Can a Spouse be Awarded 1/2 of Disability Insurance Proceeds in a Divorce?
Ahhhh, the bliss of holy matrimony with all of its romance, newness, and I love you baby until “death” do us part. But, when things go wrong. usually with the finances and at times only after a few years, it can best be described as unholy divorce; otherwise known as I want everything from the unholy union and you get nothing but the debt. I rescind the until “death” do us part and I want a divorce from you. You can go to death if you want but I plan on staying here!
I no longer refer to you as “baby” either!
California is a community property State, derived from the former colonial system of Spain; meaning half the property and debts derived from the start of the marriage until separation, are usually characterized as “community” and are thus split equally between the divorcing spouses. Sounds fair, right?
For some, 1/2 means I get your 1/2 too.
Practically speaking, however, it is just not that simple in the real world of divorce court. Below is an eye opening (not to me but perhaps to others who have not ventured in the “divorce” world) story of I want everything from the unholy union and you get nothing but the debt.
Let’s examine a recent appeal of a marital dissolution case. It is morbidly sad because Husband was struck with a debilitating illness, wisely had acquired a disability insurance policy, then the spouses were hit with a substantial tax debt, and on divorce Wife wanted to stick the poor fellow with all the tax debt and acquire 1/2 of his disability proceeds. Read on. It gets interesting.
Wife appealed from the judgment on reserved issues following the dissolution of her marriage to Husband. From what I ascertain, Wife may have acquired a status judgment of divorce and the parties came back to court on the property and debt split. This usually happens when one spouse wants to hurry up and get married, again. California is a no-fault divorce state…. According to the judgment, Wife was assigned 1/2 the tax debts from the marriage and was not awarded 1/2 of disability insurance proceeds.
Wife challenged two specific aspects of the family court’s division of marital property. She contended the court erred declaring a 2006 capital gains tax liability to be a community debt (1/2 hers and 1/2 sick Husband), notwithstanding the fact she had obtained an “innocent spouse” determination from the Internal Revenue Service (IRS). I am the “innocent spouse” and he is the “guilty spouse.”
Wife also contended the court erred in awarding Husband the post-separation proceeds of a disability insurance policy as his separate property, despite the fact the policy had been purchased with community funds and was purportedly intended to serve as retirement income. Wait, the insurance proceeds were intended to support Husband because of a disability and wife was contending that she was owed the post-separation proceeds and also post-judgment?
I detect that wife is slightly perturbed about something; she goes for the jugular. Is there a life insurance policy? Let’s read on this is getting interesting.
On appeal, it was held the trial court did not err. Judgment affirmed.
It was found that Wife acknowledged the trial court was not bound by the IRS’s innocent spouse determination in characterizing the tax liability, and the appeal court concluded its decision to treat the liability as a community debt, notwithstanding that determination, was supported by substantial evidence. Additionally, it was determined the trial court’s conclusion that the disability insurance policy was intended to replace Husband’s earned income — rather than to operate as part of a retirement plan — was amply supported by the evidence.
It was also determined on Wife’s appeal that the court did not err by awarding the proceeds to Husband.
The Marital Background
Husband and Wife were married in 1984, and separated in July 2011. Wife had worked as a registered nurse until 1987, and thereafter worked full time at home, acting as primary caregiver to the parties’ four children. Besides granting me “innocent spouse” status, also give me “Sainthood” IRS and court.
This is interesting because wife was involved in the medical treatment industry, but it is apparent she was not sympathizing with Husband. The stay at home “mommie” status may have prompted her “you owe me” attitude during this unholy divorce.
Husband worked as a dentist, and in 1989, the couple took out a loan to refurbish Husband’s dental office. As a condition of making the loan, the lender required that Husband take out both a disability insurance policy and a life insurance policy. So, the lender helped out here in Husband’s favor; good thing.
Yes, there it is, there is a life insurance policy, but, at this point we do not know who the beneficiaries are. Usually, in an unholy divorce like this, spouses will change beneficiaries to new spouses or their children. On pure speculation, this may have happened fueling Wife’s “wait and see I’ll get you” attitude.
