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In re Marriage of Haefele

Supreme Court of Minnesota

May 29, 2013

In re the Marriage of: Kathy Lynn Haefele, Respondent,
v.
Douglas Alan Haefele, Appellant.

Alan C. Eidsness, Melissa J. Nilsson, Henson & Efron, P.A., Minneapolis, Minnesota, for respondent.

Kay Nord Hunt, Lommen, Abdo, Cole, King & Stageberg, P.A., Minneapolis, Minnesota; and

Vija L. Brookshire, Messerli & Kramer, P.A., Minneapolis, Minnesota, for appellant.

SYLLABUS

1. Under Minn. Stat. § 518A.30 (2012), when determining child support, a parent's income from self-employment or operation of a business includes the parent's income from joint ownership of a closely-held subchapter S corporation. To calculate a parent's income under section 518A.30, the district court must identify the corporation's gross receipts, cost of goods sold, and ordinary and necessary expenses, regardless of whether corporate funds have been distributed or are available to the parent.

2. After calculating the presumptive child-support obligation, the district court must, pursuant to Minn. Stat. § 518A.43, subd. 1 (2012), consider all of the circumstances and resources of each parent in setting the final child-support obligation, and may rely on the unavailability of funds included in gross income in departing from the presumption.

OPINION

DIETZEN, Justice.

Appellant Douglas Haefele (Douglas) and respondent Kathy Haefele (Kathy) were divorced pursuant to a judgment and decree filed in 2000, which provided, among other things, that Douglas pay child support to Kathy. In 2010, Douglas moved to modify his child-support obligation, arguing that certain distributions paid to Kathy as a shareholder of a closely-held subchapter S corporation should be included in her "gross income, " as defined by Minn. Stat. §§ 518A.29(a) and 518A.30 (2012), for the purpose of calculating the child-support amount. The district court agreed and granted the motion. The court of appeals reversed, concluding that the distributions either were not available to Kathy or were designated to pay her income tax obligation, and therefore did not constitute gross income within the meaning of the statutes. Because we conclude that gross income from a shareholder's interest in a closely-held subchapter S corporation must be calculated using the statutory formula in Minn. Stat. § 518A.30 and does not depend on the amount actually distributed or available to the parent shareholder, we reverse the court of appeals and remand to the district court for further proceedings consistent with this opinion.

Douglas and Kathy were married in 1990 and had three children during the course of their marriage. They separated in January 2000 and eventually negotiated and entered into a marital termination agreement. On December 15, 2000, the district court filed a judgment and decree dissolving the marriage. The court awarded Kathy physical custody of the children, subject to Douglas's right of reasonable visitation. The decree imposed upon Douglas a child-support obligation of $1, 794 per month and ordered him to maintain health and dental insurance for the children.

In September 2010, after intervening amendments to Minnesota's child-support statutes, Douglas moved to modify his child-support obligation. Both parties submitted affidavits describing their financial situations. The parties agreed that Douglas's gross annual income was $178, 056, but could not agree on Kathy's gross income. Kathy argued that her gross annual income was $146, 947, while Douglas contended that it was $1, 759, 252. The reason for the disagreement turned largely on whether certain distributions paid to Kathy from Dura-Supreme, Inc., should be included in her gross-income calculation.

The affidavits established that Dura-Supreme is a subchapter S corporation, jointly owned by Kathy and her two brothers: Kevin and Keith Stotts (Kevin and Keith). Kathy and Kevin each own 20% of the company. Keith is the majority shareholder and oversees the day-to-day operation of the business. Kathy considers herself a "passive investor" in the company. She does not work at Dura-Supreme and exercises no control over the business. But Kathy's 20% ownership of the company does have certain tax consequences. As a subchapter S corporation, Dura-Supreme is subject to a pass-through taxation system, under which its earnings are not taxed at the corporate level. I.R.C. § 1363(a), 1366(b) (2006). Rather, corporate profits are deemed to pass through directly to the shareholders on a pro rata basis and are reported on the shareholders' individual tax returns. See I.R.C. §§ 1363(a)-(b), 1366(a)-(b) (2006). Therefore, Kathy must pay individual income taxes on her 20% share of Dura-Supreme's annual corporate earnings, regardless of whether the company actually distributes those earnings to the shareholders or keeps possession of the money as retained earnings. See I.R.C. § 1366(a)(1), (c).

