Maryland Family Law Maryland family law opinions and commentary
PROVIDENCE, RI — Distributions that a divorcing husband received from an “S” corporation should have been counted as part of his gross income for purposes of calculating his child support obligations, the Rhode Island Supreme Court has decided.
The husband, plaintiff Joel Trojan, had used the distributions to buy out his partners and acquire sole ownership interest in Century Drywall Inc., to pay taxes on Century’s net income and to pay an annual premium on a life insurance policy that named his daughters as beneficiaries.
A Providence Family Court judge had determined that the distributions did not count as part of the husband’s gross income because they did not inure to his personal benefit.
But the Supreme Court, while affirming with respect to distributions the husband used for taxes, reversed as to distributions he used to purchase his partners’ interests in the company and for the insurance premiums.
“It is … clear from the evidence that Joel’s obligation to pay [his partners] for the purchase of their stock in Century was personal in nature and that Joel used distributions from Century to meet that personal obligation,” Justice Francis X. Flaherty wrote for the court. “[B]y using Century’s funds to pay for his own personal obligation, Joel no longer is required to pay that debt with his own money.”
Additionally, Flaherty wrote, “the money distributed to Joel to fund the life insurance premium should have been included as gross income because that distribution was used to satisfy a personal debt that Joel chose to take on himself. There was no evidence introduced at trial that payment of Joel’s insurance premium was an ‘ordinary and necessary expense’ of Century.”
The 34-page decision is Trojan v. Trojan, Lawyers Weekly No. 60-053-19.
Different treatment?
The husband’s attorney, Laura Ruzzo Reale of McIntyre Tate in Providence, declined to comment. Patrick M. O’Connor of Madison, Wisconsin, represented the wife but could not be reached for comment before deadline.
However, John R. Grasso, a Providence lawyer who practices in the Family Court, said a takeaway from the decision is that an “S” corporation owner’s income may be treated differently from that of a child support payer with either W-2 or 1099 income.
“The latter will likely pay child support on their gross income, while the former may benefit from his or her legitimate business obligations — the amount of (his or her) income that goes to pay legitimate business purposes,” Grasso said, referencing income that passed through to the plaintiff husband in Trojan but which he had to use to pay taxes on the company’s net income or to retain as company capital to satisfy bonding requirements.
Grasso also said the decision seemed fair, even if the distributions in questions were not actually available to the husband.
“Just like (in Trojan), W-2 income earners don’t have 100 percent of their income available to pay child support, yet these folks and 1099 income earners pay child support on 100 percent of their before-tax income,” he said.
Neither the husband nor the wife will walk away from the ruling in Trojan completely satisfied, Grasso said, “but that’s usually how it goes in a divorce.”
Income dispute
Joel and Denise Trojan married in July 1990 and had two daughters.
Joel filed for divorce in March 2014, and Denise filed a counterclaim seeking child support for their teenage daughter, referred to in court records as “Tiffany,” though not for their other daughter, who apparently was an adult by that point.
On Dec. 16, 2015, the day of trial, the parties agreed to joint custody of Tiffany, with Denise having physical custody and Joel being awarded reasonable rights of parenting time.
Additionally, they agreed that the marital estate — after allocating for cash withdrawals Denise previously made — would be divided equally.
Denise also moved for temporary allowances, arguing that, during the pendency of the divorce, she had been using a joint marital account to support herself and Tiffany but that Joel had stopped depositing money in it and it had become depleted.
She further argued that, by her calculations, Joel was earning $1.8 million a year. She asked for $16,000 a month in child support, though she conceded that Tiffany did not actually need that much.
Joel countered that there was at least $1 million in the account from which Denise had just received more than $500,000. Additionally, he argued that Denise had miscalculated his earnings because it reflected pass-through income from Century.
Family Court Judge John E. McCann III rejected Denise’s motion for temporary allowances and indicated he would be willing to award child support retroactively after trial if necessary.
At trial, Joel testified that Century originally had three shareholders: himself, his brother and his brother-in-law, but that by December 2013 he had become the sole shareholder by using distributions from the company to pay off personal note obligations to the other two for their interests.
At the end of trial, McCann approved a marital settlement but continued the child support issue.
The parties reconvened in September 2016 for a hearing at which Joel testified that he had been paying $2,444 a month in voluntary child support since shortly before trial based primarily on $300,000 in wages included on his 2014 W-2 form.
He also calculated his gross income for permanent child support purposes based on $278,000 in 2015 wages plus $246 a month in taxable interest on the joint marital account. That plus an anticipated 4% return on $2.7 million transferred to Denise in the split of marital property, he argued, justified a $1,765 monthly support obligation.
Denise countered that she needed significantly more to maintain Tiffany’s lifestyle, including hundreds of dollars a month on hair and nail care, massages, clothing and shoes, shopping and social outings, plus at least $10,000 a year for vacations, including the cost of bringing along a friend.
On Dec. 14, 2016, McCann, in a bench decision, ruled that Joel’s gross salary was $278,000. The judge also ruled that Century’s $1 million net income was retained by the corporation as working capital for a legitimate business reason and thus did not count as part of Joel’s income. Similarly, McCann found that Century’s distributions to Joel did not inure to his personal benefit and thus should not be included in his gross income.
Meanwhile, finding Denise’s accounting of Tiffany’s necessary expenses to be “outrageous,” McCann ordered that Joel pay $1,796 a month in support.
Denise appealed.
Gross income
The Supreme Court found that while McCann properly excluded distributions that Joel used to pay taxes on the corporation’s net income from his gross income, he erred by giving the same treatment to distributions Joel used to buy out his partners.
In doing so, the panel agreed with Denise that Joel essentially had incurred a “personal debt” to his partners in purchasing their stake and that he was using the distributions to pay down this debt, acquiring an asset that enhanced the value of the marital estate.
“We … hold that distributions used by Joel to satisfy his personal obligation in purchasing the sole ownership in Century should have been included in his gross income calculation to determine his child support obligation,” Flaherty said.
Regarding the distribution Joel used to pay life insurance premiums, the court noted that Joel had deposited those checks into his own personal account and used personal checks to pay the premium.
“In our opinion, [this] distribution … should have been considered to be gross income” as well, Flaherty said.
Nonetheless, the court rejected Denise’s argument that McCann erred by not ordering Joel to pay interim and retroactive child support, finding that he acted “well within the bounds of his discretion” by ruling that sufficient funds were available for Denise to support herself and her daughter during divorce proceedings.
Accordingly, the court remanded the case for recalculation of Joel’s support obligations based on a gross income factoring in the distributions in question, but only for an amount “reasonable and necessary for the child’s support.”
CASE: Trojan v. Trojan, Lawyers Weekly No. 60-053-19
COURT: Rhode Island Supreme Court
ISSUE: Should distributions that a father received from an “S” corporation have been counted as part of his gross income for the purposes of calculating his child support obligations?
DECISION: Yes
