Marriage: Hope For The Best, Prepare For The Worst
What is a prenuptial agreement?
A premarital agreement (or prenup) is an agreement entered into by a couple before they are married, whereby they contractually agree as to how marital assets will be split upon death or divorce; alimony and/or support payments are also considered. If necessary, the agreement may also establish economic responsibilities during the marriage.
A prenup simply states how assets will be distributed in the event of divorce or death. It is a misconception that you need to be wealthy to obtain a prenup. If you have children from a prior marriage, a prenup can protect their interest in certain assets. In most states, assets are transferred to the surviving spouse by operation of law unless there is a prior written agreement. A prenup can also protect a family business from the perils of divorce of one of the children.
If a marriage terminates without an enforceable written prenup, generally a spouse is entitled to an equitable distribution of the assets acquired during marriage and — if deemed necessary — spousal support. The exact outcome will be determined by agreement of the parties through negotiation or at the time of the divorce by a court proceeding by a potentially sympathetic judge or jury. The factors the court would consider include:
- duration of marriage
- age and health
Prenups are no longer solely for celebrities or trophy wives. Signing a prenup does not mean you are planning for your marriage to fail. It is merely an insurance policy. After all, you do not have car insurance because you are planning to have an accident.
So, why do you need a prenup?
Statistically, half of marriages fail. Many couples simply come to the conclusion that they would prefer to follow their own wishes when it comes to the potential division of their marital property in lieu of having state law decide their fate. This would certainly be the case for individuals attempting a marriage that is not their first. If a prior union ended in a messy divorce, they probably would never marry again without the protection of a prenup.
You should be concerned that an interest in your family business might become a part of messy divorce litigation. If you desire to keep that business within the family bloodlines, a prenup for all offspring is absolutely necessary.
What will happen to my assets if I do not have a prenup?
Generally, all the assets acquired and liabilities incurred during the marriage by either spouse, without regard to how the asset is titled, are subject to equitable division upon divorce. Absent a written agreement by the parties, a court has substantial discretion in determining how the assets will be divided.
Although the courts consider the length of the marriage, even if a business was owned by a spouse before the marriage, the non-owner spouse will be entitled to half of the enhanced value of the business.
How will the courts determine what the business is worth at the time of divorce and how much the value increased during the marriage?
Absent a certified business valuation, the court may attempt to determine what the business was worth when acquired or formed, when the marriage occurred and on what date the filing of the petition for divorce took place. Most savvy business owners would not risk such an important determination to a potentially sympathetic judge or jury influenced by the counsel of the non–owner spouse believing the business is worth something greater than what the market will bear. A certified valuation performed by an independent third party (not your CPA or attorney) will provide the court with the most reliable value and the finest result.
My marriage is fast approaching — can I have my futurespouse sign it at the last minute?
Unlike what you observe in the movies, you should not force a prenup on the bride or groom moments before he or she walks down the isle. Any legal document signed under duress can generally be challenged. Instead, the parties should individually inventory all assets owned and find an attorney experienced in drafting these agreements, and who is familiar with the property laws of the state that the new couple will be residing and coordinate with the necessary estate planning. In order to be enforceable, the prenup must be entered into voluntarily by both parties with a reasonable disclosure of assets and financial obligations. A determination of the validity of the agreement may also consider the time between the execution of the agreement and the marriage to determine if both parties had adequate time to consult with an attorney. There is no magic number as to the amount of time that may be deemed adequate. Different jurisdictions may vary greatly when looking at the facts and circumstances to determine if enough time was given.
Are there any tax considerations with regards to the language in the prenup?
Absolutely. Because alimony is considered taxable income by the spouse receiving it, the spouse paying alimony can deduct it. Child support payments are considered an obligation of any parent whether married, divorced or single and are therefore not deductible. As such, it is important that any agreements regarding payments clearly define alimony and support payments.
In order for payments to be considered alimony, and therefore deductible, the following objective criteria must be met:
- Payments must be made in cash.
- The paying party’s obligation to make payments must end with the death of the payee spouse.
- Payments must be related to a divorce or separation agreement. The divorce or separation agreement can refer to the prenuptial agreement.
- The divorce or separation agreement must not state that the payments are not alimony.
- The parties cannot be members of the same household.
- The parties cannot file a joint tax return.
Who should draft my prenup?
You should seek the counsel of an experienced estate planning attorney. That experience should not be comprised of drafting simple wills. In order to draft an effective prenup, the attorney must consider what will happen by the force of law in the governing jurisdiction upon divorce or death of one of the parties. What would the surviving spouse be entitled to under the laws of a specific state? It is imperative to understand that result since the basic premise of the prenup seeks to alter that result to better suit the wishes of the individuals. The attorney must counsel the couple as to what is required by the governing statute and case law to ensure that the agreement will be respected and followed by the courts if litigation becomes necessary. A well-drafted agreement entered into freely by both parties with full disclosure of the assets should minimize the risk of litigation upon divorce or death. It is always wise to take advantage of the pre-marital bliss to save the big dollar legal fees later.
Are there other planning opportunities to consider for protecting family wealth?
Yes. You should consult with a qualified attorney to consider the use of trusts to protect family wealth and provide effective methods of moving assets to the next generations. Obviously, the drafting of the trust documents, the actions of the trustee and the handling of the assets received by the individual to avoid commingling with marital assets must be performed with great care. Trust distributions should not follow a pattern so to allow a dependency or expectation of entitlement by the other spouse.
Additionally, your attorney may recommend a family limited partnership (FLP) to better ensure that family assets stay in the family and do not become part of the claims of a divorcing spouse. Typically, these partnership arrangements restrict transfers of interest or require a divorcing spouse to offer shares back to the entity for repurchase at a specified price.
Another consideration is something that no conscientious business owner should be without—a well- drafted buy/sell agreement. A buy/sell agreement can restrict the interest in the business from being transferred to an undesirable party by requiring consent and providing a mechanism to buy back the interest utilizing a predetermined price and terms.
As a business owner, you understand that many problems and issues compete for your time. But, you should also be aware that a wide range of planning opportunities exist that allow you to proactively prevent a few major problems before they have profound personal effects on you and your family. The ideal time to put any legal document or strategy in place is when the owners, shareholders, husband, wife and children are getting along. Unfortunately, most individuals do not consider consulting with an attorney until there is a breakdown in a relationship. Do yourself, and others, a favor. Find someone who can educate you on all the proactive planning opportunities that exist for you and your business.