Husband testified the disability policy was never intended to operate as a retirement policy. It was shown to the trial court that when Husband took out the disability policy to satisfy the lender’s requirement, he already had what he described as a “retirement policy.” The parties also contributed to IRAs and 401(k) accounts.
In 2002, Husband became disabled as the result of a degenerative autoimmune disease, and he sold his dental practice. As a consequence of his disability, Husband began receiving $10,000 per month in benefits under the disability policy. Not bad, I am feeling sorry for Husband but they are not even separated yet. Wife had a $10,000.00 a month income here plus rental income.
The couple also owned the office building in which Husband’s dental practice had been located. After the practice was sold, they retained ownership of the building for a period, before finally selling it in 2006. The proceeds of the sale were invested in a limited partnership known as Orange Tree Lane, which was formed “to buy land and build an office condominium development.”
However, according to Husband, his original intention when selling the building had been to use the sale proceeds to purchase another property in accordance with Internal Revenue Code section 1031 — a “1031 exchange” — and thereby defer capital gains taxes on those proceeds. Unfortunately, Husband was “somewhat misled by [his] accountant on how to do it,” and “[w]hen it came time to filing, . . . he didn’t file it as a 1031.” Husband is taking charge and relying on a professional here. I do not see the Wife involved but Husband did obtain assistance from a professional. She accuses him of breach of fiduciary duty; not to anybody’s real surprise though.
It was not until 2009 that the couple filed any tax return at all for 2006. And because of the 2006 sale of the office building, that belated return reflected capital gains of $1,735,615. As a consequence, the IRS assessed federal capital gains taxes of over $300,000 (including interest and penalties), and the California Franchise Tax Board (FTB) assessed capital gains taxes of approximately $265,000 (also including interest and penalties). So, that is $2,300,615.00 divided by two. Wife was there, she had a duty to make sure tax returns are filed. C’mon, the poor guy is sick.
Wife testified at trial that she applied to both the IRS and the FTB for a determination she qualified as an “innocent spouse” for purposes of the 2006 capital gains tax liabilities, and that the FTB granted her request in part. I am innocent! He is guilty of bad, bad, husbandry! I demand relief from the court!
During trial Husband testified he was aware Wife had applied for an innocent spouse determination, and he acknowledged filing an opposition to her request in “the proceeding” — albeit without identifying whether he filed his opposition in a proceeding before the IRS or the FTB. How dare he file an opposition to my request for innocent spouse determination (emphases on innocent) That, that, man!
Before trial Wife filed a trial brief covering many of the issues disputed between the couple, plus separate trial briefs addressing her claim that the 2006 tax liability should be allocated solely to Husband, and her claim that the disability insurance benefits should be treated as community property. That’s right, put it in black and white before the court!
In her brief addressing the tax liability, Wife argued that while the trial court “isn’t bound by the determinations of the Internal Revenue Service and Franchise Tax Board, the case law on the issue clearly provides that [Husband] would have no standing before either the Internal Revenue Service or the Franchise Tax Board if he were to try to challenge their determination that [Wife] is an innocent spouse.” Innocent, with emphasis! Wife argued that because Husband had “a full right to be heard and to contest the determinations,” those decisions “should be considered . . . to be res judicata as to the allocation of the 2006 tax debt.” Wait, there was no finding of innocent spouse? Read on it gets better.
Wife claimed in her opening brief that the IRS also granted her request for innocent spouse relief, in full, but she cited no evidence in our record to support that assertion. Instead, Wife cited “Exhibit 7,” presumably a document admitted at trial but not included in the appeal record, along with her counsel’s argument. The appeal court held that argument is not evidence, and could not consider citations to evidence which is outside the appellate record. C’mon now, if you are “granted” this innocent spouse relief, at least bring the correct document to court or have the right person at trial testify regarding the status; as if the “granting” of this status is by a higher authority like being ordained. Get it right, especially on appeal. So, innocent spouse relief granted or not? Well, we know the answer to that now.
Husband did not directly challenge Wife’s characterization of the facts. Instead, he merely acknowledged her assertion of innocent spouse status (I hereby declare you “Innocent Spouse”) and explained why the evidence as a whole was nonetheless sufficient to support the trial court’s decision on the issue. “Assertion.” I like that.
