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Can A Business Entity Protect Assets in The Event
of A Divorce in Nevada (A Community Property State)?
This research addresses the issue of whether an entity
such as a corporation or an LLC can shield assets from a spouse upon
dissolution of a marriage. For example, if one spouse's entity made
$2 million per year, but they pay themselves a salary of $100,000, which
amount is subject to be tapped for alimony or property distribution?
The Nevada Supreme Court has laid out the basic rules, in conjunction
with the Nevada Revised Statutes.
The key issue is whether the entities in question are
community property or separate property. Pursuant to NRS 123.130:
1. All property of the wife owned by her before marriage,
and that acquired by her afterwards by gift, bequest, devise, descent
or by an award for personal injury damages, with the rents, issues
and profits thereof, is her separate property.
NRS 123.130(2) is identical, except that it refers to "husbands."
If property is acquired after marriage by either spouse
or both of them, and it does not fall within the reach of NRS 123.130,
it is community property. NRS 123.220.
The powers of the divorce court to award alimony and
distribute property are statutory. NRS 125.150 allows the court to do
many things. First, the court may "award such alimony to the wife
or to the husband, in a specified principal sum or as specified periodic
payments, as appears just and equitable." NRS 125.150(1)(a). Second,
the court:
Shall, to the extent practicable, make an equal disposition
of the community property of the parties, except that the court may
make an unequal disposition of the community property in such proportions
as it deems just if the court finds a compelling reason to do so and
sets forth in writing the reasons for making the unequal disposition.
When
the Community Owns the Property, it Must be Divided Equally Between
the Parties
NRS 125.150(1)(b).
Third, "the court shall dispose of any property
held in joint tenancy in the manner set forth in subsection 1 for the
disposition of community property." NRS 125.150(2).
The fourth power is quite significant:
In granting a divorce, the court may also set apart
such portion of the husband's separate property for the wife's support,
the wife's separate property for the husband's support or the separate
property of either spouse for the support of their children as is
deemed just and equitable.
NRS 125.150(4).
The court also possesses the power to modify its adjudication
of property rights, NRS 125.150(6), and its award of alimony can be "modified upon a showing of changed circumstances, whether or not
the court has expressly retained jurisdiction for the modification." NRS 125.150(7).
We will now see how these powers have been applied by
the courts in the context of businesses owned either by one spouse or
by the community.
When the community owns the property, it must be divided
equally between the parties. In Johnson v. Johnson, 76 Nev. 318,
353 P.2d 449 (1960), the couple owned a coffee shop as community property.
Upon divorce, the court awarded the business to the husband, but ordered
him to pay the wife $5,000 for her interest in the entity. The Supreme
Court upheld this, stating that it would not have been practical to
have both parties jointly participating in the business post-divorce.
Thus, the order of the trial court was "in effect a division of
community property, with the husband receiving the community property
asset and being required to pay the wife for her interest in the same."
Id. at 323. This case shows that the court can be creative in
how it divides a community property business asset.
A Completely
Separate Issue is Whether the Income from a Separately Owned Business,
or its Increase in Value During the Marriage, Becomes Community Property.
When the property is owned by one spouse as separate
property, two rules are in conflict. These are that the separate property
of one spouse, together with the rents, issues and profits thereof,
belongs to that spouse alone, and the other is that the court has the
power to set aside such separate property for the support of the spouse
or the couple's children. Cf. NRS 123.130 with NRS 125.150(4).
The conflict is ameliorated somewhat by the fact that a set aside cannot
be made unless evidence exists of an actual need by the non-owning spouse
of the other's separate property, for their support. See, e.g.
Zahringer v. Zahringer, 76 Nev. 21, 348 P.2d 161 (1960)(corporate
stock); Campbell v. Campbell, 101 Nev. 380, 705 P.2d 154 (1985);
Stojanovich v. Stojanovich, 86 Nev. 789, 476 P.2d 950 (1970).
Cf. Jacobs v. Jacobs, 83 Nev. 73, 422 P.2d 1005 (1967).
A completely separate issue is whether the income from
a separately owned business, or its increase in value during the marriage,
becomes community property. Many cases have addressed the issue. The
cases will be discussed chronologically.
