Tax-effecting marital property: the wild card in valuation.

The equitable distribution process of identifying, valuing and distributing the marital assets and liabilities continues to be plagued by the problem of the tax effects that are an inherent part of the undertaking. Since our law has evolved to require equal distribution in most cases, the determination of the asset values used in arriving at that equality can become a most hotly contested issue. Like goodwill, the tax-effecting of assets is another wild card in the valuation process. Take the simple example of a marital estate which contains $100,000 in cash and a $100,000 IRA. If one asset goes to each, then equality has not been achieved since the IRA is essentially pre-tax money while the cash is not.

The law is now well settled that the court must take into consideration the tax consequences in making its equitable distribution, and failure to do so is ordinarily reversible error.[1] However, this rule is clear only in those circumstances in which there will be a taxable event by virtue of the distribution itself or other awards in the proceedings. For instance, the court may order liquidation of a restricted fund, such as an IRA or deferred compensation savings plan, or a property sold, in which case there will be an immediate income or capital gains tax due.[2] The more difficult question is how the courts should consider contingent tax liabilities inherent in the assets distributed. For example, if an IRA is not to be liquidated by virtue of the dissolution judgment, then what consideration should its contingent tax liability be given in the scheme of equitable distribution?[3]

This issue was analyzed at length in this column in "Equitable Distribution in Dissolution of Marriage: Consideration of Contingent Tax Liabilities of Assets in Valuation and Distribution, Part 1 and Part 2, by Stephen Sessums and Melvyn Frumkes (April and May 1987).[4] Since that time, our courts have begun to address the issue, and the law is currently evolving, although somewhat differently in the different districts.

One of the most oft-cited cases on this issue is from California. Weinberg v. Weinberg, 67 Cal. 2d 557, 63 Cal. Rptr. 13,432 P.2d 709 (1967), holds that contingent tax liabilities should not be considered in the equitable distribution scheme unless the payment of the taxes is "immediate and specific." The Florida courts have not discussed Weinberg nor applied an "immediate and specific" standard by name, but have given the argument serious consideration. This doctrine has not been adhered to in Florida, and it appears that we are developing a much more liberal and more enlightened approach on a case-by-case basis without adherence to a strict rule. The argument in Weinberg for not considering the tax liability is that the ultimate and future payment of the tax is too speculative and uncertain, and therefore it should not affect the distribution value. However, in dissolution cases we are often forced to project the future based on the specific facts of the case and the overall financial history of the parties, and projection of tax liability is frequently necessary to do equity between the parties.

In the nine years since the Sessums and Frumkes article, there have been numerous cases out of the appellate courts addressing this issue. The First District has been the leader in establishing a trend toward considering all tax consequences, including contingent tax liabilities, in light of the specific facts of each case.

In Nicewonder v. Nicewonder, 602 So. 2d 1354 (Fla. 1st DCA 1992), the court stated that the trial court should consider all tax consequences, including contingent tax liabilities, that affect the value of the properties being distributed. The Nicewonder court held that the valuation of various investment properties without consideration of the tax consequences attendant upon depreciation and recapture did not fairly reflect the fair market value of the properties.[5]

The First District went on to develop a fact-based analysis in England v. England, 626 So. 2d 330 (Fla. 1st DCA 1993), and stated, "It is unproductive to attempt to set forth any bright-line rule as to when potential tax consequences are appropriately considered and when they are not." In England, the trial court tax-effected the value of the business awarded to the husband, reasoning that the husband would be subject to capital gains taxes when and if the business was sold. However, the appellate court stated that there was insufficient "evidentiary predicate" for the tax-effected treatment, since there was no evidence presented that the sale of the business was imminent or even contemplated. Further, it went on to discuss the possibility that the business could continue to appreciate, or could lose value in post-dissolution years. It was also pointed out that various tax strategies utilized by the business in future years could affect greatly the amount of capital gains tax which might eventually be incurred. It is worth noting that factually, there were no prior depreciation or investment tax credits involved; there was simply the issue of a capital gains tax on the appreciation in the value of the business.

