Divorce issues and business succession planning.

• Author: Capassakis, Evelyn M.

A CPA can play an important role in divorce tax planning that involves a closely held business. This article identifies some common issues the tax adviser faces when a divorcing client or spouse owns a closely held business and discusses planning techniques.

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Stock in a closely held business can be one of" a business owner's most dominant--and illiquid--assets. Similarly, in the event of" a divorce, the closely held business can also be the largest portion of the business owner's marital estate. This category also includes the marital home and retirement assets. Thus, for many business owners, the majority of their assets arc illiquid. Equally important for planning purposes, closely held business interests are both centrally important to the wealth of the family and key to its ability to generate future income.

Because spouses in the midst of a divorce are often consumed with stress and emotion that may impede rational thinking, it is incumbent on their advisers to assist them in taking the steps they need to ensure sound financial results. This article is a primer for some of the issues that a practitioner faces in advising clients in the event of (or in anticipation of) a divorce, when one of the divorcing (or potentially divorcing) parties has (or may have) an interest in a closely held business.

In a divorce, the parties' financial rights and obligations revolve around three basic concepts, any one of which can affect the business: alimony or spousal support rights, child support rights and property settlement rights. The most obvious and profound effect is when the "property" interests in the business must be divided between the spouses. This can be very problematic for a business owner with spoused or child support obligations; he or she often relies on the business as a source of funds to provide such support. (1)

Conflicts and Issues

"People" issues in a divorce arise when one or both of the divorcing parties manage a closely held business or, perhaps, neither party plays a part. To further complicate the picture, other people could be involved in the business, such as the owner's child or in-law. Emotional issues also surround a divorce and could have a huge effect on ownership sharing and management and, ultimately, the business's survival.

"Property" issues that commonly arise might include ownership rights, valuation disputes, division of the business, tax ramifications and the rights of' third-party creditors. The following discussion briefly covers these concerns and the ways a practitioner can resolve them.

Valuing the Business

For purposes of dividing marital assets, the obvious first step is to value them. Assets are usually valued at current "fair market value" (FMV), winch is generally defined as "the amount a willing buyer and a willing seller would exchange assets absent duress." (2)

The valuation of a closely held business is no easy task. One possible starting point is for one or both parties to engage an appraiser. The appraiser should be accredited in business valuation and be a member of an accredited organization, such as the AICPA, the American Society of Appraisers, the National Association of Certified Valuation Analysts, the Institute of Business Appraisers, Inc. or the Association for Investment Management and Research.

Once the appraiser has used a valuation method or combination of methods to determine a base value of the business, discounts are sometimes applied to arrive at a final value. Discounts, such as for lack of marketability or minority interests, are often used to value certain gifts and third-party sales. It is not clear whether they are appropriate for valuing a business in a divorce context)

Pre- and Post-Nuptial Agreements

The most obvious way for business owners to protect their business interests on divorce is to execute a pre- or post-nuptial agreement. Among other things, the agreement should discuss whether the nonowner spouse will have any right to the business on divorce, and, if so, the manner in which the business will be divided. If the nonowner spouse does not fully release any rights in the business, the agreement should, at a minimum, set forth a valuation method.

To avoid ambiguities requiring court intervention, a client's pre- or post-nuptial agreement should coordinate with any buy-sell agreement for the business. For example, if the buy-sell agreement requires the company to redeem the shares of an exiting shareholder, the pre-nuptial agreement should not require the other spouse to redeem the shares. The agreement should also specifically address whether potential appreciation from the time of the agreement to the date of a subsequent divorce will be considered in valuing the business.

If children of either or both spouses are active in the business or are expected to take it over, it may be prudent to ask for their input before executing a pre- or post-nuptial agreement. This may avoid conflict later.

Shareholder Buy-Sell Agreements

A buy-sell agreement is a contract governing the sale of a business interest for a specified price at a future date or on the happening of a future event. The sale typically negotiated in a buy-sell agreement usually takes one of two forms: "redemption" by the company or "cross-purchase" between shareholders?

Buy-sell agreements can provide for the possibility of divorce. For example, a buy-sell agreement may state that if any relative by marriage of X or Y (founders) is divorced from a blood relative of X or Y, any shares owned by the former (or acquired in the divorce) will be offered for sale for a set price to a specified buyer.

Buy-sell agreements can also set forth the desired method for valuing the business. Such valuation methods, although not binding on a court, are often considered in a divorce proceeding. However, as noted above, issues such as discounts, tax liabilities and business goodwill might be used in a third-party context, but may not be acceptable in divorce valuations. A separate agreement between the spouses may be able to...