Following the court trial, the court issued a 31-page statement of decision, detailing the many rulings which comprised its judgment. With respect to the issue of the disability insurance policy, the court pointed out the parties had originally purchased the policy because it was required by a lender. It found their intention in doing so was to replace Husband’s earnings, rather than to provide for the couple’s retirement, and that intention never changed. The court also noted “the parties had invested in other assets (income producing realty) anticipating future retirement, had life insurance, and had IRA accounts.” Based upon those findings, the court concluded the post-separation proceeds of the disability policy were Husband’s separate property.
And with respect to the tax liability, the court characterized Wife’s argument as one based on the assertion that “federal law, specifically section 6013(e) of the Internal Revenue Code, preempts all state law efforts to impose liability for federal income taxes on anyone designated an ‘innocent spouse.’” The trial court rejected the argument, however, pointing to case law stating that the IRS does not treat applications for “innocent spouse” designations as an adjudication of the rights between the spouses, and does not treat the other spouse as a party to the proceeding. The court concluded the “innocent spouse” determination would not be entitled to res judicata effect under California law because there was no evidence it was made by a “court of competent jurisdiction,” nor that Husband took any “active role” in the proceeding — even though he may have filed an “opposition” to Wife’s application. He dare he oppose and especially after all those faithful years as stay at home “mommie.” It is not mine!
Wife contended the appeal court should apply de novo review to her claims because “both issues constitute mixed questions of law and fact where the questions of law predominate.”
The appeal court disagreed. They held:
“Mixed questions are those in which the ‘“historical facts are admitted or established, the rule of law is undisputed, and the issue is whether the facts satisfy the [relevant] statutory [or constitutional] standard, or to put it another way, whether the rule of law as applied to the established facts is or is not violated.”’” (People v. Cromer (2001) 24 Cal.4th 889, 894.) In such cases, “[i]f the pertinent inquiry requires application of experience with human affairs, the question is predominantly factual and its determination is reviewed under the substantial-evidence test. If, by contrast, the inquiry requires a critical consideration, in a factual context, of legal principles and their underlying values, the question is predominantly legal and its determination is reviewed independently.” (Crocker National Bank v. City & County of San Francisco (1989) 49 Cal.3d 881, 888.)
In this case, the appeal court stated the alleged errors Wife identified were not the product of the trial court’s application of established facts to undisputed law. Rather, Wife’s argument rested on a series of more specific assertions, which, by turns, challenged the trial court’s legal rulings and factual findings.
The appeal court reviewed each under the applicable standard.
The Tax Liability
Wife first contended the trial court erred by failing to allocate the 2006 capital gains tax liability in a manner consistent with the “innocent spouse” determination (Where is it?) she received from the IRS and FTB. Significantly, Wife acknowledges the court is not bound by the decisions of the IRS or FTB in deciding how to allocate the tax liability. But then argued, in essence, that the court nonetheless should have followed those decisions based on equitable principles. The appeal court stated Wife’s argument is analytically flawed for several reasons:
First, there is no discretion in the court’s application of res judicata. The decision in a prior proceeding is either binding in the successive action, or it is not. The issue presented a pure question of law, and our review is de novo. (City of Oakland v. Oakland Police & Fire Retirement System (2014) 224 Cal.App.4th 210, 228 [“Whether the doctrine of res judicata applies in a particular case is a question of law which we review de novo.”].) So by conceding the prior proceeding is not binding, Wife left no legal issue to be decided.
Second, Wife’s argument that the innocent spouse proceeding should be accorded binding effect was determined to be internally inconsistent. She alluded to factors that might be considered in determining whether res judicata would apply, pointing out that (1) Husband would have no standing to challenge such a ruling before the IRS or the FTB; and (2) he had “a full right to be heard and to contest the determinations made by” both taxing authorities.
Holding that when “[a] party lacks standing,” it means the party “does not have an actual and substantial interest in, or would not be benefited or harmed by, the ultimate outcome of an action.” (City of Santa Monica v. Stewart (2005) 126 Cal.App.4th 43, 59.)
