Determining the Nonmarital Portion of Retirement Benefits and Other Property
Determining the nonmarital portion of property is like building a house. It involves different experts having different skills and responsibilities as may be required based upon the nature of the property in question. Because such determination involves a mixed question of fact and law, the matrimonial attorney must necessarily be a significant part of the construction process. A forensic accountant, an economist, and an actuary/pension expert may also be important parts of the construction team. Retirement plans and benefits are particularly difficult to analyze properly, so it is not surprising that the courts seem to have the most difficulty properly dealing with valuation and apportionment of these types of assets in determining the equitable distribution scheme. Appellate courts rarely reverse trial court valuations. The trial court then becomes the “court of last resort.” When you have only one chance to get it right, you need to make sure to get it right!
The foundation must be in place before a house is built, and it must be able to support the house. The starting point for a determination of the nonmarital portion of any asset is F.S. §61.075, which defines what is marital property and what is nonmarital. The valuator must be well versed in this statute. The case law interpreting this statute is not a substitute for utilizing the statute and for identifying the valuation principles driving the result.
This article will address the typical issues associated with determining a nonmarital portion of property, which will not be divided under equitable distribution. This includes many issues associated with passive earnings. It also includes valuation issues associated with an interspousal gift under F.S. §61.075(3).
Identifying the Passive Earnings Component — §61.075(5)(a)(2)
One of the biggest problems in family law and one with which courts often have the most difficulty is distinguishing the passive increases of nonmarital property under §61.075(5)(b)(3)
from the active increases defined in the statutes under §61.075(5)(a)(2). The result of the statute is clear: A court finding that substantial marital time has been spent improving the nonmarital property may cause some of the appreciation to be active and marital property. Narrowly construing the statute leads one to conclude that only when little or no marital time is spent improving the nonmarital value that all appreciation is passive. The increase is then the result of market forces. The difficulty begins when the results of market forces are confused with what work effort is necessary in order to achieve the market result.1
To better understand this distinction, we begin the analysis by examining the statute and searching for the common sense purpose behind it. Section 61.075(5)(a)(2)
tells us that active increases are the result of substantial work effort expended during the marriage. But is the “substantial work effort” sufficient in and of itself to define an active accrual on nonmarital property? Or is it simply a necessary element before a conclusion may be reached that the accrual is active appreciation, but by itself is insufficient to support the finding that the amount of marital property is to include the appreciation resulting from the substantial marital work effort? Simple logic tells us that it cannot be sufficient to support this finding because substantial work effort can result in a loss.2 The clear intent behind the statute is not to decrease the amount of marital property by this loss.
It is impossible to achieve a positive market result without spending some marital time even if that time is spent finding someone unrelated to the marriage to manage the nonmarital investments. It is ludicrous to suggest that marital time spent automatically transforms the appreciation into a marital asset, because if that were true there would be no point to §61.075(5)(b)(3) defining passive appreciation.3 Yet, some will spend more marital time than others, and this extra time may produce better results. When this occurs, the extra income achieved is no different than if that person acquired a second job and it produced an extra income. The test, then, is to determine when the additional time transforms some of the income into extra income, as if that person acquired a second job.4 This is easily accomplished by using averages to define the “pure” market forces. Such averages could be established by indexes such as the Dow Jones, New York Stock Exchange, or the S&P 500, when the measurement process involves active trading.5 Averages could also be established with expert testimony on the particular type of investment under scrutiny ( e.g., real estate). The measurement baseline could be the averages produced by the industry itself, which would be particularly relevant and meaningful when measuring passive appreciation of a business owned before the parties married.6
Another factor that needs to be considered is the structure of the nonmarital asset. Certain nonmarital assets may be segregated while others may not. When the nonmarital asset cannot be segregated, it is impossible to spend marital time improving the marital portion without the nonmarital portion benefiting as a result of that effort. Yet spending marital time improving the nonmarital asset does not automatically transform the income of the nonmarital portion into marital property.7 A detailed analysis must be made in order to isolate the cause of the increase and in order to separate the increase resulting from market conditions from that produced by the extra work effort.8 Examples of assets that may not be segregated include a nonmarital home owned by one spouse, a business that existed before the marriage commenced, and a retirement plan.
