Retained Earnings in Divorce

When a couple decides to divorce, among the more contentious issues is often how assets and property are to be divided. Either spouse’s ownership or investment in a businesscan make property division even more complicated. One of the biggest challenges is determining how much of a company’s value, in general, and, specifically, retained earnings are to be considered marital property, subject to equitable distribution upon divorce.

Understanding Retained Earnings

A successful company budgets its revenues carefully, both to maintain the long-term health of the business and to pursue future expansion or investment. Thus, once income levels exceed current expenses, the remainder of the revenue is either distributed as dividends to shareholders or kept in the company for future use as retained earnings. In most cases, retained earnings have already been taxed under the Sub-chapter S corporation (S-corp) structure of many family businesses. While financial experts indicate that retained earnings contribute to the overall value of the company, the question facing divorcing couples and their attorneys is whether the undistributed funds constitute marital or non-marital property.

Controlling Interest of the Company

Two separate cases in Illinois appeals courts used a similar premise to come to two separate conclusions regarding the marital property status of a company’s retained earnings. The decisions, ultimately, relied on the spouse’s ability to control the distribution of retained earnings as dividends, and therefore, whether the assets were truly available to that spouse.

In Re: The Marriage of Joynt

The first case dealt with a husband who was part-owner in a family business with his father and sister. The husband owned 33 percent of the company, his sister, owned 19.4 percent and his father held the remaining 47.6 percent. While the business had retained earnings nearing $4 million, the company did not distribute dividends from the retained earnings account. The trial court decided, based on case law examples in other states, that the husband’s interest in the company did not give him the necessary control or influence to distribute the retained earnings as dividends or profits, and thus, the company’s retained earnings were considered a non-marital property. The Third District Appellate Court later affirmed the decision.

In Re: The Marriage of Schmitt

The second case involved a husband who was the sole owner of a business which had been initially developed prior to the marriage with non-marital funds. The husband paid expenses out of the corporate accounts, including real-estate purchases and other, separate payments to benefit his wife and children. The husband, however, failed to keep clear documentation regarding what remained as retained earnings, and whether his payments and purchases were charged as distributions of retained earnings to him as a shareholder, albeit the only shareholder. The trial court initially found that real estate assets acquired through the company’s accounts to be non-marital property. The Second District Appellate Court, however, disagreed.

The appeals court held that, as sole owner, the husband retained full and complete control over the distribution or retention of earnings. Since the money generated to make the purchases was attributable to his personal efforts, as are wages, salaries, and bonuses, the money was therefore marital property and subject to equitable distribution.

Details Matter

Establishing whether retained earnings are corporate assets or marital property will never be easy, but these cases have established some basic legal guidelines. Primarily, control over the distribution of dividends is a major factor in any divorce case involving business ownership. A minority shareholder with little influence is not likely to have his or her share of retained earnings considered marital assets. The retained earnings of a sole owner are more likely to be considered marital property, but other considerations may exist based on the facts of the case.

If you are considering a divorce in Illinois and would like to know more about how your company’s retained earnings may be considered in the process, we can help. Contact an experienced Will County divorce attorney today to schedule a free consultation.