Asset Distribution in a Divorce can Get Complicated
In New York, asset distribution is not completed until the end of a divorce. There are some exceptions if the equities of the case warrant it. For example, if real property is in, or on the verge of, foreclosure, a court may direct its sale before the end of the case to preserve the asset.
Even if it is just the family home and retirement accounts which need to be settled upon, distributing assets in a divorce can be complicated. Valuations of even the most common assets could become points of contention.
In financially complex divorces, couples often have assets that are more difficult to identify and distribute, or potentially easy to overlook.
Assets may either be tangible or intangible. They usually include commercial, as well as residential real estate, ownership interests in different types of businesses, and professional practices. At times, they involve post-marriage appreciation of separate property, stock options, intellectual property such as copyrights, patents, and goodwill, celebrity status and contingent interests.
Of these, stock options, restricted stock, and contingent interests are some of the most complicated and difficult assets to distribute fairly.
At times, these cases involve foreign bank accounts or foreign trusts, and “tracing,” the purpose of which is to ferret out hidden assets.
There are many issues that must be carefully evaluated prior to the distribution of marital property in a high-asset, multimillion-dollar divorce case.
Aside from the asset distribution of marital property, there can also be concerns about publicity and, sometimes, business partner resentment that can be better contained by a divorce lawyer who is experienced in handling such situations.
Asset Valuation and Distribution Issues
For wealthy couples, valuation and asset distribution can be the most important aspects of a divorce.
The selection of a valuation date for a particular asset can make a substantial difference in the amount one gives or receives for it due to any fluctuation in value while the divorce case is pending.
In New York, valuation dates must be between the date the divorce action is commenced and the trial date, depending upon what is “equitable.” And what is equitable can lead to substantial disputes.
For example, if the value of a business or professional practice is greater at the time of trial than it was at the time the divorce action was commenced, one might argue that this appreciation in value is due to their active individual post-commencement efforts and therefore, the valuation date should be as of the time the action commenced. However, their spouse might argue that the appreciation is the result of passive market conditions, which is why the valuation date should be the date of the trial.
Valuation date disputes can involve other types of assets as well, such as real estate and non-discretionary securities accounts, where the client, not the broker, makes all the trading decisions.
Once these hurdles are overcome and the valuation of the asset is determined, the next step is to decide how much of that value, or what percentage of it, should be distributed to each spouse based upon their respective contributions to the acquisition of that asset, the value and marketability of the asset, and tax consequences of a proposed disposition of the asset.
Executive Compensation and Divorce
Some of the esoteric executive compensation arrangements will be added to the marital estate and will likely also be considered prospectively in one’s earning power. These include incentives such as a “sign on” bonus, a forgivable loan, a performance bonus, a “stay on” bonus, stock options, phantom stock options, restricted stock, and restricted stock units. Rabbi trusts may also be a factor during divorce. The term “Rabbi trust” derives from the first initial ruling, which was made by the IRS on behalf of a synagogue; these forms of trusts create security for employees because the assets within the trust are typically outside the control of the employers, and they are irrevocable.
Sometimes referred to as “grantor trusts,” these trusts are created for the purpose of supporting the non-qualified benefit obligations of employers to their employees.
Stock Options Received or Earned During Marriage
If the stock options were received during the marriage, they are part of the marital estate and will likely be valued by a forensic accountant. They will usually be distributed as part of the marital estate “true up.” By “true up,” we mean included and accounted for in the valuation and respective distribution of the marital estate to each spouse, though not actually divided between them in kind.
Stock options and restricted stock are compensation based upon an implied promise of future riches, but with no guarantees.
Determining the current value of stock options and restricted stock for a privately-held company can be difficult. Although stock options are meant to benefit the employee, otherwise they would not be a viable part of a compensation package, before the options are exercised and the stock is sold, the ultimate value of their worth is unknown. Determining the current share value for many publicly-traded companies, however, may be considerably less arduous.
Perhaps the most complicated issue of all is valuing stock options and restricted stock, which were granted, but have not yet vested.
The current value of stock options and restricted stock depends upon a number of factors, including how far into the future they will vest. It is easier to compute this for restricted stocks because unless a company goes bankrupt, the stock should have some value. Stock options, however, might have an exercise (strike) price that is greater than its market value, which is a condition commonly referred to as “being underwater.”
