Divorce cases get complicated quickly, and sorting out a shared business can cause even more confusion. Couples who co-own or co-operate a business face serious decisions during divorce, including the division of assets and the future of their involvement.
Before approaching decisions about a business, couples who are divorcing should determine where they stand in terms of ownership. They also need to learn about how divorce could affect their business, depending on what type of entity it is.
In the first part of our series “Divorce and Business Ownership,” we explore the types of businesses that might be the subject of conversation for a couple in divorce proceedings.
Types of businesses discussed in divorce
Before thinking about the legal definitions of business types, consider the number of professional business factors that could exist between two people getting divorced.
The business in question might have been established by:
- one spouse before the couple were married.
- one spouse’s family (parents, siblings, children, etc.) before the couple were married.
- both spouses before the couple were married.
- one spouse after the couple were married.
- both spouses after the couple were married.
The business in question could be a(n):
- the single independent small business operated from a storefront or out of the home.
- chain of small businesses, operated by the couple or other managers.
- a cluster of independent small businesses, such as a couple who own a restaurant and also related catering and party planning businesses.
- franchised business, such as a couple who own three dry-cleaning franchise units.
- investment business, in which funds are being held in real estate, for example.
Several types of businesses are commonly divided in divorces. While every case is unique based on the people and type of business involved, it’s important to understand the implications of entering into a business with a spouse. These details become imperative during divorce proceedings.
C CORPORATIONS AND DIVORCE
What most people think of as a standard business, C corporations are entities taxed separately from the business owner’s personal taxes.
Business owners report profits and losses to the Internal Revenue Service on a separate set of forms, unattached to their own personal tax return. Therefore, tax debts belong to the C corporation, not its owners at an individual level.
One critical factor when considering C corporations during divorce is that income from these businesses may be paid out to the business owners from the corporation. These dividends are then considered personal income, and a family court judge may include the profits as part of the owner’s total income when determining spousal support. This is a very complex issue to be discussed with an attorney.
S CORPORATIONS AND DIVORCE
As “pass-through” tax entities, S corporations are businesses that do not file corporate tax returns. Instead, income and losses from an S corporation are “passed through” and reported on the owner’s personal tax returns.
As a result of this pass-through S corporation status, tax debts are owed at the individual level by the business owners. During divorce proceedings, a family court judge may consider the profit from an S corporation as the owner’s personal income, while also considering the personal impact of tax debts from this business. Again, this is a very complex issue to be discussed with an attorney.
LIMITED LIABILITY CORPORATIONS AND DIVORCE
Establishing a limited liability company (LLC) provides its owners with a business structure that protects them from personal responsibility for the company’s debts and liabilities.
This structure allows the business owners, usually called “members,” to benefit from the tax characteristics of a corporation, with the organizing simplicity of a partnership or sole proprietorship. Depending on relevant state regulations, LLCs can include members consisting of people, corporations and even other LLCs.
Types of LLCs
Domestic LLC: Conducts business in the state in which it was incorporated.
Foreign LLC: Registration of an existing LLC for an office or physical presence in another state.
Professional LLC: Designation for an LLC in which certain members must have state licenses to perform the relevant professional service, such as with a medical or legal practice. With this type of LLC, protection from personal liability does not extend to professional malpractice claims.
Series LLC: A unique type of LLC in which a “parent” LLC provides limited liability protection to a series of “child” LLCs, while the child LLCs are protected from the liabilities of the other child businesses.
Usually, LLCs are pass-through tax entities that do not file corporate tax returns. Profits and losses are passed through to members, who claim them on their tax personal returns. However, LLCs can elect to be taxed as a C corporation or S corporation, if the members find it to be more beneficial.
BUSINESS PARTNERSHIPS AND DIVORCE
Two or more people can sign a Partnership Agreement, agreeing to be partners in a business and share in the profits and losses.
No federal statute actually defines business partnerships, however, the Internal Revenue Code includes detailed rules on the department’s federal tax treatment of such entities.
A business partnership does not pay income tax as an entity. Rather, the tax reporting and debt responsibilities pass through to the partners.
While being drafted, Partnership Agreements should contain legal language that addresses how disputes will be resolved between partners and how to handle a buyout of a partner. For spouses entering a partnership, this language could include a plan for the business if the couple enter divorce proceedings.
Three main types of business partnerships
General Partnership: All partners equally share profits, as well as bear equal personal legal and financial liability.
Limited Liability Partnership: Limits each partner’s personal liability, so that the actions of one partner do not jeopardize the assets of the other partners.
Limited Partnerships: In this structure, one or more partners has full liability for the company’s debts, while at least one “silent” partner exists who does not participate in day-to-day operations and whose liability is limited to the amount they invested.
For part two: “How Business Is Divided in a Divorce.”
All of the above discuss business types that need to be addressed during the divorce. Reviewing these issues with your attorney is of extreme importance.
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