In fact, under a retirement plan, the federal public policy on retirement plans should defeat the application of §61.075(5)(a)(2), because this policy created a 29 USC 1103 trust, which is exempt from creditors (29 USC 1056(d)(1)) and which owns the assets and any income thrown off by them.9 Accordingly, it is impossible for one to spend marital time improving the (calculated) marital portion without the (calculated) nonmarital portion benefiting by an identical percentage of improvement. The entire congressional purpose of the 29 USC 1103 trust is defeated when plan participants adopt a “hands-off policy” for the fear that active management of the funds leads to an adverse ruling in family court.10 If the court were to find that §61.075(5)(a)(2) applies to retirement plans, the only way to ensure against an adverse ruling is for the participant to spend no marital time improving the marital portion. If no time is spent improving the marital portion and the marriage stays intact, the husband and wife will never have enough money to retire. Considering that the face of retirement planning has shifted nationally from the traditional retirement plan with plan-appointed investors to the 401(k) plan in which investment decisions fall on the shoulders of the employee, when the Fourth District recently applied §61.075(5)(a)(2) to retirement plans, the result of such rulings may have transformed this retirement haven into a retirement nightmare for divorcing spouses and the parties of intact marriages. The Fourth District in O’Neill v. O’Neill, 868 So. 2d 3 (Fla. 4th DCA 2004), and Chapman v. Chapman, 866 So. 2d 118 (Fla. 4th DCA 2004), failed to acknowledge or disregarded the Congressional public policy purpose of the 29 USC 1103 trust. Other districts should consider whether Florida has a public policy interest in this. The O’Neill and Chapman rulings may have an enormous impact on the 401(k) plan money of the Florida retiree population, upon which all of its citizens depend for a healthy economy.
In Landay v. Landay, 429 So. 2d 1197 (Fla . 1983),11 The Supreme Court was faced with determining a nonmarital portion of such property when nonmarital money was used to purchase or otherwise improve the value of the property. Recognizing that the nonmarital portion could not be segregated, it found that a particular formula was appropriate for separating marital and nonmarital components. It ruled that the nonmarital or special equity portion is determined by multiplying the value of the residence on the date of division by a fraction, the numerator of which is the nonmarital dollar value invested, and the denominator is the value that the house had acquired when the investment was made. There are a number of problems with this formula particularly when we test to see whether it conforms to the Florida Statutes.
To begin this analysis, we note that special problems are created when the residence was titled in one name and title was transferred to both parties during the marriage. This poses serious gifting problems under §61.075(5)(a)(3). It would follow that if the court were to find a special equity interest for one spouse that this interest need not be credited with passive appreciation in any particular manner and that the Landay formula would appear to be appropriate. We, therefore, limit this discussion to when the marital residence was previously owned by one spouse and title was never transferred to the other spouse.12
The Landay formula has many problems associated with it. Chief among them is the very essence of §61.075(5)(b)(3)
(passive appreciation of a nonmarital asset) is that time is required for passive appreciation to occur. In addition, it is axiomatic in the formula that the more time passes, the more appreciation accrues. Landay is problematic with respect to this axiom. Time does not properly figure into the equation because the nonmarital portion is determined without respect to when the investment is made. Clearly, when an investment is made 25 years before the house is valued and divided, it should receive proper credit for the 25 years of compounding. To illustrate the severity of this problem, assume that a house was free and clear of encumbrances when the parties married. The nonmarital portion under Landay becomes a decreasing percentage interest with the passage of time. Furthermore, the numerator portion in Landay reflects the investment made when the house was purchased. This results in a further discount to the nonmarital portion. Add to that the fact that pure market forces involving no effort are disproportionately credited to the marital portion of the house’s value.
