How a closely held business is divided in a divorce Under The Illinois Marriage And Dissolution Of Marriage Act (“IMDMA”)
Business Started During The Marriage
Oftentimes, a business is started during a marriage. This can either be one spouse starting a business by himself, or both spouses starting a business together. Section 5/503 of the Illinois Marriage and Dissolution of Marriage Act (“IMDMA”) deals with the classification of property, and whether or not an asset belongs to the marital estate. Marital property includes all property acquired by a spouse subsequent to marriage, with certain exceptions, including property owned prior to the marriage, received by gift, legacy, descent, or in exchange for such non-marital property.
Therefore, a business started after the marriage is an asset in and of itself, and is acquired by the parties subsequent to the marriage, which would make it marital. Arguments could be made that a business started after the marriage but using non-marital assets may also be non-marital. If, however, the business was started using marital funds, it would certainly be marital.
A Business Owned By A Party Prior To The Marriage
A business that is owned by a party prior to the marriage would generally be separate property. However, as a general rule, the marriage would be entitled to reimbursement for any contribution to that separate asset. Therefore, any marital funds that are used to enhance the non-marital business would have to be paid back to the marriage. This contribution must be traceable by clear and convincing evidence. A common example might be a husband who owns a family restaurant prior to the marriage. If he uses marital funds to buy new kitchen appliances, the marriage will be entitled to reimbursement for those funds.
Marriage Entitled To Compensation Of Marital Efforts
Income from a separate asset, including a business, will be considered marital if the income was a result of personal efforts of a spouse. A party cannot attempt to shield income earned simply because he or she earns it while running a separate business full time (absent a premarital agreement). This equates such business income to employment income by a spouse; they are both marital.
A marriage is also entitled to reimbursement of marital efforts if those efforts were significant and resulted in a substantial increase in the value of that separate business as a result of those efforts. The amount of reimbursement required would generally be in the amount of a reasonable salary. This need not be the highest salary that the spouse could have received; the only question is whether the salary was adequate. If there was an inadequate salary, then the marriage will be entitled to reimbursement for the difference.
A unique problem arises on the issue of retained earnings in a closely held corporation. Retained earnings are profits that are held in a business rather than distributed to the owners. In cases where a spouse is a majority or controlling owner, retained earnings can be considered to be marital, even if not distributed. This can create a problem in that retained earnings that are reinvested into the business can “contaminate” the separate business to become marital.
Division of the business
When dividing assets between the parties, courts will try to sever ties as cleanly as possible. This serves a public policy interest that parties to a divorce having certainty and finality with regards to their financial position, and want to discourage spouses to a divorce from returning to courts to litigate future problems over property. When it comes to a business, a divorce court will rarely, if ever, award one spouse an interest in that business where the parties are still business partners. Instead, the court will probably have the business valued, and order a buy out or offset against other assets.