Tax Ramifications and Costs in Equitable Distribution

The recent Pennsylvnia Superior Court case of Balicki v. Balicki has sent shock waves throughout the family law community. The question family law practitioners face is whether the Balicki decision mandates the court to apply tax ramifications and the costs of sale to all assets when equitably dividing the marital estate. Balicki v. Balicki , 2010 PA. Super 134, July 30, 2010.

Background

In 2005, the Pennsylvania Divorce Code was amended. Section 3502 pertains to “Equitable division of marital property.” The following two subsections (10.1 and 10.2) were added to Section 3502(a): “(10.1) The Federal, State, and local tax ramifications associated with each asset to be divided, distributed or assigned, which ramifications need not be immediate and certain”; and “(10.2) The expense of sale, transfer or liquidation associated with a particular asset, which expense need not be immediate and certain.”

Section 3502(a) states, in part: “the court shall equitably divide … the marital property between the parties … after considering all relevant factors … factors which are relevant to the equitable division of marital property include the following [13 factors that include 10.1 and 10.2].”

The Dilemma for Family Law Practitioners

When the Divorce Code was amended in 2005, family law practitioners debated whether subsections 10.1 and 10.2 had to be “applied” in all cases, or merely “considered.” It appeared that subsections 10.1 and 10.2 would be considered and applied on a case-by-case basis.

Prior to the 2005 Amendments to the Divorce Code, Section 3502(a)(10) read as follows: “The economic circumstances of each party, including Federal, State and local tax ramifications, at the time the division of property is to become effective.” The Pennsylvania Supreme Court case of Hovis v. Hovis was handed down shortly after the 1988 Amendments to Divorce Code became effective. The 1988 Amendments added the language to Section (a)10 pertaining to tax ramifications. The supreme court in Hovis held that “potential tax liability may be considered in valuing marital assets only where a taxable event has occurred as a result of the divorce or equitable distribution of property or is certain to occur within a time frame such that the tax liability can be reasonably predicted.”

The 2004 Official Comment to Section 3502 stated:

Notwithstanding the legislative statement in the 1988 amendments, and perhaps because the Hovis opinion was handed down after the amendments had become effective (but clearly decided under pre-amendment law), lower court cases after Hovis have required tax ramifications to be immediate and certain in order for them to be considered in equitable distribution. New subsection (a)(10.1) seeks to change this interpretation by making clear that tax ramifications are relevant and need not be immediate and certain.

Balicki

In the recent case of Balicki, the parties were had been for 26 years when they separated. According to the opinion, Bobbi Balicki was a homemaker and Jeffrey B. Balicki was a part owner of a family insurance company and a shareholder in a Pittsburgh law firm. Mrs. Balicki filed a divorce action against Mr. Balicki in Allegheny County, PA, and a four-day equitable distribution master's hearing was held.

Because Allegheny County follows Rule 1920.55-2, the master's hearing was a record hearing. According to the opinion, the master, inter alia, awarded Mrs. Balicki 65% of the marital estate plus alimony. In valuing the marital estate, contrary to Mr. Balicki's request, the master did not reduce the value of the insurance company in which Mr. Balicki had an ownership interest because it was a second-generation family business, and the parties' children, who were now adults, “may someday inherit the business as Husband did.” According to the opinion, in his report and recommendation, the master valued the marital portion of the business to be $610,490. The husband filed exceptions to the master's report and recommendation with the trial court.

The trial court granted “most” of Mr. Balicki's exceptions and, among other things, lowered “the marital value of Husband's insurance agency from $610,590 to $469,655 to account for the tax ramifications and expenses of sale.”

Both parties appealed the trial court's ruling on numerous grounds. The Pennsylvania Superior Court affirmed the trial court's decision to reduce Mr. Balicki's interest in the insurance company to account for the tax ramifications and expenses of sale. The standard of review regarding an order of equitable distribution is “whether the trial court abused its discretion by a misapplication of the law or failure to follow proper legal procedure.” An abuse of discretion “requires a showing of clear and convincing evidence.”

