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Business Aspects of Community Property

Updated: Feb 18

Most people have heard of community property, but many don't know exactly what it means (even those who live in community property states). In fairness, it's pretty difficult to define.


What exactly is community property?


A short (but probably unhelpful) definition would be something like: "a family law concept and marital property regime that defines property received during the marriage as communal with few exceptions."


But the concept is simple enough: if I collect a paycheck, that money is as much my spouse's as it is mine. If my spouse and I buy a house, the house is presumed to be ours (rather than only mine or only my spouse's). If I collect paychecks and use that community property money to start a business, my spouse has an interest in that business. The idea is that both spouses contribute equally to their marriage, and the law considers those contributions to be financially equal.


What states are community property states?


There are nine community property states in the United States (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin), and the five populated American territories are community property jurisdictions (American Samoa, Guam, Northern Mariana Islands, Puerto Rico, US Virgin Islands).


Three states allow married couples to elect into community property rules (Alaska, Kentucky, Tennessee). So it is a minority "marital property regime" in the United States.


What property is separate property?


Not all property is community property. If I buy a house and later get married, that house is still considered my "separate property." If I receive a gift, that could be considered my separate property. And in California (but not Texas), if I purchased stock before my marriage, but continue receiving dividends during my marriage, those dividends are my separate property.


What is the "California (but not Texas)" exception about?


Income received during the marriage is community property. But what if the source of that income is separate property?


California follows what is called the "American Rule." That is, any income that can be traced to a separate property source is treated as separate property. See Cal. Fam. Code section 770(a)(3).


Texas follows the "Spanish Rule" (also occasionally called "Civil Rule"). Texas presumes that all income received during the marriage is community property unless it is defined as separate property. Tex. Fam. Code section 3.002. Texas defines "separate property" in a way that does not include income from separate property. Tex. Fam. Code section 3.001. Because the dividends described above do not fit in with the Texas definition of "separate property," they are community property.


According to the IRS, Arizona, California, Nevada, New Mexico, and Washington follow the American Rule, while Idaho, Louisiana, Texas, and Wisconsin follow the Spanish Rule.


How can this affect my business?


If you formed your business in a community property state during your marriage, on divorce, your spouse might be entitled to a share in the business. Many business attorneys, when forming a business, will recommend that your spouse to sign a spousal consent. Such a consent does not affect community property rights generally, but it does prevent the spouse from involving himself or herself in the management of the business in case of divorce.


Moreover, if the community contributed to the increased value of the business, the community will be entitled to reimbursement. This valuation process can be costly and involved.


California actually has two methods of determining the value of a business: one for when the character of the business is the reason for its increased value (Van Camp accounting, named for the case establishing it), and another for when the management is the main reason for its increased value (Pereira accounting). As you can see, this gets complicated.


How can this affect my investment real estate?


If you obtained investment real estate prior to your marriage, the rents from that real estate could be categorized as separate or community property, depending on if your jurisdiction is an "American Rule" or "Spanish Rule" jurisdiction. If there is a divorce, one party might need to buy out the other when it comes to real property.


Where does this concept come from?


Community property is an ancient concept. It dates back to the Visigoths, an early Germanic tribe that eventually settled in (mostly) what is now Spain. The Spanish picked it up and eventually exported it to the New World (you'll notice most community property jurisdictions are former Spanish colonies).


Conclusion


Community property, as a legal regime, can have dramatic effects on your business or other investments. If you operate a business in a community property jurisdiction, for the sake of yourself and your co-owners and employees, it is worthwhile to familiarize yourself with your jurisdiction's community property rules.

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