When a person owns a family business during a marriage and is involved in a divorce, generally the value of the business must be included in the property division to be determined by the court. If the business-owner spouse retains the business, the other spouse must be awarded other property to offset the value of the business. Although it may not seem fair, it’s the law.
However, what happens when the business owner spouse started or acquired the business before the marriage, or received a gift of or inherited stock in a family business during the marriage? In those situations, the business-owner spouse may have a non-marital claim relating to some or all of the value of the business. Any portion of the value of the business which is determined to be non-marital is not subject to property division in the divorce.
Proving a non-marital claim to an ongoing business involves a complex analysis of the nature of the non-marital claim (i.e., premarital, gift, inheritance), as well as the role the business-owner spouse played in the operation of the business during the marriage. For example, if the value of the business increased during the marriage, and the business-owner’s spouse is partially or entirely responsible for its growth, then a portion of the value of the business must be included in the property division of the divorce.
How Business Value Is Determined
The manner of establishing a value for a business is governed by state divorce laws, the Internal Revenue Code and other applicable laws. An analysis starts by determining the value of all business-owned assets. Then, any debts are subtracted. The assets may be subject to appraisal. The value of a business, however, can be significantly more than just the value of the assets less the debts owed by the business. It may also include an additional component known as “goodwill.” Goodwill generally includes intangibles such as a business’s customer base, name, reputation and other aspects which may justify a sales purchase price, and exceeds the difference between the assets and the debts.
Non-Marital Claims
All property owned and acquired by both spouses during a marriage is considered marital property, unless it fits an exception such as to render that asset, or part thereof, as non-marital property in the divorce. Generally speaking, non-marital claims relating to a family business come from three sources:
- A spouse owned the business before the marriage (i.e. a premarital asset)
- A spouse received a gift of stock in the family business from another family member
- A spouse inherited stock in the family business upon the death of a relative
Valuing A “Non-Marital” Claim
Once the basis of the non-marital claim is determined, an analysis will show the value of the non-marital aspect of the business. Generally, this will be the value of the business at the time of the marriage, gift or inheritance. If the divorce occurs long after the gift or inheritance was received, the valuation process can be challenging. It may require copies of financial statements from several years earlier, and attempt to value assets from a distant point in time.
Growth During the Marriage
The most challenging determination for attorneys and courts is how to deal with the increase in value of a business between the time of the gift or inheritance and the divorce, especially if the business grew significantly during the marriage. If the business-owner spouse has been significantly active in the business, and the growth in the value of the business resulted from his or her operation of the business during the marriage, then that portion is considered “marital.” The other spouse is entitled to credit for increased value, regardless of the fact that the business was acquired by gift or inheritance.
However, if the business grew during the marriage for reasons other than the efforts or activities of the business-owner spouse, then the growth can be classified as “non-marital” property and is not subject to division. In such cases, it all comes down to what caused the business value to increase during the marriage. If it was because of the business savvy, experience and hard work of the business-owner spouse, then it’s “marital.”
At times, a business can grow as a result of general economic conditions, the management of the company by someone other than the business-owner spouse or other circumstances. Some examples of “non-marital” growth of a business are:
- Enhanced demand for the product or services produced by the business due to its role in a changing society
- Superior management abilities of family members (other than the business-owner spouse)
- Increase in value of company assets for special reasons, such as a new highway being built adjacent to the business property, closure of competing businesses or changes in industry regulations.
Under these conditions, the business-owner spouse may be able to demonstrate to the court that the growth in the business did not occur as a result of activities in which the business-owner spouse engaged during the marriage, but rather due to other circumstances. If successful, the favorable impact on the property division can be significant. When business owners divorce, selecting competent legal counsel is critical. Your attorney must not only have good knowledge and experience in divorce law, but also have a strong background in business and finance. Strauss & Troy has attorneys who are highly-qualified in these areas.
For a free confidential consultation, contact attorney Tim Theissen at tbtheissen@strausstroy.com or 513-768-9711.