Community Property States & LLCs: Everything You Need to Know Before Getting Started
If you’re getting ready to start your business, you already have a million things on your mind: how to build awareness of your products or services, where to find capital, how to structure your business and more. One aspect of starting a business that you may not have considered is the community property laws in your state, and how they may impact you if you happen to go through a divorce with a business involved.
What Are Community Property States?
Community property refers to assets that are owned jointly between two spouses. If the couple decides it’s time for divorce, in community property states, the married couple’s assets are considered “community property” and split 50/50. There are currently nine states in the U.S. that have community property laws on the books requiring married couples to share evenly in the event they decide to split.
States that currently have community property laws are:
- New Mexico
How Does Divorce Work With a Business Involved?
Whether you already own an LLC or are in the startup phase, you should consider how community property laws in your state could affect your business. Even if you do not live in one of these states, you should still consider how divorce could impact any business.
This even applies to business owners who are single: If you have business partners who own part of your company and are married, it could cause headaches for you and the other partners if that marriage ends — or if proper planning isn’t performed on the front end when setting up your company.
Every community property state has its own unique laws regarding this concept. Going through a divorce with a business involved is not a simple matter; you should take time to plan how you would compensate your spouse or handle the business if it happens to outlast your marriage. There are steps you can take to protect the time and energy you put into your business, whether you want to avoid becoming unwilling business partners with your ex or prevent one of your partners from involving you in the dissolution of their marriage.
Ensuring Equitable Distribution
When you form a company with outside partners in a community property state, you should spell out in your operating agreement what would happen in the event of a divorce by any of the partners. If you don’t, you could wind up with an angry ex-spouse as a shareholder or partner. This could result in a situation that has a negative impact on growth, revenue, and new business decisions that are critical to your company’s success. Additionally, even in the case of an amicable divorce, the business could still incur additional legal bills and accounting fees just to navigate the situation.
Prenuptial agreements that are signed before a marriage can be a way of protecting businesses and business partners from these types of situations. Some companies have amendments that require all owners to sign a “prenup” with their future spouse to ensure they won’t have any future interest in the company. Owners can also add amendments that give them the right to purchase shares and approve of all share transfers in the event of a divorce. These are just a couple of ways that businesses can protect themselves from being forced to include new owners who might be angry or unqualified after a divorce.
Defining Marital Property
Community property laws aren’t only relevant to situations involving divorce. Even if you are happily married and setting up a single member LLC with your spouse, you may be wondering how this could complicate things come tax season. Fortunately, many community property states allow filers who own a single member LLC to treat it as a disregarded entity (or “pass-through entity”) under certain conditions. Essentially, this lets the owners report their business and other personal income on the same tax return, which they can file jointly. The IRS only allows this simple structure if there are no other partners in the business and the company is not viewed as a corporation by the federal government.
If your business doesn’t meet these conditions, then your jointly owned business would be considered a partnership, which is a little more complicated for filing taxes. This is a perfect example of why you need to speak with a tax professional, no matter what state you reside in. You may have options for structuring your business or filing your tax return in a way that could save you money at tax time, whether you live in a community property state or not.
It’s also a good idea to discuss this with a business attorney to make sure you and your spouse make the best decisions when forming the business and managing the day-to-day operations. At the very least, you should document each of your contributions to the company and define your roles as clearly as possible. This can include time tracking; keeping an online company calendar in Outlook, Gmail or another service can be a great organizational tool for this purpose.
No one wants to go through a divorce with a business involved — especially if you live in a community property state where the dissolution of your marriage might also lead to collateral damage to your business. But with careful planning and adjustments along the way, you can keep your business safe from the worst case scenarios, and hopefully continue running a successful company for a long time…even if your marriage ends prematurely.
Are you ready to start a business, form an LLC, or reorganize your current business structure with business incorporation services? Talk to Incfile today! Our incorporation experts can help you evaluate your options with state-specific advice.