Guide to Community Property Division for Business Owners in Arizona

Arizona is one of nine states that follows a “community property” definition of marital assets.  In the most basic sense, in Arizona, property acquired during a marriage by either spouse is deemed “community property” belonging to both spouses equally, regardless of which spouse paid for or did the work to obtain that property, and regardless of in whose name title to the property was taken. Community property includes wages and earnings of a spouse, tangible property acquired during marriage, and the proceeds of community property (e.g., investment income). In contrast, property brought into the marriage by one spouse, acquired by gift or inheritance, or designated as belonging to one spouse or the other by agreement, constitutes “separate” property belonging only to one spouse.

In a divorce, Arizona spouses generally have an equal, 50/50, right to share in community property, but each retain “separate” property for themselves. That might seem like a straightforward concept when it comes to distributing the contents of a savings account. It can get complicated, however, when the marital assets to be characterized and divided comprise ownership interests in, and proceeds of, an operating business.

In this blog post, we briefly discuss the effects of community property rules in an Arizona divorce where the assets at issue include ownership interests in and proceeds of an Arizona business. For answers to specific questions about how Arizona law may characterize your ownership of and proceeds from your business in a divorce, contact an experienced Arizona family law and business attorney today.

Ownership Interests: Separate or Community Property?

An ownership interest in a business, be it corporate stock, membership units of a limited liability company, or interests in a partnership, may constitute “community” or “separate” property under Arizona law. Generally, how they get characterized depends upon how they were acquired. For example, if a spouse incorporates an LLC to operate a business after getting married, then even if that spouse is the sole owner of the membership interests of that LLC, the interests likely constitute community property. In contrast, if a spouse already owns interests in a business before marriage, then the interests likely constitute “separate property.”

As a basic proposition, business ownership interests that constitute community property must be divided equally in a divorce, no matter what implications the division might have on the management, control, or operation of the business itself. This can cause significant complication for a business owner and for the business itself. For example, suppose a spouse and a third party form a business during the spouse’s marriage in which the spouse owns 60% of the business and the third party owns 40%. Absent agreement to the contrary, in a divorce the spouse’s ownership interest would be divided, leaving the spouse with just a 30% ownership interest in the business and giving the business a new 30% owner, the spouse’s ex. Further complication could follow from that eventuality if, for example, the LLC agreement barred transfer of the LLC’s interests, or allocated management rights according to ownership interest.

Because of the potential complications above (which merely illustrate one scenario in a vast array of business-related headaches that can occur in an Arizona divorce), spouses who form Arizona business entities after marriage are well-advised to enter into agreements with their spouses that expressly characterize ownership interests as either “separate” or “community” property, and into agreements with their business partners that contemplate the eventuality of an owner getting divorced.

Business Proceeds: Separate or Community Property?

As if the complications described above were not enough to make your head spin (if you don’t have the help of experienced family law and business counsel, that is), Arizona law can make division of business ownership proceeds even more tricky. That is because even if business ownership interests constitute one spouse’s separate property, Arizona law may, in some circumstances, characterize the proceeds of those ownership interests – distributions, dividends, or capital appreciation, for example – as community property.

To be clear, Arizona law sets a baseline rule that proceeds of separate property also constitute separate property. But not always. Proceeds of business ownership interests that constitute separate property could still be characterized as community property if:

• The proceeds reach the owner spouse in a form commonly characterized  as community property, such as if a business pays a salary to the spouse, rather than making dividends; or
• The proceeds if the business are attributable to the efforts of the non-owner spouse.

Speak with an experienced Arizona family law and business attorney to evaluate whether how community property rules may affect how you receive income from a business you own, and how your spouse’s contribution to the marriage may affect the characterization of proceeds of those business interests.

How Arizona Lawyers Help to Plan for Business-Related Community Property Issues

The best way to navigate community property division of Arizona business ownership interests and proceeds is to plan ahead. Through the careful execution of prenuptial and postnuptial agreements, as well as agreements among business owners (such as LLC Agreements and stockholder agreements), business owners in Arizona can plan for the eventuality of a divorce and spare themselves significant difficulty and financial strain if it happens.

Should you find yourself in the position of not having planned ahead for how your business assets would be divided in a divorce, the advice and counsel of an experienced family law attorney may well prove critical. You may , for example, need to prove that certain business ownership interests constituted separate property, or that your ex-spouse did not materially contribute to the enhancement of the business in a manner that would transform proceeds into community property. Consult with an Arizona family law and business attorney as soon as possible if you are facing a divorce that your business planning never contemplated.

Unwary Arizona business owners can easily find themselves neck-deep in a thicket of legal complication by failing to consider the impact of the state’s community property rules on their business. Do not wait to seek sophisticated, experienced legal counsel. Contact a skilled, experienced Arizona family law and business lawyer today to gain an understanding of your rights. Call (602) 252-1968 to speak to one of our attorneys.