The Superior Court provided a reminder that “in determining the propriety of an equitable distribution award, courts must consider the distribution scheme as a whole,” and measure it “against the objective of effectuating economic justice between the parties.”

Mr. Balicki's interest in the business was the largest asset in the marital estate. According to the opinion, the distribution scheme included Mrs. Balicki receiving a large payment from Mr. Balicki, while the latter retained his interest in the business. The trial court indicated that Mr. Balicki's retaining his interest in the insurance business was “much different” from Mrs. Balicki's receiving a cash payment, and if Mr. Balicki desired to convert his interest in the business to cash, he would have to incur income tax, a broker's commission, finder's fee, attorney fees and accountant fees. Because of this, the trial court reasoned that deducting the tax ramifications and expense of sale from the value of the business was appropriate.

The Appeal

On appeal, Mrs. Balicki claimed that the trial court “usurped the fact-finding function and credibility determinations of the master.” The Superior Court did not agree and held that the “record does not support the Master's conclusion that Husband would not sell the family-held insurance agency.” As such, the Superior Court held that Mrs. Balicki's claim was without merit and affirmed the trial court on that issue on appeal. It is to be noted that the Superior Court also affirmed the trial court's tax affecting the alimony award.

Conclusion

The Balicki decision appears not to have settled the debate of “consider” versus “apply” the tax ramifications and expense of sale to all assets when equitably dividing the marital estate. Can a court “consider” the tax ramifications and expense of sale without same being calculated? If the tax ramifications and expense of sale are to be calculated for every asset in a marital estate, it will be a very costly endeavor for the litigants as experts will be needed in many situations. Once they are “considered,” do the values of the assets have to be reduced accordingly? It appears that arguments for both sides continue to exist. Regardless, in Pennsylvania, practitioners and the court must focus on and analyze the Balicki decision in equitable distribution matters.

Michael E. Bertin is a partner at Obermayer Rebmann Maxwell & Hippel, LLP. The article also appeared in The Legal Intelligencer, an ALM sister publication of this newsletter.

The recent Pennsylvnia Superior Court case of Balicki v. Balicki has sent shock waves throughout the family law community. The question family law practitioners face is whether the Balicki decision mandates the court to apply tax ramifications and the costs of sale to all assets when equitably dividing the marital estate. Balicki v. Balicki , 2010 PA. Super 134, July 30, 2010.

Background

In 2005, the Pennsylvania Divorce Code was amended. Section 3502 pertains to “Equitable division of marital property.” The following two subsections (10.1 and 10.2) were added to Section 3502(a): “(10.1) The Federal, State, and local tax ramifications associated with each asset to be divided, distributed or assigned, which ramifications need not be immediate and certain”; and “(10.2) The expense of sale, transfer or liquidation associated with a particular asset, which expense need not be immediate and certain.”

Section 3502(a) states, in part: “the court shall equitably divide … the marital property between the parties … after considering all relevant factors … factors which are relevant to the equitable division of marital property include the following [13 factors that include 10.1 and 10.2].”

The Dilemma for Family Law Practitioners

When the Divorce Code was amended in 2005, family law practitioners debated whether subsections 10.1 and 10.2 had to be “applied” in all cases, or merely “considered.” It appeared that subsections 10.1 and 10.2 would be considered and applied on a case-by-case basis.

Prior to the 2005 Amendments to the Divorce Code, Section 3502(a)(10) read as follows: “The economic circumstances of each party, including Federal, State and local tax ramifications, at the time the division of property is to become effective.” The Pennsylvania Supreme Court case of Hovis v. Hovis was handed down shortly after the 1988 Amendments to Divorce Code became effective. The 1988 Amendments added the language to Section (a)10 pertaining to tax ramifications. The supreme court in Hovis held that “potential tax liability may be considered in valuing marital assets only where a taxable event has occurred as a result of the divorce or equitable distribution of property or is certain to occur within a time frame such that the tax liability can be reasonably predicted.”

