At the time of divorce, a business may be in one spouse’s name or in both spouses’ names. The business may have been created by one spouse before the marriage, or by one or both spouses during the marriage, and may be owned in part by persons other than the spouses.
Ownership may be in the form of interests in a partnership, membership interests in a limited liability company, or shareholder interests in a corporation. Or the business may be operated as a sole proprietorship (an individual person) and not as a separate legal entity. Businesses owned by a small number of persons (often family members and friends) and whose shares are not publicly traded on a stock exchange are known as closely-held businesses.
The questions of (1) whether the business was created by one spouse before the marriage or was created during the marriage and (2) the form of the business entity and the related agreements between the business owners may impact the division of the divorcing spouses’ interests in the business.
If the spouses live in a community property state (as opposed to an equitable distribution/common law property state), and if the business was created by one spouse before the marriage, income earned from the separate property business and any appreciation (increase) in the value of the business interest during the marriage may be community property rather than separate property. Community property states generally include Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
In other states—so-called equitable distribution or common law property states—the divorce court attempts to divide the spouses’ assets equitably (fairly) and may order one spouse to contribute separate property to the other spouse in an effort to do so. In practice, the difference between the division of assets in community property states and in equitable distribution states is sometimes not as great as it may seem, as the court in a community property state may have the discretion to divide the spouses’ community property on a 60-40, 70-30, or other unequal basis.
When evaluating the division of a business interest in divorce, it is also important to consider any tax implications for the division of the business. And it may be necessary for the spouses to hire a business appraisal expert to make a valuation of the business.
In Pennsylvania, which is an equitable distribution state, the division of business interests during a divorce is subject to fair division rather than equal division. This means that if a business was created by one spouse before the marriage, it may be considered separate property, but the increase in value during the marriage and income earned may be subject to division. The form of the business entity and any pre-existing agreements between business owners can significantly affect how business interests are divided. For businesses that are closely-held, the division can be more complex due to the personal nature of ownership and the lack of a public market for the shares. Pennsylvania courts will aim to divide assets fairly, which may not always result in a 50-50 split, and may consider contributions of each spouse to the business, the length of the marriage, and other factors. Tax implications are also a critical consideration, and often a business appraisal expert is hired to determine the value of the business for equitable distribution purposes. It's important for individuals going through a divorce involving business interests to consult with an attorney who specializes in family law and has experience with business valuations to navigate the complexities of the process.