In Leland v. Leland, 71 Nev. 346, 291 P.2d 905
(1955), the trial court refused to award the wife any portion of two
corporations formed by the husband prior to marriage. During the marriage,
the corporations provided a large amount of income to the husband, but
the evidence indicated that the corporations were of little real value
at the time of the divorce. The Supreme Court affirmed, since there
was no evidence that any community property could be traced into the
corporations.
The next case is Wells v. Bank of Nevada, 90
Nev. 192, 522 P.2d 1014 (1974). Here, the husband was the co-owner (with
his brothers) of a corporation that was his separate property. The company
existed for 13 years prior to the marriage, but much of its growth occurred
after the marriage, due in part to the efforts of the husband. The issue
before the trial court was how to classify the increase in value of
the stock after the date of marriage.
The trial court found that the husband was partially
responsible for the corporate growth, but that "the increase in
the stock's value must be ascribed to other sources." Id. at 195.
Further, the court found that, because the husband took a salary of
between $50,000 and $60,000 per year for services rendered to the corporation,
the community had been fully compensated for the husband's community
labor. Therefore, the court held that the wife did not have a community
interest in the shares of the corporation. The Supreme Court affirmed.
The high court initially stated that affirmance was
mandated by the holding of Lake v. Bender, 18 Nev. 361, 4 P.
711 (1894). There, the court held that if profits from separate property
come mainly from the property rather than the efforts of either spouse,
the profits belong solely to the separate property owner. "On
the other hand, if profits come mainly from the efforts or skill of
one or both, they belong to the community." Wells, 90 Nev.
at 195.
The court then pointed out that while the Wells
appeal was pending, it decided Johnson v. Johnson, 89 Nev. 244,
510 P.2d 625 (1973), which departed from the rule of Lake. In
Johnson, the Supreme Court held that the increase in the value
of separate property during marriage should be apportioned between the
separate property owner and the community estate based upon either of
the approaches of two California cases. (The cases are Pereira v.
Pereira, 103 P. 488 (Cal. 1909) and Van Camp v. Van Camp, 199 P.
885 (Cal. App. 1921)).
The Wells court stated that, under Van Camp:
Community income is determined by designating a reasonable
value to the services performed by the husband in connection with
his separate property. Once that amount is determined, the community's
living expenses are deducted therefrom to determine the balance of
the community property.
Wells, 90 Nev. at 196.
Since Mrs. Wells offered no evidence as to the couple's
living expenses, the Supreme Court had no choice but to affirm.
To
Protect Themselves, Separate Property Owners should Pay Themselves a
Substantial Salary While Married, thus Contributing Annually to the
Marriage Community!
The next case, Cord v. Neuhoff, 94 Nev. 21, 573
P.2d 1170 (1978), expounded further on the new rules. In this case,
the worth of the husband's separate property rose from about $8 million
at the time of marriage to about $40 million at the time of his death.
The wife asserted a community interest in the estate. Based upon a postnuptial
agreement signed 22 years into the marriage, the trial court dismissed
the wife's action. The Supreme Court reversed, finding the agreement
invalid on the basis of its intent to limit the husband's duty to support
his wife while they were married. Since the agreement was integrated,
the invalid support provision could not be severed from the contract's
property settlement provisions wherein the wife released her present
and future community property rights. The court remanded the case to
the trial court for a determination of the percentage of the husband's
separate estate that belonged to the community. In so doing, it explained
the applicable rules.
Either
that, or Structure their Separate Property so that they will Meet the "Minimal Effort" or "Natural Enhancement" Tests!
The court stated:
The law of . . . Nevada is that rents and profits
from a spouse's separate property is separate property. However, it
is also true that the earnings of either spouse during converter are
allocable to the community. It is evident that these concepts come
into conflict when a spouse devotes his time, labor, and skill to
the production of income from separate property, or to the enhancement
in value of that separate property.
Id. at 25-26. The court continued:
It is now settled . . . that in such circumstances
there must be an apportionment of any increment in value between the
separate estate of the owner and the community (citing Pereira and
Johnson), unless the increment is due solely to a natural enhancement
of the property, or the owner of the separate estate expended only
minimal effort and there was no evidence presented attributing a value
to his services.
Id. at 26 (emphasis added).
Where there is no "natural enhancement" or
"minimal effort," one of two apportionment methods is utilized:
that of Pereira or Van Camp. As stated by the high court:
The Pereira method of apportionment is to allocate
a fair return on the investment to the separate property and to allocate
any excess to the community property as arising from the husband's
efforts. In the absence of evidence of a 'fair return' the court will
adopt the rate of legal interest, 7 percent per annum.
