Attorney
Reading through the reams of documents created when you started or bought into a S-corp is a task you likely delegated to an attorney. Your job was running the business, or supporting your business-running spouse, not checking to see that every i was dotted and t crossed. You likely opted not to read through every IRS regulation that makes S-corps so appealing too.
But now that you are getting divorced, all that fine print and regulatory mambo jumbo will determine how the shares of your business (or at least their value) are split between you and your soon-to-be-ex-spouse under New Mexico’s community property laws.
Make the wrong move, and you will jeopardize the business or get hit with a huge tax bill. Which is why the right move is bringing in attorney Bob Matteucci. Bob holds both an MBA and a law degree. He spent years running his family’s multi-generation, and multi-million dollar, retail shoe business before a divorce of his own led him to law school. His training and lived experience mean he understands how much is at stake when business interests must be divided at divorce.
Keeping Your S-Corp Out of Court is Good for Business
New Mexico is a community property state, which means S-corp shares that were acquired or increased in value during your marriage, are generally presumed to be jointly owned, regardless of whose name is on the stock certificate. In order to finalize your divorce, the value of these shares, or even the shares themselves, must be divided 50/50.
For most business-owning couples, dividing shares (or their value) is just one of many boxes to check as your separation agreement is finalized. It’s also important to make sure the business keeps running, and the IRS isn’t too invested in what you are doing. Checking those boxes is just as important to making sure the non-owner spouse is fairly compensated, but that’s not how New Mexico divorce law and the judges that oversee it view things.
Rather than handing your financial future to someone who’s got a gavel, but limited time to dig into the details and no accounting background, wealthy couples in the Albuquerque area are opting to craft their own agreements through mediation or a collaborative divorce process, then bring them to a judge for approval.
Sometimes that means one spouse buys out the other’s interest outright. Sometimes it means restructuring how shares are held. Sometimes a trust is the right vehicle; sometimes it isn’t. What works best depends on your family, the business, IRS regulations, and the fine print in your S-corp’s articles of incorporation, corporate bylaws, stock certificates, and buy-sell agreements.
The rest of this post will cover some of the issues that arise when the actual shares of an S-corp, rather than their value, are going to be divided.
Limits On Who Can Hold Shares Will Shape Your Settlement
The fine print in an S-corp’s governing documents often shapes what options are available when a divorcing couple heads to the negotiating table.
S-corporations aren’t allowed to have just any shareholder, and this is where the fine print can quietly derail an otherwise reasonable settlement.
- Eligible shareholders are limited by law to individuals who are U.S. citizens or residents, certain estates, and a narrow list of qualifying trusts. If part of your settlement contemplates placing shares into a trust to formalize the ownership split, or for the benefit of children, or for estate planning purposes, that trust has to meet IRS requirements or the company risks losing its S-corp election entirely. These trusts are often referred to as QSSTs (Qualified Subchapter S Trust) or ESBTs (Electing Small Business Trust).
- An S-corp’s governing documents can limit shareholders. It’s common for these documents to require existing shareholders’ consent before new shares are issued or transferred, grant other owners a right of first refusal to buy out a departing shareholder, or bar transfers to a spouse or ex-spouse entirely in the event of divorce. If your settlement calls for one spouse to receive shares outright, these provisions need to be double checked since a conflict between your divorce decree and the company’s own governing documents can stall a transfer or force a renegotiation of the settlement’s structure.
- S-corps are also capped by law at 100 shareholders.
In most divorces the 100 cap isn’t the obstacle. The real risk is inadvertently creating an ineligible shareholder.
If Shares Change Hands, the IRS Wants to Know
If shares are going to change hands, Internal Revenue Code (IRC) §1041 comes into play.
Under this law, transfers of property between spouses (or between former spouses, if the transfer is “incident to divorce”) don’t trigger immediate capital gains tax. The receiving spouse simply steps into the transferring spouse’s original cost basis, known as carryover basis. There’s no taxable event at the moment of transfer.
The receiving spouse will be responsible for paying tax on gains eventually, which is something to consider when negotiating a buyout or offset.
Another thing to keep in mind is that a transfer only qualifies as “incident to divorce” if it happens within a certain time period. Miss that window and §1041 treatment can be lost.
Serving Families with Dignity & Compassion
If S-corp shares are part of your marital estate, the fine print of your organization’s creation and governing documents is going to shape your divorce settlement. Whether you end up dividing the shares themselves, or simply the value of them, having an attorney at your side who understands both business and family law is critical.
Thanks to his background as a small business owner, Attorney Bob Matteucci is as comfortable talking about shareholder eligibility and cost basis as he is spousal support and joint custody. It’s a rare combination of skills that he is ready to put to work for you, so you, your family, and your business can move forward. Please contact him today to schedule a meeting and discuss your case.