Divorce and Corporations

May 24th, 2016 by

Many couples today have an interest in some type of corporation, whether it be a family business, a business of one or both spouses, or an entity set up for investment purposes (such as an entity holding real estate). Even where the decision to divorce is mutual and amicable, the presence of a corporate entity will implicate several issues under Illinois family law.

First, it is important to recognize the different kinds of corporations and what implications they may have on a divorce.

C corporations. C corps are what most people think of as a standard corporation. They are separate taxable entities. They file a corporate tax return. In addition, corporate income may be distributed to business owners as dividends, which is then considered personal income- which would be taxable as income and includable as income for the purposes of determining support obligations.

S corporations. S corps are pass-through, and not separate tax entities. They file a federal tax return for informational purposes, but no income tax is actually paid at the corporate level. The profits/losses of the business are instead “passed-through” the business and reported on the owner’s’ personal tax returns. Any tax due is paid at the individual level by the owners.

Marital/Non-Marital. Whether the corporation is a C or S Corp, both the individual and corporate tax returns will be vital in a divorce proceeding. Any corporation, whether marital or nonmarital, will have to be valued in order for the parties to make an informed decision about the division of either that asset, or their other assets. Under Illinois law, the size of a spouse’s nonmarital estate can inform the court’s decision on things such as the property settlement, maintenance obligation, or child support obligation. So, even if a spouse does not have an interest in the corporation, it will still impact divorce proceedings.

Also, the status of the corporation as marital or nonmarital property should be carefully evaluated. In a long-term marriage, it is common that money may have gone in or out of the corporation from home equity or other marital property. The co-mingling of funds in this way may bolster a claim that a small business is actually marital property. When a corporation is marital property, the valuation is even more crucial, because the non-participant spouse will generally be bought out of the business.

Some spouses may want to remain business partners even after going through a divorce. However, it is important to fairly evaluate the long-term implications of retaining an interest in a formerly marital corporation. Inevitably, one former spouse will have more control over the day-to-day operations of the business, and may be able to make decisions that create a liability for the other former spouse. In addition, relationships that may be amicable at one point may be difficult in the future. These and other risks should be carefully considered before former spouses remain in business partnership together.

Income. Individuals may receive income from a business in the form of a salary or in terms of dividends. However, in a divorce, a party may have the motivation to reduce their income in the hopes of a court establishing a lower amount for maintenance or child support. This can be done by leaving money in the business in the form of retained earnings. However, in Illinois, retained earnings may be marital property even if the corporation itself is a a spouse’s nonmarital property, when the spouse is in control of the decision whether or not to leave the money in the business.

In addition, a spouse may try to do other things such as pay out dividends or salaries to third parties fraudulently. A recent case involved a spouse who hired his new live-in girlfriend at an artificially inflated salary. He was attempting to circumvent support obligations by reducing his income, while maintaining his standard of living with the income being paid to his girlfriend. When a spouse intentionally and wrongfully reduces his income, the total income into the business may be imputed to the individual for the purposes of calculating support obligations.

These issues are only some of the many challenges presented when a divorce involves a corporation, no matter the size or scale. For more information, contact Gwendolyn J. Sterk and the Family Law Group.

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