YOU own a successful business, as a sole proprietor, prior to marriage. You later meet the love of your life and decide to marry her. Years into the marriage, you decide to incorporate the business. A common question when the couple later divorces becomes 1) did your separate property business become community property by virtue of incorporating it during the marriage? 2) Was your separate property business “transmuted” to community property by incorporating it during the marriage?
No community property presumption
Family Code §760 defines “Community property” as “Except as otherwise provided by statute, all property, real or personal, wherever situated, acquired by a married person during the marriage while domiciled in this state is community property. However under Marriage of Koester, the Court held that the community does not “acquire” a separate property business simply because the business is incorporated during the marriage. The mere incorporation of a business operated by spouse is not a change in its character, for purposes of division of community estate following divorce. In Koester, the Court stated that he incorporation simply effects a change in the legal form under which the business is conducted and property does not change its character merely because of a change in form or identity. Marriage of Koester (1999) 73 CA4th 1032, 1035, 1038, 87 CR2d 76, 79, 81. The Court in Koester also stated that “In contrast with the way title is taken when a married couple own residential property, the incorporation of a sole proprietorship business is typically done for reasons extrinsic to the marital relationship. To say… that an asset was ‘acquired’ by the community… because some aspect of corporate formation took place during the marriage is to elevate semantics over substance”
No transmutation
Incorporation of a sole proprietorship business during the marriage can trigger a family code § 2640 tracing right of reimbursement only when it is also accompanied by an unambiguous express written transmutation of the business to community property as required by Family Code § 852. Marriage of Koester, supra, 73 CA4th at 1036–1037, 87 CR2d at 79–80 & fn. 5. Under Family Code §852, a transmutation of real or personal property is not valid unless made in writing by an express declaration that is made, joined in, consented to, or accepted by the spouse whose interest in the property is adversely affected. In Koester, the act of changing the legal form under which a business is conducted does not meet the requirements of family code § 852 for a valid transmutation. Marriage of Koester (1999) 73 CA4th 1032, 1037, 87 CR2d 76, 80 & fn. 5. Incorporation of a sole proprietorship business is typically done for reasons extrinsic to the marital relationship.
Although the mere act of incorporating a separate business during the marriage does not change the character of the business to community property, the community may still acquire an apportionment interest if the value of the business substantially appreciated during the marriage due to the labor and hard work of the managing spouse during the marriage. The apportionment calculation is done using the formula in the Pereira or Van Camp case where the contributions of effort and return on capital are separated from the value of the business.
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Please note that this article is not legal advice and is not intended as legal advice. The article is intended to provide only general, non-specific legal information. This article is not intended to cover all the issues related to the topic discussed. The specific facts that apply to your matter may make the outcome different than would be anticipated by you. This article does create any attorney client relationship between you and the Law Offices of Kenneth U. Reyes, APLC. This article is not a solicitation.
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Attorney Kenneth Ursua Reyes is a Certified Family Law Specialist. He was President of the Philippine American Bar Association. He is a member of both the Family law section and Immigration law section of the Los Angeles County Bar Association. He is a graduate of Southwestern University Law School in Los Angeles and California State University, San Bernardino School of Business Administration. He has extensive CPA experience prior to law practice. LAW OFFICES OF KENNETH REYES, APLC is located at 3699 Wilshire Blvd., Suite 747, Los Angeles, CA, 90010. Tel. (213) 388-1611 or e-mail [email protected].
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