Dividing Business Profits During Divorce
Dividing business profits during divorce in Arizona can be a very complicated issue. The Arizona Court of Appeals addressed whether the profits of a business earned between the date the Petition for Dissolution of Marriage is served on the other spouse and the date the final Decree of Dissolution of Marriage is issued should be divided.
In 2010, Husband filed a petition for dissolution of marriage. Early in the case, Wife filed a motion for temporary orders seeking a declaration that, pending the final decree, she was entitled to receive half of all distributions made from Husband’s two businesses. The trial court held a hearing on the motion and received testimony from both parties as well Husbands certified public accountant.
The court determined that no matter how the distributions were characterized, the parties must report the same as taxable income. There were no reductions in capital accounts and the distributions were appropriately characterized as salary or earned income. Therefore, the court denied Wife’s request for one-half of the distributions made to Daniel.
The parties also disputed the character of the distributions from the business following Husband’s filing of the petition for dissolution. Husband argued Wife was not entitled to any of the monies paid to him because they were in the nature of salary or earned income and thus constituted his separate property.
Wife countered by arguing Husband’s salary from one of Husband’s businesses was limited by contract to $250,000.00 per year and, therefore, everything Husband received above this salary amount was community property. She further argued that all distributions from Husband’s second company were also community property.
Husband’s CPA testified Husband received a base salary of $250,000 from his first company, but, as a tax saving measure, Husband restructured the rest of his compensation for his “toil and labor” as distributions.
The trial court also rejected Wife’s claim that she was entitled to her share of the payments Husband received that exceeded his $250,000 salary. The trial court decided that, with regard to Husband’s second business, the business was small enough that it relied on Husband’s toil and labor to remain profitable and therefore, all the post filing distributions were his separate property. After the court entered a signed decree of dissolution, Wife filed a motion to amend and a motion for reconsideration, which were denied by the trial court.
Wife also argued the trial court improperly classified the distributions from both companies made subsequent to the filing of the petition for dissolution as Husband’s sole and separate property. Although property acquired by either spouse after service of a petition for dissolution of marriage is the separate property of the acquiring spouse, Arizona statute states that the service of a petition for dissolution doesn’t alter the status of preexisting community property.
Likewise, notwithstanding the filing of a petition for dissolution, when community property is used to acquire new property, the new property is community property. The court also cited Brebaugh v. Deane, which ruled that because property acquired during marriage is presumed to be community property, the spouse seeking to overcome the presumption has the burden of establishing the separate character of the property by clear and convincing evidence.
The parties did not dispute that both businesses were acquired during the marriage and constituted community property. It was also undisputed that the operating agreements for both companies provided for distributions to members in proportion to their percentage interests.
Nor did they dispute that under his employment agreement Husband received a base salary from his second company in the amount of $250,000 and that amount, since the time he filed the petition, was his sole and separate property.
Wife contended, however, that all business post-petition distributions in excess of $250,000 constituted profits of the community’s interest in the businesses and she was therefore entitled to half of the disbursements he received before the final decree was entered, when, pursuant to court order, the character of the businesses was transmuted from community property to his separate property.
Husband countered that all of the distributions were wholly earned income that he received for his toil and labor after his filing of the petition and thus constitute his separate property. To support his argument
Husband cited Rueschenberg v. Rueschenberg, which states that where either spouse is engaged in a business whose capital is the separate property of that spouse, the profits of the business are either community or separate in accordance with whether they are the result of the individual toil and application of the spouse, or the inherent qualities of the business itself.
The court reiterated that Husband bore the burden of establishing the separate nature of all the distributions he received above his $250,000 salary by clear and convincing evidence to establish they were not community property.
The operating agreements for both companies provided that distribution of cash or other property would be made to the members in proportion to their percentage interests. At trial, Husband’s CPA testified that before 2010, Husband had consistently earned an annual salary of approximately $500,000. Then in 2010, his compensation was restructured such that he received half of his compensation as salary and the other half as distributions.
Although the record reflected this change was made as part of a tax savings strategy and not in anticipation of the divorce, the court ruled that the restructuring was not dispositive as to whether all the distributions made by the two businesses became
Husband’s sole and separate property pending the final decree. Instead, the court had to take into account that the source of the compensation was an asset owned by both parties and, therefore, the amount must be reasonable given the totality of the circumstances.
As his CPA acknowledged, Husband received a significant amount of money as profit distributions each year, but even if he didn’t work for the businesses, he nonetheless would have been entitled to claim whatever profits or losses were generated by both businesses.
Husband’s CPA testified that the profits disbursed to Husband, in excess of his compensation for his labor, were approximately $50,000 per year, presumably for Husband’s second business.
Dividing Business Profits During a Divorce Arizona | The Ruling
The justices stated that the parties did not identify, nor did their review of the record, reveal any evidence regarding the reasonable amount of compensation Daniel received for his toil and labor at his first business. Thus, the court found that the trial court’s ruling that all monies paid to Daniel by both companies were his sole and separate property wasn’t supported by the record because it had failed to adequately consider Wife’s community interest in the businesses.
The justices also concluded the record did not show the trial court placed the burden on Husband of proving by clear and convincing evidence that the distributions he received from both businesses over the three year period should be deemed his sole and separate property.
Therefore, the Arizona Court of Appeals vacated the trial court’s ruling regarding the character of the distributions from both companies and remanded the case back to the trial court to determine the amount of compensation Husband reasonably received from both companies for his toil and labor.
The justices indicated any distributions Husband received in excess of that reasonable amount were attributable to the community as profits derived from existing community assets and subject to equitable division.
Several important points of information can be concluded from these proceedings. Firstly, a trial court has the discretion to decide if a minority discount is appropriate on a case by case basis depending on the relevant factors.
Also, when the court determines the value of a business asset, it must do so in accordance with the valuations given by experts in the case and other evidence provided. Additionally, property acquired during the marriage is presumed to be community property, so if a spouse seeks to overcome that presumption they have the burden of proving the separate character of the property by clear and convincing evidence.
Lastly, any income a spouse derives from their toil and labor in a community property business after the filing of the petition for dissolution is their sole and separate property, but any amount they earn above that amount is usually considered community property and is subject to equitable division.