Consequently, the determination that a party lacks standing will preclude the party from litigating an issue. (Blumhorst v. Jewish Family Services of Los Angeles (2005) 126 Cal.App.4th 993, 1000 [“We will not address the merits of litigation when the plaintiff lacks standing, because ‘“California courts have no power . . . to render advisory opinions or give declaratory relief.”’”].) Further stating that if Husband had no standing to litigate Linda’s “innocent spouse” claim before the IRS or FTB, he did not have a “full right to be heard and to contest” it.
The appeal court further stated, as explained in In re Marriage of Hargrave (1995) 36 Cal.App.4th 1313, 1320 (Hargrave), an innocent spouse proceeding is not intended to adjudicate any rights as between the spouses. “[T]he IRS’s only concern [in an innocent spouse proceeding] is the identity of the spouse to whom it will look for payment of the delinquent taxes in the first instance.” (Ibid.) Thus, “the IRS does not treat this as a determination of the rights and duties between the spouses.” (Ibid., italics added.)
Indeed, “[t]he federal government has no interest in how the states allocate tax liability between divorcing spouses, as long as they do not attempt to interfere with IRS collection efforts.” (Id. at p. 1321.) And because the innocent spouse determination is not intended to allocate a tax liability as between the spouses, it cannot be accorded preclusive effect on that issue. (Ayala v. Dawson, supra, 13 Cal.App.5th at p. 1327.)
In it’s analysis of Hargrave, the appeal court also suggested the IRS determination of innocent spouse status is not subject to any particular formality: “[T]he determination of innocent spouse status is made at an administrative hearing or, as in this case, during the course of informal negotiations. (Hargrave, supra, 36 Cal.App.4th at p. 1320, italics added.) A decision reached in such a casual process does not comport with due process and thus does not warrant preclusive effect. (See Ahmadi-Kashani v. Regents of University of California (2008) 159 Cal.App.4th 449, 461, [holding a claim under California’s Fair Employment and Housing Act not barred where internal grievance proceeding lacked sufficient judicial character to justify application of res judicata].)
Wife’s attempts to distinguish Hargrave were unpersuasive. First, Wife pointed out that the potential preclusive effect of the innocent spouse determination was not raised in Hargrave until after the marital dissolution judgment had already been entered between the spouses, and thus it was untimely. The Hargrave court itself acknowledged that point, noting, “The time to raise all issues relating to distribution of marital debts, including the propriety of assigning one-half the federal tax burden to an ‘innocent spouse,’ was prior to entry of that judgment.” (Hargrave, supra, 36 Cal.App.4th at p. 1321.) But that acknowledgement came only after the Hargrave court had already explained why the assertion failed on its merits. Thus, it did not affect the applicability of that analysis to this case.
Wife also suggested that because Hargrave addressed only an IRS proceeding, it cannot be relied upon to support the court’s refusal to follow the FTB’s determination of her innocent spouse status. However, the burden was on Wife, as appellant, to establish that a different rule is applicable to a FTB ruling, and thus that the trial court erred by applying the same analysis to both. The appeal court noted wife has made no effort to do that and has consequently waived the claim. (See Berger v. California Ins. Guarantee Assn. (2005) 128 Cal.App.4th 989, 1007 [argument waived when parties “fail to make a coherent argument or cite any authority to support their contention”]; Dills v. Redwoods Associates, Ltd. (1994) 28 Cal.App.4th 888, 890, fn. 1 [appellate court “will not develop the appellants’ arguments for them”].)
Wife also argued that the IRS procedures for determination of innocent spouse status have changed since Hargrave — under current regulations, the nonrequesting spouse is entitled to notice and an opportunity to submit information pertaining to a request for innocent spouse status — and thus she contended Husband was given “the requisite notice and opportunity to be heard that was not present in the Hargrave case.”
The appeal court stated that may have been true, but the bare opportunity to submit information pertaining to an issue under consideration does not equate to being a party to the proceeding in which the issue is decided. Nor does it expand the scope of issues to be decided in that proceeding. Wife did not contend otherwise.
