Theresa Hines v. David Hines (2013)

MEMORANDUM OF DECISION RE PLAINTIFF'S MOTIONS FOR ACCOUNTING (# 249.00 AND # 258.00) AND DEFENDANT'S CROSS MOTION FOR ACCOUNTING (# 251.00)

This postjudgment matter comes to the court for assistance in carrying out the provisions of their divorce settlement agreement (# 126.10) (Agreement) relating to alimony which was incorporated into the judgment dissolving their marriage on March 28, 2007.   Ironically, that was the last date on which the parties have been able to agree on anything.

The defendant has a variety of business interests.   He owns 85 percent of Hines Sudden Service, Inc. (HSS) and 60 percent of Chowdhury–Hines Chicken, Inc. (CHC).  Both are Subchapter S corporations, which are taxed as partnerships.   The two businesses operate a total of twenty-nine Kentucky Fried Chicken franchises here in Connecticut and in the state of Florida.   Additionally, the defendant owns some of the real estate on which several of the restaurants are located.   His partner in the restaurant operations does not have an ownership interest in the real estate.

In their original Agreement, the parties worked out an alimony provision which was designed to share equally the defendant's income from his various business interests.   That Agreement contained various provisions developed to insure that the plaintiff had an appropriate level of support on an ongoing basis by providing her with monthly payments while protecting both parties with an end of the year adjustment based on the year's incomes.¹  They actually spelled out the intent of the parties as the Agreement states:  “It is the intention of the parties that the funds available to each from the husband's income from business and rental income shall be equal.”   To further this goal, the Agreement also prohibits the defendant from “reducing his income by inflating any deferred compensation,” as well as “not compensat[ing] any employee in a manner which defeats the intent and purpose of the agreement.”   Later in the Agreement, when discussing the ultimate sharing of the businesses, the language states:  “Husband understands that he is taking on an obligation of loyalty to not defeat the intent of this Agreement—that he shall not reduce his income in any artificial manner and he shall not reduce the asset value in any manner designed to defeat the purpose of this Agreement ․ Husband shall have the same fiduciary duties toward Wife as he does towards his business partner.”

Despite the lofty language and honorable intent of the Agreement, the parties have been unable to agree on what the alimony obligation was from the very first year.   The dispute was eventually heard by the court in a two-day hearing in which each side presented expert testimony as to the correct calculation.   The court, Dyer, J., issued its memorandum of decision (# 186.10) on September 25, 2009.   In its decision, the court dismissed the calculations presented by each side as not “accurately track[ing] the equalization formula delineated in the judgment” and presented to the parties its own calculation.

The major issues before the court in 2009 concerning the equalization calculation for the year 2007 included the issue of how shareholder or officer loans from the corporation should be handled for the purposes of calculating alimony.   Should it be included or not?   Was it income or a loan that had be repaid?   Another issue was whether undistributed corporate earnings should be included in the calculation.   The court rejected that because the Agreement referenced only distributed earnings.   As for the loans, that was an issue not directly or specifically addressed by the Agreement.   The court, given its understanding of the nature of Subchapter S corporations—and closely held businesses in general—ruled that it was income for the purposes at hand.   It was a manipulation that although legal, “thwarts the intent and the spirit” of the Agreement.

In an effort to avoid future disputes, the court spelled out in some detail its calculation and in doing so added some specificity to the general terms of the Agreement.   Still, the court recognized the growing reality of the problem when it suggested to the parties:

To be workable, the parties' agreement requires a level of communication and cooperation that the parties have not yet been able to achieve.   To be workable, the agreement requires the recognition on the part of the plaintiff that the defendant may be required to utilize the retained earnings of his Subchapter S corporations for operating expenses, to make legitimate capital improvements, and to comply with bank covenants.   To be workable, the agreement requires recognition by the defendant that he owes a duty of fiduciary responsibility, openness, and fairness to the plaintiff.   Unfortunately, the parties have yet to embrace such concepts.