This last issue can best be illustrated with the following example: Consider one spouse made a $50,000 down payment on a house valued at $150,000 (leaving a mortgage balance of $100,000), and further consider that the home was purchased six months prior to the marriage. The mortgage balance two years after the marriage is $99,000. Realizing that they were not compatible, the parties divorce after two years. The house was purchased in one of Florida’s rapidly expanding new communities that was almost fully built during that two-year marital period and the house is now worth $300,000. The equity is, therefore, $201,000 ($300,000 – $99,000). Under Landay, the nonmarital portion is but $66,999 (50,000/150,000 x $201,000) and the marital portion is the balance, $134,001. The payments made on the mortgage balance during the marriage were almost entirely interest and a similar amount of money would have been spent during the marriage had the parties instead rented that house. Furthermore, two years of mortgage payments on $100,000 including interest could not possibly exceed half of the $50,000 down payment in today’s economy. Under what theory, then, should the marital estate include almost of all the $200,000 improvement?13
All of the problems presented in Landay are corrected when the nonmarital portion is credited with the timeliness of its investment. A vast number of jurisdictions have recognized the importance attached to the timing of the nonmarital investment and have corrected the problem by eliminating payment of interest on the mortgage balance in the fraction.14 This is accomplished by restricting the numerator of the fraction to the respective share payments it makes toward the mortgage balance and also by restricting the denominator to the combined marital and nonmarital share payments to the mortgage balance. The modified fraction is then multiplied by the appreciation on the asset, not the equity. This is generally known as the debt financing method. When this method is employed, the $1,000 reduction of mortgage principal made during the marriage makes the nonmarital share $196,078 ($50,000/$51,000 x $200,000). The marital share is the balance, $4,972 (201,000 (equity) – $196,078). Even this approach overstates the marital interest because the $1,000 of principal contributed during the marriage was not made at the same time that $50,000 down payment was made, and is in fact spread throughout the marriage. But the $196,078 nonmarital result better reflects the share interest of the nonmarital portion while it preserves the simplicity of the Landay -type formula.15
Opponents to the modified formula may argue that the marriage fails to receive a proper percentage of ownership based upon the actual dollars it contributed toward the mortgage. This argument is flawed because it is based on the erroneous assumption that if marital funds were not used to satisfy the interest portion of the mortgage payment, these funds would have been utilized to acquire additional other assets. Whatever enrichment the marriage might have sustained is offset by the rent the parties would have been required to pay for a primary residence.
Measuring Passive Increases on a Business
Whether the appreciation that occurred during the marriage is active or passive depends upon a number of factors. Market forces can account for passive increases. These include population growth of the area, legislative influences that may have aided a particular industry, and a general expansion of an industry, such as occurred with the high tech industry. Once the contribution of market forces has been identified, the task is to determine whether the increased value was the result of good management, and if so, to what extent the marital efforts played a role.16 The mere fact that the husband or wife exerted marital efforts is entirely irrelevant if they were properly compensated for the efforts. The marriage would have been enriched by the compensation. If the husband or wife was improperly compensated, as typically occurs in a closely held corporation, then there is an obvious marital component. Reasonable compensation should not be determined on the basis of what competing companies would pay, but should be geared to the actual performance of the individual and what could have been paid from available revenues to reward that performance. A ratio could be used on the basis that actual pay bears to performance pay in order to determine what percentage of the appreciation is passive.
The performance pay should include a payout of the company profits made in that year and which is proportional to the ownership percentage of the employee. Naturally, the bonus is determined after deducting normal business expenses that do not include a component for growth. This definition of performance pay can produce a lower value than a similar sized employer would have to pay for those job responsibilities during the startup years. To correct this problem we define performance pay as the greater of the two formulas. The above method should even apply when market forces largely contributed to the company’s growth because the issue of the marital component is still tied to whether the employee is properly compensated in the growth years of the business.
Interspousal Gift — §61.075(5)(a)(3)
When a party who owns an asset prior to the date of the marriage changes the titling of that asset to include his or her new spouse, that party makes a presumed gift of the asset to the marital estate.17 This presumption may be rebutted if that was not the clear intent.18 The burden of proof under §61.075(7) is a very high one and is seldom overcome. While few parties may have actually intended the gift, little thought is usually given to the gifting issue when the marriage is expected to continue. One of the conditions often cited as necessary to satisfying the burden in the case law is that the moving party must now demonstrate a nonmarital portion by means of “tracing investments.”19 But while tracing very often will be required, this requirement is based upon the facts of the particular cases weighed against which the principle of §61.075(7)
is applied. It is often believed that if the party having the burden did not intend a gift, steps would have been taken to segregate the asset, thereby showing that no intent of a gift existed at the time of the transaction. This belief assumes that no thought was given to the consequences of the transaction because the parties were happily married at that time. Suppose, however, that commingling was necessary to accomplish a financial objective and that the consequences of the transaction were both considered and dealt with in a contract. This contract provides that the nonmarital addition does not lose its nonmarital character. As the “no gift” intent has clearly been established without segregation of funds and without the need to trace the investment, a method which recognizes an investment result of the merged funds should be permitted. This is accomplished by considering the timing of all transactions made within the commingled funds. Of course, both marital and nonmarital shares will be credited with an identical rate of return for the time that the particular marital and nonmarital amounts were subject to the force of investment earnings. The methodology and formulas will be especially relevant in determining nonmarital shares of defined contribution account balances.
