Should S Corp retained earnings be attributable to a minority owner’s income for child support determinations?

BVWireIssue #79-5
April 29, 2009

When the Wright’s marriage went wrong, the central issue in their divorce was whether the husband’s 25% interest in a Subchapter S corporation was sufficient to permit the court to consider the company’s retained earnings for purposes of determining child support. The court had met this issue before, when the parent/spouse was a sole or majority owner of an S corporation. Under those circumstances, it followed the majority rule:

The overwhelming majority of states…have held that when the parent is a minority shareholder in a closely held or subchapter S corporation, and therefore does not control the decision on the distribution of earnings, then the retained earnings of the corporation cannot be attributed to him/her as income.

In this case, the husband wanted the court to focus exclusively on his minority status, ignoring that he owned the business with his brother and another (unnamed) individual. He also wanted the court to use the $84,000 that he reported as adjusted income on his annual tax return as the basis for child support, overlooking the $340,000 that he reported on his schedule K-1. Adding final insult to income, he admitted that for each of the years of the marriage, the S Corp set aside approximately $50,000 in retained earnings attributable to his minority share. In the year the couple divorced, however, it set aside nearly seven times as much.

Given its prior decisions permitting a trial court generally to attribute the retained earnings of a closely held corporation to the parent shareholder, the Alabama Court of Appeals in Wright v. Wright, WL 724153 (March 20, 2009) upheld the trial court’s finding that the husband’s income exceeded the applicable guidelines and confirmed its award of $3,000 in monthly child support.

The court also considered the application of minority and marketability discounts to the husband’s share of the company—and in an interesting evidentiary twist, it also considered whether the husband/owner could give an opinion not only as to the value of the business (acceptable under the applicable rules) but also to rebut the opposing expert’s opinion. The trial court said that was the exclusive province of “dueling” experts—but the court of appeals took a wider approach, citing the “liberalizing” purpose of the rules. The full case abstract will make good reading in the forthcoming, June 2009 Business Valuation Update, and the complete text of the court’s opinion will be available at BVLaw.

What is your experience with income determinations in divorce? Like the experts in the Wright case, do you primarily focus on the valuation of a business, and only occasionally assist with income determinations as they arise? Or are income determinations more of a separate and discrete focus of the engagement and your practice? Please take a few moments to email the editor and we may publish your comments in future issues of the ‘Wire.

Please let us know if you have any comments about this article or enhancements you would like to see.