How is an LLC Treated in a Divorce?
What is an LLC?
A limited liability company (LLC) is a business structure that combines aspects of partnerships and corporations. Like a corporation, an LLC protects its owners from personal liability for business debts and obligations. However, unlike a corporation, ownership interests in an LLC are not represented by stock certificates.
An LLC can be owned by one person (a single-member LLC) or multiple people (a multi-member LLC). The owners of an LLC are referred to as “members.” An LLC has great flexibility when it comes to management structure – it can be member-managed or manager-managed.
How is an LLC Treated in a Divorce in Texas?
Here is a brief overview of how an LLC (Limited Liability Company) is typically treated in a divorce in Texas:
- Texas is a community property state, so any LLC interests (shares of ownership) acquired during the marriage are generally deemed marital property subject to equitable division.
- The LLC interest itself is valued and divided. The spouse being divested of interest may get a payout of their share.
- The LLC operating agreement can specify in advance how members’ interests will be divided in a divorce. Courts will usually enforce this contract.
- An LLC interest may be awarded in its entirety to one spouse. The other may get an offsetting amount of other assets.
- Income generated by the LLC during marriage is community income. Profit distributions and appreciation of the company’s value are divisible.
- Non-member spouses in Texas have no automatic rights to LLC management or information. Access is granted through court orders.
- Premarital LLC interests remain separate property of the owning spouse, but income and growth during marriage is shared.
So Texas courts will determine the equitable division of marital share of LLC interests and associated income, but cannot compel an unwilling member to accept a non-member ex-spouse into the LLC.
How are assets divided in a divorce?
Equitable distribution laws
In the event of a divorce, states follow “equitable distribution” laws to divide marital property fairly between spouses. This does not necessarily mean a 50/50 split. Rather, assets are divided equitably based on each spouse’s contributions and needs.
Separate vs marital property
The court first determines which assets are marital property versus separate property. Marital property generally includes assets acquired during the marriage. Separate property is property brought into the marriage or received by gift or inheritance during the marriage.
Is an LLC considered marital or separate property?
Factors courts consider
Whether an LLC is deemed marital or separate property depends on factors like:
- When it was formed
- The source of funds used to acquire/operate it
- Both spouses’ involvement
Scenarios where LLCs are treated as marital property
Some common scenarios where courts treat an LLC as marital property:
- The LLC was formed during the marriage
- Marital funds were used to purchase the business
- Both spouses were substantially involved in running the LLC
Valuing an LLC in Divorce
Valuing an LLC for the purposes of equitable distribution in divorce can be challenging. Common valuation approaches include:
This looks at the LLC’s assets/liabilities on its balance sheet. However, book value may not adequately capture the LLC’s worth.
A business appraiser can estimate the LLC’s market value by looking at sales of comparable companies.
This method focuses on the LLC’s earnings capacity. The value is based on the LLC’s cash flows discounted to present value.
Dividing an LLC in Divorce
There are a few options for actually dividing up an LLC in a divorce:
One spouse buys out the other spouse’s share of the LLC at a mutually agreed upon or court-determined price.
The LLC’s assets are split up between spouses (who then might become 50-50 owners of the continuing LLC).
It’s critical to involve a tax professional when dividing up an LLC in divorce. Transferring LLC ownership between spouses may trigger taxes and/or impact the LLC’s pass-through tax status.
Protecting an LLC in Divorce
For business owners entering marriage, it’s wise to consider:
A prenup allows prospective spouses to define separate property ahead of marriage, like existing businesses.
A postnup made during marriage can also designate an LLC as separate property. Postnups require full financial disclosure and independent legal advice.
How an LLC is classified and divided in divorce depends heavily on state law, how and when the business was acquired, each spouse’s role, and more. Given the complexities, speaking to legal and financial professionals is highly recommended to navigate LLC asset division while also minimizing the tax impacts. With proper planning, an LLC can be protected as separate property in many cases.
1-Can my spouse take half ownership of my LLC in a divorce?
It depends. If the LLC is deemed marital property under state law, courts can award partial or full ownership to a spouse as part of equitable distribution. Proper planning can help protect an LLC as separate property.
2-What if my ex-spouse gets 50% ownership in my LLC after divorce?
You could negotiate a buyout agreement or partition agreement to divide ownership. Or, you may end up as 50-50 co-owners of a continuing LLC post-divorce, which would require operating agreements defining rights and responsibilities.
3-If my LLC loses value after my divorce, can I claim losses?
If you retain full or part ownership in the LLC, you can still claim your share of LLC losses on your personal tax return. The ability to use LLC losses to offset other income depends on tax rules like passive activity loss and at-risk limitation rules.
4-Can my LLC protect my assets in a divorce?
To an extent, yes. Because LLC owners have limited personal liability, membership interests in an LLC may be better protected compared to owning unincorporated sole proprietorships or partnerships. Creditors of an LLC cannot access owners’ personal assets.
5-Should I change my single-member LLC to a multi-member LLC before divorce?
That strategy carries risks and may be viewed as deliberately attempting to undermine your spouse’s property claims. Courts can still award equitable ownership in multi-member LLCs. Focus instead on documenting your separate property claims from the outset.
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