For all of the foregoing reasons, it was held the trial court in this case did not err in failing to accord binding effect to whatever innocent spouse determination Wife may have received from the IRS or the FTB with respect to the parties’ 2006 capital gains tax liability. I like that as well, “whatever.”
Alternatively, Wife argued the trial court should have allocated the capital gains tax liability in a manner consistent with the innocent spouse determination “because Bryan breached his fiduciary duties to Linda and the community in his management and control of the commercial building sale and [his] subsequent failure to timely file the parties’ 2006 joint income tax returns.” (Italics added.) But Wife could not show error on appeal unless she demonstrated there was insufficient evidence to support the court’s explicit finding against her on the issue of Husband’s alleged fiduciary breach. Alleged. That burden is a heavy one: “‘A party who challenges the sufficiency of the evidence to support a particular finding must summarize the evidence on that point, favorable and unfavorable, and show how and why it is insufficient. [Citation.]’ [Citation.] ‘[W]hen an appellant urges the insufficiency of the evidence to support the findings it is his duty to set forth a fair and adequate statement of the evidence which is claimed to be insufficient. He cannot shift this burden onto respondent, nor is a reviewing court required to undertake an independent examination of the record when appellant has shirked his responsibility in this respect.’” (Huong Que, Inc. v. Luu (2007) 150 Cal.App.4th 400, 409.) See, he is a bad, bad, Husband, I allege so, and I am “innocent!”
The Disability Benefits
Wife also contended the court erred in ruling the proceeds of Wife’s disability insurance policy were his separate property. She first points to the general rule that “Property . . . acquired during the marriage is community property [citation] unless it is (1) traceable to a separate property source [citations], (2) acquired by gift or bequest [citation], or (3) earned or accumulated while the spouses are living separate and apart.” (In re Marriage of Valli (2014) 58 Cal.4th 1396, 1400.)
But as Wife acknowledged, a more specific rule applies to the proceeds of disability insurance policies because “[t]he purpose of term disability insurance . . . is to replace lost earnings.” (In re Marriage of Elfmont (1995) 9 Cal.4th 1026, 1034.) The character of those proceeds will usually follow the character of the disabled spouse’s earnings: “If during the marriage an insured spouse becomes disabled, the benefits received are community property because they replace community earnings. [Citation.]
If the benefits continue after the spouses have separated, they are the separate property of the insured spouse whose earnings they replace.” (Ibid.)
Wife relied on a limited exception to that rule, applicable to cases in which the nondisabled spouse can establish that “during the marriage the premiums were paid out of community funds with the intent that the benefits provide retirement income.” (In re Marriage of Elfmont, supra, 9 Cal.4th at p. 1034, italics added.) And Wife argued the court erred by not applying that exception.
The appeal court rejected the argument. The issue was determined to be purely factual, and the court explicitly rejected Wife’s contention that the disability policy had been purchased and maintained with the intent to provide for the parties’ retirement. Instead, the court affirmatively concluded “the disability policy was purchased with the intent to replace the income stream of earnings for [Husband], and the intent of the parties was not for a ‘retirement’ policy.”
That factual finding was amply supported — not only by the evidence of the circumstances under which the policy had been purchased, but also by Husband’s direct testimony on the point. The appeal court held they were consequently bound by it.
Wife also argued that even if the disability benefits were properly considered to be Husband’s separate property earnings as of the time the parties separated, they should nonetheless be treated as retirement funds once Bryan has reached the “retirement portion of his life.” (See In re Marriage of Briltz (1983) 141 Cal.App.3d 17, 20 (Briltz).)
Wife relied on In re Marriage of Samuels (1979) 96 Cal.App.3d 122 (Samuels) for the proposition that after Bryan reaches the minimum age of retirement,“ the predominant purpose of such payments shifts to retirement support rather than disability compensation resulting from premature retirement [citation]; at that point the true character of the disability benefits . . . [citation] effectively constitutes community property . . . .” However, in both Briltz and Samuels, it was determined those courts were faced with a situation in which the husband had reached the age where he was entitled to receive both disability benefits — his separate property — and pension benefits which were community property. The courts were concerned that the husband should not be allowed to manipulate or dissipate the wife’s interest in the community pension benefits by electing to rely on his disability benefits in lieu of taking his retirement. Thus, it was held that in that matter “where the employee spouse elects to receive disability benefits in lieu of a matured and vested right to retirement benefits, only the excess over the retirement benefits constitutes compensation for [disability] and is, thus, the employee spouse’s separate property. The amount received in lieu of matured retirement benefits remains community property subject to division upon the dissolution of marriage” (Briltz, supra, 141 Cal.App.3d at p. 20.)
