Tax Consequences on Property Division
A Virginia Case Study: Horacio Eugenio Sobol v. Christine Marie Sobol, 74 Va. App. 252, 867 S.E.2d 774 (Virginia Court of Appeals, January 25, 2022)
By Elizabeth Ciccone, Partner, Advisory Services
After a 20-year marriage, Horacio Eugenio Sobol (“Husband”), a partner at an accounting firm (the “Firm”) and Christine Marie Sobol (“Wife”) separated. At the time of the separation, Husband was reporting annual average income of $1 million. He had a deposit capital account with a balance of $231,100 and an accrual capital account with a balance of $131,181, offset by a loan balance of $72,214. The evidence was clear that Husband did not have, and would not have, access to the accrual capital account until he retired, at which point the amount received would be taxable.
In addition to the two capital accounts, Husband’s earnings were deposited in a partner deposit program account (“PDP”) established by the Firm where it earned 5% interest on the funds held therein, as well as participation in the Partner Retirement Plan (“Pension”), designed to provide income after retirement. The Firm requires partners to retire at age 60. If the Firm has sufficient assets at the time, the Pension provides an annual annuity; otherwise, the Pension is an unfunded and unqualified plan that is not guaranteed and not subject to division pursuant to a qualified domestic relations order (“QDRO”).
While Husband and Wife were able to resolve many of their disputes via collaborative divorce proceedings prior to trial, they were unable to come to a resolution with respect to Husband’s Firm ownership interest, his PDP account, his Pension and several other fee-related issues. Wife engaged an expert in forensic accounting and business valuation, who testified that the value of Husband’s ownership interest in the Firm was equal to the balance in each of his deposit capital account and accrual capital account, reduced by the outstanding loan balance. Wife’s expert described the accrual capital account as, “…the untaxed balances of…essentially income earned with the firm, less amounts attributed to him [Husband], the difference between his accrual basis income and his cash basis income…”
Husband testified on his own behalf about the value of his ownership interest in the Firm He calculated the value in much the same manner as Wife’s expert, but with a notable exception: Husband tax-affected the funds in the accrual capital account, which he’d receive when he left or retired from the Firm. He assumed a total tax rate of 50.1% and reduced the accrual capital account value by that percentage.
The trial court accepted the Wife’s expert’s methodologies with respect to husband’s ownership interest in the Firm concluding that the value was equal to each of the deposit capital account balance and the accrual capital account balance, reduced by the outstanding loan. The trial court awarded 50% of the value of Husband’s ownership interest in the Firm to Wife. Husband filed a motion to reconsider, specifically asking the trial court to reevaluate his partnership interest in the Firm and to account for the taxes he would pay on the accrual capital account portion of the ownership interest upon his retirement. The trial court rejected Husband’s tax-consequence argument, finding the issue of future taxes to be “too speculative.”
Several issues, including the value of Husband’s ownership interest in the Firm were then presented for appeal. As with his motion to reconsider, Husband argued, on appeal, that the trial court did not appropriately consider the tax consequences to the parties in the equitable distribution of his ownership interest in the Firm. Specifically, he contended that because he will be liable for taxes, the trial court was required, as a matter of law, to reduce Wife’s share of the asset by some amount.
The appellate court disagreed with Husband’s argument, upholding the trial court’s decision and award and ruling that the trial court had properly considered the evidence regarding the future tax consequences. The court determined that, while there would be a future taxable event, there were “too many uncertainties,” including the date payment would be made and the tax rates in effect at the time, for the trial court to calculate the ultimate effect with precision. The appellate court ruled the trial court did not abuse its discretion in the valuation, classification, or distribution of the marital share of Husband’s ownership interest in the Firm, affirming that portion of the trial court’s judgment.