S-Corp Buyout Versus Retirement Assets
Marriage of 19 years. Alex, 47, owns 100% of a medical billing S-corp valued at $4.1 million; his W-2 salary is $240,000 and the company pays him $90,000 a year in distributions. Jordan, 45, stopped working 14 years ago to raise their two children, now 12 and 15. Marital assets: home equity $1.6 million with a $4,300 monthly mortgage and 12 years left, a brokerage account of $850,000 with $300,000 unrealized gain, Alex's 401(k) of $1.3 million, Jordan's IRA of $120,000, and $45,000 cash. Alex proposes Jordan receive the house, brokerage, and 401(k) in exchange for all business interest and no spousal maintenance. Jordan's budget is $11,000 a month; Alex says the business is illiquid and his income will fall after divorce. No QDRO has been drafted. Trial is in 60 days.
1. What valuation and tax issues must Jordan's CDFA examine before accepting the business-for-retirement trade?
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Start by separating three questions: what the business is worth, what income it supports, and what Jordan actually receives after tax and costs.
- Valuation. A $4.1 million figure is only useful if it is a neutral, credentialed valuation using normalized owner compensation. If Alex's $240,000 salary is above market, the business may be worth less; if it is below market, distributions are partly compensation and the business may be worth more. Do not let Alex use a low salary for support and a high salary for valuation.
- Tax basis. The 401(k) is pre-tax: $1.3 million may be worth roughly $850,000-$950,000 after federal and state tax. The brokerage has a $300,000 embedded gain, roughly $45,000-$60,000 of tax unless transferred with a basis carryover. The house is not the same as cash: selling costs and the $250,000/$500,000 gain exclusion rules matter.
- Liquidity and control. Alex keeps an asset that produces income and can support his lifestyle; Jordan gets a house with a $4,300 mortgage and a retirement account she cannot access without tax. A marketability discount is not a gift to Alex; it must be paired with maintenance or more liquid assets.
- No QDRO. Without a QDRO, the 401(k) cannot be divided. The proposal is incomplete.
The CDFA should demand a neutral business valuation, a QDRO, a tax-impact analysis, and a cash-flow projection before comparing the trade.
2. Compare the after-tax, after-cost economics of Alex's proposal and identify at least two adjustments Jordan should demand.
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Rough after-tax comparison (illustrative, not a settlement opinion):
| Asset | Face value | Adjustment | Rough net to Jordan |
|---|---|---|---|
| Home equity | $1,600,000 | 8% selling cost; gain exclusion uncertain | $1,470,000 |
| Brokerage | $850,000 | $300,000 gain × 20% | $790,000 |
| 401(k) | $1,300,000 | 30% effective tax | $910,000 |
| Total | $3,750,000 | ≈$3,170,000 |
The business is $4.1 million before tax and before any lack of marketability discount. Jordan's $11,000 monthly budget is $132,000 a year. A 4% draw on $3.17 million is about $127,000, before taxes and before the house's ongoing costs; that is not a comfortable match, especially since the house is not liquid.
Adjustments to demand: (1) a QDRO dividing the 401(k) rather than leaving it in Alex's name; (2) a neutral business valuation with normalized compensation and a marketability discount; (3) spousal maintenance for a defined term, since the federal tax law for post-2018 agreements gives Alex no deduction but also gives Jordan no taxable income; (4) a tax-reimbursement clause if Jordan must sell the brokerage or house; (5) survivor-benefit protection if maintenance or retirement is involved. The CDFA should model a sale-of-house scenario and a keep-house scenario.
3. How should the CDFA treat the $90,000 of distributions for support and valuation purposes?
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The $90,000 of distributions should be treated as a control and tax issue, not automatically as support income.
- For support, the question is cash available for living expenses. Start with Alex's $240,000 salary. If that salary is at or above market for his work, the $90,000 is a return on capital and should not be added again as compensation. If the salary is below market, part of the distributions is really compensation and should be added back.
- For valuation, normalize owner compensation to a market salary. If the CDFA adds the full $90,000 to income for support and also capitalizes the same distributions in the valuation, the same dollars are counted twice.
- The CDFA should review the S-corp's K-1, payroll records, and distribution history. A stable $90,000 distribution supports the conclusion that the business is profitable; it does not prove Alex needs that amount personally.
- If Alex claims income will fall after divorce, require evidence: lost contracts, new expenses, or a compensation change. A projection without documentation is not a basis for reducing support.
The practical answer: use salary plus normalized distributions for cash-flow analysis, but keep the valuation and support models separate and reconcile them.