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Determining Whether a Small Business Is Community or Separate Property in a Texas Divorce

Determining Whether a Sma…

Getting a divorce in Texas causes upheavals throughout a person’s life. Planning for these upheavals, and working to manage them to the greatest extent possible is one of a family attorney’s most important jobs. For small business owners, divorce can bring uncertainty not only for themselves, but their employees and customers. It therefore requires close attention and careful planning. The business is an item of property, just like other assets involved in a divorce. Texas is a community property state, meaning that the spouses jointly own property acquired during the marriage. The first step for a small business owner going through a divorce is to determine whether the business is community or separate property. Every other consideration, including the valuation of the business, will depend on this question.

Community and Separate Property

The Texas Family Code defines “community property” as anything “acquired by either spouse during marriage” that is not separate property. The definition of separate property offers more specifics. A spouse’s separate property includes:

  1. Property that a spouse owned before the marriage;
  2. Property acquired by one spouse through gift or inheritance during the marriage; or
  3. Settlements or awards received by one spouse during the marriage for personal injuries, except for damages for “loss of earning capacity.”

State law presumes that the property owned by either spouse when a divorce petition is filed is community property. If the parties to the divorce do not agree on whether certain property is community or separate, the spouse claiming it as separate property must produce “clear and convincing evidence” that it fits one of the statutory definitions of separate property.

The earnings that a spouse receives from their business are generally considered community property, regardless of whether the business itself is community or separate property. This includes any salary or wages that the spouse pays themselves, as well as other revenue derived from the business.

Separate property can lose its “separate” character and become part of the community estate if the spouse does not keep it separate from the community property. Combining separate and community property is known as “commingling.” For example, if a spouse inherits a sum of money and deposits it in a joint bank account, that money could become community property unless the spouse specifically accounts for it as separate property.

Types of Business Entities

Small business ownership can take many forms, each of which will have a different effect on how the business is treated in a divorce. A small business owner can operate a business with no formal legal structure, or they can organize it with a formal business structure, such as a corporation or limited liability company (LLC). In the former situation, the business itself could be separate or community property. In the latter case, the question is over the spouse’s ownership interest in the business.

Without a formal structure, a business is known as a “sole proprietorship” if it only has one owner. If the business has more than one owner, it is considered a “general partnership” under Texas law. A sole proprietorship could be entirely separate or community property. With a general partnership, the parties must first determine exactly how much of the business the spouse owns.

A formal structure establishes the business as a distinct legal entity, and allows business owners to express their ownership in clearly-defined units. Ownership of a corporation is represented by “shares.” Texas law does not define ownership in an LLC quite as specifically. It could be expressed as a percentage of the business, if there is more than one owner, or as units similar to shares in a corporation. The community/separate property analysis focuses on these units or shares.

Co-ownership of a Business by Spouses

Our discussion up to this point has assumed that only one spouse owns all or part of a small business. Sometimes, both spouses are directly involved in a business. This could greatly simplify the analysis, especially if the spouses started the business together after getting married. That particular business is probably community property, absent other factors. If the spouses started the business together, and then got married, each spouse’s ownership interest in the business could be their separate property. The biggest question for spouses in either situation might be whether to continue running a business together after the divorce.

Business Formed by One Spouse During the Marriage

Anything acquired by a spouse during the marriage is community property under Texas law, with a few exceptions mentioned earlier. A business started by one spouse during a marriage is therefore likely to be community property.

One possible exception involves the use of separate property to start the business. If a spouse uses their separate property to acquire an asset, such as using inheritance money to buy stocks or other investments, the asset they acquire remains separate property. It is possible, at least in theory, for a spouse to start a business using separate property, and then maintaining the business separately. In reality, running that business would probably require contributions at some point from the spouses’ community property.

Business Formed by One Spouse Before the Marriage

A business that one spouse owned before the marriage is their separate property, unless commingling occurred with community assets after the marriage. Eventually, commingling of community property and the business could transform the spouse’s entire ownership interest in the business into community property. Prior to that, the other spouse could claim a community interest in the business, based on contributions from the community estate.

Community Contributions to a Separate Business

Texas law allows a spouse to claim reimbursement from the other spouse’s separate property on behalf of the community estate in certain situations. This includes “capital improvements to property other than by incurring debt,” like using community property to increase the value of a business that is otherwise separate property. A spouse who is not an owner of the business could claim reimbursement to the community estate for community funds invested in or applied to the business, or for their own investment of time and effort in maintaining or growing their spouse’s business and its value.

Dividing a Community Property Business in a Divorce

As mentioned earlier, determining whether a business or business interest is separate or community property is a crucial step in a divorce, but it is only the first step. From here, the spouses must determine how to value the community portion of the business or business interest, and what to do with it. If they ran the business together, do they continue to do so? Do they become business partners post-divorce? Does one spouse buy the other out? Do they sell the business in its entirety? And so forth.

Stacey Valdez is a board-certified family lawyer who serves the greater Houston, Texas area. Family law disputes, such as divorce and child custody, are among the most difficult ordeals that many people face. As a client of Stacey Valdez & Associates, representing you and your family with compassion, support, and tireless advocacy will always be a top priority. Please contact us through our website, or give us a call at (713) 294-7072 today to schedule a confidential consultation to discuss your case. Your first meeting with us is free in most situations.

Categories: Property Division