Getting a divorce? Be aware of tax implications if you own a business
If you’re a business owner and you’re getting a divorce, tax issues can complicate matters. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it. Taxfree property transfers You can generally divide most assets, including cash and business ownership interests, between you and your soontobe exspouse without any federal income or gift tax consequences. When an asset falls under this taxfree transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for shortterm or longterm holding period purposes). Let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be taxfree. And the existing basis and holding periods for the home and the stock would carry over to the person who receives them. Taxfree transfers can occur before a divorce or at the time it becomes final. Taxfree treatment also applies to postdivorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:
More tax issues Later on, there will be tax implications for assets received taxfree in a divorce settlement. The exspouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies). What if your exspouse receives 49% of your highly appreciated small business stock? Thanks to the taxfree transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your exspouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing. Note that the person who winds up owning appreciated assets must pay the builtin tax liability that comes with them. From a netoftax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement. In addition, the beneficial taxfree transfer rule is now extended to ordinaryincome assets, not just to capitalgains assets. For example, if you transfer business receivables or inventory to your exspouse in a divorce, these types of ordinaryincome assets can also be transferred taxfree. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability. Plan ahead to avoid surprises Like many major life events, divorce can have major tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. We can help you minimize the adverse tax consequences of settling your divorce. © 2021 |
