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Tax Implications of Dividing Business Assets During a Divorce

Rob Frazer | April 15, 2024

Divorce is stressful on its own but, for business owners, there are specific tax issues that tend to complicate the matter even more. A business is one of the biggest assets a person can own and, in many cases, it will count as part of your marital estate during a divorce. This means that it could, possibly, be divided up between you and your spouse.

Since Texas is a community property state, the rule of law is that the community estate owns all of the property accumulated during the marriage – and is, therefore, subject to be divided between the spouses. If the business was purchased, started, or given to one spouse before the marriage began, then it could be considered a spouse’s separate property, and it’s not subject to division in the divorce. However, if the business was created or purchased during the marriage, its value must be accounted for in the division of the community estate.

Some divorcing spouses are able to put aside their differences and work together with the business, especially if they both end up retaining an ownership interest in it. However, spouses may struggle to work together effectively. In these situations, one spouse may retain the controlling interest in the business while the other has a passive stake. Other times, one spouse is awarded the business and the other spouse is awarded other community assets as part of the entire division of the community estate. This decision can have significant tax consequences, so it’s important to know what to expect.

How Are Assets Taxed During a Divorce?

Most assets fall under the tax-free transfer rule, allowing your assets to be divided during a divorce without worrying about federal income tax or gift tax. This includes business ownership interests. Tax-free transfers can occur before the divorce or when it’s finalized, as long as they are made within a reasonable time frame, usually one year after the marriage ends. For example, if you opt to give up another asset to your spouse in exchange for keeping 100% of your business, you can make that swap tax-free. However, there are future implications of receiving tax-free assets in the divorce settlement.

What Are the Potential Tax Implications of Dividing My Business After the Divorce?

While you may not have to deal with tax consequences right away, they can be an eventuality. When the asset is sold, whoever owns that asset at the time of the sale is the one who is liable for the taxes on that income. This includes taxes on any gains in value since acquiring ownership. However, you’re only liable for taxes on what you own: If you split ownership of the business 50/50 with your ex-spouse, for example, you’d only pay the taxes on the 50% that’s yours.

What Strategies Can Be Used to Minimize Financial Implications During the Divorce?

• Maintain detailed and accurate financial records for your business. This is especially important if the business is actually not community property and legally should belong to only one of you. Disorganized bookkeeping can make it difficult for capital contribution sources to be traced and recorded, and subpar records can open the door for a former spouse to make claims that some contributions may have come from marital funds.
• Keep business and personal expenses separate. If you report one amount for compensation and another amount in personal expenses paid through your business, you and your records could be subject to more intense scrutiny. Disentangling these expenditures can also be incredibly difficult for your legal and financial teams, so you may need to call in a forensic accountant before you move forward with your divorce proceedings.
• All wages should be consistent with market standards. There are consequences for paying yourself unfair wages, especially if you are underpaying yourself, since your spouse could use the market standard income for your work as the basis for determining how much spousal support they think they should get. If your spouse works at the business with you, they should also be receiving market rates for the work they do, or else they could argue for compensation in the divorce.
• Unreported cash distributions from your business should not support your lifestyle. Courts will notice if things like private school tuition, new homes, or lavish vacations are not paid for with your reported income, and this could put you at risk. The court may assume that you are not being truthful about the amount of money you make and could subject you to an audit or an intensive review of business records.

Thoughtful planning can help both spouses in the long run, especially if there’s a business involved. It’s also important to choose a divorce attorney who’s skilled at preserving as much of their clients’ wealth as possible. If you’re a business owner facing a divorce, call Goranson Bain Ausley for a consultation today.

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An experienced family lawyer and partner, Rob’s goal is to help individuals protect what they have built over their lifetime and avoid the destruction of business or personal assets in divorce. Rob is board-certified in family law by the Texas Board of Legal Specialization and is a director of the Austin Bar Association. Named in The Best Lawyers in America© in the field of Family Law, 2019 – 2023, Rob has an extensive litigation history and a seasoned track record. A tireless advocate for his clients, Rob excels in the complexities of high asset property division. 

For more information on how to protect your business in a divorce, please contact Rob Frazer at 512-842-4365. 

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