562 – Depreciation and Amortization is used to claim deductions for the depreciation or amortization for tax purposes. Other uses include making an election under Section 179 to expense certain property, and to provide information on the business/investment use of automobiles and other assets. Individuals and businesses can claim deductions for tangible assets, such as a building, and intangible assets, such as a patent. Section 179 property does not include property held for investment, property used outside of the United States, or property used by a tax-exempt organization.The Depreciation & Amortization Schedule can assist the divorce process by providing a listing of depreciable assets. While the form refers to all as “property,” the term stems from an accounting identification of “property, plant & equipment.” These types of assets typically qualify for depreciation, while intangible assets are typically those that qualify for amortization. Amortization is similar to the straight-line method of depreciation in that an annual deduction to taxable income may be allowed over a fixed time period. The taxpayer can amortize such items as costs of starting a business, goodwill, and certain other intangible assets. Part VI – Amortization is the last section of Form 4562, where the business amortization costs are described and listed to calculate amortization for the year for the individual taxpayer.Depreciation and amortization can be found on both the balance sheet and the income statement. Annual and accumulated depreciation/amortization are contra-assets to the respective underlying asset on the balance sheet. On the income statement (also referred to as the profit and loss statement), depreciation and amortization are expense items.One other focus area for divorcing parties is Part V – Listed Property – specifically, Section A – Depreciation and Other Information – Lines 26 and 27. These lines are used to determine depreciation for property used more or less than 50% in a qualified business use, respectively. Generally, a qualified business use is any use in trade or business; however, it does not include investment use, leasing to a 5% or less owner, or the use of property as a compensation for services performed. Column (C) – Business/investment use percentage is where this will be displayed.Schedule L – Balance Sheet per Books, Schedule M-1 – Reconciliation of Net Income/(Loss), and Schedule M-2 – Analysis of Partner’s Capital Account are also worthy schedules to review in conjunction with individuals who own business(es) or interest(s) in business(es). These schedules within Form 1065 or Form 1120-S for S corporations present the financial statements of the business and the activity on a capital account. If business financial statements, such as an income statement and balance sheet, are obtained, these schedules can be used in conjunction with the review of the financial records. Schedule C Profit or Loss from Business can also be helpful if the business owner is a Sole Proprietor, as this schedule is specific to sole proprietorships. As the name implies, this Schedule C provides income, expenses, cost of goods sold, and other expenses during the respective tax year.Schedule L provides the beginning and ending balances on the items on the balance sheet. Schedule M-1, as its name implies, provides the reconciliation of income or loss. The reconciliation occurs because some items are allowed, disallowed, or capped for tax purposes, which may be present on the income statement of the business – travel and entertainment and depreciation are two examples included within Schedule M-1. As we previously discussed, the business may take all of its depreciation in one year for tax purposes, while using straight-line depreciation in accordance with GAAP (generally accepted accounting principles). Depending on the current tax laws, a maximum dollar threshold may be allowed for expensing travel and entertainment for tax purposes, while the business may choose to expense more for internal financial purposes.A review of Schedule M-1 can provide information about potential differences between profits or losses prepared for tax purposes versus internal financial reporting purposes.Some small businesses may not maintain financial statements beyond the information presented in the tax return schedules; hence, it is important to understand which schedules and sections to review if your client owns an interest(s) in a business. However, for businesses that have financial statements, one should request multiple years of financial statements in addition to multiple years of tax returns and understand how to review the documents in conjunction with one another.Reviewing the items listed in these schedules can provide useful information and lead to further document requests in order to review and evaluate business assets, business ownership(s), and active and passive income, among other information.ConclusionUnderstanding how to navigate key areas of Schedule K-1 and supporting schedules is often necessary in divorce proceedings. While we provided background on Form 4562, Schedule C, Schedule E, Schedule L, Schedule M-1, and Schedule M-2, there may be further supporting schedules with helpful information or indicators to request further information. Remember that each case presents different facts and circumstances, and tax returns may vary (specifically which schedules are included).Information within the tax return and supporting schedules can provide support for marital assets and liabilities (specifically those associated with business ownership and/or other types of assets), sources of income, and potential further analyses. Reviewing multiple years of Schedule K-1s and accompanying supplemental schedules may provide helpful information on trends and/or changes and could indicate the need for potential forensic investigations.While we do not provide tax advice, Mercer Capital is a national business valuation and financial advisory firm and we provide expertise in the areas of financial, valuation, and forensic services.