Beyond the Imminent Sale Doctrine: Valuing Assets with Imbedded Tax Consequences
This article is a summary of the evolution of the federal and state courts’ treatment of tax liability for equitable distribution of marital assets, with a specific focus on the current law in Florida. Under the old standard, Florida courts followed the federal “imminent sale” doctrine in divorce cases, holding that the value of an asset for divorce purposes is not discounted to reflect potential future taxes unless the taxable event was “immediate and specific.” However, the federal “imminent sale” approach has since been repudiated by federal and tax courts as erroneous and contrary to the well-established principles of asset valuation. As a consequence of this development in the federal courts, Florida state law now adheres to the principle that all tax consequences, including contingent tax liabilities, must be taken into consideration to achieve a fair and equitable distribution of assets.
Tax Impacting Under the Old Standard: The Imminent Sale Doctrine
It is true that, in earlier times, some of Florida appellate districts, like the courts of some other states, followed the “imminent sale” doctrine, under which courts were discouraged from tax impacting assets unless a sale was “imminent.” Weinberg v. Weinberg, 432 P.2d 709, 713-14 (Cal. 1967), and other state cases imported the then-current (now reversed) federal “imminent sale” approach into state divorce law, holding that the value of an asset for divorce purposes is not discounted to reflect potential future taxes unless the taxable event was “immediate and specific.” For example, in Weinberg, the trial court awarded a money judgment to the wife for the value of the husband’s interest in a corporation instead of ordering a stock distribution to her.1
On appeal, the husband argued that the trial court failed to adjust for the tax consequences he would suffer if he satisfied the judgment by withdrawing funds from the corporation or selling some of his stock. The Weinberg court found there was no indication that the husband had to follow, or intended to follow, either of those paths to satisfy the judgment. The court explained:
He may choose to borrow the money or make the payments out of other property. Of course, once the property is divided pursuant to the trial court’s order, the future tax consequences may vary on further sale or liquidation from what they would have been had the property been divided differently. The trial court need not speculate on such possibilities, however, or consider tax consequences that may or may not arise after the division of the community property.2
The husband’s argument failed in Weinberg because it was not supported by an “immediate and specific tax liability to establish any error in the trial court’s failure to consider the possible tax consequences involved.”3
There is only one state case in Florida following Weinberg, and that is Levan v. Levan, 545 So. 2d 892 (Fla. 3d DCA 1989). In Levan, the Third District rejected the argument that the trial court erroneously failed to take into account the future impact of federal tax consequences on the husband if he should dispose of certain assets awarded to him in the distribution of the marital assets. The court reasoned “that a majority of the jurisdictions which have considered this issue hold that it is not error for a trial court to refuse to take into account the potential future tax liability in making awards to the respective parties.” Citing a decision from Pennsylvania, the court wrote, “where there is merely a likelihood or possibility that a taxable event will occur, the court is left to speculate as to the tax consequences….”4 The court quoted further, “[W]e hold that potential tax liability may be considered in valuing marital assets only where a taxable event has occurred as a result of the divorce or equitable distribution of property or is certain to occur within a time frame such that the tax liability can be reasonably predicted.”5
However, starting in the early 1990s, the Florida courts began to reject a “bright line” application of the restrictive Weinberg standard for tax impacting and began to require that the tax consequences of an asset be considered when distributing the marital assets for purposes of achieving a fair and equitable distribution. In fact, there are numerous Florida divorce cases that have considered tax consequences, even if contingent, in valuing marital property, notwithstanding that taxes will be triggered only upon an eventual sale at an unknown date.6
The Emergence of a New Standard for Tax Impacting Applied by Florida’s Appellate Courts
