On Thursday, I wrote about a client in the middle of divorce who wanted to launch a small business. It would be a sole proprietorship and would be in name only, as opposed to being operated online or from an actual location. Her dilemma was whether she should wait to launch her business until after the divorce is finalized to avoid any future problems with her husband. She was afraid he may be entitled to any future profits if she launched her business now, since all property is supposed to be disclosed and divided as part of a final settlement.
I spoke with an attorney who stated that as long as she avoids making any significant profits before the divorce goes through then she should be okay. Her husband can come back after the divorce and try to make a claim for any future profits since the business was launched during the divorce process, but it was unlikely. Even if he does sue her in the future, she can make several arguments in her favor. The most qualified would be that her business had not generated any profits before the marriage ended. She was assuming a big risk though, so he recommended she postpone her plans.
Under the tax laws, businesses acquired during marriage are categorized as property. Whether or not a spouse is entitled to any portion of that property when a divorce commences depends on whether it was owned in community or separately. It would need to be determined whether that property, in this case the business, was purchased jointly or solely by the owner. According to IRS Publication 504, even if property is transferred as part of a settlement, there is never an exchange of profit or loss to a former spouse.
There are two requirements that must be met: the transfer has to be as part of the original or modified settlement and it must occur within six years of the divorce. Tax rules differ once if these exceptions are not met. But the transferer (in this case the client) is required to report that profit or loss on her tax returns up until the time of the transfer. There are exceptions to consider, such as what happens after that six year period expires and the time frame in which a modified settlement would occur. As the attorney explained, a spouse can appeal a settlement so the statute of limitations on that appeal would need to be considered as well.