Divorce and Your Business: Protecting Your Business and Finances During Divorce

Divorce presents significant challenges, particularly for individuals who own businesses. Business ownership interests frequently represent substantial personal assets, which may be classified as marital property in many instances. Familiarity with applicable tax regulations regarding asset division is essential to mitigate potential financial risks and safeguard future interests.

Tax-Free Transfers

In general, assets such as cash, investments, real estate, and business interests may be allocated between spouses without incurring federal income or gift tax obligations. Under this tax-free transfer rule, the recipient spouse inherits the transferring spouse’s original tax basis (used to determine capital gain or loss) and holding period classification (short-term or long-term).

For example, if one party transfers their interest in the marital residence to the other in exchange for retaining business stock, both exchanges typically qualify as tax-free. The receiving spouse acquires the original tax basis and holding period for the home, while the transferring spouse maintains these attributes with respect to the business stock.

Tax-free treatment generally applies to transfers made:

• Before the divorce is finalized,

• At the time of the divorce, or

• After the divorce, as long as the transfer occurs within one year of the marriage ending — or within six years if required by the divorce agreement.

Future Tax Consequences

Even though a transfer may be tax-free at the time, the recipient could owe taxes later when an asset is sold.

For example, if your ex-spouse receives 48% of your appreciated company stock, there’s no tax due on the transfer. But if your ex later sells that stock, capital gains tax will be calculated based on your original cost basis and holding period.

Keep in mind, appreciated assets carry built-in tax liabilities, which make them less valuable than an equal amount of cash or non-appreciated property. It’s important to account for these differences when negotiating your settlement.

The same concept applies to ordinary-income assets like business receivables, inventory, or nonqualified stock options. These can also be transferred tax-free, but the recipient must recognize the income and pay the related taxes when the asset is collected, sold, or exercised.

Business Valuation and Tax Adjustments

Determining the fair value of a business is a crucial component in divorce proceedings involving business interests. This valuation process must adhere to applicable state laws and established legal precedents, as jurisdictional rules may differ. Disputes can arise, particularly when one spouse is actively involved in the business while the other is not.

A comprehensive professional valuation takes into account both tangible assets such as equipment, inventory, and real property and intangible assets, including intellectual property, goodwill, and brand value. Additionally, it should carefully consider potential tax liabilities, including:

• Deferred taxes associated with appreciated assets,

• Liabilities stemming from unreported income or prior distributions,

• Tax consequences related to goodwill or business restructuring.

These factors can significantly affect the business’s appraised value and the fairness of the final settlement.

Other Key Considerations

Beyond taxes, several practical and financial issues often arise for business owners going through divorce:

Cash Flow and Liquidity

Meeting settlement terms such as buying out your spouse’s share or paying alimony can strain your company’s finances. Planning ahead can help preserve liquidity and avoid business disruption.

Privacy and Confidentiality

Divorce proceedings can make sensitive business information, such as financial statements or client data, part of the public record. Work with your legal and financial advisors to maintain confidentiality through protective orders or sealed filings.

Plan Ahead to Protect Your Interests

Divorce may result in tax and financial consequences, especially in situations involving business interests and retirement accounts. Business owners often face unique considerations, which can make early planning and careful settlement structuring important.

Our team provides guidance on relevant tax regulations, assesses business value, and develops strategies intended to minimize tax obligations in accordance with state property laws. With VAAS, proper planning can support the protection of both personal and business financial interests over time. Contact us when you’re ready!