Most divorces involve division of marital assets, either by agreement or by a judge’s order. How assets are divided in Connecticut is based upon a concept called Equitable Distribution. Equitable distribution applies to all assets such as real estate, bank and brokerage accounts, retirement accounts and personal property. Property division can be particularly challenging in High-Net-Worth Divorce which often times involve lucrative executive compensation packages and complicated investments owned by either spouse.
In its lower Fairfield County practice, Needle | Cuda: Divorce and Family Law's cases often include asset division scenarios with investments involving Carried Interest, Restricted Stock Units, and Limited Partnership Ownership Interests with wide ranging restrictions and liquidity challenges.
These assets present significant issues, both in valuation and in distribution. In Connecticut, the title of ownership is generally irrelevant in a divorce when it comes to property division. Likewise, it is not dispositive whether an asset was acquired before or during the marriage when it comes to property division. Many factors need to be evaluated and considered prior to a determination of how a particular asset or the asset’s value will be split in a divorce.
Carried Interest Valuations in Connecticut Divorce
Partners in a private equity or venture capital fund are entitled to a share of profits made from the sale of a portfolio investment. If a fund performs well, it can generate substantial distributions and dividends, which are known as Carried Interest. Valuation of such assets can be complicated by a fund’s future capital commitments, the manor and length of time that these investments are held, and the complex nature of the tax rules that apply the them. These assets can be valued in different ways such as the present value of cash received or the value or expected distributions over the life of the fund.
2018 Tax Reform Act and Tax Liabilities Related to Carried Interest
In recent years there has been much debate over the application of tax treatment for Carried Interest distributions as ordinary income vs a long-term capital gain. Historically, carried interest was treated as a long-term capital gain. Treating this income as a capital gain resulted in a lower tax liability (Example: 23.8 percent tax rate) to the taxpayer who received a K-1 from the partnership that held the investment. This tax rate was much lower compared to an ordinary income tax rate (Example: 39.6 percent). A difference of 15.8 percent was meaningful, especially when significant monies were exposed to taxes.
The 2018 Tax Reform Act instituted a minimum (3) three year holding period to allow carried interest generated from partnership interests, owned by individuals not corporations, to qualify for capital gains tax treatment (i.e., to be taxed at a lower tax rate). So, if an investment manager received carried interest where the investment was held for less than 3 years, the income generated was treated as ordinary income for tax purposes and not as long-term capital gains.
Initially, the ruling left a loophole because it focused on ownership interests owned by individuals and excluded interests owned by Corporations. Fund Managers immediately began exploiting this loophole and considered transfers of their ownership interests from partnerships to S Corporations in order to capture and/or preserve the long-term capital gains tax rates for their investment income (structurally circumventing the three-year holding period the regulation intended to block). As a result, the government closed this loophole requiring the 3-year holding period for Corporations-- separating the application of ordinary income tax vs long-term gains tax on carried interest.
How does the Tax Liability related to Carried Interest Income impact a Divorce?
At tax time, a (3) three-year holding period measurement applies to each Carried Interest Income Investment based on when the related investment was made and when it was sold. This measurement period determines whether the sale of the investment is treated as ordinary income or capital gains.
Tracking measurement periods and settlement dates is therefore critically important. Many questions need to be diligently addressed to maximize a divorcing party’s wealth such as:
- Which spouse will own the equity interests after the settlement date(s)?
- Will the divorce transaction reset the measurement period of the investment for tax purposes?
- If the spouses cannot agree on how to divide the Carried Interest Income, can they agree on a cost transfer of the tax differential between them (the difference between the ordinary income and capital gains rate) to narrow the financial divide between them?
- What happens if the investment does not have the money to payout the carried interest yet the divorce decree requires one? Should the non-equity spouse have the right to force a distribution?
- When an investment is sold should it be treated on a FIFO basis for purposes of the divorce decree? What are the risks?
- Could a divorce decree make the non-equity spouse liable to pay for future tax liabilities as a means of offsetting other agreed upon compensation?
- What happens if an investment manager already transferred the investment from a partnership into an S Corporation? How does this impact a divorce decree?
- Carried interest has a number of variables and risk factors that have the potential to impact one or both divorcing parties over time. It is absolutely essential that key questions are raised upfront, thoroughly vetted, and analyzed by professionals to ensure that a divorcing party is protected and maximizes their wealth through a divorce transaction.
Restricted stock units (RSU’s) division and distribution in Connecticut Divorce
A form of deferred executive compensation for highly compensated individuals, RSUs are company shares given to employees based on length of employment or achievement of performance goals. However, employees do not receive their shares immediately. Rather, they are subject to a vesting schedule. Since stock prices are constantly fluctuating, there is no definitive value until the restrictions lapse on the RSUs and the employee cashes out. In a divorce, RSUs can be divided in several ways depending on the terms of the company Stock Plan but typically division is deferred until vesting.
What information do you need to obtain for Restricted Stock Units (RSU’s) in Connecticut Divorce?
Gathering information is key to understanding a spouse’s compensation package, including RSUs.
For each RSU award, here’s what you need to know:
- Grant number
- Grant date
- Vesting commencement date
- Number of shares granted
- Vesting schedule
Here’s a short list of the information you need:
RSU Plan Agreement: Unlike the grant notice, the plan agreement isn’t specific to a particular RSU award. Rather, the plan agreement is a formal governing document that sets out:
- Why the company issues RSU awards,
- Transferability of RSUs
- What happens to unvested RSUs if the employee retires, gets disabled, etc.
