What is Your Business Tax Responsibility After a Divorce?
Amid all the attention given to alimony, property division and other financial issues in a divorce, it’s possible that couples may not fully consider tax issues related to business entities that they own. This is a problem for a number of reasons, not the least of which is that many small business owners sometimes use business assets for personal purposes, which can create tax liabilities. We warn clients against running personal expenses through their businesses, but it still happens regularly and can create complications during divorce.
For most divorcing couples who own businesses, those interests make up a large chunk of their marital property. In theory, both spouses could retain ownership of their shares of the business and keep it running. This rarely works in real life though, as former spouses usually can’t get along at all, let alone co-manage a company. More often, one spouse ends up retaining a controlling interest in the business and the other spouse is bought out, retains a passive stake or is awarded other marital assets in the property settlement.
How the couple’s business ownership interests are divided can affect how the parties are taxed. The federal Internal Revenue Code generally allows property, including cash and business ownership interests, to be transferred between spouses without any income or gift tax consequences. This tax-free treatment also applies to division of property incidental to a divorce. While the exemption is beneficial, there are plenty of situations where it does not apply. For example, a tax-free division of the business may not be possible depending on what type of organization is involved and how that entity is classified for federal tax purposes. Transferring assets out of the corporation or limited liability company may require the sale of appreciated property or other actions that trigger tax consequences.
Post-divorce tax issues for business owners usually cannot be entirely avoided, but many of the concerns can be addressed by including in the divorce agreement a set of well-drafted tax indemnification provisions related to business entities. Also, a final word of caution: do not sign tax returns with your spouse unless you are certain the amount of income reported is accurate. If you sign tax returns that underreport business income and later allege in the divorce that your spouse makes millions more, the truth will come out during the litigation and will affect your property settlement.
Bryan L. Salamone & Associates, P.C. handles highly complex business owner divorce and related tax issues for clients in Nassau County, Suffolk County and all of Long Island. Call 1.631.479.3839 or contact us online to schedule a free initial consultation with our lawyers today.