California business owners face a unique set of challenges when they divorce. By law, a divorcing business owner may be required to hand over up to 50% of their interest in a business to their ex. Several factors determine the division of a business during divorce, even in a community property state like California. So to understand who gets what when it comes to business and divorce, here’s what you need to consider.
Is The Business Community or Separate Property?
In simple terms, the assets and property acquired during marriage are community property. While assets and property acquired before or after the marriage are separate property. So, when a spouse or couple acquires or starts a business during the marriage with community resources, courts will consider it to be community property and divide the asset equally between both ex-spouses.
When it comes to dealing with a business that a spouse acquired or started before the couple got together and continued after the wedding, things get a little more complicated. Even though the business began before marriage (separate property), it may have increased in value while the parties were a married couple (community property). When this happens, the court will look to two apportionment methods, Van Camp and Pereira, to divide a business in a divorce.
What is Van Camp Apportionment?
The Van Camp apportionment method applies when the increased value of a business is attributable to capital appreciation, market factors, or both. To calculate the value of the community property interest in a business using Van Camp, the court will assign a fair salary to what the owner spouse might have been paid as an employee of the company and multiply that by the years of marriage. From that amount, it will deduct any amounts paid for community expenses and any salary already received. The total that remains as a result of this calculation is community property. The rest of the profits are separate property. The effect of Van Camp apportionment is that net income earned by the owner-spouse becomes community property.
Let’s take a look at a Van Camp apportionment example: Jim and Julie are divorcing after 30 years of marriage. Prior to marriage Jim owned an ice cream parlor in downtown Walnut Creek, CA, which is not far from parks and shopping centers. At the beginning of the marriage in 1990, Jim’s Ice Cream Parlor had been in business for 3 years and made approximately $200,000 per year after expenses. However, Jim never really worked at the ice cream parlor and his responsibilities at the business were minimal. Each year he would file the business tax returns and each quarter he reviewed the company books. Jim never drew a salary from the business, preferring to keep the money within the company. At time of trial on this case, the company makes approximately $2million per year in revenue. The Judge finds that the increase in the company (valued by the Judge as an increase of $1.8million) was due to market conditions and not due to Jim’s marital efforts or labor. The Judge further finds that Jim’s review of the books on a quarterly basis and the filing of the company tax returns should be valued at a salary of $25,000 per year.
Under the Van Camp apportionment in this example, Jim should have been paid $30,000 per year over the 30 year period, which is $900,000 ($30,000 x 30 years). The community never received any compensation for Jim’s work, since he never withdrew funds from the business; therefore, Jim’s marital labor will be deemed the community component of the business. The Judge will find that Julie should receive one-half of what Jim should have been paid (1/2 of $900,000), which is $450,000. The Judge will further find that the business is awarded to Jim, who gets the business and the appreciation in the business value. Jim shall pay Julie $450,000 for the business in the Judgment.
What is Pereira apportionment?
Courts use Pereira apportionment when the increase in the value of the business is primarily the result of the labor or management by a spouse during the marriage. Using Pereira, the court will add the original principal value of the business at the date of marriage to a reasonable rate of return based on the nature of the company. The result of this calculation is the separate property of the owner-spouse. The court then will subtract this separate property from the business valuation amount and classify the difference as community property.
For Pereira to apply to the example of Jim and Julie and the ice cream parlor above, we need to change some facts. Instead of Jim being on the side-lines of the business, Jim is now an ice cream aficionado. In this example, Jim works at the ice cream parlor as his primary job. Jim is in the ice cream parlor Monday to Friday each week. He manages the employees. He does the company books. He makes sure the marketing is top-notch. At time of trial the Judge finds that the increase in the business revenue is due to Jim’s management of the business. At time of trial, the Judge finds that a reasonable rate of return for Jim’s efforts is $60,000 per year. All other factors of our example above remain the same. In this example, the court will find that Jim should have received $60,000 per year in salary. Over 30 years of time this is $1,800,000. Therefore, the community component of the business is $1,800,000. Jim will need to pay Julie her one-half community property share, which is $900,000; however, Jim gets the business after paying Julie her share.
Can both Pereira and Van Camp apportionment apply when dividing a business in divorce?
In the 2015 case In Re Marriage of Brandes, the court recognized that a hybrid apportionment to approach might apply in certain circumstances. In that case, the court applied Pereira to the years of the marriage where the husband’s labor was the primary factor in the company’s growth. In the later years of the marriage, the court determined that the Van Camp approach was more appropriate because the husband’s efforts were no longer the primary reason for business growth. Since In Re Marriage of Brandes, courts take a more nuanced approach when classifying a business as separate or community property in a divorce.
If you need help navigating the complex waters of dealing with a business in a divorce, contact the Bay Area Family Law Center today. We can help. Our office can be reached at (925) 258-2020 or you may contact us from our webpage at www.bayareafamilylawcenter.com.
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