The present matter proves the court was correct on all counts.

What faces the court at the present time is simply an extension of the issue in 2009.   The parties now find it impossible to reconcile the alimony obligations for the years 2008–2011.   Among the issues that are present are the continuing question of officer loans and how exactly to calculate adjusted gross income to meet the court's suggested calculation.   Specifically, how should such income tax concepts, such as depreciation, be used in the alimony calculation under the Agreement as defined by the 2009 memorandum of decision?

Regarding the officer loans, the defendant raises a new consideration.   He has been found by the Internal Revenue Service (IRS) to be liable to the corporation for interest on the loans he has taken at the rate of 6 percent per annum.   It is his position that if he has to pay interest and the loan is to be considered income for alimony purposes, that the plaintiff be required to pay interest on the portion of that loan that she receives.   He also argued that when the defendant repays such a loan, the plaintiff is required to repay what she received as alimony or that her potential interest in the ownership of the businesses be reduced by one-half of what was repaid since she already received the benefit of that money.

As stated above, in regard to the loan issue, it is already the law of the case that officer loans are to be considered as income for the purposes of the alimony calculation.   The fact that the defendant elected to take the money as a loan rather than as taxable income is his decision to make and the plaintiff should not be responsible for that election.   It is no different from any other party required to pay alimony and that payor finding him/herself in a cash flow problem.   If that person decides to liquidate an asset to cover the alimony obligation, the recipient would not be held liable for the costs of any sale or the taxable consequences of the liquidation.   If that person borrowed the money from a bank or a friend, the recipient of the alimony would not be asked to pay the interest on that loan.   The same logic applies to the defendant's request that the plaintiff repay one-half of the money borrowed by the defendant when he repays the loan to the corporation.   It is his debt and his obligation.   As to how the repayment might impact the plaintiff's share of the business when liquidated, that will be decided at the appropriate time.   Nothing is being sold now and there is no reason for the court to rule on a potential event that may or may not occur sometime in the future.

The issue of how does one determine the defendant's adjusted gross income for the alimony calculation, however, is a much more difficult problem.   It is understood by all that accounting for tax purposes and other accounting procedures are not always the same thing.   Certainly, the calculation of cash flow for a business and accounting for tax purposes are very different for a number of reasons, but probably the most distinctive difference is the concept of depreciation.   Depreciation is a legitimate accounting tool for allocating the cost of capital good over the effective life of that item on the theory that there is a cost to acquire that item and there will be another cost to replace it at the end of its effective life.   Yankee Gas Co. v. Meriden, Superior Court, judicial district of New Haven at Meriden, Docket No. CV 960072560 (April 20, 2001, Bishop, J.) [29 Conn. L. Rptr. 285] (“Depreciation is a loss in property value from any cause.   It may also be defined as any difference between reproduction cost or replacement cost and market value”).   For tax purposes, “[p]ursuant to the IRC, depreciation is deductible from taxable income as an ordinary and necessary business expense.”   Connecticut Light & Power v. Department of Public Utility Control, Superior Court, judicial district of New Britain, Docket No. CV 03 0523949 (June 20, 2006, Levine, J.).   For the purposes of determining the cash a business has for a specific period of time, however, one employs other accounting techniques that do not include depreciation.

The defendant takes the position that his income should be what it states on his tax return and that amount will include all properly taken depreciation.   This may well result in the defendant having a loss of income for taxation purposes as indeed it has for some of the years in question here.²  The plaintiff takes the position that since the defendant controls his businesses he can manipulate his tax reporting—both individual and corporate returns—to his advantage.   Accordingly, a simple use of that figure will result in times when he will have no alimony obligation at all despite the fact that he has received money from the businesses in that same time period.   The court agrees with the plaintiff, but also recognizes that the defendant must be able to make appropriate business and tax decisions in the best interests of those businesses.