England was followed by Goodwin v. Goodwin, 640 So. 2d 173 (Fla. 1st DCA 1994). The First District again based its analysis on lack of evidence that the sale of the marital residence (which had been used both as a rental property and as a personal residence) by the parties, was imminent. Whether any tax would be owed at all and the amount of any tax, were termed "pure speculation."[6] Although not specifically mentioned, the court may have reasoned that the tax might disappear completely under the one-time exclusion rule, at least up to a taxable gain of $125,000.[7] Again, this case turned on the lack of evidence presented as to the sale of the property and the existence and amount of any tax to be incurred. In dicta, the First District appeared to be persuaded by the argument that a property that has been heavily depreciated during the marriage and which generated prior tax benefits should be tax-effected. Further, the court held that adjusting asset value for potential tax consequences was a discretionary determination for the trial court, and affirmed once again, as in England, that it is unproductive to follow any bright-line rule.

In several of the cases in which the appellate court reversed the trial court on this issue, it did so by finding an abuse of discretion. However, the determination appears to be legal rather than factual, notwithstanding these holdings. Perhaps this will be addressed and clarified in later opinions.

In Yunus v. Yunus, 658 So. 2d 1043 (Fla. 1st DCA 1995), the most recent case to come out of the First District, the court accepted the argument that the IRA being divided carried with it a deferred tax liability since the parties had avoided taxes during the marriage by placing funds into individual retirement accounts. Following Judge Zehmer's concurrence in Nicewonder, the court determined that the trial court should indeed consider the tax- effected value of the IRA funds, especially in light of the prior benefits obtained.

In Goodwin, Yunus, and England, the appellate court followed the lines set out by Judge Zehmer in Nicewonder, which placed great emphasis on the fact that tax strategies utilized during the marriage had reduced taxes for that time period, but had created future tax liabilities attaching to particular assets being distributed. This reasoning seems to create a distinction without any substantive difference. The court appears to believe that since both parties benefited during the marriage from the use of depreciation and/or investment tax credits, a marital liability has been created thereby, which should be recognized, considered, and, in effect, equitably distributed right along with the marital assets, even though that liability may only be realized at some far distant date.

The Second District has not addressed the issue squarely. Lorman v. Lorman, 633 So. 2d 106 (Fla. 2d DCA 1995), and Holmes v. Holmes, 579 So. 2d 769 (Fla. 2d DCA 1991), provide some inconclusive and indirect authority.

The Third District appeared to follow the Weinberg standard of "immediate and specific" in Levan v. Levan, 545 So. 2d 892 (Fla. 3d DCA 1989). Levan does not discuss the nature of the assets distributed, nor the potential tax impact. The court simply held that tax liability may be considered only when a taxable event has occurred directly as the result of the divorce, or is certain to occur within a timeframe that can be reasonably predicted. The only other case out of the Third District, Werner v. Werner, 587 So. 2d 473 (Fla. 3d DCA 1991), follows the same rule, i.e., that the value should be tax-effected when there is a known, existing tax liability connected to that property.

The Fourth District, in direct contravention to the position of the Third District in Levan, held in Calamore v. Calamore, 555 So. 2d 1302 (Fla. 4th D.C.A. 1990), that the trial court committed error in not considering the differences between the pre-tax and post-tax values of the husband's deferred compensation savings plan. Once again, there was contingent liability which the court determined should have been taken into consideration in valuing the asset, even though the liability was in no way immediate.

The Fifth District noted in Miller u Miller, 625 So. 2d 1320 (Fla. 5th DCA 1993), that "the trial court cannot be faulted for not considering the tax consequences if counsel for the parties neglect to present evidence on the subject."[8] Miller emphasizes the fact-determinative nature of this issue in its review of various post-dissolution tax scenarios.[9]

Florida has therefore not adhered to a strict "immediate and specific" rule or any other doctrine; in fact, the commentary in England decrying the application of "a bright-line rule" is probably the best description of the status of law in our state. This issue in a trial context is extremely fact-oriented, and the courts seem much more inclined to tax effect an asset when given the tools to do so from a factual standpoint. Further, they seem more willing to require the accounting of these tax liabilities in properties that are obviously tax burdened, such as rental property, IRA accounts, and pensions. They seem to have more difficulties when dealing with a business or personal residence, both of which can be more easily shown to have many different potential outcomes in terms of ultimate taxation.

