Factoring Taxes into a Divorce Settlement

In Ontario, when a married couple goes through the divorce process there is normally an equalization payment required from one spouse to the other spouse. In the absence of a valid marriage contract that states otherwise, the spouses would be entitled to 50% of the increase in the total net family property value from the date of marriage up to the date of separation.

When contemplating the equalization payment there are some very important tax consequences to consider.

Simple example:

If it is determined that at the separation date Harold had $400,000 in net property and Susan had $200,000 in net property, then Harold would have to pay Susan $100,000 so that they each end up with $300,000 in value.

You'll notice in the example that Harold would have to provide Susan $100,000 in order to equalize the net family property value. To be clear though, if Harold provides $100,000 in cash to Susan that would NOT be the same as providing her with investment real estate that is appraised at $80,000 + $20,000 in cash. Why is that? Because of taxes. More on this later.

What is the property that is normally dealt with in a divorce? Let's examine the table below, which outlines the property that Harold and Susan each own at the separation date. Let's assume that they do not own a home, that they rent.

 

Divorce: How are Personal Guarantees on Business Debt Handled ?

It is a common situation where one spouse owns and operates a privately-held business and the non-owner spouse agrees to guarantee some portion of the business debt.

This blog post will examine how personal guarantees for business debt are dealt with in the context of a divorce.

The use of a simple example can illustrate some of the issues that are at play:

Suppose that a couple is going through a divorce. Assume the husband (Mr. John Smith) owns and operates a business through a privately-held company, of which he is 100% shareholder. Let's pretend this corporation has $100,000 in loans from the bank and that Ms. Nancy Smith has personally guaranteed the full $100,000. Nancy is NOT a shareholder of the company.

The question is, how is the personal guarantee from Nancy dealt with now that the couple are divorcing? Is it a liability for Nancy?

Possibly. It is a contingent liability. In other words, it is a liability that may come to fruition.... but may not.

What is a Right of First Refusal ??

When a privately-held company has more than one shareholder, a right of first refusal (“ROFR”... sometimes pronounced as "roofer") is an agreement among them as to how potential sales of shares to third parties are handled.

ROFRs provide procedures on how potential future share sales are managed.

Example:

Suppose Sam and Tom each own 50% of a privately-held company that produces video games. Tom is tired of dealing with Sam, and he wants to retire so he has found a buyer willing to pay him for his 50% of the company. Sam is not thrilled with this since he doesn't want to be stuck with a new 50% shareholder he knows nothing about.  Also, Sam would like to own 100% of the company himself, if he can manage it. Sam remembers that when he and Tom executed their shareholders' agreement that there was a ROFR clause included in it. Sam has decided to exercise his ROFR and will pay Tom for his shares at the same price and terms that were offered to Tom by the third-party purchaser.

A background on rights of first refusal

There are essentially two types of rights of first refusal: