Many spouses in the United States own businesses, and dividing these assets can be tricky during a divorce. This can be especially complex when you consider the various tax implications of dividing a business. It is important for spouses to understand these implications in order to avoid unnecessary taxes and complexities as they end their marriage.
The Three Options for Dealing with a Business in a Divorce
There are three main options for spouses who want to deal with a business in a divorce:
- Buyouts: In this situation, one spouse retains full ownership of the business in exchange for buying out the other spouse’s share. The exact amount of the buyout fee depends on the value of the business.
- Selling: Alternatively, spouses may decide to sell the business and split the proceeds.
- Co-ownership: Spouses may also decide to simply continue running the business as a pair with few changes to the existing arrangement. This is quite rare, as most spouses want to cut ties with each other after a divorce. However, it may be possible if the split is amicable.
The Tax Implications for Buyouts
If spouses choose the buyout option, there are a few tax implications that are important to understand. When a spouse pays a sum to buy out their ex’s share in the business, this “sale” is not treated as a taxable transaction. In fact, all transfers of property between spouses during divorces are treated this way. Generally speaking, spouses can only enjoy these benefits under certain circumstances:
- They transfer property within a year of the cessation of the marriage
- They transfer property within six years after the marriage ends if transfers are made pursuant to your divorce agreement
- The transfer is made before the divorce
- The transfer is made at the time it becomes final
If spouses turn around and sell their share in the business to a third party years later, they would be required to pay taxes. In addition, it is important to recognize that buyouts are only possible if the purchasing spouse has the liquid assets necessary to actually complete the transaction.
What Happens When Corporations are Involved?
If both spouses hold significant shares in a closely-held corporation, the same general rules are followed. One spouse can simply buy out the other spouse’s shares, and this is not a taxable transaction. Just like our other example, the spouse who purchased these stocks would incur a substantial tax liability if they sold these stocks later.
But what happens when the entity that buys out the other spouse is the corporation? Things can go one of two ways:
- It is treated like a redemption transaction that occurs strictly between the corporation and the selling spouse. No tax consequences exist, and the selling spouse may have the ability to treat it as a sale of their personal stock back to the corporation. Alternatively, it may be treated as a dividend paid by the company.
- The deal follows the same format as a collected redemption payment that is then transferred in exchange for shares in the corporation. The redeeming spouse has no tax consequences, while the other spouse accepts the full tax implications alone.