At the time of divorce, a business may be in one spouse’s name or in both spouses’ names. The business may have been created by one spouse before the marriage, or by one or both spouses during the marriage, and may be owned in part by persons other than the spouses.
Ownership may be in the form of interests in a partnership, membership interests in a limited liability company, or shareholder interests in a corporation. Or the business may be operated as a sole proprietorship (an individual person) and not as a separate legal entity. Businesses owned by a small number of persons (often family members and friends) and whose shares are not publicly traded on a stock exchange are known as closely-held businesses.
The questions of (1) whether the business was created by one spouse before the marriage or was created during the marriage and (2) the form of the business entity and the related agreements between the business owners may impact the division of the divorcing spouses’ interests in the business.
If the spouses live in a community property state (as opposed to an equitable distribution/common law property state), and if the business was created by one spouse before the marriage, income earned from the separate property business and any appreciation (increase) in the value of the business interest during the marriage may be community property rather than separate property. Community property states generally include Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
In other states—so-called equitable distribution or common law property states—the divorce court attempts to divide the spouses’ assets equitably (fairly) and may order one spouse to contribute separate property to the other spouse in an effort to do so. In practice, the difference between the division of assets in community property states and in equitable distribution states is sometimes not as great as it may seem, as the court in a community property state may have the discretion to divide the spouses’ community property on a 60-40, 70-30, or other unequal basis.
When evaluating the division of a business interest in divorce, it is also important to consider any tax implications for the division of the business. And it may be necessary for the spouses to hire a business appraisal expert to make a valuation of the business.
In Texas, which is a community property state, the division of business interests during a divorce can be complex. If a business was established by one spouse before the marriage, the income and appreciation of the business during the marriage are typically considered community property. However, the original ownership interest may be deemed separate property. For businesses created during the marriage, whether by one or both spouses, the entire business is generally considered community property. The form of the business entity and any agreements between owners can also affect the division of interests. Texas courts aim to divide community property equitably, which does not always mean equally, and may result in a division that is not a 50-50 split. Tax implications and the need for a business valuation by an expert are important considerations in the division of business assets in a divorce. An attorney can provide specific guidance based on the unique circumstances of the business and the marriage.
