§ 10.01 The Business Started During Marriage
| Jurisdiction | United States |
| Publication year | 2021 |
§ 10.01 The Business Started During Marriage
[1]—The Business as Marital Property
In a marital property state, a business started during marriage is marital property if the business is capitalized with marital property.1 If separate property is used to purchase corporate stock during marriage, the stock is separate property.2 Similarly, if the spouse receives the stock as a gift from a third person during marriage, the stock would be separate property if gifts from third parties are separate property.3 In most instances, spouses capitalize businesses started during marriage with marital property. If a spouse borrows funds to purchase the interest, the interest will be marital property.4 A non-profit corporation established during marriage is normally not considered a marital asset.5
Sometimes it is unclear whether the interest involved should be considered acquired during marriage. For example, in a New York case6 the husband was working for a major accounting firm at the time of marriage. He was made a partner during marriage, and the court considered the partnership interest totally marital property.7 It could be argued that the separate estate should receive some credit for the husband's work at the accounting firm before marriage, since these services partially earned the partnership interest.
A Louisiana court has held that the separate character of stock is not affected if that corporation is dissolved during marriage and "reincorporated" with essentially the same assets.8
In a California case, a spouse started a proprietorship business before marriage and formed a corporation during marriage. Apparently the assets of the proprietorship were contributed to the corporation. No stock was ever issued. The trial court concluded that the corporation was marital property, but that the owning spouse's separate estate should get a credit for the value of the assets contributed. The appellate court reversed, holding that the corporation was separate property.9
In an Illinois case, the spouses disagreed about whether the marital contribution to the separate property business was a loan or an equity investment.10 If it was a loan, it would have to be repaid.
A Florida court held that, although the husband did not pay for a partnership interest he received during marriage, it was a marital asset, not a gift.11
[2]—Rents and Profits
Profits or dividends received during marriage relating to a marital property business are marital property. Profits received during marriage relating to a separate property business would be characterized based on the rule chosen in the forum state for income from separate property.12
[3]—Increases in Value During Marriage
All increases in value during marriage of a marital property business generally are marital property.13 The reason for the increase is irrelevant. Any increase in value during marriage of a separate property business would be characterized based upon the rule adopted by the forum state for increase in value of separate property.14
[4]—Valuing the Marital Property Business
[a]—In General
In order to divide the marital estate equitably, the divorce court first must value all marital assets, including a marital property business. The valuation of a marital property business can be affected by a number of factors,15 such as the type of business organization (i.e., whether it is a sole proprietorship, partnership, limited liability company or corporation), the nature of the business, the prospects for the industry, whether there are other partial owners of the business (and, if so, whether the spouse's interest is a controlling interest16 or a minority interest),17 the income of the business, whether the shares are traded on a national securities exchange,18 and the aggregate amount of the business's assets and liabilities.19
[b]—Valuation Techniques
Various valuation methods have been used. Commonly used methods include the book value approach,20 capitalization of excess earnings,21 capitalization of earnings (not excess earnings),22 and valuation based upon a multiple of the earnings of the business.23 An Alabama case referred to the "income approach," the "asset approach," and the "market approach" as the three recognized valuation methods.24
IRS Revenue Ruling 59-6025 is frequently referred to as a guide. The valuation set forth in a buy-sell agreement signed by shareholders can also affect value.26 Although a number of courts have considered the value set forth in a shareholders' agreement to be an important factor when determining the value of shares,27 some have not used the valuation approach set forth in the agreement if the agreement did not apply to a transfer of shares in connection with a divorce.28
A New Jersey case includes a detailed discussion of various issues that can arise using a capitalization of earnings valuation approach.29 For example, when valuing a business based on its income, experts first will make "normalizing adjustments" to find the accurate income of the business.30
Such calculations can be very complicated. For example, in a Missouri case both experts valued a company using the "excess earnings" approach. However, one expert reduced the earnings by considering depreciation, whereas the other ignored depreciation if the asset had not in fact lost value. Also, the question arose whether only the assets and earnings of the parent corporation should be considered or whether all subsidiaries should be included.31
If the standard for valuing an asset at divorce in the state is its "fair market value," evidence of recent sales of the interest could be relevant.32
In a Massachusetts case, the court considered whether to incorporate a discount for corporate income tax despite the fact that the business was being operated without tax as an S corporation. The trial court incorporated such a discount, accepting the argument that any buyer would incorporate a discount in any future sale. The Massachusetts Supreme Judicial Court reversed, concluding that the shares should be valued reflecting the tax advantages of an S corporation compared to a C corporation.33
Another Massachusetts case discussed the appropriate valuation approach for different business association forms. The court stated that the direct capitalization of income method was the preferred formula for valuing corporations and stock holdings, and that the discounted cash flow approach should be used to value a partnership interest.34
An Oregon court held that, when an interest in a business is valued at divorce, the valuation has to be based on some evidence in the record that sets forth the valuation methodology utilized to determine the value.35
[c]—Various Possible Discounts
[i]—Discount for Taxes
A Nebraska court has concluded that it was reversible error to reduce the value of an interest in a business for tax liability for depreciation recapture or capital gains absent evidence that a sale of the business is reasonably certain at the time of divorce.36
An Alabama court has held that it was an abuse of discretion to value a spouse's interest in a closely held business at liquidation value when it was contemplated at divorce that the business would continue operating.37
In a North Carolina case involving the husband's interest in his medical practice, the court held that no discount for capital gains taxes was needed because the husband had no immediate plans to sell his interest.38
In an Ohio case, the court rejected the husband's argument that the court should have deducted a factor for capital gains taxes when valuing marital assets, because he would have to sell some assets to be able to make the payments to the wife ordered by court. The appellate court ruled that the husband had not established that a sale of assets would be necessary.39 The valuation of a business normally includes a factor for goodwill, to the extent that goodwill developed during marriage is a marital asset.40
A New Jersey court has ruled that, when property is valued at divorce, the court generally should not discount the value for the hypothetical tax consequences of a future sale of the asset, unless it is certain in connection with the divorce that the asset will be sold.41
The New Hampshire Supreme Court has reversed a valuation of marital property that included a deduction for estimated tax consequences when no sale of the property was contemplated.42
The Idaho Supreme Court held that the value of an ownership interest in a closely-held business at divorce should not be reduced for hypothetical tax due, when no sale of the interest was planned.43
A Missouri court affirmed a deduction for hypothetical tax due when valuing a business at divorce when it seemed quite possible the parties would need to sell the business in light of the parties' financial difficulties.44
[ii]—Discount of Lack of Marketability and Lack of Control
When valuing a spouse's interest in a marital property business, most courts attempt to determine the "fair market value" of the interest. Pursuant to this approach, the court attempts to determine the amount the spouse would receive from a third party on the open market. From this perspective, the value of the interest may well need to be discounted for a number of reasons.45
From this perspective, if the spouse owns a minority interest in a closely held business, the value of the interest should be discounted.46 A lack of marketability discount may also be appropriate if the shares are subject to restrictions upon transfer,47 or for some other reason would not be easy to sell.48 Such discounts can be substantial. For example, in a Mississippi case a marketability discount of 50% was applied.49 A Florida court applied a 20% discount for lack of control.50 If the court finds that the owner will not have to sell his interest by itself, but that all the owners will sell at the same time, a minority interest may not be warranted.51 A South Carolina case held that...
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