When marital and nonmarital portions are commingled without changing the titling of the nonmarital asset, no gift is presumed. This can occur in a variety of ways. As previously discussed, this can occur inside a retirement trust that owns both shares and all the income they produce. It can also occur with a business that was operated at the time the parties married. It can similarly occur with ownership of a house prior to the marriage. In each of these cases, no gift could be made when the party who owned the asset had no control (or ability) over segregation. One cannot gift an asset over which he or she has no control. The presumption is also not applicable when marital funds are commingled with nonmarital funds inside nonmarital accounts and this occurred as a result of certain typical erroneous beliefs that many married spouses bring to the marriage. For example, many married professionals believe that what they each earn from their respective jobs is theirs to keep should the parties divorce. If a few paychecks were deposited to nonmarital accounts, that action has not demonstrated any intent to make a gift. If anything, intent of the parties is clearly established otherwise by the actions that were taken and the only remaining problem is to segregate the marital and nonmarital shares. This is where a great deal of confusion occurs.
Case law has established that one of the problems that occur when liquid funds are commingled is that they become untraceable. The term used to describe this activity is that money is “fungible.” But the valuator cannot lose focus that a determination that money is fungible rests on the conclusion that §61.075(5)(3)
is applicable and the fungibility issue goes directly to that party’s inability to sustain the burden under §61.075(7). If interspousal gifting does not apply, then the conclusion that money is fungible does not apply either because he or she has no burden under §61.075(7)
that needs to be satisfied.20 Yet the owner of the asset still has the burden to demonstrate a nonmarital portion.21 This is where the dollar-weighted method will become useful.
A method used by both actuaries and economists to determine an investment rate of commingled funds is called the “dollar-weighted method.” It derives its name from the fact that it provides starting balances with the full weight of one fiscal year, and adds to that balance a specific percentage of each contribution made for a partial year, or by subtracting from it a specific percentage of each disbursement made during that fiscal year. If the starting balance accrues an addition not yet made, or an expense not yet paid, these accruals are treated as additions or withdrawals made at the end of the fiscal year under which the rate of return is sought. The percentage which is applied to both additions and withdrawals is the value determined by multiplying 100 by a fraction, the numerator of which is the number of remaining days to the end of the fiscal year and the denominator is 365. For simplicity purposes, the calculation may be done in months, with any resultant inaccuracy very small. The value that one obtains by adjusting the beginning balance with the additions and subtractions is the net dollar exposure subject to the force of earnings, denoted herein as “E.” “E” works as if the adjusted beginning balance had been in place at the beginning of the year and there were no transactions made throughout the year. The earnings during the year are denoted as “I,” representing the investment component in dollars and cents. The calculation of the rate of return “i” is therefore determined as follows: i = I/E.
Example: Suppose that the beginning balance in a year is $100,000, and that $10,000 of marital funds are added in the fifth month of that year and a $5,000 marital purchase is made with such funds in the seventh month. The ending balance is $117,000. The commingled funds increase by 11.566 percent that year, determined as follows:
I = ($117,000 + $5,000) – ($100,000 + $10,000) = $12,000.
E = $100,000 + (7/12 x $10,000) – (5/12 x $5,000) = $103,750.
i = 100 x 12,000/103,750 = 11.566 percent.
If the nonmarital portion is $25,000 at the beginning of the year, it grows to $27,891.50 at the end of the year and the marital portion is the difference between the ending balance of $117,000 and the $27,891.50 nonmarital amount. The method is applied to assets already reflecting compound appreciation in the value of the assets.
The foundation for any valuation is the Florida Statutes that govern the process. This article shows that an active marital accrual on nonmarital property is not necessarily based upon whether significant marital efforts have been expended. Instead, it requires significant marital efforts to produce an active accrual, but the effort by itself only means that some portion of the accrual may be marital property. It has also been shown when §61.075(7) applies to a particular transaction and when it does not. But if §61.075(7) does not apply, then the nonmarital portion may be determined with methods other than tracing investments. This article offered the dollar-weighted method as one of many solutions for determining a nonmarital portion of liquid securities. The debt financing method is a simple method for determining the marital investment of a nonmarital house because it gives the marital investment proper credit for appreciation. Finally, the article offered a straight forward method for distinguishing active from passive improvement on a business that existed before the parties married.
1 See Anson v. Anson, 772 So. 2d 52 (Fla. 5th D.C.A. 2000); Mitchell v. Mitchell, 841 So. 2d 564 (Fla. 2d D.C.A. 2003).
2 Anson, 772 So. 2d at 54-55.
3 See Straley v. Frank, 612 So. 2d 610 (Fla. 2d D.C.A. 1992).
4 See Anson, 772 So. 2d 52; and Mitchell, 841 So. 2d 564.
5 See O’Neill v. O’Neill, 868 So. 2d 3 (Fla. 4th D.C.A. 2004).
6 Anson, 772 So. 2d at 54-55.
7 See Straley v. Frank, 612 So. 2d 610; Adkins v. Adkins, 650 So. 2d 61, 63-64 (Fla. 3d D.C.A. 1994); and O’Brien v. O’Brien, 508 S.E. 2d 300 (N.C. App. 1998).
