How to Make Divorce Less Painful When a Business Is Your Baby

In partnership with Bloomberg Media Studios

The increased rate of divorce among older couples has repercussions not just for the families involved, but also for family businesses.

Divorce itself is hard enough; it’s even more complicated when it involves a shared business. While the high-profile Gates and Bezos divorces feature many more zeros than most, they’re part of a growing trend of older couples facing complicated issues around splitting a shared business when they part ways.

The overall divorce rate in the U.S. may be at a 50-year low, but for couples over age 50, it’s higher than ever. The rate of “gray divorces” has been on the rise for the past two decades, in part due to an aging population with a greater propensity to end marriages.

The increased rate of divorce among older couples has repercussions not just for the families involved, but also for millions of family businesses; Baby Boomers and Gen X are the demographics most likely to own a small business.

“These are peak earning years. If they have a business they’ve been building, this is when it’s really achieving its top potential, so it’s likely to be a huge part of the marital assets. But that presents a major problem in divorce because a business doesn’t divide neatly,” says Ben McGloin, Head of Advice, Planning and Fiduciary Services at BNY Mellon Wealth Management. 

WORKING TOWARD A CLEAN BREAK

There are three main options for splitting a shared business when divorce is in the works. In most cases, one spouse, usually the one who was most active in the business, buys out the other. A potential complication can occur if the spouse who intends to buy doesn’t have enough liquid assets to buy out the other. In other situations, a spouse can refuse to sell.

As a buyout is often the best solution for both parties, the spouse who wants to make a purchase should explore possible sources of funds, which can include:

  • Cash value on life insurance
  • Qualified Domestic Relations Orders (QDROs) that allow qualified retirement assets to be used as tax-free, penalty-free collateral for loans
  • A promissory note to a non-business spouse that can be secured by interests or assets in the business. (This option may pose risks for a non-business spouse and call for protective measures, such as creating a trust with an independent trustee.)

Another choice is to sell the business altogether and split the proceeds. The downside to this approach is if the couple intends to pass the business on to their children, or if it’s a bad time to sell because of market conditions. McGloin recalls one situation in which a couple sold a family business because of the divorce, only to see the new owners fire all of the family’s adult children who were working there. 

The third option is to stay in business together, even after the divorce. That’s usually seen as a temporary fix, and it only works if the divorce is amicable and both spouses have enough of a financial cushion to get by until the sale can happen.

CREATE A STRONG TEAM AND PLAN WHILE YOU’RE STILL TOGETHER

There are pros and cons to each of these approaches, but all can get messy. Advisors say that it helps to do some prep work even if they’re still happily married, especially if the business comprises the bulk of marital assets. Advance planning helps not only in case of a divorce, but also with estate planning and potential sale or transfer of the business to a successor.

McGloin advises couples, whether or not they see divorce in the future, to set a strong foundation for the business by assembling a team that includes an investment advisor, attorney, and CPA.

“The earlier they can start, and the more that the business is part of the marital assets, the more critical this planning is,” says McGloin.

DON’T STAY IN THE DARK, OR GIVE UP CONTROL

Couples should ensure that their business and personal expenses are kept separate and that the business is structured properly. If there is a future sale, business valuation professionals will struggle if there are commingled expenses and unclear structures. And if the IRS conducts an audit, discovery of misallocated expenses may lead to costly tax assessments and possible penalties.

Boryana Zamanoff, Senior Wealth Strategist at BNY Mellon Wealth Management, emphasizes that both spouses should stay abreast of company and personal finances, even if one isn’t heavily involved in the business.

“Not abdicating control over your financial life is truly the one thing that will prepare the spouse for divorce,” says Zamanoff.

Having a strong personal balance sheet, individual access to credit as well as a solid understanding of each other’s assets and liabilities can help both spouses enter a divorce negotiation armed with facts and, hopefully, less drama. 

ESCAPING THE TAX-FREE TRANSFER TRAP

In the current environment of changing tax regulations, divorcing couples are battling it out over gift tax exemptions. Allocating existing higher exemptions to irrevocable trusts for the benefit of joint children is an item of discussion for many marital settlement agreements.

Another area of focus, advisors say, is Spousal Lifetime Access Trusts, or SLATs. Many married couples rushed to form these a decade ago when there was concern that exemptions would decrease from $5 million to $1 million. SLATs allow one spouse to transfer assets in a trust for the benefit of the other spouse by using the current lifetime gift tax exemption before it’s reduced. Proposed reductions in the estate and gift tax exemptions are now causing renewed interest in SLATs.

As it turns out, the tax-free transfer can end up as a trap. Depending on how the trust was drafted, some divorcing spouses now find that they have to continue paying income tax on the trust of which their ex-spouse is a beneficiary, even though they themselves no longer have access to the funds and have given up that lifetime gift and estate tax exemption because it’s wrapped up in the SLAT. 

For couples drafting a new trust, it’s important to consider provisions that address what happens in case of divorce, says Zamanoff. For instance, couples can include a provision that specifies that in case of divorce, the trust will convert to a non-grantor trust, so the spouse who is not a beneficiary doesn’t have to continue paying income tax on those assets. 

“For clients who still have the opportunity to include these provisions, they should really discuss that with advisors, because we’re seeing the unintended consequences,” she says.  

The bottom line: With more assets to split, gray divorces can be more complicated from a financial standpoint. Couples should create a solid plan for both personal assets and the shared business—whether or not divorce is in the works.  

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