BUSINESS & ENTITY INTERESTS

A closely held business is usually the largest and least liquid asset in a marital estate. It is also the one where the valuation and the tax analysis are most often confused for each other.

The forensic accountant produces a value. That is a different question from what the business is worth to the spouse who receives it after tax, and a different question again from what dividing it will cost.

WHAT THE VALUATION DOES NOT SHOW

• Built-in gain. An entity holding appreciated assets carries an embedded tax liability that appears on no balance sheet and reduces what the interest is actually worth.
• Outside basis. A partner’s basis in the interest — sections 704(d), 705 and 752 — determines what can be distributed without gain and what losses can be used. Two partners with identical percentages can have very different bases.
• Debt allocation. Partnership liabilities are included in basis, and a shift in the allocation of debt on division can itself be a taxable event.
• Suspended losses. Losses suspended at the entity or the owner level attach to the owner. Who takes the interest takes them.
• S corporation limits. The single class of stock requirement and the eligible shareholder rules restrict how an S corporation interest can be divided without terminating the election.
• Compensation versus distribution. How the operating spouse is paid affects both the value of the business and the support analysis, and the two interact.

THE DIVISION ITSELF CAN CREATE TAX

Section 1041 covers transfers between spouses incident to divorce. It does not cover every structure used to divide a business. A redemption of one spouse’s interest by the entity, rather than a transfer between the spouses, can produce a taxable event and can shift the burden in ways neither party intended — a question with a body of case law behind it and a result that depends on how the documents are drafted.

This is a place where the structure chosen by the drafting lawyer, in good faith and for non-tax reasons, determines who pays.

WHAT THE FIRM DOES

Reads the operating agreement, the partnership agreement, or the shareholders’ agreement alongside the valuation; identifies the basis, debt, and suspended-loss positions; models the tax consequence of each division structure under consideration; and works with the litigator so the mechanism chosen produces the intended economic result.

Related: Partnership Audits and Tax Planning.

ELSEWHERE IN THIS SECTION

• Divorce Special Counsel — the overview, and how the engagement is scoped
• The Tax Gap in Divorce — Why the litigator and the forensic accountant both correctly decline the question, and what falls through between them.
• Testing Tax Claims Across the Table — An asserted tax consequence is a legal position, not a fact. It can be verified, and it is frequently wrong.
• After-Tax Value of Marital Assets — Basis, built-in gain, recapture and character — and why dividing the schedule down the middle is rarely an equal division.
• International Assets in a Marital Estate — Foreign trusts, PFICs, offshore holding companies and non-US pensions, where the penalty exposure can exceed the asset.