Can a Failed Marriage Lead to Business Failure?
The divorce rates in the U.S. show that between 41 and 50 percent of first marriages end in divorce. The rate rises to 60 to 67 percent for second marriages, and to 73 to 74 percent for third marriages. With the odds stacked against you, have you thought about what would happen to your business if you became one-half of a grim marital statistic?
Consequences of No Planning
When a spouse owns a business or an interest in one, that interest is an asset that becomes part of the marital dissolution process. A variety of results can ensue.
Couples can amicably agree that the spouse continues to own the business. Usually, the other spouse receives assets of comparable value — the couple’s house, securities, or an interest in the business owner’s retirement plans. Where the business interest is very valuable compared with the couple’s other assets, it can be challenging to provide compensating assets to the non-business spouse without leaving the business-spouse penniless except for the business interest.
Where couples cannot agree on how to allocate the assets of the marriage, it’s up to state law. The allocation of other assets to the spouse who’s not in business depends on where the couple lives:
- Community property rules in Arizona, California, Idaho, Nevada, New Mexico, Texas, Washington, and Wisconsin usually award half of community property assets to each spouse, but the couple can agree to an alternative allocation;
- Marital distribution rules in all other states usually allow the court to allocate assets between the spouses; it may be half or some other division at the discretion of the judge;
Tax results. When there is a property settlement incident to divorce, no immediate tax consequences result. However, the potential for a future tax burden should be taken into account.
For example, say a wife who owns a business that’s now valued at $1 million started it a number of years ago for $25,000. Her husband is an employee at another company and does not own a business. The couple has a home worth $1 million that they bought for $750,000. If the wife keeps her business interest and the husband gets the home, she faces a potential capital gain of $975,000 ($1,000,000 - $25,000); at a 15% rate, this would effectively bring the value of the asset (the business) down to $853,750 ($1,000,000 - $146,250 tax on potential gain). In contrast, the husband could sell the home and, because of the home sale exclusion rule, pay no capital gains tax; his $1 million asset is really a full $1 million after tax.
Attorney’s fees in a divorce action usually are not tax deductible, even if they involve a spouse’s business interest.
Special Concerns for Husband-Wife Businesses
There are many successful husband-wife businesses in the U.S. today, including Cisco and Flickr. But if the marriage fails, the question of business ownership is more complicated than just a financial resolution.Will both spouses stay on with management participation in the company? Will one spouse buy out the interest of the other? The answers depend on the couple’s situation.
Those with an amicable divorce and who continue to get along may want to remain with the business. Where the parties can no longer see eye to eye, it may be preferable for only one spouse to remain active in the business; the other spouse can continue to have an ownership interest as a “silent partner” or separate from the company entirely.
The best course of action for a business owner planning to marry is to have a prenuptial agreement specifying that the business interest will remain with the spouse-to-be who created it in the event that the marriage fails. The agreement may or may not provide some allocation of other assets to the non-business spouse-to-be.
If a business is created during the course of a marriage and the couple does not have a prenuptial agreement (a pre-marital contract), they can create a post-nuptial agreement. This is simply a contract created during the marriage between the spouses describing what happens to the business interest if the marriage fails.
If the couple co-owns a business, the couple should have a buy-sell agreement between them. The agreement spells out what happens to their ownership interests in case of divorce.
It is essential for a business owner to discuss his or her situation with a knowledgeable attorney who can make sure that the business interest is protected in case of a marital dissolution. Each spouse should be represented by his and her attorney when crafting a pre- or post-nuptial agreement and/or buy-sell agreement. The best time to plan for the worst case scenario is when the spouses are on good terms and believe their union will last until death do them part.