Divorce can complicate company ownership

    Last updated on May 13th, 2019 at 02:43 pm

    When business owners think about wealth management, they may think of stocks and bonds, trusts and other investment options. But one thing that is not often discussed – although it can have a significant impact on the accumulation of wealth – is divorce.

    The statistics show that 40 to 50 percent of couples who marry this year will divorce. When that statistic is added to the fact that people are marrying later and often after successful careers are under way, it means that the impact of divorce on wealth management is probably more significant than ever before. 

    The divorce of a business owner or executive can cause serious complications, not only to the individual, but also to the company. This is because unless precautions are taken, a married person’s ownership of a partnership or corporation will be presumed to be marital property subject to division in divorce.

    To avoid finding itself with unwanted partners or shareholders, a business needs to plan. It can prevent stock or partnership interests being transferred to a non-employee spouse by several different means.
    Shareholder or partnership agreements, employment agreements and buy-sell agreements are some of the tools available to prevent strangers from acquiring an ownership interest in a company. Such agreements can provide that no shareholder or partner may transfer any ownership interest to a non-employee, or to one not in a specified category of persons.  Or, the agreement can ensure that the company has the option to purchase any stock or partnership interest owned by a shareholder or partner who is going through a divorce.

    Another factor to consider is that businesses sometimes award unvested stock options or unvested restricted stock to their executives. The options or restricted stock will be deemed marital if earned during the marriage, but most courts will not consider them marital if earned in the future, after the marriage is ended. Because neither the individual nor the business wants them split with a divorcing spouse, which would eliminate literally half of the company-provided incentive for the executive, the company should make clear in its documents whether the award is compensation for past performance or whether it is an incentive for the executive to remain employed at the company and earn benefits in the future.

    Additionally, unless stock or a partnership interest is inherited or acquired as a gift, the interest will be considered marital property, subject to being split with a spouse in a divorce, or if awarded solely to the employee-spouse, requiring an offsetting payment to the non-employee spouse. If the stock or partnership interest is ordered split, the once-majority owner loses control, or if the employee already owns merely a minority interest, the position is further diluted.  

    How a business is structured is also an important factor to consider. Not only property division but also support awards are affected by the form of ownership in a business. For example, if a spouse owns an interest in a subchapter S corporation (a business that passes its income through to the individual owner’s tax return) courts will presume that all the reported income is actually received by the individual, and thus is available to be paid for maintenance or child support.  (Many lawyers and judges do not understand that the income reported on line 17 of the individual’s 1040 tax return may have no connection with the cash distributions actually received by the individual from the business.)

    While the decision whether to become a C corporation (a business that reports and pays taxes on its income rather than having the owners report the business income) is a very complicated one, if the business owner has the option, he or she should consider the possible advantages of converting to a C corporation prior to divorce.

    In my experience, the typical small business owner who is divorcing wants his or her spouse to be awarded something other than an ownership interest, making non-transferability of stock or options crucial. However, even if the company does not have agreements preventing transferability, of course a shareholder or partner of a small business can also protect that interest through a prenuptial or post-nuptial agreement.

    The spouse cannot be divested of rights to marital assets unilaterally or without a fair deal being struck, but such an agreement can be structured to protect the business interest while being fair to the spouse.

    These various options are only a few to consider and are best explored with trusted business advisors. There is no doubt that with careful planning, many business complications that could arise during a divorce can be avoided.

    Patricia Ballman is a family law attorney with Quarles & Brady LLP.

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