How an LLC is treated in a divorce depends primarily on whether it is marital property or not. If the LLC is a marital asset, then it may be divided during the divorce proceedings.
However, the divorce court will divide your ownership interest in the LLC, and not the business assets. Even if the LLC is your separate property, the increase in its value during the marriage may be awarded to your spouse.
The second most important factor is whether you own the entire company, or just a part of it. If you are a part owner, then the LLC’s operating agreement probably prohibits transfer of your ownership share in the event of divorce. In that case, only your share of the value of the business is divisible.
Who Will End up with the LLC in a Divorce?
Many small business interests a married couple may own are LLC’s. This is because a Limited Liability Company is easy to form, easy to manage, and easy to adapt to accommodate growth.
If you and your spouse own the entire business, then in over twenty years of divorce lawyering, my experience has been that one of the spouses ends up with all of the company. The other spouse then gets other marital property in exchange, such as the marital home.
There a number of reasons for this.
First, most small businesses are one person’s “baby,” even if the other spouse put in a lot of hard work to build it.
Second, you are probably less motivated to run the company if your former spouse owns half of the business.
Third, if you are part owner of a family business, the operating agreement probably prohibits transfers to people who are not family members.
One of my clients and his wife did decide to continue to own and operate their family businesses together after their divorce. It is possible, if you are better business partners than a married couple. However, their situation is definitely the exception.
Is the LLC marital property or non-marital property?
This is the first question you must answer. However, the answer depends on several factors.
Do you live in a community property state or an equitable distribution state?
Community Property State
Community property states generally consider all marital property acquired during a marriage as marital property. It does not matter which spouse’s name is listed as owner of the property.
Your LLC is presumed to be marital property, if you live in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas or Washington, then .
Equitable Distribution State
If you do live in any other state, then you are in an equitable distribution, or a common law state. In these states, if the LLC is in one spouse’s name, then it is presumed to be separate property.
Presumptions in Both Types of States are Rebuttable
In practical terms, it does not matter all that much which type of state you live in. The same factors that can overcome the presumption that an LLC is part of the community estate can in the alternative defeat the presumption that an LLC is separate property.
For instance, if an LLC was funded with money from an inheritance, it is probably considered separate property in a community property state. On the other hand, if an LLC is started with marital funds, then it is probably marital property, regardless of who “owns” the LLC.
Was the LLC Formed Before or During the Marriage?
If the LLC was formed before the marriage, then it starts out as separate property. However, in order to for it to remain separate, there must be no commingling with other marital assets.
Was the LLC Acquired Through a Gift or an Inheritance?
Sometimes people will inherit an LLC through a will or a trust fund. Sometimes a family member gift people an LLC. In all of these cases, the LLC is not subject to the division of property during the divorce process. If the receiver of that LLC continues to operate it as separate property, then it will remain theirs in the event of a divorce.
Was the LLC Capitalized with Separate Funds?
If a person inherits some money and then uses that money, and only that money, to form an LLC, then that LLC is separate property. However, if the LLC was formed during the marriage, and funded even partially with marital funds, then it is usually part of the marital estate.
Is the LLC subject to a prenuptial agreement?
A prenuptial agreement can protect an LLC from becoming marital property. However, a prenuptial agreement is not a magic bullet. They require careful drafting. You should get some legal advice from a competent family law attorney if you need to keep your LLC separate.
Even if there is a good prenuptial agreement in place, you must remain careful not to commingle the LLC with your marital property.
Is the LLC Subject to a Postnuptial Agreement?
A postnuptial agreement is made after marriage between spouses. Although the parties are still married, these agreements are kind of like separation agreements. They determine property division between the spouses in the event of divorce, and sometimes death.
Postnuptial agreements are even more difficult to draft correctly than prenuptial agreements. However, if done correctly, then they can keep an LLC as separate property.
Are Both Spouses Actively Involved Operating the LLC?
Sometimes an LLC is in only one spouse’s name, but both spouses are actively involved in its operation. In most divorce cases, such an LLC will be considered a disregarded entity for purposes of considering it as non-marital property.
Are LLC Funds and Assets Commingled With Marital Funds Assets?
This is probably one of the most important questions to ask. If the LLC is commingled with the marital estate, then it is almost never separate property, regardless of where you live.
Limited Liability Companies are designed to protect their owners from liability, not to protect the business during a divorce. Commingling the LLC with other personal property can also destroy its protection from owner liability. Therefore, commingling should be avoided, period.
How do you avoid commingling your LLC?
The LLC must be operated wholly separately from the remainder of the marital estate.
There must be no additional investments from any other source than the earnings of the company. If you invest marital savings, home equity, or spouses’ earnings, then you have commingled.
However, if you inherit money from your grandparents as your separate asset, then you can invest that in the LLC without commingling.
The non-owner spouse cannot work for the company for “free.” They must earn a fair wage, and those wages must be paid. Otherwise, the non-owner spouse’s contribution of labor will be considered their investment, and then the LLC will be commingled.