One of the first cases in which it was held that courts must consider contingent tax consequences in equitable distribution was Calamore v. Calamore, 555 So. 2d 1302 (Fla. 4th DCA 1990). In Calamore, the trial court erred in awarding the wife $15,000 from the husband’s deferred compensation savings plan as lump sum alimony with no apparent consideration of the “tax” and penalty consequences “to be incurred.”7 The asset in question was a deferred compensation plan, which, upon withdrawal, the husband would be obligated to pay taxes and penalties on the tax deferred portion. Using the current tax rate, the husband’s accountant determined that the savings plan would be worth significantly less if the money were to be withdrawn at the time of the final judgment. Because of the considerable difference between the pre- and post-tax values of the plan, the appellate court concluded that the trial court failed to equitably distribute the parties’ assets.8
One year later, in Holmes v. Holmes, 579 So. 2d 769 (Fla. 2d DCA 1991), the appellate court affirmed the trial court’s decision to make the former wife responsible for certain tax consequences in connection with the condominium awarded to her. The parties owned a condominium for investment during the marriage, and both benefited by taking $52,700 worth of depreciation deductions on the condominium on their joint tax returns. Evidence was presented at the final hearing that “because of the depreciation taken, a sale of the condominium at the time of the final hearing would have resulted in taxable income to the appellant of more than fifty thousand dollars.”9 The trial court awarded the condominium to the wife and ordered that she was “responsible for the liquidation and payment of the mortgage, insurance, liens and taxes, and to save the husband harmless from consequent liability.”10 In other words, when the condominium was sold, the wife was to pay all of the depreciation recapture tax and hold the husband harmless from that tax. The Second District Court of Appeal reversed the trial court. The appellate court concluded, “this tax burden should be shared by the parties” and that “[t]he final judgment should, accordingly, be amended to provide that ifthe condominium is sold within five years of the date of the amended final judgment, the appellee will be responsible for one-half of any taxes imposed upon the sale as a result of the depreciation taken by the parties” during their marriage.11
A landmark case on this issue from the First District Court of Appeal is Nicewonder v. Nicewonder, 602 So. 2d 1354 (Fla. 1st DCA 1992). In Nicewonder, the appellate court reversed the trial court’s decision that required “the husband to pay all federal income tax liabilities involving the businesses and properties operated during the marriage without determining the amount of such liabilities and without giving due consideration to such amounts in effecting an equitable distribution.”12 The appellate court affirmatively mandated that the trial court consider contingent tax liabilities as well, explaining:
A trial court is required to consider the consequences of income tax laws on the distribution of marital assets and alimony ordered by it, and failure to do so is ordinarily reversible error. Accordingly, the trial court should consider all tax consequences, including contingent tax liabilities, that affect the value of the properties….13
Judge Zehmer’s concurring opinion in Nicewonder makes clear that the tax liabilities were those that would be triggered upon an eventual sale at an unknown date.14 Judge Zehmer explained that the failure to consider that liability may have been inconsistent with application of fair market valuation:
It is obvious that some of these properties having provided income tax deductions taken during the marriage as a means of deferring the tax due on marital income to a date in the future when the properties are sold, will give rise to substantial income tax liabilities immediately upon their disposition pursuant to the recapture provisions of the Internal Revenue Code. It cannot be said, therefore, that the valuation of these investment properties without considering such tax consequences is fairly reflective of their correct fair market value to the parties to this marriage. In determining the value of the properties being equitably distributed, the trial court’s use of a perceived fair market value without considering potential income tax consequences and including the effect of such contingent income tax liabilities generated during the marriage simply ignores the value of both assets and liabilities created during the marriage, a determination obviously necessary to equitably allocate both between the parties. On remand, the parties should present competent evidence regarding the income tax consequences of such contingent liabilities and the trial court should make findings thereon.15
