Moriarty & Dee, Attorneys at Law, in Buffalo, New York.

Marital Property (page 2):

Stopping the Acquisition of Marital Property

The commencement of an action for divorce stops the acquisition of marital property. Property acquired by one's effort after an action is commenced, but during the litigation, remains separate property. This provision is important in view of the fact divorce proceedings can take many months to bring to completion. By allowing parties to acquire separate property during litigation, free from fear it will be included in the marital kitty, the parties are encouraged to continue with their lives and business affairs in as normal a fashion as possible. Care must be taken, however, to avoid the possibility that newly acquired separate property not be deemed to relate back to the marital property.

Suppose, for example, John and Betty Smith commenced an action for divorce in March 1999. Shortly thereafter, in April, 1999, John purchases an interest in ABC Oil and Gas Leasing, a limited partnership attractive to John for both investment and tax shelter purposes. Assuming the purchase is made with income earned by Mr. Smith after the action commenced, the investment is separate property and not reachable by Mrs. Smith.

But suppose Mr. Smith purchases the unit with appreciated funds from an account traceable in part or in whole to an inheritance received by Mr. Smith from his mother during the marriage. Presumably, the part of the investment equal to the amount originally inherited by Mr. Smith would still be regarded as separate property. However, now Mr. Smith runs the risk that Mrs. Smith will argue that the appreciation in the account during the partiesí marriage was due in part to their contributions or efforts as, a spouse, and by extension, therefore, she is entitled to a percentage of that share of the limited partnership which is proportionate to the amount of appreciated funds vis-a-vis the original inheritance. Simply put, Mrs. Smith is arguing that the appreciation is marital property, and not separate property.

Unlike publicly held corporations, closely held corporations, the shares of which are held by a small number of stockholders who are often members of a family, present difficult problems of valuation. Infrequent trading and the lack of an established market prevent the estimate of value by traditional means such as arms-length sale, defined by the IRS as ìthe price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.î

IRS Ruling 59-60

Despite the difficulty of valuing the closely held corporation, the necessity to do so for many different purposes has brought the IRS to grips with the issue. The result, Internal Revenue Service Revenue Ruling 59-60, lists the factors to be considered to determine the value of a business. This set of guidelines is a widely accepted approach to valuation questions. The factors are:
1. The nature of the business and the history of the enterprise from its inception.
2. The economic outlook in general and the condition and outlook of the specific industry in particular.
3. The book value of the stock and financial condition of the business.
4. The earning capacity of the company.
5. The dividend--paying capacity of the company.
6. The existence of goodwill or other tangible value.
7. Sales of, and size of the block of stock to be valued.
8. The market price of stocks of corporations engaged in the same or in a similar line of business having stocks actively traded in a free and open market.

Revenue Ruling 59-60 is a long step in the right direction and perhaps as much as we can reasonable expect to achieve in the establishment of guidelines for valuations of a business. Its approach is to list as factors the most widely used approach to complex issue of valuation. Each is given weight. The rule does not mandate each factor be treated equally. The list of factors does not exclude the use of other considerations when appropriate. One desirable result of 59-60 is that a particular business may be valued by standards unique to its own industry, but still be judged within the more acceptable framework of federal agency guidelines.

A number of valuation methods are in common use, and we will discuss briefly some of them.
Perhaps the primary methods for evaluating an ongoing business is the earnings approach or return on investment method. Examination of a companyís earnings for a reasonable period of time, usually the past five years, will be made in most cases. Generally, this approach assumes, among other things, a company positioned in a relatively stable industry, the ability of new ownership to maintain or improve successful management policies, and the likelihood of no future disruptive influence in the form of supply shortages, strike, increased competition, or similar happenstance.

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The capacity of a closed corporation to pay dividends is another methods to be used. Dividend-paying capacity is not the same as dividends actually paid. To determine dividend--paying capacity, it will be necessary to compare the company under analysis to other similarly situated companies in the same industry. Once stabilized, dividend--paying capacity is capitalized by the capitalization rate appropriate to the industry to determine worth of share of the companyís stock. In view of the fact dividends are easily manipulated in a closed corporation, dividend--paying capacity is regarded as a more reliable indicator of net worth and dividends actually paid.