Some other ways to avoid commingling are listed below:
- Maintain a separate bank account for your LLC
- Keep a separate credit card for your LLC
- Do not charge your groceries or your family vacations on your LLC card
- Pay yourself a salary, and withhold taxes, social security and medicare
- Do not pay for personal things from your LLC account
How is a marital LLC treated in a divorce?
If the limited liability company is indeed marital property, then the shares can be split between the spouses, one of the spouses can receive the whole LLC in return for a larger share of other assets, or the LLC can be sold or liquidated.
Can the LLC interest be split or shared between the spouses?
If the spouses can continue to share their interests in the LLC, then the solution is simple. Each spouse is awarded half of the LLC. There is no need for a business valuation, since it doesn’t matter how much the LLC is worth.
Other marital assets are easier to value. Real estate, cars, jewelry, and such can be appraised. Investments, bank accounts, and other such intangible assets do not need to be appraised.
Unfortunately, most LLCs do not lend themselves to sharing between former spouses.
Some type of LLC, such as a professional practice, cannot be shared between spouses, unless they are both in the same profession. For instance, a medical practice usually cannot be owned by non-doctors. The same is true for law firms.
Finally, if the LLC is a family business, and has members in addition to the married couple, then the family will have a lot to do with how an LLC is treated in a divorce. It is unlikely that the remaining LLC members would allow the divorced “non-family” person to remain in the business.
Buying out a spouse from the LLC
If the LLC cannot be shared, but one of the spouses wants to continue to operate it, then they will have to “buy out” the non-owning spouse.
In such cases, the spouses can agree on the value of the LLC, or they can spend some money to determine the value of the company. This may be easy if the LLC is a type of business that basically holds real estate.
However, the value of a business is a subjective thing. The person who is going to keep the business usually thinks it is worth less, while the other thinks it is worth more. Their respective divorce attorneys will certainly argue accordingly.
A judge would want to know the fair market value of the business. Arriving at that value in court will usually require testimony from a couple of expensive business appraisers as experts.
When the value is determined, then the remaining marital assets are divided in such a way that each spouse receives an equal amount of the total value of the marital estate.
Selling or Liquidating an LLC In Divorce
Sometimes a divorcing couple does not wish to continue LLC. Sometimes the business value is mostly made up of assets such as vehicles or heavy equipment. In those cases, it may make more sense to sell or liquidate the company.
If the company can continue to operate during the sale process, then the parties could each be awarded half the LLC. They would then split the proceeds at the time of closing.
If the company consists mainly of physical assets, then it could become an asset division case. The divorce decree could award certain pieces of equipment to each party, to do with as they please.
How Are Other Business Structures Treated In a Divorce?
If you have some other business structure, it will be treated similar to an LLC in divorce.
How is a Sole Proprietorship Treated in a Divorce?
A sole proprietorship type of business is not a separate entity from its owner. Examples of these would be a carpenter, handyman, e-bay reseller, author, etc., who has not created an entity for their business.
A sole proprietorship therefore is unlikely to be split between the couples. Nevertheless, if the business has some value, the non-owning spouse’s interest would be awarded as other property. In the alternative, the equipment and/or the inventory could be split between the couple.
If both spouses worked in the business, but they treated it as a sole proprietorship, the court would most likely consider the business to be a general partnership. In that case, both spouses would be equal owners, and many more options would be available to the Court.
How are Limited Partnerships Treated in a Divorce?
Limited partnerships, or a limited liability partnership, consist of one or more general partners and one or more limited partners. The general partner runs the business, while the limited partners contribute capital, but do participate in running the business.
These are complicated business arrangements. They are almost always governed by a comprehensive limited partnership agreement. The terms of that agreement will have a major impact on what happens to those interests in a divorce.
How is an S Corporation Treated in a Divorce?
An S corporation is generally a small business corporation with a limited number of shareholders. It becomes an “S Corporation” when it elects to have its shareholders taxed at regular income tax rates.
S Corporations usually have share transfer restrictions. Therefore, when those shares are marital property, an S Corporation is treated much like an LLC in divorce.
How is a C Corporation Treated in a Divorce?
A C Corporation is a regular corporation, managed by a board of directors and operated by officers. If it is a close corporation, share transfers are tightly controlled. The spouse that is not “in” is unlikely to get shares of the corporation as part of a divorce settlement. They will almost certainly receive their share as other marital assets.
If on the other hand the corporation is public, or its shares are widely dispersed, then the Court would probably just split the marital shares between the parties.
In summary, the form of LLC ownership before the divorce will have the greatest impact on how an LLC is treated in a divorce.
If the LLC was formed, owned, and operated by one of the spouses before the divorce, then it may very well be treated as that spouse’s separate property.
However, if the pre-marriage LLC was commingled during the marriage, or if it was formed during the marriage, then it will almost certainly be treated as marital property.
A marital LLC will usually end up as the property of one of the spouses, and the other spouse will be compensated with a greater share of other marital assets.
However, if the parties cannot, or do not want to, sell or continue the business, then the court will order liquidation of the LLC, as prescribed by state law.
By Steve Harton, a divorce attorney licensed in Florida, Utah and Wyoming. Steve serves clients in all three states from his office in Rock Springs, Wyoming. If you need some legal advice about probate, please schedule a consultation!