Business Ownership Interests

Here's the situation: Your soon-to-be-ex owns part of your closely held business. (In the nine community property states, this may be by virtue of the community property laws.) Now you want to buy him or her out by transferring some other stuff (cash, investments, whatever) in exchange for that ownership position.

As long as this happens before the divorce, there are generally no tax consequences because of the tax-free transfer rule. The same is usually true if the deal gets done after the divorce under the terms of your property settlement. Under the general tax-free transfer rule, you simply take over your ex's basis and holding period for the ownership interest in question (stock, partnership interest or LLC interest), and your ex takes over your basis and holding period for the assets received in return. This tax outcome is usually acceptable to both sides.

But watch out if you want to use your C corporation to redeem your ex's shares with the company's money. Yes, this will get you your full ownership position back, but the corporate payout to your ex may be treated as a taxable dividend to you. If so, you could be taxed at 15%, and the company gets no deduction. Your ex has no taxable income on this deal, and you are stuck with your ex's presumably low tax basis in the stock. From your perspective, this really stinks (although your ex would be delighted).

Bottom line? To avoid adverse results, consult your tax pro before making any moves here.