When a young entrepreneur looks to marriage after starting a new business, a sole proprietor who’s married decides to incorporate, or a married couple decides to open a family business, they’re often filled with hope and optimism. But without adequate planning, any of these scenarios could end in financial disaster in the event of a divorce. By putting safeguards in place prior to a divorce becoming imminent, you can mitigate or avoid problems that often arise when business owners face a divorce.
What Is Community Property?
First off, it’s important to understand what community property is. In Texas, community property is defined as “the property, other than separate property, acquired by either spouse during the marriage.” When a couple divorces, all property is assumed to be community property, but that presumption can be rebutted by “clear and convincing” evidence.
Community property differs from separate property. Separate property consists of:
Property owned or claimed by a spouse before marriage
Property acquired by a party during marriage by gift, devise, or descent
The recovery for personal injuries sustained by a spouse during marriage (except any recovery for loss of earning capacity during marriage)
A spouse’s time, toil, and effort during the marriage is an asset of the married couple, and all income derived during the marriage is community property.
Is Your Business Separate or Community Property?
Often, a business is community property, but that’s not always the case.
Determining whether any property is separate property involves determining when the property was acquired, either before or after marriage, and how it was acquired (this is called “inception of title”).
For example, a car owned before marriage can be clearly shown by the certificate of title to be a spouse’s separate property. A car purchased during the marriage is presumed to be community property but may be established as separate property if it can be shown that the car was a gift to one of the spouses, it was inherited by one of the spouses, or, through a process known as “tracing,” the funds used to purchase the vehicle can be traced to a separate property source.
It’s important to understand that the way a business is operated can affect its characterization. Strictly maintaining the formalities of the business by avoiding co-mingling business funds with personal funds is critical to keep the business as separate property. Likewise, pay yourself a fair salary. The community estate can maintain a claim for your time, toil, and effort used to build up the value of your business if you fail to adequately compensate yourself.
Are There Any Legal Documents or Agreements I Can Put in Place to Safeguard My Business in the Event of a Divorce?
With a bit of foresight, spouses may be able to settle issues that could affect the fate of a business long before facing an imminent divorce.
For example, a young entrepreneur with a new business who’s planning to get married should strongly consider entering into a prenuptial agreement to declare the startup business as separate property. This will prevent having to later attempt to defeat the community property presumption in the event of a divorce. Also, agreeing that each spouse’s income or profits earned during the marriage will be separate property may avoid a costly reimbursement claim.
Likewise, a sole proprietor seeking to incorporate a business during their marriage should carefully consider the effect of doing so, as the stock will be created and acquired during the marriage and, therefore, is presumed to be community property. The source of the funds used to capitalize the new corporation can certainly create a separate property claim, or the sole proprietor may want to consider entering a post-marital agreement that characterizes the new corporation as separate property.
A married couple starting a business together may wish to own their family business as a community asset or enter a post-marital agreement characterizing their respective ownership interests as separate property. The couple may further wish to create a “buy-sell” agreement to trigger in the event of the parties’ divorce, thus preventing future problems regarding the operation of the business.
How Can I Ensure That My Business Assets Are Protected During the Divorce?
It’s important to plan for the possibility of a divorce before it becomes imminent by creating a prenuptial or postnuptial agreement. But, even if a spouse has started a business during marriage and the business is inarguably community property, there are steps the operator can take to retain ownership of the business after the divorce.
Initially, your spouse may have no interest in owning any portion of the business, only being concerned with receiving fair value for the business in the ultimate property division. Getting a neutral business valuation early in the case can help frame the parties’ expectations and allow for meaningful negotiations regarding the disposition of the business in the divorce. The valuation process is information-intensive, and cooperation with the valuation expert is critical in obtaining an accurate value as well as in saving a substantial amount of attorney fees.
Often, one party may not have sufficient assets to trade for the spouse’s portion of the business. In such instances, creativity in structuring a buyout is crucial.
Ultimately, a party trying to maintain the economic engine that a closely held business represents should contact an experienced family law attorney to plan for the possibility or manage the risk associated with a divorce. After all, you’ve worked too hard building your business to leave its continued success to chance.
Our attorneys are experienced in all aspects of family law and will guide you through each step of the process, ensuring you have the information you need to make wise decisions and prepare for the future.
At Goranson Bain Ausley, we strive to deliver clarity about what comes next and confidence that you and your family’s future are more secure. Contact our team and discover how we can help you.
Managing Partner P. Lindley Bain shares common tax issues that you should discuss with a qualified tax professional prior to reaching a final divorce settlement.
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