Divorce Threatens Family Business Succession

James Dickinson

A recent survey shows that only 52% of married couples will celebrate their 15th wedding anniversary. A marriage ends in only two ways, namely, divorce or death. The ownership and control of a family business are jeopardized when family business assets are owned by a deceased family member or are owned by a party to a divorce.  While another survey published in 2003 found that 80% of family business owners wish to pass ownership to younger generations. Business owners will either give or sell business interests to their children in order to secure ownership and control for future generations.  So how does divorce impact the business succession planning?

How Courts Divide Separate Property from Marital Property in Divorce

Courts will attempt to divide marital from separate property in divorce cases. In general, marital property is property earned during the marriage through the efforts of the parties. Separate property is generally property owned by a party prior to the marriage or obtained through gifts and inheritance by one of the parties during marriage. In divorce, the problem arises in trying to trace the origins of the various assets. Married couples tend to commingle all assets, regardless of the source, in jointly-owned accounts and property.

Recording Business Transfers Prior to Marriage

When business interests are given to a child prior to his or her marriage the gift should be reported on a federal gift tax return. Sales should be reported on the seller’s 1040. This will serve as evidence in subsequent divorce proceedings that the asset was not the result of the child’s efforts. The problem usually occurs when the child works for the family business and it increases in value. Courts have held that the accretion in value due to the child’s efforts is a marital asset.

During Marriage: Evidence of Business Transfer to Only One Spouse

In divorce it must be shown by clear and convincing evidence that the gift or bequest was only to one spouse. A gift or estate tax return can serve as the best evidence to maintain its separate property identity. The possibility of having the asset commingled with marital assets is eliminated by making the gift or bequest to the child in trust.

Five Best Practices to Help Protect Business Interests in Divorce

The dangers to a family business upon the death or divorce of a child who owns business interests can be reduced by one or more of the following measures:

  1. Prenuptial Agreement. Prenuptial agreements are recognized in every state of the union and are generally effective to bar the claims of ex-spouses upon divorce and death. State law generally requires full or substantial disclosure of the assets of the parties coming into the marriage.
  2. Postnuptial Agreement. Many states allow the parties to enter into an agreement during the marriage if each side is represented by separate counsel and there is a full disclosure of assets.
  3. Asset Protection Trust. Every state allows a parent to create a trust for the benefit of a child and protect the assets in the trust from the claims of creditors including ex-spouses. Several states now allow a child to create a trust for himself or herself and protect the assets from creditor claims. However the trust must be created and funded prior to a marriage in order to protect from the claims of ex-spouses.
  4. LPs and LLCs. A family business asset or interest can be protected by placing the interest or asset into a limited partnership or limited liability company and restricting the transfer of the interest through the terms of the partnership or operating agreement.
  5. Buy-Sell Agreements. The ability to transfer any interest in a family business must be restricted by agreement.

For more information about succession planning and how to ensure your business is passed on to the next generation without the legal complications of a divorce, contact James Dickinson, a shareholder and attorney at Cavitch, Familo & Durkin who focuses on succession planning, general corporate matters and estate planning.

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