Maryland follows the principle of equitable distribution when dividing marital property during divorce. This means the court will divide marital assets fairly, though not necessarily equally, based on various factors. Understanding what constitutes marital property versus non-marital property is crucial for business owners.
What Makes a Business Marital Property?
Under Maryland law, marital property includes assets acquired during the marriage, regardless of whose name appears on titles or who paid for them. This broad definition often encompasses business interests, making many businesses at least partially subject to division during divorce.
A business can be entirely marital property, entirely non-marital property, or part marital and part non-marital property. The classification depends on when and how the business was acquired and what happened during the marriage.
Entirely Marital
If you started or purchased the business during your marriage using marital funds, the business is typically considered entirely marital property subject to equitable distribution.
Entirely Non-Marital
If you owned the business before marriage, kept it completely separate from marital finances, and your spouse made no contributions to its growth, it may remain non-marital property. However, this scenario is relatively rare because most businesses evolve during marriage.
Part Marital and Part Non-Marital
This is the most common scenario for businesses owned before marriage. If you owned a business before getting married but the business grew in value during the marriage, or if marital funds were used to support or expand the business, the increased value or improvements may be considered marital property even though the original business was not.
For example, if you started a business worth $100,000 before marriage and it grew to $500,000 during the marriage, the $400,000 increase in value might be subject to division. The Maryland court will examine what caused the growth, was it passive appreciation, or did it result from active efforts during the marriage? Were marital funds invested in the business? Did your spouse contribute to the business's success?
Business Valuation in Divorce
One of the most contentious aspects of Maryland divorce for business owners involves determining the business's value. Even business valuation experts may reach wildly different conclusions about what a business is worth, and these disagreements can significantly impact the final property division.
Methods of Business Valuation
Maryland courts typically rely on professional business appraisers who use three primary valuation approaches:
Asset-Based Approach
This method focuses on the business's balance sheet, calculating value based on assets minus liabilities. This approach works well for asset-heavy businesses but may undervalue companies whose primary worth lies in goodwill, intellectual property, or future earning potential.
Income-Based Approach
This method examines the business's earnings, cash flow, and profitability, then projects future earnings. Appraisers may use various formulas to capitalize earnings or discount future cash flows to present value. This approach often produces higher valuations for profitable businesses with strong earnings history.
Market-Based Approach
This method compares your business to similar businesses that have recently sold. The appraiser looks at comparable sales to determine what buyers would likely pay for your business. This approach requires finding truly comparable businesses, which can be challenging for unique or specialized companies.
Each method can produce dramatically different results. A manufacturing company with substantial equipment and real estate might have high asset-based value but lower income-based value if profits are modest. Conversely, a consulting firm with few physical assets might have minimal asset-based value but high income-based value due to strong cash flow.
Complicating Factors in Valuation
Several factors make business valuation particularly complex in divorce:
Personal Goodwill vs. Enterprise Goodwill
Much of a small business's value may be tied to the owner's personal reputation, skills, and relationships. Courts distinguish between "personal goodwill" (value attributable to the individual) and "enterprise goodwill" (value that would transfer with the business). Only enterprise goodwill is typically considered marital property subject to division.
Control Premiums and Minority Discounts
Owning a controlling interest in a business is generally more valuable than owning a minority interest. If you own 75% of a company, your interest is worth more than simply 75% of the total business value because you control business decisions. Valuations may include premiums for control or discounts for minority interests.
Marketability Discounts
Shares in a closely held business are difficult to sell compared to publicly traded stock. Appraisers often apply marketability discounts, recognizing this limited liquidity. These discounts can substantially reduce the appraised value.
Income Manipulation
Business owners who control their company's finances may be tempted to artificially reduce business value by inflating expenses, deferring revenue, or reducing their own compensation. Maryland courts are aware of these tactics and may adjust valuations to reflect true earning capacity rather than temporarily reduced income.
Protecting Your Business: Proactive Measures
The best time to protect a business from divorce complications is before marriage occurs, but business owners can take steps at various points to minimize risk.
Prenuptial and Postnuptial Agreements
A well-drafted prenuptial agreement signed before marriage can specify exactly how a business will be treated in the event of divorce. The agreement can designate the business as separate property, establish a valuation method, or set a formula for calculating any marital interest.
Prenuptial agreements involving businesses should address:
- Whether the business remains entirely separate property
- How business appreciation during marriage will be treated
- Whether a spouse who works in the business gains any ownership interest
- What happens if marital funds are invested in the business
- How the business will be valued if divorce occurs
Postnuptial agreements signed after marriage can accomplish similar goals, though they may face more scrutiny from courts since marital rights have already attached. Still, if circumstances change during marriage, such as receiving a substantial inheritance to invest in a business or starting a new venture, a postnuptial agreement can provide protection.