The plaintiff employed an accountant as her expert witness for the purposes of the litigation.   She hired Joseph A. DeCusati of the firm of Meyers, Harrison & Pia, LLC. DeCusati is a certified public accountant (CPA) and is also accredited in business valuation (ABV), as well as a certified fraud examiner (CFE) within the Association of Certified Fraud Examiners.   DeCusati was very clear in his testimony that he believed the defendant manipulated the businesses to reduce his alimony obligation to the plaintiff and that he failed to “show a pattern of fiduciary responsibility in compliance with the ‘openness and fairness' referred by [the court].”

According to his testimony, DeCusati deconstructed the court's calculation of the 2007 alimony amount to build a working formula for the calculation for the years 2008, 2009, 2010 and 2011.   As part of that formula, he included officer loans that were not repaid and discounted depreciation and other accounting procedures which he believed artificially reduced the income to the defendant.   In a series of such calculations for each year in question (plaintiff's exhibit # 22), DeCusati determines, according to what he viewed as being in compliance with the court's calculation for 2007, is the amount necessary to equalize the incomes of the two parties as required by the Agreement incorporated into the judgment.   The court finds these calculations to be clear, fair and within the spirit and the letter of the Agreement of the parties as interpreted by the 2009 memorandum of decision, but does not adopt them in their entirety.

The essential aspect of this analysis adopted by the court is that it allows the defendant to take business losses necessary to reduce his taxable income, but does not allow such losses above what is required to achieve that goal.   In 2011, for example, the losses taken by the two Subchapter S corporations controlled by the defendant far exceeded what was necessary to reduce the defendant's tax liability to zero.   One could rightfully ask what the purpose of such excessive deductions might be other than to provide the defendant with an advantage as to his alimony obligation.   If one accepted the defendant's accounting, he would not owe the plaintiff any alimony at all and she would be required to reimburse him for all the payments made.   The reality of the situation, however, was that the defendant had income in 2011—cash in his pocket income—but for taxation purposes he lost hundreds of thousands of dollars.

The Agreement of the parties addressed this issue when it stated that “Losses for any such Subchapter S corporations shall not reduce the Husband's gross annual earned income from his employment except to the extent that such losses are actually realized by him.” (§ 4.1.) That prohibition, when taken with the other language quoted above recognizing the potential for inappropriate manipulation of the books by a controlling shareholder, clearly supports the restriction of what losses can be taken in any given year.

The defendant also had expert witnesses testify in support of his calculations.   He called Philip J. DeCaprio, Jr. for that purpose.   DeCaprio is also a CPA and an expert in forensic accounting and business valuations.   Having worked as an accountant for almost fifty years, DeCaprio has performed peer review work in his field for twenty years and has served on the Connecticut Board of Accountancy since 1999.   He is clearly well qualified in this field and an appropriate expert witness.

His calculations were quite different from that of the plaintiff's witness, but he also testified that he only made calculations based on the information given to him by the defendant.   The witness was asked to do the calculation with the information given and he did that.   He did not challenge anything.   In his words, he compiled;  he did not analyze.   The limitations created by the way in which he was directed to perform his tasks left him with some serious gaps in his information.   For example, he testified that he was not aware of the fact that the defendant had been audited by the IRS for the tax year 2009 and that as a result of that audit the defendant's income was increased by some $73,000.   DeCaprio also testified that he did not consider any officer loans in his calculation of income for the determination of alimony.   Accordingly, the court did not find DeCaprio's testimony helpful.