The most important step in evaluating a closely held corporation is the selection and preparation of an expert who is able to render a competent opinion on the business fair market value. Many factors come into play in choosing an expert. The importance of finding an expert who knows the business or industry in question, particularly when the product or service rendered is unusual, can be critical. In such instances trade or industry journals are good sources to obtain an expert with a specific familiarity or expertise in the unusual business.

State Law Guides Courts On Divorce Assets
Judges Are Not Bound to Divide Marital Properties Evenly

The final step in the resolution of the financial issues which are part of divorce proceedings is the distribution of marital assets.

Factors to be Considered in Distributing Property

The New York State Equitable Distribution Law lists detailed criteria to be used by the court as guidelines in effectuating the distribution of properties:

Marital property shall be distributed equitably between the parties, considering the circumstances of the case and of the respective parties.

In determining an equitable distribution of property, the court shall consider:

"1. The income and property of each party at the time of the marriage, and at the time of the commencement of the action;

2. The duration of the marriage and the age and health of both parties;

3. The need of a custodial parent to occupy or own the marital residence and to use or own its household effects;

4. The loss of inheritance and pension rights upon dissolution of the marriage as of the date of dissolution;

5. Any award of maintenance under sub-division six of this part;

6. Any equitable claim to, interest in, or direct or indirect contribution made to the acquisition of such marital property by the party not having title, including joint efforts or expenditures and contributions and services as a spouse, parent, wage earner and homemaker, and to the career or career potential of the other parties;

7. The liquid or non-liquid character of all marital property;

8. The probable future financial circumstances of each party;

9. The impossibility or difficulty of evaluating any component asset or any interest in a business, corporation or profession and the economic desirability of retaining such assets or interest intact and free from any claim or interference by the other party;

10. Any other factor which the court shall expressly find to be just and proper."

"In any action in which the court shall determine that an equitable distribution is appropriate but would be impracticable or burdensome or where the distribution of an interest in a business, corporation or profession would be contrary to the law, the court in lieu of such equitable distribution shall make a distributive award in order to achieve equity between the parties. The court in its own discretion, also may make a distributive award to supplement, facilitate or effectuate a distribution of marital property."

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Equitable Does Not Mean Equal

Initially, it should be noted equitable distribution does not necessarily mean equal distribution. Although the courts usually seek to divide marital property evenly between the parties, they are not bound to do so. In the right circumstances, property can be divided 60-40, 75-25, or even awarded in its entirety to only one party. (Oft-proposed legislation would, however, create a rebuttable presumption, that each party be entitled to an equal distribution of marital property. The presumption would be rebutted in the event the court expressly declared that justice and equity require an unequal distribution).

To illustrate, let us assume John and Betty were married in 1981 and now--in their late 40ís, with four children--ranging from 17-12-- they are divorcing.

The main source of income for the Smithís is the closely held family corporation started by John's father and his uncle in 1950. John and his cousin Richard are each 50% stock holders, with each controlling 50 shares of the outstanding stock.

John received his shares by a combination of means. Ten shares were gifted to him by his father in the years 1968 to 1970, before his marriage. Another ten shares were gifted to John by his father after John's marriage to Betty. Twenty shares were purchased by John from his father during the marriage, it being his father's desire to make his son earn some part of his ownership in the family business. The stock was purchased by John with earnings from his wages and with money held by him in an account in his own name funded with the proceeds of an inheritance received from his mother upon her death in 1982. The remaining ten shares were purchased by John with proceeds of a settlement received by him as a result of a car accident in which he was involved in 1984.

How many shares are marital property and how many shares are separate property?

Setting aside questions of appreciation in the value of the shares during the marriage which are discussed elsewhere, the shares gifted to John before the marriage (10) and after the marriage (10), as well as the shares purchased by John with the proceeds of his auto accident (10), are clearly separate property.

The twenty shares acquired by John with his earnings, and the inheritance received by him from his motherís estate, however, are mixed marital and separate property. The income was earned during the marriage and therefore any acquisition made with it is marital property; the inheritance is separate property; and there will need to be a determination as to how much of the value of the twenty shares relates to each component.

The rules become less clear, however, when the nature of the assets or income used to use John Smithís interest in the business are not clearly identifiable. Suppose the accident proceeds used by John to purchase the last ten shares were initially placed in the joint name of John and Betty. Did John's act of placing the proceeds in his personal injury claim in joint create a gift of one-half of the settlement to his wife? Can the law disregard the gift and trace the proceeds back to their original nature as separate property? These are issues which the courts continue to wrestle with today.

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