Take the February 7, 2014 decision of the Fourth Department in Foti v. Foti. Here, the Court reversed the order of Supreme Court, Monroe County Justice Kenneth R. Fisher which had granted a wife partial summary judgment determining that various real estate entities and management companies were her separate property. She had proven that her interests were received from her father by gift.
Generally, under New York’s Domestic Relations Law §236B, property that is owned by a spouse before the marriage constitutes “separate property,” and is not divided on divorce, except, under some circumstances, to the extent of some portion of appreciation in value of the separate property over the course of the marriage. Inheritances and gifts (from someone other than the other spouse) are also “separate property.” On divorce, the court will divide the parties’ “marital property,” property acquired during the marriage which is not “separate property.”
In Foti, the Fourth Department held that there was an issue of fact whether the wife commingled her interests in the entities, transforming the nature of those interests to marital property. The possible “commingling” arose from deductions taken on the parties’ joint tax return: “Here, the parties filed a joint federal tax return in which defendant reported her interest in the entities as tax losses, and ‘[a] party to litigation may not take a position contrary to a position taken in an income tax return,’” quoting from the 2009 decision of the Court of Appeals in Mahoney-Buntzman v. Buntzman, 12 N.Y.3d 415, 881 N.Y.S.2d 369.
In Mahoney-Bunztman, the Court of Appeals held that a husband’s decision to declare on his joint income tax return that money he received on the disposition of his interest in a real estate development company was ordinary earned income prevented him from later claiming that that money was merely a transformation of his separate property.
Prior to his 1993 marriage, Mr. Buntzman had had an interest in Arol Development Corporation (ADC), a real estate development company he founded with his father in 1971. In 1983, husband founded another company, Big Apple Industrial Buildings, Inc., 80% of which he sold to ADC in 1989. In 1998, the husband entered into an agreement with his father under which he agreed to relinquish his stock ownership in both corporations in exchange for a lump sum payment.
Apparently, however, the husband and his father negotiated an agreement that the money to be paid the husband would be treated as ordinary income: the transfer would not be treated as a capital transaction. Presumably, in this fashion the entities would then fully deduct the money paid to the husband as an expense, as if the businesses were simply paying a salary. In order to somewhat account for the increased tax liability that husband would incur as a consequence of treating the payment as ordinary income rather than as a sale of stock, the consideration was increased by 17%. The money, amounting to $ 1.8 million, was received by husband during the marriage and reported on the parties’ joint income tax return as self-employment business income.
As a general rule, self-employment business income, like all earnings, is “marital property.” The Court of Appeals held that it was a proper exercise of the trial court’s discretion to hold that Mr. Buntzman was estopped from arguing that the funds received from the sale of his corporate interests to his father were proceeds from the sale of stock and thus, separate property, because he had reported the funds as business income on the parties’ joint tax returns.
A party to litigation may not take a position contrary to a position taken in an income tax return.
Mr. Bunztman had declared that this was not a “capital” transaction in which the money received for his interests would keep there separate property character. Rather, he declared that this was earnings; it was marital property.
In Foti, however, that is not at all what the wife declared on her tax returns when she took deductions for the losses suffered by her separate property interests. Rather, she merely properly reported the losses incurred by the separate property business interests which she continued to own.
Analogously, the fact that dividends may be received on separate property stock and are reported on a tax return should not change the character of the separate property stock; the fact that interest is received on separate property bank accounts is reported on a tax return should not change the character of the separate property accounts; the fact that depreciation on separate property realty is reported on a tax return should not change the character of the separate property realty.
In Mahoney-Bunztman, it was the asset itself as to which the declaration was made. In Foti, it was not the assets, themselves, as to which there were representations, but rather the losses generated by those assets.
That is not to say that if marital funds were used to pay the taxes incurred on dividends generated by separate property stock, that the spouse might not have a claim to share in at least a portion of those dividends; if marital funds were used to pay the taxes incurred on interest generated by separate property bank accounts, that the spouse might not have a claim to share in at least a portion of that interest.
The logic does not cleanly extend to losses. If losses generated by separate property are taken on joint tax returns, the couple’s tax burden is reduced; the marital pot is enhanced (perhaps a claim could be made by the separate-property holder that the reduction in taxes was separate property).
Thus, Mr. Foti contributed nothing to his wife’s separate property. Ms. Foti made no declaration that her separate property was “joint,” or “marital.”
The Fourth Department in Foti would seem to be holding that any reference in a joint tax return to a “separate” asset constitutes commingling of the asset in the “marital” pot. The remedy, then, to preserve separate property, is never to file “jointly,” but as “married filing separately.” That, in and of itself, would seem to be a waste of marital assets.
Of course, the better remedy is never to marry holding assets without a pre-nuptial agreement; and to attempt to enter a post-nuptial agreement whenever receiving separate property during a marriage. Good luck with that.
Finally, it should be noted that when reversing Justice Fisher in Foti, the Fourth Department did not grant the husband partial summary judgment either. Rather, whether there was commingling will be determined by the judge at trial. However, the impact of the estoppel by tax return would seem to have a dramatic effect.
Additionally, if finally determined to be “marital property,” the trial court need not award the husband half of the asset’s value; the wife could still be awarded up to 100% of the marital asset.
In Foti, Michael Steinberg, of counsel to Joan De R. O’Byrne, of Rochester, represented the husband. Michael G. Paul, of Kaman, Berlove, Marafioti, Jacobstein & Goldman LLP, of Rochester, represented the wife.