The defendant also called Barry Fischman as witness.   Fischman, an experienced CPA, is a senior member of the firm which does accounting and tax preparation work for the defendant and his various business interests.   Originally called as a fact witness only, Fischman testified as to how and why certain business deductions were taken.³  He explained, for example, the difference in how depreciation is viewed for tax purposes as opposed to how it is treated for accounting purposes under the Generally Accepted Accounting Principles (GAAP), which are widely used to prepare, present and report financial statements for a variety of entities, including publicly traded and privately held companies, non-profit organizations, and government authorities.   For tax purposes, depreciation can be taken in a variety of ways under different sections of the IRS Code. A taxpayer may accelerate the deduction and take it all at once for tax reporting purposes.   This is allowed for reasons other than accounting principles.   Such a rule will, for example, encourage more capital investment by companies which the government would find as desirable as it applies to the economy of the country;  it serves a political or policy purpose rather than an accounting purpose.   GAAP requires that the deduction be taken over the useful life of the item if that life is more than one year.   While accelerating depreciation is not illegal or unethical in any way, it does not necessarily comply with the letter and, more importantly, the spirit of the alimony calculation as detailed in the Agreement.

Fischman testified that both HSS and CHC were not doing well as of the end of 2011 which is the last full period for which records are currently available.   Acceleration of the depreciation eliminated the need to use available cash for taxes and allowed that money to be used for other necessary expenses.   There was also testimony offered to show that the KFC restaurants which were built on land owned by the defendant have stopped paying rent.   The rationale offered was twofold:  one reason was that there was not enough income from the businesses to make the payment and secondly that receiving rental income would violate the forbearance agreements the defendant and his partner had with their creditors.   Neither reason is completely persuasive to the court.   The fact that the defendant could not pay himself is really just proof of his ability to control the situation and lends credibility to the charge by the plaintiff that he is not treating her fairly.   There was only an opinion by the defendant and one of his experts that the receipt of rental income would be treated as part of his officer compensation under the forbearance agreement that was offered into evidence.   There was no testimony from the lender to that point nor was there any exhibit, other than the forbearance agreement itself, that supported that conclusion.   It is not clear from the reading of that document that the defendant was correct as it made no reference to rental income;  only officer compensation.

These issues once again underscore the difficulty for the court in attempting to enforce the parties' Agreement.   One could not criticize the business decisions of the defendant in his tax filings, but those decisions clearly impact the plaintiff and perhaps unfairly.   The court will not micro-manage the business decisions made by the defendant, but the court must—given the inability of the parties to do so—determine “the funds available ․ from the husband's income from business and rental income” and in so doing, the court must examine certain financial machination of the defendant that may legitimately reduce the tax burden of the corporations, but unfairly (and in violation of the spirit of the Agreement) limit the income available to the plaintiff.   The fairest way to do that is to allow only losses that are actually realized by the business in real dollars and not by the way of depreciation.   Courts have held that “actual cash losses,” such as capital loses, are distinct from depreciation.   Hillis v. Hillis, Superior Court, judicial district of Stamford–Norwalk, Docket No. FA 00 0179465 (February 19, 2003, Shay, J.) (34 Conn. L. Rptr. 232, 234).   Furthermore, this approach has been implemented in the context of calculating income for child support purposes.   Burns v. Burns, Superior Court, judicial district of Tolland, Docket No. FA 91 0048287 (May 29, 2004, Lifshitz, J.) (“Items such as depreciation which do not represent an actual cash flow, or items that would not be deducted by a wage earner, such as commuting costs, are not deductions for purposes of a child support computation, even if they are lawful deductions allowed by the Internal Revenue Service for tax purposes.”);   Austin v. Nelson, Superior Court, Docket No. FA 87 0244210 (September 17, 1996, Bassick, J.) [17 Conn. L. Rptr. 663] (although in context of child support, court added depreciation back into income because depreciation is not legitimate business expense).   Such an approach will allow the defendant to take advantage of depreciation and other tax planning techniques for IRS purposes, but will require a more reality based analysis for alimony purposes.   Hopefully, this direction will help to prevent future disputes over the calculation.⁴

There were a number of other issues that were raised in the calculation dispute before the court.   One was the question of state income taxes.   DeCusati, in his testimony, noted that although the court, Dyer, J., said such taxes should be included, he did not include state taxes in the calculation that was produced as part of the decision.   Accordingly, he did not include state taxes in his calculations to be consistent with the court's calculation.⁵  State taxes should be included.   There is no reason to exclude that item.