Your divorce team will advise you as to the likely scenarios for the probable worth of stock options and restricted stock. Based on independent evaluations of a company’s potential and performance, it is be possible for a forensic accountant to predict, at the very least, whether these assets have value or not. If they have value, the accountant could then look into other factors to fine-tune the assessment as much as possible.
Protecting an Inheritance
If one spouse inherits a significant amount of money or property during the marriage, those assets must never be commingled with marital assets if you wish to preserve the separate property character of the inheritance in the event of a future divorce.
Transmutation by commingling can occur when separate and marital property become mixed together to such a degree that each cannot be identified and isolated for purposes of classification and distribution. When this occurs, the separate property characterization of a particular asset is lost, and the commingled asset is transformed into one hundred percent (100%) marital property.
If you stand to inherit or have inherited significant wealth, you should consider putting those inherited funds in a trust to avoid the danger of commingling.
Hidden Assets and How to Find Them
There are many ways to hide assets during divorce. Dishonesty and greed know no limits, and strategies to hide assets can be as varied as the personalities of the individuals involved. Some individuals simply refuse or “forget” to disclose bank accounts held in their name, some of which may be in other states. Others set up offshore, or foreign trusts. Cash could be used to purchase art, coins, or other collectibles, while the other spouse is completely unaware of the purchase and existence of these valuable items. Some give their money to third parties to hold for their benefit, or “pay back” phony loans or debts. Business owners can pay salaries to nonexistent employees and later void the checks, or “cook the books” to show “losses,” which never occurred. Some falsify documents, while others try to defer income. Additionally, if one works in a cash-based business, there may very well be undeclared cash from under-the-table work.
Many things could be done to ferret out such assets and income. The following are a few methods used to do so:
- Income tax returns are the first place to look. They provide a roadmap to the discovery of income-earning assets and asset sales. They also describe sources of income and foreign bank accounts. Scrutiny of income tax returns may lead to audit trails, which a forensic account could trace. Discovery demands, interrogatories and depositions are tools which may provide critical information such as bank and credit card statements;
- Court orders could be used to require a party to execute an asset search authorization for undisclosed assets which are held in his/her name;
- Lifestyle (spending) analysis could be conducted by a forensic accountant. If the parties were living well beyond their reported means, but somehow not incurring any debt, then income and assets are likely not being reported;
- Discovery subpoenas and non-party depositions could be conducted; and
- Forensic examinations are designed and can be used to “follow the money.”
Financial Misbehavior in a High-Net-Worth Divorce
Unfortunately, financial misbehavior is fairly common in high-net-worth divorce cases. One of the more effective ways for a wealthy spouse to hide money overseas is by using trust structures, such as Off Shore Asset Protection Trusts with foreign trustees. This involves transferring large sums of money to a foreign jurisdiction, thereby, in theory placing those assets beyond the reach of United States court judgments. The foreign jurisdiction is usually selected because it has enacted special legislation that protects debtors against foreign creditors.
Fortunately, these trusts do not usually work to prevent the unwitting spouse’s team from discovering hidden assets. Unfortunately, however, the expense of reaching those assets could be discouraging, if not prohibitive.
With respect to foreign bank accounts, as opposed to Offshore Asset Protection Trusts, the spouse must report these accounts on their United States Federal Tax Returns. The IRS could impose substantial penalties for failure to report foreign bank accounts.
There is usually some type of audit trail, since no one is allowed to take large sums of cash out of, or into, the country.
If international business is being conducted, there can be additional difficulties in finding and retrieving the marital portion of the assets.
Full Financial Disclosure is Key in High-Net-Worth Divorce
In high-net-worth divorces, a large amount of money, property, businesses, assets and other items are at stake. Because they tend to be quite complex, high-net-worth divorces have a much higher potential for mistakes on both sides.
Failure to properly account for assets and liabilities could prove to be very costly. It is important to take this inventory seriously, and to ensure that all information is accurate and up to date. It is time-consuming and tedious to put said items together, but failure to do so properly may result in leaving you with liabilities you should not have, or the giving up of assets or alimony which you otherwise could have had.