Divorces With Sole Proprietorships
By Beverly Bird
Updated March 17, 2020
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Divorce issues such as support and property division can be pretty clear-cut when a spouse works for someone else and his income is reported on a W-2. However, when he's a sole proprietor, this can muddy the waters. A sole proprietor's business is his personal business. There's no line separating the two, nor a specific entity, such as a corporation or partnership, with which the court must deal.
Personal Expense Add-Backs
Sole proprietors typically take money from their business accounts as their paychecks -- and some may also pay personal expenses from business funds. When determining income for support purposes, the court adds these personal expenses back to the business's revenues. Necessary and reasonable business expenses and taxes are usually the only permissible deductions from a sole proprietorship's gross revenues. The balance – not any draws he may take – counts as his income. If a certain expense is not necessary to do business, the court considers the money as income available for calculating child support or awarding alimony. For example, if you regularly make your $400 car payment from your business account, that comes to $4,800 a year. This counts as income to you, just as it would if you worked for someone else, collected your paychecks and then used your paycheck to make your car payments.
Distribution of Assets
Because a sole proprietorship isn't a distinct business entity, separate from its owner, it doesn't own its equipment, supplies or assets – the business owner does. Therefore, they're considered marital property in a divorce, assuming they were purchased after the date of the marriage. For example, if you're an artist, your spouse is technically entitled to a share of your paintbrushes, easels and other supplies. If you operate a restaurant, a portion of the appliances, furniture and equipment is hers. As a practical matter, the court won't make you count up all your paintbrushes and give her half of them, but your spouse is typically entitled to other marital assets of equal value.
Valuing the Business
Valuing a sole proprietorship is complicated and usually requires the assistance of an accounting professional. Your business's value includes its equipment and your supplies, but it also encompasses your accounts receivable and even contracts. If you own a restaurant, the money in the till contributes to the value, as does the deal you made with a local organization to cater five events a year, even if the events haven't yet occurred. Goodwill also contributes value – the reason customers and clients come to you in the first place. Some states, such as Texas, draw a line between professional goodwill and commercial goodwill. If customers flock to your restaurant on Friday nights for your wings special, this is commercial goodwill as it's related to your business entity. If you're a writer or artist and clients hire you for your skills, this is professional goodwill because you personally produce the work and it cannot exist without your talent. Some courts have ruled that commercial goodwill is a marital asset in divorce and contributes toward a business's value, whereas professional goodwill does not.
Another issue arises if your spouse contributed effort or labor to establishing or maintaining your business. For example, she might have waited tables in your restaurant for years just to help out, never drawing a paycheck. If so, she's usually entitled to some compensation for this – if not cash, then additional marital property. If your sole proprietorship is based entirely on professional goodwill, however, valuing any contributions your spouse made, such as caring for the home while you toiled away at your easel, can create murky waters. You may need the assistance of an attorney to protect your rights.
- The Law Offices of Philip A. Wasserman: Suggestions for the Self-Employed Sole Proprietor
- Jackson Law: Texas Divorce Business Evaluation – The Sole Proprietorship
- The Woodlands Divorce: Five Rules for Your Sole Proprietorship and Your Divorce
- The Harris Law Firm: Colorado Divorce and Sole Proprietorships
- Business Evaluation Systems: Professional vs. Practice Goodwill
Beverly Bird is a practicing paralegal who has been writing professionally on legal subjects for over 30 years. She specializes in family law and estate law and has mediated family custody issues.