The defendant raised the issue of FICA and medicare taxes not being included in the calculation.   It was his position that they should be included as they are mandated to be paid and, therefore, must be paid.   Some opposition to this was raised on the argument that although called a tax, the money is actually applied to a potential benefit to the defendant in the form of social security benefits and medicare benefits.   The Child Support Guidelines allow for their deduction from gross income for the purposes of child support because they are mandatory deductions and they are treated that way for most similar calculations, so the court sees no reason why they should not be so used in the alimony calculation.  Regs. Conn. State Agencies § 46b–215a–2b(c)(2).   See also Golden v. Mandel, 110 Conn.App. 376, 386, 955 A.2d 115 (2008) (referring to child support guidelines' calculation for income in context of both alimony and child support).

[The] interpretation of a separation agreement that is incorporated into a dissolution decree is guided by the general principles governing the construction of contracts.   Thus, if there is definitive contract language, the determination of what the parties intended by their commitments is a question of law ․ The language used in a contract must be accorded its common, natural, and ordinary meaning and usage where it can be sensibly applied to the subject matter of the contract.   Where the language of the contract is clear and unambiguous, the contract is to be given effect according to its terms.   A court will not torture words to import ambiguity where the ordinary meaning leaves no room for ambiguity ․ Finally, in construing contracts, [the court must] give effect to all the language included therein, as the law of contract interpretation militates against interpreting a contract in a way that renders a provision superfluous ․ Therefore, when interpreting a contract, we must look at the contract as a whole, consider all relevant portions together and, if possible, give operative effect to every provision in order to reach a reasonable overall result.  (Citations omitted;  internal quotation marks omitted.)  Afkari–Ahmadi v. Fotovat–Ahmadi, 294 Conn. 384, 390–91, 985 A.2d 319 (2009);  1598;  1598.   See Russell v. Russell, 95 Conn.App. 219, 221–22, 895 A.2d 862 (2006), as cited by an unpublished decision in Leopard v. Leopard, Superior Court, judicial district of Hartford, FA 05 4011468 (November 16, 2010).

As stated above, the parties were quite clear in their Agreement as to their intent and in their efforts to give guidance to the alimony calculation to be made in the years to come.   The mechanics of that calculation has proven troublesome despite the clear intent.   This decision and the decision issued by the court in 2009 does not modify their words, but only attempts to give clearer guidance to those mechanics based on the issues raised.

The court, having carefully considered all of the sworn testimony of the witnesses, having observed their demeanor while testifying and after examining the exhibits offered as evidence during the trial, makes the following findings of fact:

A. The defendant, as the majority shareholder in the two SubChapter S corporations in question, has the ability to control his reported income by using a variety of accounting and tax reporting techniques and practices;

B. Such ability on the part of the defendant, while entirely legal and ethical from an accounting and tax perspective, can distort the agreed upon alimony calculation devised by the parties in their divorce settlement agreement incorporated into their dissolution of marriage judgment on March 28, 2007;

C. The letter and the spirit of that Agreement required the defendant to assume a fiduciary responsibility to the plaintiff requiring a high degree of openness and fairness in the alimony calculation;

D. Two prior courts have found the defendant to have acted in ways contrary to his fiduciary responsibility to the plaintiff as expressed in the Agreement;

E. The defendant's behavior for the years 2008–2011 has not risen to that level and such behavior has resulted in an underpayment for at least three of those four years;

F. Examples of such behavior are the taking of officer loans in lieu of salary or taxable distributions and not including such funds in the alimony calculation, the acceleration of depreciation to create tax losses which do not reflect the realities of the defendant's actual cash flow and failure of the defendant's companies to pay rent for occupying the real estate also owned by the defendant;

G. The tax oriented calculations performed by the defendant's experts have not been found to be helpful to the court in interpreting the Agreement and the prior court rulings in this matter;  and

H. Further calculations by an appropriate court appointed expert will be required to apply the principles enumerated by the court in this decision in order to calculate the correct alimony equalization payments required for each of the four years.