Dura-Supreme set a business goal to achieve gross annual sales of $150 million. But the company had a manufacturing capacity limited to producing only $125 million in gross annual sales. Therefore, the company devised an expansion plan. The company planned to self-finance at least some of the expansion and began accumulating significant cash reserves. In 2008, Dura-Supreme's legal counsel and audit firm recommended that the company transfer its cash reserves to a separate business entity in order to protect the company from the "risk of unknown corporate liabilities." The plan was for this separate business entity to act as a lender for Dura-Supreme's expansion. Kathy and her brothers would transfer Dura-Supreme's cash reserves over to the separate business entity, and the separate business entity would then lend the money back to Dura-Supreme at a favorable interest rate to finance the expansion.

In 2009, therefore, Kathy and her brothers created TK Investments, LLC, and signed a Member Control Agreement (the Agreement) for the company. Section 2.1 of the Agreement provided that each sibling "shall make an initial Capital Contribution . . . to the Company in exchange for [his or her] initial Interest." With respect to additional capital contributions, the Agreement provided that "[n]o Member shall at any time have any obligation to make any Capital Contributions to [TK Investments] in addition to those provided for in Section 2.1 (initial capital and interests)." But the Agreement provided that "[o]n behalf of the Members, Dura-Supreme, Inc. shall be permitted to transfer all or a portion of any dividend distribution, as authorized by the board of directors . . . directly to [TK Investments], and, as directed by Dura-Supreme, Inc., such dividend distribution shall be deemed to be an additional capital contribution to [TK Investments] on behalf of the Members." Finally, the Agreement provided that each sibling would have a one-third ownership interest in TK Investments, but that Keith would retain all the voting rights. Kathy has no control over TK Investments' operations.

Between 2007 and 2009, Dura-Supreme made several distributions to Kathy (or on her behalf), which are the subject of this dispute: $885, 300 in 2007, $2, 647, 000 in 2008, and $1, 417, 149 in 2009. Although the record lacks detail as to the precise nature and mechanics of these distributions, they served three basic purposes. First, Kathy retained a relatively small portion of the distributions for herself, and she agreed before the district court that the amounts she retained should be included in her gross income. Second, money from Dura-Supreme's distributions in 2008 and 2009 was used to fund TK Investments. Specifically, of the 2008 distributions, $1, 600, 000 was initially deposited into the Stotts Family Revocable Trust and, after the creation of TK Investments in 2009, was transferred from the trust to TK Investments. Of the 2009 distributions, $1, 090, 000 was transferred to TK Investments.[1] Third, portions of the Dura-Supreme distributions in 2007-09 were used to cover Kathy's income tax liability on her share of Dura-Supreme's annual corporate earnings. Of the 2007-09 distributions, $777, 800 was applied to Kathy's income taxes in 2007, $567, 500 in 2008, and $254, 650 in 2009.

In sum, Kathy received $4, 949, 449 in distributions from Dura-Supreme between 2007 and 2009, with $2, 690, 000 ultimately transferred to TK Investments, and another $1, 599, 950 applied to pay her income tax liability on Dura-Supreme's corporate earnings. Kathy argued to the district court that the money transferred to TK Investments and applied to her taxes should not be included in her gross income, while Douglas argued that the total amount distributed should be included.

On May 5, 2011, the district court issued an order modifying Douglas's child-support obligation. The court found that Kathy was not attempting to hide money in the family companies or avoid her child-support obligation. But the court ultimately held that "the law is clear that distributions are income for the purposes of determining child support." The court concluded that whether the funds were available to Kathy to pay child support was irrelevant, noting that the "subsequent availability of income received is not mentioned in Minn. Stat. § 518A.29." The court also rejected Kathy's argument that the funds distributed to pay income taxes should be excluded because the payment of taxes is an ordinary and necessary expense required for business operation. The court reasoned that allowing Kathy to exclude the amount applied to taxes would contravene the command of section 518A.29 that child support be based on gross (not net) income. Therefore, the district court held that all $4, 949, 449 of Dura-Supreme's distributions met the ...


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