A fact pattern can be woven in almost any case to show the incurrence or avoidance of tax liability. Rental property might never be sold and, in fact, if the owner dies with it, it obtains a stepped-up-basis and taxes are never paid. On the other hand, the same property may need to be sold quickly because of other economic conditions, the particular personal lifestyles of the parties, or for any number of other reasons. It is incumbent upon the practitioner to make sure the court is presented with a full factual presentation to support the position advocated, as well as expert testimony. The simple IRA example used in the beginning of this article can actually mathematically be presented in such a fashion to show that if the parties are young, the interest rates high, and the IRA held for a long enough period, that because of the tax-deferred interest accumulations, receiving an IRA rather than cash will actually result in less tax in the long run. Hence the overall distribution and support scheme, ages of the parties, investment programs, projected tax brackets, and other financial conditions of the particular litigants become crucial in making a presentation of that which at first blush seems quite simple.

The law in Florida is evolving on a case-by-case basis, and perhaps because of the fact-oriented nature of this issue, appears to be developing a series of rules applicable to individual assets rather than a dogmatic principle of law, such as the "immediate and specific" doctrine or otherwise. The Florida courts seem progressive and attentive to this issue, and hopefully they will continue to be so.

[1] Calamore v. Calamore, 555 So. 2d 1302 (Fla. 4th D.C.A. 1990); Werner v. Werner 587 So. 2d 473 (Fla. 3d D.C.A. 1991); Miller v. Miller, 625 So. 2d 1320 (Fla. 5th D.C.A. 1993); Nicewonder v. Nicewonder, 603 So.2d 1354 (Fla. 1st D.C.A. 1992).

[2] A more problematic scenario is where the sale or liquidation of property is necessary in order to pay a cash award to the other party; the liquidation is not required by the court, but the party is unable to comply with the court order otherwise.

[3] A simplistic solution would be for the court to retain jurisdiction to revisit the issue when and if the tax was actually realized; however, at least one Florida court held that to do so was error, holding that property distribution may not be readdressed. Sweeney v. Sweeney, 583 So. 2d 398 (Fla. 1st D.C.A. 1991). Other jurisdictions have found differently. See Re Marriage of Clark, 80 Cal. App. 3d 417, 145 Cal. Rptr. 602 (1978), and Bagwell v. Bagmell, 668 S.W. 2d 949 (Ark. 1984).

[4] Stephen Sessums and Melvyn Frumkes Equitable Distribution in Dissolution of Marriage: Consideration of Contingent Tax Liabilities of Assets in Valuation and Distribution, Part 1, 61 Fla. B.J. at 45 (Apr. 1987) and Part 2, 61 Fla. B.J. at 66 (May 1987).

[5] The Florida Supreme Court, in Thompson v. Thompson, 576 So. 2d 267 (Fla. 1991), in establishing the exclusive method for valuing goodwill, embraced the fair market value approach, defined as what a willing buyer would pay and a willing seller would accept for the sale of a business, with neither acting under duress. This definition of fair market value contemplates that the business (or other asset) will, or at least can be sold. As Judge Zehmer detailed in his concurring opinion in Nicewonder, the fair market value of an asset cannot be fairly determined absent consideration of the tax consequences of a transfer. Few sellers, acting without duress, would accept a sale price which is insufficient to compensate for tax liability incident to the sale.

[6] Goodwin v. Goodwin, 640 So. 2d 173, at 175 (Fla. 1st D.C.A. 1994).

[7] I.R.C. [sections] 21 (providing for the one-time exclusion of gain from the sale of a principal residence after the age of 55).

[8] Miller v. Miller, 625 So. 2d 1320, at 1321 n.2 (Fla. 5th D.C.A. 1993).

[9] It was contemplated that the wife could be forced to sell the residence awarded to her because she couldn't afford to live there; also, the future sale of the husband's corporation could have any number of possible tax consequences, depending on the value of the f business at the time of sale, the nature of B the sale, and interim tax strategies.

William H. Stolberg is a partner in the Ft. Lauderdale law firm of Stolberg and Pence. He practices solely in the area of family law. He is Florida board certified in marital and family law, and is a member of American Academy of Matrimonial Lawyers Mr. Stolberg received his B.S. from Cornell University in 1868 and his J.D. from the University of Florida College of Law in 1973.

Kyle D. Pence is a partner in the law firm of Stolberg and Pence in Ft. Lauderdale. He practices solely in the area of family law. Mr. Pence received his B.A. from Nortwestern University in 1975 and his J.D. from Nova University in 1986. Mr. Pence is a member of the Family Law Section of the Broward County Bar Association.

This column is submitted on behalf of the Family Law Section, Renee Goldberg, chair, and William D. Palmer and Edna Y. Elliot, editors.