If you or your spouse own a business or professional practice and decide to divorce, a common concern is how that business may be divided. Under New York law, a spouse who doesn’t have title to the business may still be entitled to a share of the appreciation depending on various factors. There are specific rules governing this, although the parties also have the flexibility to negotiate their own settlement.
General Rules
A business or professional practice is generally considered an “active asset” for divorce purposes. An active asset is one that changes in value due to the efforts of a party actively working the asset on a regular basis during the marriage. This is distinguished from a “passive asset” that increases or decreases in value due to external market conditions, such as stocks and bonds, retirement accounts and real estate. In dividing active assets, the court looks at when the business was started and the degree of contribution made by the non-titled spouse to determine how much the non-titled spouse may be awarded.
Where one spouse solely owns a business or professional practice, the spouse who has title to the business typically gets 10% of the value automatically because of his or her name recognition and/or reputation in the community that the business or professional practice is serving. Thereafter, courts will look at the non-titled spouse’s degree of contribution to the business. Contributions can be direct or indirect.
Regardless of whether contributions are direct or indirect, a non-titled spouse can only receive a portion of the appreciation in the value of the business that occurred during the marriage as explained further below.
Direct Contributions
If the non-titled spouse worked in the business, that work constitutes “direct contributions.” Where direct contributions were made, the non-titled spouse can be entitled to 25%-45% of the appreciation in the business during the marriage. This is a key point. If the business was started before the marriage, then the court looks only at the gain in value from the date of marriage until the date of filing for divorce. If the business was started during the marriage, then the non-titled spouse has a claim for a percentage of the appreciation from the start of the business.
Direct contributions can involve any type of work – manual labor, administrative, professional, etc. – and need not be on the same level as the titled spouse. However, the more work contributed to helping the business and its growth, the greater the share the non-titled spouse may receive.
Indirect Contributions
A non-titled spouse’s “non-economic” or “indirect” contributions are also taken into account in dividing the business. Indirect contributions are activities that help the business without providing money or direct services such as taking care of responsibilities the party actively working the business would otherwise have to do or making contributions through other work. These can include working in the home to maintain the house, cooking, cleaning, taking care of children, shopping, running errands, paying bills and other duties. The law recognizes that by handling these tasks, the titled spouse has more free time to devote to the business.
Where a non-titled spouse has made indirect contributions to the business, his or her claim is likely to be valued at around 5%-25%. However, the spouse can only receive that percentage on the business’s appreciation during the marriage. If the business was started before the marriage, then the court looks only at the gain in value from the date of marriage until the date of filing for divorce.
Effect of Commingling Business and Personal Assets
The rules above assume that business assets are kept separate from personal assets. However, it is not unusual for small business owners to mistakenly pay personal expenses with a business check or credit card or vice versa. Commingling business and personal accounts is a bad practice not only for business and tax law reasons but because it can also affect the division of property in divorce. Such commingling may subject business accounts to an equitable distribution analysis that may cause them to be split with a non-titled spouse.
A business’s bank accounts, real estate, furniture, equipment, inventory and other assets are the exclusive property of the business entity. When any of these are utilized for something outside of the business entity, questions arise as to the exclusive ownership of the asset which, in turn, could cause the business valuation to be compromised.
For example, the contents of a bank account are deemed 100% exclusive to the business and belong to no one else – including the spouse(s) owning the business. When a spouse uses a business bank account to pay personal expenses, he or she is compromising the boundary between business and personal expenses raising the question as to whether a business account is for the exclusive use and payment of business expenses. When found that such a boundary has not been respected by the titled spouse(s), courts will also not respect this boundary and treat the bank account as a personal asset because that is how it was used.
Accordingly, business owners should always maintain separate bank accounts and credit cards for their company and pay personal expenses from personal accounts. Doing this will help shield more assets in the event of a divorce, among other benefits.
Valuing the Business
A business is valued at the time the divorce action is filed so that the non-titled spouse does not benefit from the appreciation of the asset due to his or her efforts after the point the marriage is deemed to have ended by the filing of the divorce action.
Valuation should be done by a valuation expert. If the business was started before the marriage, the expert will calculate the amount of appreciation that occurred from the date of the marriage until the date the divorce action was filed. Where the business was started during the marriage, the appreciation is determined from the date the business started to the date the divorce action was filed.
The cost of a valuation expert may be split between the parties depending on whether the non-titled spouse has independent resources to contribute to the expert’s fees. In any event, the cost may be reallocated at the end of the divorce case once all assets have been valued and divided.
Valuing Partnership Interests
When a spouse owning the business shares ownership with one or more partners, it is necessary to first value the spouse’s partnership interest before determining the non-titled spouse’s share.
First, a valuation expert must be brought in to value the business. The whole business must be valued, including the amount of appreciation in value for the relevant period. If the business began before the marriage, the non-titled spouse’s claim is limited to the business’s appreciation from the date of the marriage to the date the divorce action was filed. Where the business was started during the marriage, the appreciation is from the start of the business to the date of filing for divorce.
Second, after the business is valued and the appreciation calculated, the titled spouse’s partnership interest must be determined as the non-titled spouse is only entitled to a portion of the titled spouse’s interest and cannot share in the value of the entire business.
Finally, the amount the non-titled spouse gets is calculated as previously discussed based on his or her contributions to the business.
Resolving Disputes
Financial matters like dividing a business can be contentious. Importantly, spouses can negotiate their own terms in divorce, including settling on a lesser or greater share of the business in exchange for some other benefit. A crucial point is to hire experienced legal and financial advisors to ensure fair terms in litigation or settlement.
If you are considering divorce, contact us to discuss how we can help you obtain the best result in your case.