Judge Zehmer’s reasoning is echoed in subsequent Florida opinions. In Miller v. Miller, 625 So. 2d 1320 (Fla. 5th DCA 1993), the trial court’s failure to consider income tax consequences on the distribution of marital assets and alimony was reversible error. The Fifth District Court of Appeal agreed with Nicewonder that “[c]onsideration of the consequences of income tax laws on the distribution of marital assets and alimony is required and failure to do so is ordinarily reversible error.”16 In Miller, even though a sale of the assets was neither imminent nor required by the judgment, the tax consequences would create an inequitable disparity favoring the spouse receiving the marital residence, and, therefore, valuation of the assets without taking into account the tax consequences is not fairly reflective of the market value of the assets to the parties.17
In Yunus v. Yunus, 658 So. 2d 1043 (Fla. 1st DCA 1995), the First District Court of Appeal again held that the trial court should consider tax consequences attendant to distribution of IRA accounts in divorce even though there was no imminent or required cashing out of the IRA at the time of the judgment. The Yunus court reasoned that consideration of tax consequences was appropriate because the parties deferred income tax liabilities during the marriage on the funds placed into the IRAs.18
One year later, the Fifth District Court of Appeal in Vaccaro v. Vaccaro, 677 So. 2d 918 (Fla. 5th DCA 1996), explained the importance of considering tax consequences as follows:
The purpose of considering tax consequences is to strive for a fair and equitable distribution of marital assets to both parties. One party should not be charged with the full value of an asset that is burdened with an inevitable payment of taxes. The effect of the burden should be considered so that neither of the parties gains an unfair advantage or suffers an unfair burden because he or she receives a particular asset in distribution.19
In Vaccaro, the court acknowledged that consideration of tax consequences with respect to the distribution of the parties’ stock would have been appropriate if the parties offered evidence as to the tax consequences on the distribution, which they failed to do.20
The most recent cases are out of the Second and the Fourth district courts of appeal. In Diaz v. Diaz, 970 So. 2d 429 (Fla. 4th DCA 2007), the Fourth District reversed the trial court for its failure to consider the tax consequences on the distribution in the husband’s pension and DROP account. The Diaz court made it clear that “[w]hen evidence of a tax impact is presented, it is error for the trial court to fail to consider these consequences.”21 Both parties’ experts agreed that the husband’s pension and DROP account would be tax-affected, thus, requiring the trial court to take these consequences into account when dividing the parties’ assets.
The Second District issued what appears to be the most recent opinion in Austin v. Austin, 12 So. 3d 314 (Fla. 3d DCA 2009). The opinion does not discuss the issue at length, but holds that the trial court committed reversible error in failing to consider the tax consequences in valuing the husband’s IRA, which was the largest asset of the parties. It should be noted that the opinion specifically makes reference to the fact that the husband had provided testimony by a certified public accountant of the amount of taxes the husband would have to pay on his IRA. This is critical because, without adequate evidence presented to the trial court, appellate courts will affirm a valuation which on its face fails to take into account the tax impact as occurred in Kadanec v. Kadanec, 765 So. 2d 884, 886 (Fla. 2d DCA 2000).
The Family Law Financial Affidavit form approved by the Florida Supreme Court likewise states that contingent assets and liabilities must be listed as follows: “If you have anypossible assets (income potential, accrued vacation or sick leave, bonus, inheritance, etc.) or possible liabilities (possible lawsuits, future unpaid taxes, contingent tax liabilities, debts assumed by another), you must list them here.”22
The Imminent Sale Doctrine Has Been Rejected and Repudiated by the Tax and Federal Courts
The “imminent sale” doctrine that was originally developed by tax and other federal courts hearing tax cases has now been expressly repudiated and rejected by those very same federal courts as simply incorrect, erroneous, and contrary to well-recognized principles of asset valuation. The following cases are the key revenue cases which demonstrate the trend in the tax and federal courts that abandons the “imminent sale” doctrine and adopts the “net asset value” (NAV) method of fair market valuation (FMV).
