As a general rule, an individual is attributed any ownership interest held by their spouse under IRC §1563(e)(5). If the individual and the spouse are legally separated under a decree of divorce or separate maintenance, there is no attribution.
Individuals are not attributed any ownership in their spouse’s business if all the following are met:
- The person does not have direct ownership in the company or business;
- The person is not a director or employee and does not participate in any management of the company;
- No more than 50 percent of the business’s gross income for a given year comes from passive investments (rents, royalties, dividends, interest, and annuities); and
- The spouse’s ownership does not have disposition restrictions running in favor of the individual or the minor children of the individual and the spouse. As an example, the business owner cannot have a right of first refusal to their spouse or children before selling the business interest to a third party.
Example – Exception to Spousal Attribution
R is a doctor and owns 100 percent of a professional corporation engaged in the practice of medicine. L, R’s spouse, is an attorney and owns 100 percent of a separate professional corporation engaged in the practice of law. Neither one is involved as a director or employee of the other’s corporation nor in the management of that corporation. R is not attributed to L’s interest in L’s corporation. Similarly, L is not attributed to R’s interest in R’s corporation.
An individual’s community property interest in their spouse’s business ownership would appear to disqualify the individual from the exception described above. In a community property state, the spouses are automatically considered to own half of the assets acquired during the marriage, except for certain limited situations.
The individual would be able to qualify for the exception if the community property interest is relinquished or the spouse’s business ownership is treated as separate property under the applicable community property law. Eight states apply community property interests. They are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
