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________________________________________________ Corporations / Divorce
One recurring issue in divorce is how to divide the marital estate
when the couple owns all of the stock of a closely held corporation.
This can be a daunting task, especially when the value of the business
exceeds half of the value of all marital assets. Although the spouses
can continue the business through joint ownership after the divorce,
this often proves difficult. Spouses (and former spouses if the transfer is made pursuant to
divorce) can transfer property to each other without income or gift
tax, so the easiest way to divide a marital estate is simply to
split it between the spouses. This will not work, however, if the
value of the business dominates the value of the entire estate.
Thus, Jeff and Jessica must look at other options. Redeem
the Stock of One Spouse If only one spouse wishes to continue the business, the best alternative
may be for the corporation to redeem the stock of the other spouse.
For example, if Jeff wanted to continue the business and Jessica
wanted to liquidate her interest, the corporation could redeem her
stock at its fair market value. Jessica would walk away with cash
of $400,000. From a tax perspective, the goal is to have the transaction treated
as an exchange to take advantage of capital gains tax rates, which
are lower than ordinary income tax rates. The tax consequences of
a stock redemption in this context, however, are unclear. Interpreting
the interplay of several tax provisions, a court might classify
the redemption of Jessica's stock as a dividend to Jeff. As a dividend,
it would be taxed at the higher, ordinary income rates. Transfer
Stock and Pay Alimony To avoid the tax uncertainty of a redemption yet still equalize
division of the assets, one spouse could transfer all of his or
her stock to the other spouse, who then would pay alimony to the
transferring spouse. Properly structured, a divorce-related transfer
of property would not result in taxable gain or a taxable gift.
To take advantage of this planning opportunity, Jessica would transfer
her stock to Jeff pursuant to a written agreement. Jeff would then
pay alimony to Jessica, which would include an amount equal to the
value of the stock. He would make payments over a number of years
until the full amount was paid. Jeff would also be able to deduct
the payments. Payment for Jessica's stock as alimony would result
in ordinary taxable income to her, but it could be structured so
that the parties would share this additional tax liability. Split
the Business If the corporation consists of two separate and distinct lines
of business or specialties, the couple might wish to divide the
company into two businesses. The corporation could transfer the
assets and liabilities of one of the businesses into a new corporation.
Consider
All the Opportunities The estate and gift tax aspects of divorce normally involve a number of complex issues. When a closely held business is part of the mix, however, the complications increase exponentially due to the many planning opportunities available. Careful planning is required to avoid potential adverse tax consequences that may accompany the use of some of these strategies. We would be pleased to help you structure a property settlement to minimize the tax consequences and meet both spouses' needs. Why
Not Liquidate? The easiest alternative may be to liquidate the corporation. The
proceeds then can simply be distributed between the spouses. There
is a major potential obstacle to this solution, however: Both spouses
may not want to sell. And, even if both are willing, this method
is often still undesirable, because the business will usually be
worth more as a going concern (especially if it's a service business)
and finding a buyer may be difficult.
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Copyright 2001 Fahlman & Olson. All rights reserved.
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