by Sheren Javdan
October 21, 2014
With divorce rates so high in California, it is important to consider what happens to a business, run by one or both spouses, upon divorce.
California is unique in that it is a community property state.
This means that, unless there is an agreement stating otherwise, fifty percent of all property¬†acquired during a marriage while domiciled in California is presumed to belong to the other spouse or domestic partner.
Property can include anything with a value from a house, car, cash, clothes,¬†stocks, a business and even intellectual property like a patent.
Upon divorce, the court is required to formally divide all the property and debts acquired during the marriage between¬†the spouses.
Although a couple may agree to divide their property in the comfort of their own home (or attorney’s office), a judge is required to legally sign off on the agreement to take legal effect.
In order to better understand what can and cannot be categorized as community property and how it is separated upon divorce or separation, and what will happen to your business during a¬†divorce, consider the following.
Community, Quasi-Community & Separate Property
The California Family Code¬†¬ß760 defines community property as “all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in this state” this includes debts incurred during the marriage as well.
Quasi-community property¬†is all property acquired by either spouse while domiciled outside California which would have been categorized as community property had the acquiring spouse been domiciled in California at the time of its acquisition.
Upon divorce, quasi-community property is treated exactly like community property.
Separate property on the other hand is all property (1) acquired before or after a marriage, (2) during the marriage by gift, inheritance or a will, and (3) the rents and profits derived from a separate property.
100% of all separate property belongs to the party who acquired it.
It is important to note that whether or not the property is categorized as community or separate property can also depend on the intent of the parties at the time the property was acquired, how title to the property was held, whether or not the funds were¬†commingled and other factors including whether or not there was an agreement between the parties.
How to Divide Community Property Upon Divorce¬†
Divorce can get messy. To avoid further complications associated with the divorce process, be sure to familiarize yourself with any rights you might and or do have to your property.
Absent any exceptions or agreements that might apply. each spouse is entitled¬†to 50% of all the community’s property, whether or not the spouse contributed to the acquisition of that property.
The most common example of community property¬†is a house purchased during the marriage.
California law does not require “in kind” division which would require a literal physical division of each property owned by the community. Rather, the law requires that each spouse receive assets which net value equals the other spouses’.
Therefore, it is common that upon divorce one spouse receives the deed to the family home estimated at $1 million, and the other spouse receives the $500,000 investment property, family cars and paintings valued at¬†$250,000 and the patent for a device valued at $250,000.
So long as the total net value of each spouses’ assets are equal, the division of the properties will be acceptable.
Generally, equally dividing¬†the properties is fairly simple. However, it does get complicated when there is a family business involved.
Specifically, where the business was purchased before the marriage by one spouse but both spouses contributed to its success¬†during the marriage.
Who Owns the¬†Company’s Appreciation?
Many business owners find themselves wondering what will happen to their business once they get a divorce.
Specifically a business that was purchased with separate property before the marriage began but flourished during the marriage with community funds. Absent a prenuptial, postnuptial or other agreement, division of the business can get messy.
Nonetheless, upon divorce and division of all the community’s property, the business must be taken into account.¬†
The key component in determining whether or not the appreciation in a business that has occurred¬†since the marriage is community or separate property is how the appreciation occurred.
Where the appreciation of the business is primarily due to community efforts such as the skill and efforts of one particular spouse, the spouse’s investment plus interest is allocated to him or her as separate property and the excess profits will be categorized as community property.
However, where a company’s appreciation is primarily due an external factor such as capital appreciation or a change in the market, the spouse will be reimbursed for his or her separate property contribution and the reasonable value of the spouse’s services to the business during the marriage will be allocated as community property.
In addition, any remainder in profits will be allocated to the initial spouse as separate property.
What Happens When the Parties Don’t Agree About a Family Business?
In the scenario in which the spouses cannot amicably decide which spouse will take over the family business, the courts will award it to the individual who brings the most value. The spouse with the most knowledge, experience and customer relations will generally be granted the business.
In order to facilitate the division, business owners must be willing to provide the courts with 100% transparency and full disclosure of their company’s operations. This includes information about the company’s debts and revenues.
Consult With a Professional
It’s always best to immediately consult with an attorney and CPA as soon as divorce becomes an option. The right professional can help steer you towards an amicable division of assets.