Part 1 in an ongoing series about keeping your business assets safe in the event of divorce.
When people get married they are all hoping for the "happily ever after," but the sad fact is that 52% of all first marriages and 70% of second and third marriages end in divorce. While divorces are always very difficult for everyone involved, it can become that much more difficult when one or both spouses own a business.
Your business is probably the most valuable financial asset you own. You've spent countless hours (nights and weekends) and resources nurturing and growing it. But did you know that you might be unwittingly doing things that could put your business at risk in the event of a future divorce?
Depending on your individual circumstances, your spouse may be entitled to as much as 50% of your business in a divorce. Since it's probably safe to assume that you will not want your ex-husband to become your business partner, what can you do now to protect your business in the event of a future divorce?
This 5-part series will first explain the basic differences between separate and marital property and then give you a number of effective tools that could help protect your business against the possibility of a future divorce. We will also discuss several ways to mitigate the damage if you are already heading for divorce.
Before we begin, please keep in mind the following critical piece of advice:
To be truly effective, these protective methods should be in place well before the possibility of divorce enters anyone's mind. Obviously, something like a prenuptial agreement needs to be signed before the wedding (and please not the night before), but techniques such as transfers to an irrevocable trust need to be done years in advance. Depending on your state's fraudulent transfer laws, transactions can be voided up to seven years after the transfer!
OK, so let's begin with the basic differences between separate and marital property.
Separate vs. Marital Property - What's the difference and why is it important to me?
Although there are differences from state to state, in general, separate property includes:
•property that was owned prior to the marriage;
•an inheritance received by one spouse solely;
•a gift received by one spouse solely from a third party (your mother gave you her diamond ring);
•the pain and suffering portion of a personal injury judgment
Warning: Separate property can lose its separate property status if you commingle it with marital property or vice versa. For example, if you re-title your separately owned condo by adding your husband as a co-owner or if you deposit the inheritance from your parents into a joint bank account with him, then that property will most likely now be considered marital property.
All other property that is acquired during the marriage is usually considered marital property regardless of which spouse owns the property or how the property is titled.
(State laws vary greatly, especially between Community Property & Equitable Distribution States, so please consult with your attorney).
Marital property consists of all income and assets acquired by either spouse during the marriage including, but not limited to: Pension Plans; 401Ks, IRAs and other Retirement Plans; Deferred Compensation; Stock Options; Restricted Stocks and other equity; Bonuses; Commissions; Country Club memberships; Annuities; Life Insurance (especially those with cash values); Brokerage accounts - mutual funds, stocks, bonds, etc; Bank Accounts - Checking, Savings, Christmas Club, CDs, etc; Closely-held businesses; Professional Practices and licenses; Real Estate; Limited Partnerships; Cars, boats, etc; Art, antiques; Tax refunds.
In many states, if your separately owned property increases in value during the marriage, that increase is also considered marital property.
However some states will differentiate between active and passive appreciation when deciding if an increase in the value of separate property should be considered marital property.
So what's the difference?
Active appreciation is appreciation that is due, in part, to the direct or indirect contributions or efforts of the other spouse (e.g. your husband helped you grow your business by giving you ideas and advice; he entertained clients with you; he helped raise the kids and did some household chores, which allowed you to work late, entertain clients, travel to conventions; etc.).
Passive appreciation is appreciation that is due to outside forces such as supply and demand and inflation (a parcel of land increases in value even though you and your husband made no improvements to it). However, if you used marital income and/or assets to pay the mortgage and/or taxes on this parcel of land, your husband might have a very good argument that this property, or at least the increase in value during your marriage, should now be considered marital property. As you can see, this can get quite complicated and convoluted. (Hiring a good Divorce Financial Strategist can help you sort all of this out.)
It is also very important for you to know if you reside in a Community Property State or an Equitable Distribution State.
There are nine Community Property States - Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Community Property states consider both spouses as equal owners of all marital property (a 50-50 split is the rule).
The remaining 41 states are Equitable Distribution States, which consider factors such as the length of marriage, the age and health of the parties, the income and future earning capacity and many other factors when determining a settlement. And remember, settlements in Equitable Distribution States do not need to be equal, but they should be fair (equitable).
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Jeffrey A. Landers, CDFA™ is a Divorce Financial Strategist™ and the founder of Bedrock Divorce Advisors, LLC, a divorce financial strategy firm that exclusively works with women, who are going through, or might be going through, a financially complicated divorce. He also advises women business owners on what steps they can take now to "divorce-proof" their business in the event of a future divorce. He can be reached at Landers@BedrockDivorce.com.