Divorce Proceedings and Asset Divison

Businesses can represent one of the most substantial assets in a person's possession, and during divorce proceedings, they frequently become part of the marital estate subject to division. The emotional turmoil that often accompanies divorce impedes effective negotiations. As such, the appropriate distribution of business ownership, community assets, and estate rights can be put at risk. Business owners must be informed of and recognize the variations of asset distribution depending on state statutes to prepare for any tax ramifications.[1] Asset division protocols vary depending on whether the divorce occurs in a state following equitable distribution (common law) or community property principles. Forty-one states follow equitable distribution, whereas the other nine (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin) follow community distribution.

In proceedings with equitable distribution, assets are not divided equally and instead depend on various factors presented to the courts, including the duration of the marriage and child custody rights.[2] In community distribution states such as Texas, assets are split without distinctions based on individual contributions. Any contracts, accounts, or estate subsidies developed after marriage are considered joint community property between spouses, not separate personal property.[3] The Texas Family Code reiterates that any community property shall be divided in a way the court deems "just and right, having due regard for the rights of each party and any children of the marriage."[4] Ultimately, within community distribution states, community property is typically divided equally.

The Internal Revenue Service (IRS) allows tax-free transfers following a divorce and room for written changes in assets up to one year after the end of the marriage. Tax-free asset transfers can be made in exchange for retaining business ownership or an operational role.[5] State distribution systems determine how business assets are allocated in the courtroom, thus determining tax liability over specific assets. Throughout the swapping or equal distribution of funds and property, an individual may be unaware of the type of taxes they are expected to pay. If a former spouse acquires a large percentage of a highly appreciated small business stock, transferring ownership or shares within the family business does not incur immediate tax consequences. Additionally, any sold property or assets by an ex-spouse will incur capital gain taxes, which the ex-spouse must take sole liability for and pay. The individual who assumes ownership of appreciated assets must address the inherent tax liability associated with such assets. From a net-of-tax standpoint, appreciated assets hold a lesser value than an equivalent sum in cash or non-appreciated assets.[6]

Spouses can sidestep future tax implications through antenuptial agreements and separating personal and business assets. Antenuptial agreements allow for a predated outcome regarding all marital assets and allow parties to isolate personal assets. Suppose personal expenses are intertwined with business assets: in that case, specific acquisitions can be considered part of a couple's communal property. Thus, such assets would be divided equally between both parties, despite a specific partner's lack of contributions.[7] Securing precise expenditure records is essential in ensuring communal collection does not influence business assets.

The division of business assets during divorce proceedings is a complex and emotionally charged process that can significantly impact the financial well-being of both spouses. Understanding the legal framework governing asset distribution in one's state is crucial, and seeking legal counsel can help individuals safeguard their business interests.