Maintaining Separate Finances
Mixing personal and business finances is one of the biggest mistakes business owners make. When you use marital funds for business expenses or pay personal expenses from business accounts, you create arguments that the business has become marital property.
To protect your business:
- Maintain completely separate bank accounts for business and personal use
- Never use marital funds to invest in or support the business
- Pay yourself a reasonable, documented salary rather than irregular distributions
- Keep meticulous records showing the source of all funds used in the business
- Avoid using business credit cards for personal expenses
If you must inject capital into the business, document clearly whether funds come from marital or separate sources. Consider having your spouse sign acknowledgments that any marital funds loaned to the business must be repaid.
Business Structure and Operating Agreements
The legal structure of your business and any operating agreements with partners can provide some protection during divorce.
If you have business partners, your operating agreement or shareholders agreement should include provisions addressing what happens when an owner divorces. Common protective clauses include:
- Restrictions on transfer of ownership interests without approval of other owners
- Buy-sell provisions allowing the business to purchase a divorcing owner's shares
- Rights of first refusal giving partners the option to buy shares before they go to a spouse
- Valuation formulas pre-determining how shares will be valued
These provisions protect not only you but also your partners, who likely don't want your ex-spouse becoming a co-owner of the business.
Maintaining Competitive Compensation
If you are the sole owner of your business, consider whether your current salary is competitive within your industry. Some business owners minimize their salaries to reinvest profits for growth, but this strategy can backfire in divorce.
A Maryland court might impute a higher income to you based on the business's earnings capacity rather than your actual salary. This could increase alimony obligations. Additionally, if the business shows high profits but you take a low salary, more value remains in the business that may be subject to division.
Taking a reasonable, market-rate salary documented with industry comparisons can help establish that your compensation accurately reflects your earning capacity. This may limit arguments about undercompensation and reduce the business's retained earnings subject to division.
Options for Handling Business Assets in Divorce
When divorce becomes inevitable, business owners face important decisions about how to address business interests in the settlement. Maryland courts and divorcing spouses have several options for handling a business in divorce.
Buying Out Your Spouse's Interest
The most common approach is for the business owner to retain complete ownership by buying out the spouse's marital interest. This requires negotiation or court determination of the business value, then compensating the non-owner spouse with other marital assets or structured payments.
For example, if your business is valued at $500,000 and determined to be entirely marital property, your spouse might be entitled to $250,000. Rather than dividing the business itself, you could:
- Transfer other assets to your spouse equal to their share (such as retirement accounts, real estate, or investment accounts)
- Negotiate a structured payment plan where you pay your spouse over time
- Take on additional marital debt to offset your spouse's share
- Combine multiple approaches, such as transferring some assets immediately and making payments over time
Structured payment plans, sometimes called "property settlements," allow you to retain the business while paying your spouse's share over months or years. These arrangements should be carefully documented in the divorce decree with clear payment terms, interest rates, and consequences for non-payment.
Continuing Co-Ownership
In rare cases, divorcing spouses continue to co-own and operate a business together. This typically works only when:
- Both spouses are genuinely committed to the business's success
- The divorce is relatively amicable
- Clear operating agreements define each person's role and authority
- The business structure allows for this arrangement
Continued co-ownership requires exceptional maturity and communication. Most divorcing couples find this arrangement impractical given the emotional aspects of divorce and the potential for ongoing conflict affecting business operations.
Selling the Business
When neither spouse can afford to buy out the other, or when the business cannot support both households, selling may be necessary. The sale proceeds are then divided according to each spouse's marital interest.
Selling a business takes time and may not yield the appraised value, especially in a forced-sale situation. Market conditions, industry trends, and the urgency of the sale all affect the final sale price. Additionally, selling means losing the business you built, which may have provided not just income but also purpose and identity.
If a sale becomes necessary, attempt to control the timeline and process rather than being forced into a quick sale that undervalues the business. Consider whether you might buy the business back later under better circumstances.
Award of the Business with Monetary Compensation
In some cases, one spouse receives the business while the other receives a monetary award from the Maryland court to balance the equitable distribution. This is particularly common when the business is the primary marital asset.
For instance, if total marital property, including the busines,s is worth $1 million and the court determines a 60/40 split is equitable, the business owner might retain the $500,000 business while receiving only $100,000 in other assets, with a $100,000 monetary award to the other spouse to bring the total division to $600,000/$400,000.
