There are three main types of business structures: partnerships, proprietorships and corporations. The type of business will impact the way you handle the business in the case of a divorce.
A proprietorship is essentially a “personal business” whereby the income/revenue is earned by the person(s) and therefore reflected accordingly on his/her tax return. Expenses incurred are therefore deducted from income when determining net income. Often times this structure is used when the revenue it not too high, or the business itself is more of a one person practice as in the case of a consultant. These types of businesses often do not have a business value, as the value is the direct production/output of the proprietor. In the case where a husband and wife work together they may have split revenue and expenses likely to partially minimize tax for both parties. While these types of businesses often do not have a value, they can make determining other issues such as spousal support and/or child support more complicated. Attributing the expenses directly to the business is often not black and white therefore making personal income calculations difficult. A judge will likely add back in a percentage of the expenses to personal income and depending on the nature of the business determine if there is any “value” associated with it.
Most partnerships are structured as such, due to the regulations around limited liability. Partnerships attribute the income, expenses and tax to each of the partners. Unlike corporations, partners do have a certain amount of liability and therefore the partners cannot hide behind the corporate veil. Often professional practices will use this structure of business. An outside business valuator can value a partnership and the resulting value can be used so that one partner can buy out the other. In the case where the parties no longer want to work with each other then this is the best scenario. The valuator will likely come up with two or three values given different assumptions so that the parties can settle on one amount. A judge will likely use one of those values depending on the arguments from each side. The judge could also split up the partnership so that each party can proceed on his or her own – if possible.
A corporation is an entity on to its own and stands separate and apart from the parties. The parties will hold shares in the corporation and the percentage will determine who has the ultimate say “unless a unanimous shareholders agreement sets out different terms”. In the case of the husband and wife getting a divorce, the share structure, while relevant in business, is not overly relevant when splitting assets. Regardless of who owns the shares, if it is determined (or part of it is) to be a matrimonial asset then it is going to be split 50/50 with regards to value. This can be extremely complicated and potentially damaging to the business if there is little cash and a high value. Often a business valuation is done and then the parties will need to either liquidate the business (i.e. sell it or one party has to buy out the other). A judge may order that one party buy out the other with a distribution of the personal assets to the other party. In the case where this works out almost equally (considering tax of course) then this is a good potential solution. However in some instances the cash is simply not available for a buy out in which case they need financial creative input. The other issue and an area to be very careful of is the wording around the transfer of shares. In the case of matrimonial transfers of shares it is very important to specify the exact value of the shares that are being transferred at the same time considering very carefully the tax implications to both parties of such a transfer.
Karen Stewart is the President and CEO of Fairway Divorce Solutions ®. They work to complete resolution plans for your divorce, prenup, postnup, and cohabitation. Fairway enables you to reduce time, reduce stress, protect your kids and maximize assets. They work with clients from Canada and the United States.