In Davis v. Commissioner, 110 T.C. 530 (1998), the donor gave two blocks of common stock of a closely held holding company to his sons. No liquidation of the holding company or sale of its assets was planned or contemplated on the valuation date. The Tax Court held that even though no liquidation was planned or contemplated on the valuation date, under an economic reality theory, a hypothetical willing buyer and seller would have agreed that the price of the corporate stock took into account at least some of the built-in capital gains. The Tax Court, thus, conceded that built-in capital gains could now be considered as one of the components of the marketability discount.23
In Eisenberg v. Commissioner, 155 F.3d 50, 55-58 (2d Cir. 1998), the donor gave away shares of stock in her closely held corporation. There were no plans to sell the business or liquidate the corporation. Nevertheless, the donor sought to reduce the value of the gifted shares of the closely held corporation to account for the fact that, if its asset was sold, the sale would trigger a tax gain to the corporation. The Tax Court disallowed the discount deeming the tax liability to be “speculative,” and, therefore, its discount value should be zero.24 The Second Circuit disagreed and held that the requirement of an “imminent sale” was unnecessary. A willing buyer would demand a discount to take account of the fact that “sooner or later, the tax would have to be paid.”25 The Second Circuit approved tax impacting of shares “[s]ince it is a virtual certainty that capital gains tax will ultimately be realized in this case,” notwithstanding the fact that no liquidation, sale, or distribution was planned.26
The Fifth Circuit went one step further in Estate of Dunn v. Commissioner, 301 F.3d 339 (5th Cir. 2002). The decedent owned a majority of the stock of a family-owned corporation engaged in the rental of heavy equipment. The family company planned to remain viable and in operation for some time. The Tax Court, in response to the very small possibility that a hypothetical buyer would liquidate the company, discounted the stock by only five percent of the built-in capital gains compared to the 34 percent reduction sought by the taxpayers.27 The Fifth Circuit disagreed strongly with the Tax Court. The Fifth Circuit used the NAV method of determining the FMV of shares of stock in a corporation whose assets had built-in capital gains. The Fifth Circuit held that a hypothetical buyer-willing seller must always be assumed to immediately liquidate the corporation, triggering a tax on the built-in gains.28 The Fifth Circuit ruled that the “built in gains tax liability of this particular business’s assets must be considered as a dollar for dollar reduction,” regardless of whether there was a planned or imminent liquidation of the corporate assets.29 The Fifth Circuit labeled as a “red herring” the fact that no liquidation was imminent or even likely.30
Finally, in Jelke v. Commissioner, 507 F.3d 1317 (11th Cir. 2007), the decedent held stock in an investment holding company. The assets held by the holding company had built-in capital gains, although no sale of those assets was planned or imminent. Applying the NAV method of FMV, the court discounted the value of the stock dollar for dollar for the capital gains taxes that will eventually be paid on the company’s assets, even though the company had no immediate plans to liquidate its assets at any time, let alone on the date of valuation.31
The Davis, Eisenberg, Dunn,and Jelke cases suggest that future tax liability is not so speculative and uncertain as to be disregarded merely because there is no sale imminent. In fact, the requirement that the sale or liquidation be “imminent” has been rejected as a “red herring” and “unnecessary.” Rather, the “era of valuation certainty” has begun with the courts gradually adopting the rule that tax consequences must be taken into account as a dollar for dollar reduction.32
The changes in federal and tax law clearly influence the decisions of the state family law courts, as described in one recent business article:
Family law courts often quote IRS authority and Tax Court cases in support of positions taken. And, this movement on the part of the Tax Court and the IRS could be a catalyst in family law courts for increased recognition of trapped-in capital gains liability. Many practitioners believe that it is unfair to distribute free and clear liquid assets to one spouse and give the other spouse what would be an equal value except for assuming the liability for capital gains taxes when and if the spouse decides to sell.33
Further, application of universal economic principles of FMV clearly leads to tax impacting for an equitable outcome. FMV is commonly the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. Furthermore, FMV is the standard used in Florida divorce law for valuation of marital assets.34 Therefore, the failure to account for tax liability will result in an overstatement of the parties’ assets, and overpayment to the recipient party once that asset valuation is divided in half. The buyer and seller are “objective” or hypothetical, not actual persons, and each is a rational economic actor; that is, each seeks to maximize advantage in the context of the market that exists at the valuation date. All relevant facts and elements of value as of the applicable valuation date shall be considered.35
The federal “imminent sale” doctrine has since been repudiated by the federal and tax courts as erroneous and contrary to the well-established principles of asset valuation. Concurrent with this development in the federal courts, Florida state law has evolved over time and now adheres to the principle that all tax consequences, including contingent tax liabilities, must be taken into consideration to achieve a fair and equitable distribution of assets. Both federal and state courts have recognized that this approach is necessary to properly value assets, whether for purposes of equitable distribution in dissolution proceedings or otherwise, and is required even if a sale or liquidation is not imminent.
