Getting a divorce can be very complicated and exhausting. If you both share a business together, the added tax implications can make things even more stressful for you. Your ownership interest is likely one of your biggest personal assets. So, what will happen to it if you get divorced? In many cases, your marital estate will include all (or part) of your business interest.
Some divorcing business owners are able to continue operating the business as before. More than likely though, the divorce will affect their business relationship and they will not be able to effectively manage the business together. In this instance, it is likely that one owner gain control and the other will either retain a passive stake in the business, be bought out, or allocated other marital assets in a property settlement agreement.
Tax-Free Property Transfer
Most assets can be divided between the couple without federal income or gift tax consequences. The ex-spouse receiving an asset takes over the asset’s existing tax basis and its existing holding period.
For example, under the terms of your divorce agreement, you give the residency to your spouse in exchange for sole stock ownership of your business. That asset swap would be tax-free. The existing basis and holding periods for the home and the stock would carry over to the person who receives them.
Tax-free transfers can occur before the divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers so long as they’re made “incident to divorce.” This means transfers that occur within:
- A year after the date the marriage ends, or
- Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.
Future Tax Implications
Eventually, tax implications of the divorce settlement transfer will occur. The ex-spouse who winds up owning an appreciated asset (when the fair market value exceeds the tax basis) generally must recognize taxable gain when it’s sold (unless an exception applies).
What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex continues to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex ultimately sells the shares, they will owe any resulting capital gains taxes (not you).
Remember that the ex-spouse who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. Importantly, you should always take taxes into account when negotiating your divorce agreement.
In addition to the tax implications of your business, you must also carefully handle the splitting of your retirement plan accounts and IRAs. Seeking advice from your tax consultant can help you navigate the financial tax implications of your divorce settlement. Contact Shultz, Wood, & Rapp P.C., your experts in financial accounting in Missouri.