Maryland courts cannot directly transfer titled property like business shares from one spouse to another without consent. However, they can order monetary awards to achieve equitable distribution.
Special Considerations for Different Business Types
The type of business structure affects how it's handled in divorce.
Sole Proprietorships
As the sole owner of an unincorporated business, you have complete control but also complete exposure. The entire business is subject to valuation and division. Your spouse cannot be forced to become a partner, so buyout or monetary award arrangements are typical.
Partnerships
If you're one of several partners, your partnership agreement likely restricts transfer of ownership interests. Your partners probably don't want your ex-spouse as a new partner. The partnership agreement may give partners the right to purchase your interest at a predetermined price or prevent you from transferring ownership without consent.
These restrictions can actually protect you by limiting how the business can be divided. However, they may also affect valuation since forced sale to partners at a predetermined price might yield less than fair market value.
Corporations and LLCs
Corporate structures provide more flexibility and protection. Shareholders or members own interests that can theoretically be divided, though operating agreements often restrict transfers.
Corporate structure also makes it easier to maintain separate finances, which protects the business's status as separate property if you owned it before marriage. Corporations and LLCs create clearer boundaries between business and personal assets.
The Role of Spousal Contribution
Maryland courts consider both monetary and non-monetary contributions when dividing marital property. If your spouse contributed significantly to the business's success, whether by working in the business, providing support that allowed you to focus on the business, or sacrificing their own career, the court may award them a larger share.
Direct Contributions
If your spouse worked in the business without fair compensation, they may claim significant marital interest in the business. Document all compensation your spouse received for business work to demonstrate fair payment for their contributions.
Indirect Contributions
Even if your spouse never worked in the business, they may have made indirect contributions by:
- Managing the household and raising children, allowing you to dedicate time to the business
- Supporting the family financially while the business was struggling
- Sacrificing career opportunities to support your business efforts
- Providing emotional support and advice
These contributions don't create direct ownership interest, but Maryland courts consider them when determining equitable distribution of all marital property, including the business.
Tax Implications of Business Division
Divorce involving business assets can trigger significant tax consequences that must be considered when negotiating settlement terms.
Transfer of Business Interests
Generally, transfers of property between spouses incident to divorce are tax-free under federal law. However, this doesn't mean there are no tax implications. Consider:
- The tax basis of assets transferred
- Potential capital gains taxes when assets are eventually sold
- Income tax consequences of liquidating retirement accounts to fund buyouts
- Gift tax issues if transfers don't occur within the prescribed timeframe
Business Income and Alimony
If you retain the business and pay alimony to your spouse, alimony payments are no longer tax-deductible for divorces finalized after 2018 under current federal law. This means you pay alimony with after-tax dollars, while your spouse receives it tax-free.
The non-deductibility of alimony affects negotiation strategies. Business owners might prefer property division over ongoing alimony to avoid continued financial obligations.
Qualified Domestic Relations Orders
If your business has a retirement plan, dividing those assets may require a Qualified Domestic Relations Order (QDRO). This specialized court order allows retirement plan administrators to distribute funds to your spouse without triggering early withdrawal penalties.
Working with attorneys and financial professionals who understand the tax implications of different settlement structures can save substantial money and prevent unwelcome tax surprises.
Working with Professionals
Maryland divorce for business owners requires a team of experienced professionals beyond just a family law attorney.
Family Law Attorneys with Business Experience
Not all divorce lawyers understand the complexities of business valuation, operating agreements, and the unique issues business owners face. Seek a family law attorney with specific experience representing business owners in divorce. They should understand business structures, valuation methods, and strategies for protecting business interests.
Business Valuation Experts
Independent, qualified business appraisers provide the professional valuations courts rely upon. Choose appraisers with credentials like Accredited Senior Appraiser (ASA), Certified Valuation Analyst (CVA), or Accredited in Business Valuation (ABV) designations. They should have experience valuing businesses similar to yours.
Both spouses may hire competing valuation experts, leading to significantly different opinions about business worth. Your attorney can help you select a credible expert whose valuation methods will withstand court scrutiny.
Accountants and Tax Advisors
Forensic accountants can examine business financial records to ensure accurate reporting and identify any attempts to hide assets or income. Tax advisors help you understand the tax consequences of various settlement options and structure agreements to minimize tax burdens.
Financial Planners
A financial planner can help you understand the long-term implications of retaining the business versus accepting other assets. They can model different settlement scenarios to show how each affects your financial future.
If you're a business owner facing divorce in Maryland, consulting with an experienced family law attorney who specializes in complex property division should be your first step. The decisions you make now will affect your business and financial security for years to come, making expert guidance not just helpful but essential.