Divorce Tax and Business Considerations

Proper consideration of tax implications and the correct transfer of corporately held or LLC-held assets can help you avoid  future surprises, costs, and legal fees in a divorce case.  Your divorce lawyer should understand the importance of these objectives and may consult with tax and business law experts to ensure compliance and efficiency. Generally speaking, the transfer of assets at divorce, if handled appropriately, does not trigger any tax consequences.

 

Key Tax Implications in Divorce:

 

1. Asset Transfers and Taxation:

• Tax consequences usually arise only when an asset is liquidated or when retirement or IRA benefits are actually paid out. The mere transfer of assets between spouses at the time of divorce typically does not incur taxes if executed correctly.

2. Understanding The Total Tax Situation:

• Knowing what the basis is in all assets is critical. In effectuating Equitable Distribution, consideration must be given to the tax effect of any eventual sale or liquidation of assets. For instance Amazon stock  with a low basis may have a significantly lower fair market value due to the capital gains and net investment income tax burden.  Further consideration needs to be given to the individual’s entire tax environment. Capital loss and passive loss carryforwards may need to be considered as well as like-kind exchanges.  A thorough understanding of the historical and prospective income tax factors is necessary for a proper tax estimation.

3. Retirement Accounts – IRA and 401(k) Transfers:

• The transfer of IRA assets between spouses is non-taxable if carried out under a Final Judgment and executed according to the brokerage firm’s procedures.
• The transfer of 401-k assets and pension plans is more complex and requires a Qualified Domestic Relations Order (“QDRO”) to properly divide the funds without triggering taxes. Consulting with your lawyer before making these transfers is crucial to avoid an unnecessary tax liability.

4. Alimony and Child Support Tax Treatment:

• Alimony is no longer tax deductible for the payer, nor is it considered taxable income for the recipient (for divorces finalized after January 1, 2019, due to the Tax Cuts and Jobs Act).
• Child support has never been taxable or tax-deductible.
• Attorney fees related to general divorce proceedings are not deductible, except for fees specifically incurred for tax advice. Legal fees for securing alimony are no longer deductible. Discuss potential deductions with your lawyer and tax advisor before incurring these expenses.

5. Business Valuations and CPA Fees:

• The costs associated with hiring a forensic CPA to value a business may be a business expense under certain circumstances rather than a personal one.  Those fees could then  be paid by the business.
• Ensure that these expenses are discussed with both your lawyer and CPA in advance to manage costs effectively.

 

Corporate Ownership and Divorce Consideration

 

6. Corporate Entities and Divorce Proceedings:

• Corporate entities are not automatically parties to a divorce unless they have been formally joined in the case.
• The decision to involve an entity in the divorce should be made carefully and in consideration with your lawyer.

7. Control Over Privately Held Businesses:

• A spouse owning more than 51% of a small business or LLC may be ordered by a judge or required in a settlement agreement to direct the company’s actions.
• If an agreement mandates that a spouse must act in a certain way regarding corporate or LLC activities, that spouse must sign the agreement in their official capacity (e.g., as an LLC member or controlling shareholder).

8. Corporate Assets Are Not Automatically Divisible:

• Unlike personal assets, corporate assets are not subject to division in a divorce unless the controlling owner authorizes it.
• The controlling interest in the entity dictates whether corporate assets are part of the divorce settlement.

9. Handling Privately Held Businesses:

• When a divorcing couple are the sole owners of a privately held entity, it is essential to properly document the separation of interests.
• The withdrawing spouse should sign all necessary documents to ensure clarity and prevent future conflicts.
• Corporate counsel should be involved early in the process to streamline the drafting of these documents.

10. Remaining in Business Together Post-Divorce:

• Some divorcing spouses wish to continue operating a business together. However, this is often not advisable due to potential conflicts. Typically, divorcing spouses need to get divorced – personally and corporately.
• Before making such a decision, consult both your divorce lawyer and corporate counsel to assess the risks and feasibility.

 

Final Considerations

 

The above points highlight just some of the critical factors that must be addressed during divorce proceedings, especially when corporate interests are involved.  Ensuring that your lawyer fully understands your business and financial interests is crucial to achieving a comprehensive, final, and lasting agreement that minimizes future disputes.

Addressing complexities at the time of divorce is far more effective than dealing with unexpected consequences afterward.  A well-structured agreement can prevent post-divorce complications, helping both parties move forward without unnecessary financial and legal burdens.