Characterizing Businesses and Business Interest
Updated: Feb 15
In a Texas divorce, all of a couple’s property must be classified as either community property or separate property. Because one spouse’s separate property is usually not subject to division by a court and remains their separate property after the divorce, this categorization can be very important. However, the spouse claiming something as their separate property has the burden of proving that fact to the court.
Ownership of a business entirely or in part is considered property, which means it also must be classified as community or separate property. If one spouse’s business is categorized as community property, it could potentially be divided by the court in a divorce. Even the goodwill attached to a business can be divisible.
Notably, the particular form of a business entity does not affect whether it’s community or separate property. That is determined by looking at when and how the business interest was acquired. However, the form of the business entity does affect how the profits from that business are characterized. Generally, Texas businesses can be classified as sole proprietorships, partnerships, or corporations.
A sole proprietorship is when an individual owns and operates a business, but doesn’t form a separate legal entity to do so. Many individuals who are self-employed and practicing a trade, such as plumbers or mechanics, are sole proprietors.
When a spouse is operating a sole proprietorship during a marriage, the profits from that business are presumed to be community property. This means that even if the spouse started the business before marriage, the income from that business during the marriage is not their separate property. However, if the business is truly the separate property of one spouse, any income the business earns after the divorce is not subject to division.
Whether the business itself and its assets, such as inventory, equipment, and supplies, are considered community or separate property is based on the “inception of title” rule. This means that to answer this question, a court will look to when the ownership of the business began. If one spouse starts a business before marriage, it usually remains their separate property. Conversely, if one spouse starts the business after the marriage, it is likely to be considered community property - unless, through a process called tracing, the business owner can prove otherwise. To read more about tracing, click here.
Partnerships are formed by an agreement between two or more people. There are many different kinds of partnerships and several ways to form one. But, the important thing to know for property division in a divorce is that the partnership’s property is not subject to division. This is because the partnership is a separate legal entity, and it, independently, owns all of its own property. The property does not belong to the individual partners themselves. As a result, this property usually cannot be divided in a divorce action.
But what about the ownership interest in the partnership or the profits received from it during the marraige? Those are different stories. If one spouse is a partner in a partnership, they have the legal right to receive a share of the partnership profits. Because this right to receive profits is considered property, it can be either separate or community. To determine which it is, courts again look to the inception of title rule. If the spouse acquired their ownership in the partnership before marriage, it’s likely their separate property. But if acquired after marriage, it is likely to be community property.
If a spouse partner receives profits from the partnership during the marriage, those profits are community property. This is true even if the partnership interest itself is that spouse’s separate property.
If a court divides a partnership interest upon divorce, the receiving spouse does not necessarily obtain the right to make decisions in the partnership. Rather, they usually only get the right to receive a share of the partnership profits and surplus. Additionally, they do not become liable for any partnership liabilities.
Corporations, like partnerships, are distinct legal entities from their owners. If a person owns part of a corporation, they are said to own “stock” of that company. Just like in a partnership, property belonging to the corporation itself is not subject to division in a divorce. A spouse’s ownership interest in a corporation, however, is different. That ownership interest, represented by stock, is considered the property of that spouse. Just like all other property in a divorce, the stock must be classified as either community or separate property.
The inception of title rule determines whether ownership in a corporation is separate or community property. If the spouse can show they acquired the right to receive the stock prior to the date of marriage, it is their separate property. If it was after marriage, then the stock is likely community property and subject to division.
Any cash payouts, or dividends, from the corporation received during the marriage by the spouse who owns the stock are considered community property. This is true regardless of whether the stock itself is separate or community property. However, if the stock splits or dividends are paid in additional stock, those benefits may be separate property if the underlying stock is separate property.
As you can see, the classification of business interests can quickly become complicated. To ensure you get what you’re entitled to in your divorce, you’ll need experienced and qualified representation. You need Robert Tsai. Click here to schedule a consultation today, or call us at 832-278-1995.