- What happens to unvested RSUs if the company is acquired
Account statement for the stock plan account. Ask for all account statements from the date of separation through current. This will give you a snapshot of the owned shares, cash, and any unvested RSUs.
Transaction details. You might also need the RSU Release Confirmation Statements and any sales confirmation statements.
The release confirmation statement shows the details for a particular vesting. It will list the number of shares withheld for taxes, net shares released, taxable income, etc.
Details on reissuing. In some cases, the company will reissue RSU awards. This usually happens if there is a stock split, acquisition, or some other company event.
Why does this matter?
Well, when RSUs are reissued they usually have a different grant date. Remember, the grant date can affect the calculation of what’s marital property. So, you’re going to want to find out the details around the original grant and reissued grant.
Restricted Transfers and Selling Limited Partnership Interests in Connecticut Divorce
A limited partnership interest is a spouse’s ownership share in a business entity. In many cases, a partnership agreement will place restrictions on transferring the interest, in whole or in part, to a partner’s spouse in a divorce. This may force a sale of the interest in order to divide it. The Partnership Agreement may allow the other partners the right to buy out the divorcing partner's interest. in that event. A forensic accountant may be needed to value the spouse’s interest in the Partnership so that even if the Partnership can be divided, the value can be ascertained and included in equitable distribution.
As with all property in equitable distribution, a court will divide these assets in a manner that is fair but not necessarily equal. This could mean a husband keeps full ownership of certain assets, offset by other property he cedes entirely to his wife. This is why careful and thorough valuation is critical.
The attorneys at Needle | Cuda have extensive experience Protecting and Defending Clients with Closely Held Businesses in and obtaining favorable results in High-Net-Worth Connecticut Divorces. Call (203) 557-9500 or Contact Us Online to schedule a consultation at our Westport office.
Expert Testimony supporting business valuations is critical to driving leverage for settlement and effective trial presentation in Connecticut Divorce
The first step towards establishing and/or redirecting the narrative regarding the division of a Limited Partnership Interest in a divorce negation is to secure a Fair Market Valuation for the asset from a reliable and credible expert with relevant industry and domain experience. (Note: Depending on the circumstances, there is occasionally some debate as to whether some other type of value other than fair market value should apply, but generally fair market value is the prevailing standard in Connecticut.) And in that context, one of three methods of valuation is commonly used:
- Asset approach — This involves ascertaining the total value of the company’s assets and reducing the value by the amount of the company’s liabilities.
- Income approach — The company’s historical earnings, current earnings and projected future earnings are analyzed and used to compute a business value.
- Market approach — This method is based upon finding comparable businesses, including publicly traded companies and recently sold private companies of the same size and in the same market. There is then a judgment call applied by the appraiser in terms of comparing the business being valued with the comparable companies.
With the assistance of experts such as accountants and appraisers, Needle|Cuda analyzes the various approaches and compare and contrast the results in order to determine the optimal way to represent your position.
Our Westport Family Lawyers Use the Discovery Process to Drive Effective Business Valuation Strategies in Connecticut Divorce
Accurate valuations depend on comprehensive and accurate sets of data to support them, which are not always forthcoming in a divorce. Where one spouse is the owner of the business interest, the other spouse needs to use discovery to learn about the company’s health and profitability. Non-owner spouses seek the business’s financial records and tax returns. Requests may become necessary as non-owner analyze the data and interpret gaps and/or discrepancies.
Business owner-spouses may require effective protection from an unnecessary, overly broad fishing expeditions into their business operations. It also may be important to both sides to define who they may speak to at the company and how their data sets compare. Where both spouses are owners of the same business and have different roles and focal areas of knowledge about the business, that may still require discovery to ensure that the business valuation expert has a complete picture and that the approach between business partners is handled thoroughly but discreetly. Our attorneys skillfully conduct discovery requests and analysis of business data to attain a precise and complete business valuation. We also defend against discovery when necessary.
Experienced Westport Divorce Attorneys Find Sophisticated Solutions and Alternatives for the Equitable Division of Business Assets in Connecticut Divorce
Once a business is properly valued, it becomes part of the assets subject to equitable distribution, which means determining the fair share belonging to each spouse. That share is distributed using one of these methods:
- One spouse buys out the other — This is the best way to keep the business running without interruption. If the buying spouse does not have enough cash or other assets available from elsewhere in his or her share of the marital estate, structured payments can be made over time or the buy-out may be financed.
- The business is sold — A sale provides cash that can be easily divided and the market itself helps demonstrate the value of the business. However, it may be hard to find a third party willing to pay an amount equal or close to the true value of the business during the divorce.
- Both spouses retain ownership — One spouse continues with business operations while the other receives a share of the profits, based on an agreement spelling out each other’s rights and obligations. This method is rarely employed, as a clean break is often desired in the context of the divorce.
Our attorneys weigh the pros and cons of each scenario and help clients select the approach best suited to the particular situation.
Call our sophisticated Westport Family Law Attorneys to assemble your Business Valuation team and coordinate your Equitable Division and Distribution strategy for your Connecticut Divorce
The lawyers at Needle | Cuda understand the issues that arise when a closely held business is among the assets in a divorce. If you or your spouse own a stake in a business, you can trust our experienced team to zealously represent you. Schedule a consultation with Attorney Melissa Needle by calling (203) 557-9500 or NeedleCuda.com