1 Weinberg v. Weinberg, 432 P. 2d at 566.
2 Id. at 566 (emphasis added).
3 Id. at 567.
4 Levan, 525 So. 2d at 893.
6 See, e.g., Nicewonder v. Nicewonder, 602 So. 2d 1354 (Fla. 1st D.C.A. 1992).
7 Calamore v. Calamore, 555 So. 2d at 1302.
8 Id. at 1303.
9 Holmes, 579 So. 2d at 770.
10 Id. (internal quotations omitted).
11 Id. at 771 (emphasis added).
12 Nicewonder, 602 So. 2d at 1357.
13 Id. (emphasis added) (citations omitted).
14 Id. at 1358 (Zehmer, J., concurring).
16 Miller v. Miller, 625 So. 2d 1320, 1321 (Fla. 5th D.C.A. 1993).
18 Yunus v. Yunus, 658 So. 2d 1043, 1044 (Fla. 1st D.C.A. 1995).
19 Vaccaro v. Vaccaro, 677 So. 2d 918, 922 (Fla. 5th D.C.A. 1996).
20 Id. at 922.
21 Diaz v. Diaz, 970 So. 2d 429, 432 (Fla. 4th D.C.A. 2007) (internal citations omitted).
22 Florida Family Law Form 12.902(c) (2007) (emphasis in original).
23 Estate of Davis v. Commissioner of Internal Revenue, 110 T.C. at 530.
24 Eisenberg v. Commissioner of Internal Revenue, 155 F.3d 50, 53 (2d Cir. 1998).
25 Id. at 57.
26 Id. at55.
27 Estate of Dunn v. Commissioner of Internal Revenue, 301 F.3d at 347.
28 Id. at 354.
29 Id. at 352-53.
30 Id. at 352.
31 Estate of Jelke v. Commissioner of Internal Revenue, 507 F. 3d 1317, 1332-33 (11th Cir. 2007) (emphasis added).
32 Jelke, 507 F.3d at 1329.
33 Shannon P. Pratt, Valuing A Business 825 (4th ed. 2000). For an extensive discussion of the impact of the federal decisions on matrimonial case valuations, see Wechsler v. Wechlser, 58 A.D. 3d 62, 866 N.Y.S.2d 120 (1st Dept. 2008).
34 Smith v. Smith, 896 So. 2d 818, 823 (Fla. 5th D.C.A. 2005).
35 Jelke, 507 F.3d at 1321 & n. 11.
Jeffrey D. Fisher is a partner of Fisher & Bendeck, P.A., and is board certified in marital and family law. His practice focuses on the trial of complex family law cases.
Odette Marie Bendeck is the managing partner of Fisher & Bendeck, P.A., and is board certified in marital and family law. Ms. Bendeck currently serves as a member of the Family Law Executive Council and is active in the Family Law Section. She has authored and lectured on various family law topics for the bar and the general public. Her practice focuses on complex family law matters.
This column is submitted on behalf of the Family Law Section, Peter Gladstone, chair, and Laura Davis Smith and Ingrid Keller, editors.