Divorce and the Family Business—What Are the Options?
by Kristina Drzal Houghton, CPA, MST
Any successful family-owned business should employ protective strategies to minimize the impact of a shareholder's divorce. In a mature family-owned business, one that has been in existence long before the marriage of one of its young shareholders, the founders should have engaged in business-succession planning that contemplates the possibility of a shareholder's divorce. This can be accomplished with contractual agreements or by using trusts or other entities, such as family limited partnerships, to hold the business interests and protect against an involuntary transfer due to a shareholder's divorce. At a minimum, such strategies will track the ownership of the business and/or confirm the interest was non-marital or separate property when the marriage began. Sometimes a business enterprise is started early in a marriage and then only after the business becomes successful does the owner's marriage fail.
There are numerous tax considerations that must be addressed in the event of a divorce. The divorcing parties should try to agree on the division of a family business in whatever form that takes, and in doing so, utilize a mutually tax efficient method the benefits of which can then be further divided between the parties.
The most tax efficient method to divide a family business depends on the circumstances surrounding the business and the respective goals of the divorcing parties. In the context of a family business the advisor must consider: (i) is there a premarital agreement?; (ii) is there a buy/sell agreement?; (iii) what are the ownership interests of the divorcing parties?; (iv) how much alimony is to be paid, if any?; (v) were both parties active in the business?; (vi) what value, if any, does each spouse contribute to the success of the business?; and (vii) were both parties sufficiently compensated in the years prior to the divorce? General tax considerations for divorcing spouses include the non-recognition of property transfers, the tax-free division of retirement plans, and the tax shifting result of alimony payments.
There are no easy solutions when owners of a family business divorce. The best way to avoid many of the complications is to use prenuptial agreements, buy-sell agreements, or other forms of business succession planning. In the absence of such pre-existing agreements, there are unique and tax efficient methods to divide and exchange the spouses' interests in a family business. The advisors for both spouses will need to coordinate the goals of each spouse, the options available in light of the form, profitability, and nature of the family business, and the risks and costs of having the spouses resolve their differences in the divorce court.
Article by Kristina Drzal Houghton, CPA, MST, Partner in Charge of the tax practice at Meyers Brothers Kalicka, PC in Holyoke, MA (413)536-8510. Meyers Brothers Kalicka is a proud sponsor and advisor of the UMASS FBC.