How Does Divorce Affect My Business Taxes?
Divorce when you own a business is a complicated matter. It’s also quite important, as the business is often the largest asset in the marriage. If both you and your spouse own and operate the business together, it can be even more tricky taxwise. Divorce is usually stressful, but a focus on the tax implications is necessary if you want to manage the consequences.
The Uninvolved Spouse
If your spouse has never been involved in the business, and depending on your state’s laws, there may be claims for alimony or other compensation based on the length of the marriage and how the court views their spousal support of your business activities. Those aren’t necessarily tax considerations, but if you must liquidate part of the business or its assets to satisfy court ordered payments, you may trigger tax liability, especially if the assets were being depreciated.
In some states, the longer the marriage with a supportive spouse while you built your business, the more the court may award as compensation for that support while you grew your wealth. Again, the tax consequences, if any, would be based upon whether you had to make financial adjustments to the business or liquidate business assets. Often stock shares in the business can be transferred to the non-involved spouse as a part of the settlement. In this case, normally the event would not trigger immediate tax consequences. The spouse would trigger a tax event when the shares are liquidated in the future.
Tax Consequences of the Spouse-Involved Business
When both spouses hold ownership stakes in the business, and often both are active in running it, the situation is more complicated. At times they can continue to hold their respective ownership shares and operate the business together, but it’s not common due to the stress of the divorce. The three most common approaches to disposition of the business assets are:
- One spouse can be bought out of the business, leaving it in the total ownership and control of the other.
- The departing spouse can retain a passive ownership interest.
- The departing spouse can be awarded other marriage assets as compensation for their ownership share of the business.
The Tax-Free Transfer Rule
In most cases, you and your ex-spouse can divide the assets of the business without federal tax or gift tax liability. Later however, disposition of those assets will result in tax consequences under existing tax law. The short or long-term asset holding period will be considered.
Example #1: You and your spouse own the business and the home free and clear. Part of the divorce settlement is the agreement that you transfer sole ownership of the home to your spouse in exchange for their interests in the business. It’s a tax-free transfer under the rule. Your spouse will become responsible for tax liability when the home is sold or transferred, and you will be solely responsible for future tax liability from the business.
Example #2: Your spouse receives a portion of the ownership stock in the divorce settlement as compensation for leaving the remainder of the ownership and all operational control with you. The departing spouse will be responsible for future tax consequences for their share. You will continue to operate the business and pay taxes required of the business.
Of course, when it comes to taxes, it’s more complicated than this overview due to the many different business types and situations. However, this overview should key you into the major considerations of a divorce with the business involved.
Qualified Retirement Plans and Divorce
When a qualified retirement plan, such as profit-sharing or a defined benefit plan is involved, there can be a tax-free transfer as part of the divorce settlement. A QDRO, Qualified Domestic Relations Order, is filed to make your spouse a co-beneficiary of the retirement account. The tax liability goes with the money. Your spouse can withdraw funds and do a tax-free rollover to another or a new qualified retirement account.
Divorce isn’t fun, and there is a lot of court-involved activity, particularly when a business is involved. However, take the time to work on the tax implications for your business and personal financial future.