The 2004 Official Comment to Section 3502 stated:

Notwithstanding the legislative statement in the 1988 amendments, and perhaps because the Hovis opinion was handed down after the amendments had become effective (but clearly decided under pre-amendment law), lower court cases after Hovis have required tax ramifications to be immediate and certain in order for them to be considered in equitable distribution. New subsection (a)(10.1) seeks to change this interpretation by making clear that tax ramifications are relevant and need not be immediate and certain.

Balicki

In the recent case of Balicki, the parties were had been for 26 years when they separated. According to the opinion, Bobbi Balicki was a homemaker and Jeffrey B. Balicki was a part owner of a family insurance company and a shareholder in a Pittsburgh law firm. Mrs. Balicki filed a divorce action against Mr. Balicki in Allegheny County, PA, and a four-day equitable distribution master's hearing was held.

Because Allegheny County follows Rule 1920.55-2, the master's hearing was a record hearing. According to the opinion, the master, inter alia, awarded Mrs. Balicki 65% of the marital estate plus alimony. In valuing the marital estate, contrary to Mr. Balicki's request, the master did not reduce the value of the insurance company in which Mr. Balicki had an ownership interest because it was a second-generation family business, and the parties' children, who were now adults, “may someday inherit the business as Husband did.” According to the opinion, in his report and recommendation, the master valued the marital portion of the business to be $610,490. The husband filed exceptions to the master's report and recommendation with the trial court.

The trial court granted “most” of Mr. Balicki's exceptions and, among other things, lowered “the marital value of Husband's insurance agency from $610,590 to $469,655 to account for the tax ramifications and expenses of sale.”

Both parties appealed the trial court's ruling on numerous grounds. The Pennsylvania Superior Court affirmed the trial court's decision to reduce Mr. Balicki's interest in the insurance company to account for the tax ramifications and expenses of sale. The standard of review regarding an order of equitable distribution is “whether the trial court abused its discretion by a misapplication of the law or failure to follow proper legal procedure.” An abuse of discretion “requires a showing of clear and convincing evidence.”

The Superior Court provided a reminder that “in determining the propriety of an equitable distribution award, courts must consider the distribution scheme as a whole,” and measure it “against the objective of effectuating economic justice between the parties.”

Mr. Balicki's interest in the business was the largest asset in the marital estate. According to the opinion, the distribution scheme included Mrs. Balicki receiving a large payment from Mr. Balicki, while the latter retained his interest in the business. The trial court indicated that Mr. Balicki's retaining his interest in the insurance business was “much different” from Mrs. Balicki's receiving a cash payment, and if Mr. Balicki desired to convert his interest in the business to cash, he would have to incur income tax, a broker's commission, finder's fee, attorney fees and accountant fees. Because of this, the trial court reasoned that deducting the tax ramifications and expense of sale from the value of the business was appropriate.

The Appeal

On appeal, Mrs. Balicki claimed that the trial court “usurped the fact-finding function and credibility determinations of the master.” The Superior Court did not agree and held that the “record does not support the Master's conclusion that Husband would not sell the family-held insurance agency.” As such, the Superior Court held that Mrs. Balicki's claim was without merit and affirmed the trial court on that issue on appeal. It is to be noted that the Superior Court also affirmed the trial court's tax affecting the alimony award.

Conclusion

The Balicki decision appears not to have settled the debate of “consider” versus “apply” the tax ramifications and expense of sale to all assets when equitably dividing the marital estate. Can a court “consider” the tax ramifications and expense of sale without same being calculated? If the tax ramifications and expense of sale are to be calculated for every asset in a marital estate, it will be a very costly endeavor for the litigants as experts will be needed in many situations. Once they are “considered,” do the values of the assets have to be reduced accordingly? It appears that arguments for both sides continue to exist. Regardless, in Pennsylvania, practitioners and the court must focus on and analyze the Balicki decision in equitable distribution matters.

Michael E. Bertin is a partner at Obermayer Rebmann Maxwell & Hippel, LLP. The article also appeared in The Legal Intelligencer, an ALM sister publication of this newsletter.