A Sole Proprietorship and Divorce

The financial aspects of divorce are never easy, even when you're drawing a predictable paycheck from your employer on a regular basis. Things can become dicey and complicated for sole proprietors. Because they and their businesses are one and the same, business valuation issues become complex, and the line between personal and business expenditures can blur somewhat and cause problems.

If you're a sole proprietor and you're facing divorce, your first challenge is to determine which of your expenses are attributable to your business and which are personal. You might regularly pay household bills out of your business account, or regularly pay business expenses out of your personal account. Differentiating between the two can be pivotal. If you paid business expenses out of your personal account, your marriage contributed financially to your sole proprietorship. This is particularly true in community property states, but it applies elsewhere as well. Your spouse could potentially make a claim for a share of the business. If you've kept your business finances meticulously separate from your personal bills, dividing your business in a divorce becomes a matter of having its value professionally determined, and several factors contribute to this process.

Community property states – which include Arizona – have ruled that if you established your business before you got married, it's your separate property. The value of the business is not subject to a 50/50 split in a divorce, so you won't have to pay your spouse half its worth – unless you began it after you wed. Even in this case, however, you probably won't owe her half because sole proprietorships are a unique business form. This only relates to your ownership interest, however. Assets acquired by your business during the marriage – even for use by the business – are typically community property, with each spouse entitled to a 50 percent share. If your spouse works in the business, particularly if she did so all through your marriage and didn't draw regular wages, this opens a whole new can of worms. She's typically entitled to some compensation.

A major component of a sole proprietorship is goodwill – professional, personal and commercial. How this affects your business in a divorce depends a great deal on the nature of your business. Professional and personal goodwill come into play if your business is based on something you do that no one else can do in quite the same way. For example, if you're a freelance artist, no one else can paint your pictures the same way you do. If you're an attorney practicing alone, your education and your skills are yours alone and they form the basis of your business. Both community property states and equitable distribution states have ruled that this type of goodwill is not marital property and is not subject to division in a divorce. It's intangible – it just means you can keep earning an income going forward. Enterprise or commercial goodwill is something else – the ability of your business to go on without you if you were removed from the equation. This goodwill is typically included in business valuation for divorce purposes.

Courts typically include all sources of income when calculating alimony or child support, so in the process of divorce, you'll have to substantiate exactly what your business earnings are and average the income into monthly increments. The Schedule C you file with your tax return should simplify this because it includes all your revenues less your business expenses. If you're in your first year of business, you – or the court – will have to take an educated guess at what you're expected to earn. If business doesn't turn out like you planned, you can usually go back to court to modify a support obligation, particularly child support.