In this case, there was no community retirement benefit at issue. Instead, because the trial court made an explicit finding that the parties’ purpose in obtaining the disability insurance policy was solely to replace Husband’s earnings in the case of a disability, and not to operate as retirement funds, it was then determined those disability proceeds belonged entirely to Husband. As such, his decision to “retire” at a given age, or to consider himself not retired, had no effect on Wife’s community property rights. Consequently, both Briltz and Samuels are inapposite.
Finally, Wife argued the court was obligated to recognize that at some point a disabled spouse such as Husband would have retired from active employment in the absence of the disability, and thus any disability insurance benefits received after that assumed retirement date would necessarily have been intended to operate as a retirement asset, rather than as the replacement for his wages. That argument had some appeal, but ultimately it conflicted with In re Marriage of Elfmont, supra, 9 Cal.4th 1026, and In re Marriage of Saslow (1985) 40 Cal.3d 848 (Saslow), which affirm that “The primary purpose of disability benefits is to compensate the disabled spouse for lost earnings — earnings which would normally be separate property after dissolution.” (Saslow, at p. 860.)
And while Elfmont and Saslow do authorize an apportionment of such benefits to the extent the court finds they were intended to provide a retirement benefit, Saslow specifies that such a finding should be based on the “testimony of the spouses’ intent, both at the time the disability insurance was originally purchased and at the times that decisions were made to continue the insurance in force rather than let it lapse.” (Saslow, supra, 40 Cal.3d at p. 861.) It is only “[a]bsent evidence of actual intent, [that] the court may ascertain a normal retirement age at which the disabled spouse would have been most likely to retire had no disability occurred.” (Ibid.)
Wife’s argument had flipped Saslow around, suggesting the court must infer an intent to provide retirement benefits, based on an assumed retirement date, even if there was direct testimony bearing on the parties intentions. Because the appeal court was bound by Saslow, they rejected the argument.
For all of the foregoing reasons, the appeal court found the lower court did not err in its award of the post-separation disability insurance proceeds to Husband as his separate property.
The judgment was affirmed. Husband was awarded his costs, which may have been $2,000.00. No award of attorney’s fees. Wife flipped.
What I see here and from my experience, is that our judiciary, when faced with a political issue such as an aged disabled individual, will apply “justice” and “equity,” in their book. Besides, it just does not look good to bring the hammer down on such a person to create a hardship or appear disparate. Remember, the Family Law Court is a court of equity. ” The powers of a court of equity…are not cribbed or confined by the rigid rules of law.” Hirshfield v. Schwartz (2001) 91 CA4th 749, 770.
I hear some snarling out there. This is how it works readers. Be careful when going to divorce court and even more so on appeal.
See In Re Marriage of Linda M. and Bryan Marshall, 053897, 4th DCA California (2018).
Robert Rodriguez, Attorney at law
Robert Rodriguez has litigated well over 100 family law cases and civil litigation matters including personal injury motor vehicle cases, dog bite and slip & fall cases, breach of contract, defamation & invasion of privacy, fraud, unfair business practice, malicious prosecution, workplace and employment matters including sexual harassment, wrongful termination, wage & hour violations, discrimination pursuant to the FEHA, Gov’t Code §§ 12940 et seq., violations of the FMLA & Pregnancy Leave, Civil Rights discrimination pursuant to 42 U.S.C. § 1983 and Title VII of the 1964 Civil Rights Act in the State of California and California federal district courts.
* Disclaimer – Robert Rodriguez is licensed to practice only in the State of California & this analysis is applied only under State of California law. Robert Rodriguez is also admitted to practice in the U.S. District Courts, Central, Northern & Eastern Districts of California. Robert D. Rodriguez has practiced in the State of California Court of Appeal.
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