Are Profits From a Separate Business Community or Separate Property?
Under Arizona law, when one spouse earns profits from separate property, those profits are either community or separate property (or a combination of both). They are community property to the extent they are earned through the spouse’s efforts. The spouse earning them must offer a reasonable method to apportion the profits between the community and separate property.
In Evans v. Evans 288 P.2d 775 (1955) the Arizona Supreme Court evaluated a proposed method to segregate business income.
Facts of the Case
Mr. Evans and Mrs. Evans married in 1949. At this time, Mr. Evans owned half of the “French Café and Cocktail Lounge” business. Soon after the marriage, he bought the other half for $45,000. He paid $10,000 from a business fund, gave a note to the seller for $5,000 and borrowed $30,000 from the bank.
He secured the bank loan with a note and chattel mortgage executed by the wife and himself. He paid off both notes from business profits. He and his wife purchased a family residence, household furniture, a Buick car, a Studebaker car and a property/lot in Pinetop, Arizona.
Before husband had bought the second half of the business, he received a salary draw of $600 a month. This he put in the couple’s joint account.
After he owned the entire business, he no longer took regular draws. He drew out money when he wanted to and deposited it in the joint account.
The wife then petitioned for divorce. The court granted her divorce and divided the community property. It awarded Mr. Evans the first half of the business as his separate property. It also awarded him the second half of the business.
However, it determined that community funds had paid for 7/8 of the second half of the business. Therefore, it ordered Mr. Evans to pay Mrs. Evans $12,450 for her share of the business. Husband appeals from this order.
Status of Income from Separate Property
The Arizona Supreme Court could not figure out exactly how the trial court came up with the seven-eighths figure. However, it assumed that the trial court determined that Mr. Evans paid the $30,000 bank loan and $5,000 partnership loan with community funds.
Husband paid the loans with business income. That means that the trial court found husband’s business income to be community property.
In Arizona, income from a business that is the separate property of one spouse may be community or separate property. If the profits are the result of the labor of the spouse, they are community property. If they are due to the inherent characteristics of the business, they remain separate.
Oftentimes business profits result from both the labor of a spouse and the characteristics of the business. When that happens, a spouse can propose a method for the court to figure out which profits come from labor.
If the community and separate funds are so mixed that it’s impossible to segregate them, courts consider all as community funds.
Husband Did Not Suggest a Viable Apportionment System
The Court found that husband didn’t offer a viable manner to divide business income between separate and community property. He proposed that the court count $600 a month (his former draw) as community property, and leave the rest separate. But the Supreme Court said this was not reasonable.
The Supreme Court said that a manager’s salary did not always measure the income earned by his services. Generally, a manager produces more income than his salary. Here, the Court said the business profits from Mr. Evans’s labor were too mixed to segregate.
The Arizona Supreme Court found that the trial court correctly treated all of his business profits as community property. It affirmed the trial court decision.