8 See Anson, 772 So. 2d at 54-55; see also Thibault v. Thibault, 632 So. 2d 261 (Fla. 1st D.C.A. 1994).
9 See Dan M. McGill, Fundamentals of Private Pensions 305 (4th ed., Richard D. Irwin, Inc. 1979).
10 See H. Rep. No 93-533, 93rd Cong., 2d Sess., 1974 U.S. Code. Cong. & Adm. News 4639, 4640-4641; S. Rep. No. 93-127, 93rd Cong., 2d Sess., 1974 U.S. Code Cong & Adm. News 4838, 4839-4840.
11 Some have pointed out that the Landay formula may not apply because it was decided years before the 1988 statute, which dramatically changed the way we view property. Application of the Landay formula also seems to have diminished as the use of an award of special equity has diminished as a remedy. Most special equity claims can be dealt with as part of the equitable distribution scheme. However, special equity is the exclusive remedy where there is a marital contribution to a nonmarital asset that has not been transmuted or commingled.
12 In Gregg v. Gregg, 474 So. 2d 262 (Fla. 3d D.C.A. 1985), the court notes that these facts are distinguishable from Landay, but fails to suggest a formula to account for this difference.
13 A few states reject rationing the principal pay-down as the basis for measuring nonmarital interests and instead use the full value of payments made, including interest. Even when this approach is adopted, the nonmarital portion of the appreciation calculates to about 75 percent, not 93 percent as in Landay.
14 Brandenberg v. Brandenberg, 617 S.W. 2d 871 (Ky. Ct. App. 1981); Willis v. Willis, 358 S.E. 2d 571 (N.C. 1987; In re Herr, 705 S.W. 2d 619 (Mo. Ct. App. 1986)); Thomas v. Thomas, 377 S.E. 2d 666 (Ga. 1989).
15 While Straley v. Frank, 612 So. 2d 610 (Fla. 2d D.C.A. 1992), understood that the interest portion was nonmarital property, it failed to recognize the share of the home’s appreciation that should be credited to the payment of principal made during the marriage.
16 Brett R. Turner, Distinguishing Between Active and Passive Appreciation in Separate Property: A Suggested Approach, 13 Divorce Litigation 73 (May 2001).
17 In Crouch v. Crouch, 898 So. 2d 177 (Fla. 5th D.C.A. 2005), the court further clarifies that changing the title of joint funds in and of itself does not confer an interspousal gift. It found that in order to extend the right of joint tenancy in their entireties to personal property, the exercise of joint control must be established. Without it, §61.075(7) does not apply. Under the facts of Crouch, the husband offered unrebutted testimony that he changed the title of the AG Edwards solely for the sake of convenience. Nothing was ever withdrawn from or added to that account.
18 See Fla. Stat. §61.075(7).
19 Williams v. Williams, 686 So. 2d 805 (Fla. 4th D.C.A. 1997); Amato v. Amato, 596 So. 2d 1243 (Fla. 4th D.C.A. 1992); Archer v. Archer, 712 So. 2d 1198 (Fla. 5th D.C.A. 1998).
20 Certain decisions have found that the nonmarital account loses its nonmarital character by commingling the two funds. The courts found that it is impossible to establish intent on which portion to deduct funds expended. Thus, the rulings assume that intent is an issue when it is not. It is only an issue when an interspousal gift is presumed. It is little wonder why the Fifth District Court has expanded its ruling on presumed interspousal gifts to exclude titling in Crouch.
21 See Jahnke v. Jahnke, 804 So. 2d 513 (Fla. 3d D.C.A. 2001).
A. Matthew Miller practices in the Hollywood office of Miller, Schwartz & Miller, P.A. He is board certified by The Florida Bar in the area of marital and family law.
Jerry Reiss , ASA (1982) Enrolled Actuary (1983), provides expert testimony and support services on employment topics, equitable distribution, and alimony. He maintains offices in Ft. Lauderdale, Clearwater, and Orlando.
This column is submitted on behalf of the Family Law Section, Thomas J. Sasser, chair, and Susan W. Savard and Jeff Weissman, editors .