Id. Alternately:
The Van Camp method allocates to the community
an annual sum equal to the salary that would have to be paid an employee
rendering services proportionate to the husband's, and treats the
balance as separate property attributable to the normal earnings of
the separate estate.
Id.
Under Nevada law, the Pereira method is preferred, "unless the owner of the separate property can establish that a
different method of allocation is more likely to accomplish justice."
Id.
The remaining cases merely add gloss to the rules laid
out in Cord. The first case is Smith v. Smith, 94 Nev.
249, 578 P.2d 319 (1978). Here, the husband and wife married in 1951.
In 1955 the husband went to work for the Ideal Supply Company. In 1958
the owner died, leaving the business to his widow and their two sons.
In 1959, the widow passed on, and the stock she owned was bequeathed
to the husband in his name alone. He became the sole owner of the business
when the stock held by the late owner's sons was retired.
When the husband and wife divorced, the trial court
found that the stock was the husband's separate property. The Supreme
Court affirmed. First, the court rejected the wife's argument that NRS
123.130 should not apply when a bequest is made to one spouse during
marriage where the bequest was made in remuneration for services rendered.
As the statute makes it clear that such a bequest is the separate property
of the recipient, the wife's argument failed. The motivation for the
bequest is immaterial.
The wife then argued she was entitled to an apportionment
of the assets of the company, since the husband continued to work at
the Ideal Supply Company after becoming its owner. The court rejected
the argument:
In order to apply the apportionment doctrine, wife
must again overcome the statutory presumption that 'rents, issues,
and profits' of separate property retain the same character. NRS 123.130(2).
It was her burden to prove that husband's labor, skill, and industry
actually contributed to the increase in value of his separate property.
Id. at 251 (emphasis added).
As the evidence indicated that husband worked less than
eight hours a week, and did not participate in the day-to-day operations
of the business, the wife did not meet her evidentiary burden. Further,
the court found that "business increases were primarily attributable
to the tremendous growth in Clark County." Id. Thus, both
the "minimal effort" and "natural enhancement" tests
of Cord were present, and apportionment was unavailable.
The next case is Lucini v. Lucini, 97 Nev. 213,
626 P.2d 269 (1981). Here, the husband was the majority stockholder
of a subchapter "S" corporation prior to the marriage. During
the marriage he worked there exclusively, and drew a salary. By the
time of the divorce, the husband's ownership interest in the company
decreased from 51°/ to 30.08%. At trial, the court utilized the Van Camp method to apportion the business assets. The Supreme
Court affirmed.
The court noted that the Pereira method was the
preferred method for apportionment where one spouse devotes time, labor,
and skill to the production of income from separate property, citing
Cord. However, the other method can be used where the separate
property owner establishes that a different allocation is more likely
to accomplish justice. That was shown here, as the evidence indicated
that the husband "received full value in salary, profit distributions
and fringe benefits." Id. at 215. Citing Wells, supra,
the court held that when the community has been fully compensated for
the community labor through the separate property owner's annual salary
and benefits, the Van Camp method was proper to achieve substantial
justice.
The last case is Graham v. Graham, 104 Nev. 473,
760 P.2d 772 (1988). Here, the court again upheld the awarding of the
husband's separate property to him alone, stating:
We note that the business was financed by husband's
separate property, and that he drew a substantial salary during the
marriage that concededly was treated as community property. We therefore
decline to disturb the award of the district court.
Id. at 475. Thus, once again, the court applied
the Van Camp method.
As all of these cases reveal, it is not the form of
the property that is important, but whether the business is owned as
separate property. When this is the case, and that owner devotes time,
labor, and skill to the production of income from the separate property,
apportionment will occur. In such cases, either the Pereira method
or the Van Camp method will be utilized. To protect themselves,
separate property owners should pay themselves a substantial salary
while married, thus contributing annually to the marriage community.
Either that, or structure their separate property so that they will
meet the "minimal effort" or "natural enhancement" tests. If this is done, the nature of the separate property should be
respected if a divorce occurs.
- This research
attempts to answer the question of whether or not a state
can apply its own law regarding piercing an entity to so-called "pseudo-foreign" corporations.
