Divorce and Business Ownership: Top Five Things to Know If You Inherit or Are Gifted a Business
If you’re married and about to take over a family business, it’s not uncommon for your parents or the owners to encourage you to take steps to make sure it’s protected in the event of a divorce from your spouse. While Arizona is a community property state, there are a few things you can consider to protect the business. If this is your situation, here are the top five things you should know:
1. Anything acquired during your marriage is community property, except property that is gifted or inherited.
An Arizona divorces follow community property laws unless there is a prenup or agreement otherwise. So, any business acquired during the marriage is community property (i.e., it belongs equally to both spouses) with 3 important exceptions: a business acquired by gift, devise, or descent is not community property. Devise is an inheritance received through a will, trust, or other written instrument. Descent is an inheritance received when someone dies without a will. See intestate succession. A gift, of course, is someone giving the business to another person.
2. If the business is gifted, how you receive the gift matters.
Because the three exceptions of gift, devise, and descent are well-defined—how you receive the business matters. Inheritance generally provides a clear marker for how property was received; gifts, however, are murkier.
In a divorce, the spouse claiming the business was gifted to them has the burden of proof, and they must show (1) donative intent, (2) delivery, and (3) a vesting of irrevocable title on delivery. See Hrudka v. Hrudka, 186 Ariz. 84, 92-94 (App. 1995). In simpler terms, they must show the person who gave them the business intended it as a gift, that they actually handed ownership over to them, and when that happened, the prior owner revoked any interest they had in the business.
Sometimes what people label as a “gift” is really a buyout. Commonly, an individual who receives a business from their parents continues to pay the parents a certain amount of the profits. Such an arrangement creates a headfirst problem with the idea that the business was gifted to the spouse because it casts doubt on whether there was donative intent, and a vesting of irrevocable title. Therefore, one must beware that if money is being exchanged between the prior owner and new owner, even if it is just for a portion of the value of the business, then that is a likely purchase and not a gift. The business, therefore, will likely remain subject to community property laws and be divisible in a divorce.
3. You can take steps to protect your interest in the business.
Options to protect yourself and strengthen your case that the property is your sole and separate property:
- Legal Separation. This is the most effective way to end the marital community and stay married but also the most complicated way to do it. If you get a legal separation before you receive the gift or inheritance, it is community property because a legal separation ends the application of community property laws to a marriage. A legal separation is often misunderstood as the spouses living separately; rather, a legal separation refers to a court proceeding that mirrors that of a divorce in all aspects, but one: You remain married at the end of the process. See A.R.S. § 25-313. At the end of the legal separation process, the marital community is over. In fact, in a legal separation, all assets and debts in the marital community must be divided. The downsides: Both spouses need to agree to the legal separation, and because it is a court proceeding, it can be time-consuming and complicated.
- Postnuptial Agreement. This is an effective and simple option to protect a business that you inherited or is gifted to you. Spouses can agree to opt out of Arizona’s community property laws or change how those laws apply, if at all, to the business. A postnuptial agreement has added requirements beyond that of a normal contract. There must be disclosure of all assets and debts, a negotiation that is fair, and terms that are not unjustly one-sided. See A.R.S. § 25-202. Additionally, if challenged later, the person trying to uphold the postnuptial agreement in a divorce is the one with the burden of proof.
- Get written confirmation that the business is a gift. Since gifting a business requires showing donative intent, delivery, and irrevocable title. Written confirmation from the “Gifter” at the time of the transfer can note all these things. While far from being rock-solid legally, it can help establish these factors in court. But beware, this is not as strong as the other options listed above.
4. If you add your spouse to ownership documents, the business will likely become community property.
Even if you acquire the business as your sole and separate property, the business may still become community later—but only if you choose to transmute it. A business becomes community property either when you agree to own the business with your spouse, or if you add your spouse to ownership documents of the business. This will likely result in your spouse having an equal ownership interest.
5. Even if the business remains your sole and separate property in a divorce, your spouse may be entitled to a portion of the business.
Even if the business is awarded 100% to you as your sole and separate property in a divorce, your spouse may be entitled to a portion if the value of the business increased during the marriage.
The Court will first determine how much the business increased in value from the date you received ownership of the business to the date of service. The Court then must determine how much of that increase is due to your marital labor, and how much is due to the nature of the asset. Whatever portion of the increase is the result of your efforts during the marriage is community property, and your spouse can receive half of the increased value.
Conclusion
When getting ownership of a business during your marriage, it’s wise to discuss the potential risks and ramifications of future scenarios with an attorney. One of the biggest misconceptions is that since a business owner’s spouse had nothing to do with building or running the business, they have no interest in the business. But even if the business is your sole and separate property, when community property laws apply, the community lien may be substantial. So, it’s better to be proactive and protect your ownership before you have it.
Related Pages and Posts:
Community Property vs. Separate Property: How to Know the Difference – State 48 Law Firm
