TUESDAY, MAY 18, 2021 | SERVING CHICAGO’S LEGAL COMMUNITY FOR 164 YEARS | CHICAGOLAWBULLETIN.COM VOLUME 167, NO. 58 Retained earnings of a business: Marital or non-marital property? Property division is one of property that are to be charac- spouse had great influence the most complex parts of any terized as “non-marital prop- over the distribution of divorce case. The issues are erty.” These exceptions funds); (2) whether the cor- even more complex when a include acquiring property “by poration held the retained spouse has an ownership gift, legacy or descent,” acquir- earnings for a proper busi- interest in a family or closely ing property before the mar- ness purpose to pay owned company. riage, and acquiring property expenses; (3) whether the This not only leads to issues “in exchange for property corporation paid the tax, pertaining to determining acquired before the marriage,” through designated tax pay- income and cash flow, but also among other exceptions. In ments, relative to the owner whether the interest in the addition, Section 503(a)(8) of MODERN spouse’s share of the retained company itself is characterized the Illinois Marriage and Dis- FA M I LY earnings reported on their as marital property subject to solution of Marriage Act pro- tax returns; and (4) whether division or a spouse’s non- vides that income from the owner spouse received a KATHERINE WELZ HERR marital property. In certain non-marital property as specif- salary from the corporation instances, even when a ically delineated in Section that was fair and reasonable. spouse’s ownership interest is 503(a)(1) through (7) is non- Under the second prong of characterized as his or her marital “if the income is not KATHERINE WELZ HERRis the analysis, once a court non-marital property, there attributable to the personal an associate at Schiller determines that any retained are still circumstances where effort of a spouse.” DuCanto & Fleck LLP. She is earnings should be treated as “assets” can be considered Generally, a closely held “income” of a spouse for well-versed in all areas of marital property. This can company’s retained earnings divorce purposes rather than family law, including occur with the retained earn- are non-marital property if the an asset, the court must deter- complex financial and ings of a business. company is non-marital and mine if the “income” is due to business matters. She is a Retained earnings is defined just a part of the stockholder’s the “personal efforts” of the strong advocate for her as the accumulated portion of equity. However, retained earn- spouse. The burden of proof a business’ profits that are not ings in a closely held company client’s personalized needs. is on the spouse owner who distributed as dividends to can become marital property She uses her strong works in the business to show shareholders, but are instead for purposes of a divorce. analytical skills to develop that retained earnings were retained for reinvestment in To determine whether a cogent legal arguments on not attributable to their per- the company. Retained earn- portion of the retained earn- her client’s behalf. She can sonal effort which must be ings are typically included on ings attributable to the spouse be reached at demonstrated by clear and the company’s balance sheet owner are marital or non-mar- convincing evidence, a higher kwelzher r@sdflaw.com. as part of the “shareholder’s ital, divorce courts conduct a burden than by a preponder- equity.” The question then two-prong test. Under the first earnings considered in the ance of the evidence. In re becomes for marital property prong, the court must con- value of the company. This is Tiffany W., 2012 IL App (1st) purposes, who actually owns sider whether the retained not a bright-line test, and to 102492-B, Para. 12. The classic the retained earnings: the earnings were really “income” make this determination, example of when income is shareholder or the company? rather than an asset of the courts are directed to con- not due to a spouse’s “per- Section 503(a) of the Illinois business. To make this deter- sider a variety of factors, sonal effort” is when a spouse Marriage and Dissolution of mination, courts must con- including (1) whether the is receiving income through a Marriage Act states that “all sider the nature and extent of spouse was a controlling passive investment such as property, including debts and the stock holdings, i.e. is a shareholder and hence could rental income. In other other obligations, acquired by majority of the stock held by a disburse or withhold a divi- instances where the spouse is either spouse subsequent to single shareholder spouse dend (this does not mean that actively participating in an the marriage” is “marital prop- with the power to distribute the shareholder spouse has to asset’s daily operations (usu- erty.” However, Section 503(a) or not retain the earnings, and have a controlling interest, ally a company), the income is carves out specific classes of to what extent are retained just that the shareholder presumed a result of the Copyright © 2021 Law Bulletin Media. All rights reserved. Reprinted with permission from Law Bulletin Media.spouse’s personal efforts and interest and he could not uni- chapter S corporations that property acquired prior to the presumed marital. laterally declare or withhold the husband had owned prior marriage that was attributable For example, in In re Mar- dividends, the retained earn- to the marriage and was the to the husband’s personal riage of Joynt, 375 Ill.App.3d ings were a corporate asset sole shareholder was marital efforts and therefore marital. 817 (3d Dist. 2007), the hus- that the company used to pay property. The court reasoned The law surrounding the band had a minority, non-con- expenses, the corporation that the husband as the sole characterization of retained trol ownership interest in a paid the tax on the husband’s shareholder could unilaterally earnings of a business for business that the parties stip- portion of the retained earn- take disbursements, the divorce purposes is complex ulated was his non-marital ings, and the husband was retained earnings were not and can turn on any one fact. property. The company had fairly and adequately compen- held by the corporation to pay It is therefore imperative sizeable retained earnings that sated through his salary. expenses, dividends, or used upon any spouse in such a the court determined were a Conversely, in In re Mar- in connection with the corpo- predicament to consult with non-marital corporate asset. In riage of Lundahl, 396 ration, and the husband paid appropriate professionals and so holding, the court rea- Ill.App.3d 495 (1st Dist. 2009), the income tax on the earn- seek the appropriate informa- soned that the husband only the court determined that the ings. As a result, the retained tion through the discovery held a non-marital minority retained earnings of two sub- earnings were income from process. Copyright © 2021 Law Bulletin Media. All rights reserved. Reprinted with permission from Law Bulletin Media.