Proceeds Received from Sale of Stock in Business Were Not Included as Income for Support Purposes When They Were Reinvested

Husband worked for PRSI, a company which his adult children from a former marriage established. At some point, his adult children gifted him 51% of the stock of PRSI. PRSI was sold to and merged with USSI. He received compensation for the sale of his stock in the form of USSI stock and cash to be paid over time. The stock was subject to SEC restrictions on transfer. As part of the merger, he received an employment contract with a salary and entered into a covenant not to compete for a certain period of time. (Id. at pp. 1364-1366.) USSI was acquired by and merged into a new company, First Advantage. Husbands shares of USSI were converted into new company shares with the same SEC restrictions. Husband also continued to work for the new company. (Id. at p. 1368.) There were a number of issues in the case: arrears in child support, modification of child support upward, custody, etc.

Martin Wertleib was Husband’s expert. Wertleib’s analysis included the cash from the sale of PRSI and an assumed anticipated return on the investment (once the stock became available for sale under the SEC rules) to determine Husband’s gross income. The divorce court rejected this analysis and instead treated all proceeds from Husband’s sale of the business as income (cash installments when received and the market value of the stock as it became available for sale, whether or not it was actually sold. (Id. at p. 1372.) Husband’s divorce lawyer filed a timely appeal.

Husband’s divorce lawyer argued on appeal that the divorce court erred in treating the proceeds from the sale as income rather than capital gain. The Court of Appeal referenced the following several cases for the propositions set forth below: “Generally, the types of income specified in the statute consist of money that the support obligor actually receives, and do not include unrealized increases in the value of assets. (In re Marriage of Henry (2005) 126 Cal.App.4th 111, 119, 23 Cal.Rptr.3d 707 [“If the Legislature had intended that the unrealized increase in the value of an asset should be considered income, it would have said so.”].) This is consistent with “[t]he traditional understanding of ‘income’ [as] the gain or recurrent benefit that is derived from labor, business, or property [citation], or from any other investment of capital [citation].” (In re Marriage of Scheppers, supra, 86 Cal.App.4th at p. 650, 103 Cal.Rptr.2d 529.) Put another way, “[s]upport payments usually are paid from present earnings, not liquidation of preexisting assets.” (Mejia v. Reed (2003) 31 Cal.4th 657, 670, 3 Cal.Rptr.3d 390, 74 P.3d 166; cf. In re Marriage of Scheppers, supra, 86 Cal.App.4th at p. 651, 103 Cal.Rptr.2d 529 [“ ‘Income is the key *1373 factor in our system, not capital or net worth.’ ”]; In re Marriage of Reynolds (1998) 63 Cal.App.4th 1373, 1380, 74 Cal.Rptr.2d 636 [“Only investment income, not investment principal, should be available to pay spousal support….”].)” (Id. at pp. 1372-1373.)

The Court of Appeal however, acknowledged that assets are not entirely irrelevant in determining income, and cited to an example of where the support payor invests his/her funds in non-income producing assets, a trial court can impute income to the assets, which is the approach Wertleib took in his analysis. (Id. at pp. 1373-1374.) The divorce court in Pearlstein, however, treated the unrealized gain in Husband’s stock as if it were shares of stock options that one may receive as part of a compensation package for past, present or future work. Agreeing with Husband’s divorce attorney, the Court of Appeal found the divorce court misunderstood the difference between a stock option obtained as compensation and shares of stock acquired as part of the proceeds from the sale of equity in a business. It held the unliquidated stock received for equity is the same as other kinds of acquired nonliquid assets that are not normally considered income for support purposes. (Id. at pp. 1374-1375.)

The Court of Appeal concluded that the market value of the unsold shares received by Husband in connection with the sale of the business are generally not income for child support purposes. Further, It held: “Moreover, to the extent that [Husband] sold the shares only for the purpose or reinvesting them in income-producing assets, the resulting gain also was not income, but merely the replacement of one capital investment with another. (Cf. In re Marriage of Kuppinger, supra, 48 Cal.App.3d at pp. 634–635, 120 Cal.Rptr. 654 [rejecting argument that income should be imputed to supported spouse based on asserted obligation to invest in income-producing assets, where funds derived from sale of one non-income-producing asset had been reinvested in another].)” (Id. at pp. 1375-1376.) If Husband sold the stock and spent the proceeds, as opposed to reinvesting them, the divorce court could treat the realized gain as income and also the divorce court could attribute a reasonable rate of investment on the value of the stock available for sale (which is what Wertleib suggested).

In connection with Husband’s divorce lawyer’s argument that the divorce court also erred in treating the cash he received from the sale as income, the Court of Appeal held: “We agree with Irwin that the cash he received from the sale was also a capital asset, because it was the proceeds from the liquidation of a capital asset. Nonetheless, there is a distinction between the case and the stock, in that the cash represents realized rather than unrealized capital gain. With respect to the treatment of realized capital gain as income, the governing principles are somewhat different. To the extent that a support obligor has spent funds derived by liquidating his or her capital, rather than reinvesting them, the trial court acts within his discretion in considering the funds expended to be income for support purposes.” (Id. at p. 1376.)

The Court of Appeal remanded agreed with Husband’s divorce lawyer and remanded the matter back to the divorce court, stating the divorce court may treat sales funds Husband expended as opposed to reinvested, as income, but otherwise the stock and cash must be treated as capital assets, and the court’s discretion is limited to imputing an income stream to the assets for support purposes. (Id. at p. 1377.)

In re Marriage of Pearlstein (2006) 137 Cal. App. 4th 1361