Accordingly, having carefully reviewed the findings of the court, the evidence presented and having applied all relevant statutory and case law criteria, the court hereby

ORDERS

I. That the parties present to the court no later than thirty (30) days from the date of this memorandum of decision the name or names of a neutral certified public accountant to act as the court's expert for the calculation of the alimony equalization payments necessary for the years 2008, 2009, 2010 and 2011, pursuant to the provisions of Practice Book § 25–33;

II. The court shall select its expert from the names provided by the parties and shall notify the parties of the selection.   Such selection shall be subject to said expert's willingness to accept the appointment;

A. The parties shall share the cost of the court appointed expert, including any retainer fee, with the plaintiff paying 40 percent of the cost and the defendant paying 60 percent;

B. The parties shall cooperate with the court appointed expert by providing the expert with all records and documents requested within forty-five (45) days of the date of the request which shall be in writing;

III. Said expert shall calculate the appropriate payments for the equalization of the alimony by applying the following rules as they apply to the Agreement as explained by the memorandum of decision issued by the court on September 25, 2009;

A. Any loans taken by the defendant from his businesses are to be counted as income for the purposes of alimony unless repaid within the same tax calendar year;

B. All tax liabilities actually paid by the parties for state and federal income taxes as well as FICA and Medicare taxes are to be deducted from gross income for that year;

C. No deductions shall be allowed for depreciation, other tax related reasons or for accounting purposes unless they are based on actual losses realized by the party regardless of whether or not such deductions are allowed by the taxing authority;

D. Any rental income or other business related income must be based on arms' length, fair market values whether or not such payment are actually being made unless in the expert's professional opinion there is an overriding business reason for accepting a lower amount;

IV. The expert shall provide the court with the calculation for each of the years 2008–2011 along with the computation used to develop that number and shall provide the parties with the same;  and

V. The court shall hold a hearing no later than sixty (60) days after the filing of the expert's report to review and accept, modify or reject the expert's amounts.

Adelman, J.

FOOTNOTES

FN1. In addition to the defendant's income, an imputed income was developed for the plaintiff..  FN1. In addition to the defendant's income, an imputed income was developed for the plaintiff.

FN2. For the tax year 2011, for example, the defendant's tax return indicates a loss of $241,000..  FN2. For the tax year 2011, for example, the defendant's tax return indicates a loss of $241,000.

FN3. Later, he was qualified as an expert witness for the limited purpose of commenting on the calculations done by the plaintiff's expert as detailed in plaintiff's exhibits # 21 and 22..  FN3. Later, he was qualified as an expert witness for the limited purpose of commenting on the calculations done by the plaintiff's expert as detailed in plaintiff's exhibits # 21 and 22.

FN4. The Supreme Court discussed the problem of dealing with Subchapter S corporations and the undistributed income produced by them in dealing with alimony and child support issues in Tuckman v. Tuckman, 308 Conn 194, 61 A 3d 449 (2013).   Relying on a Massachusetts case, the court quoted directly from that decision:[T]he better reasoned decisions require a case-specific, factual inquiry and determination ․ We follow the lead of these cases, and similarly conclude that a determination whether and to what extent the undistributed earnings of an S corporation should be deemed available income to meet a child support obligation must be made based on the particular circumstances presented in each case.   Such a fact-based inquiry is necessary to balance, inter alia, the considerations that a well-managed corporation may be required to retain a portion of its earnings to maintain corporate operations and survive fluctuations in income, but corporate structures should not be used to shield available income that could and should serve as available sources of child support funds.(Internal quotation marks omitted.)  Id., 210–11.Although, the instant case is evaluated based on the agreement of the parties, this case is supportive of the court's decision not to simply accept the shareholder's representation of what business income is available for alimony purposes..  FN4. The Supreme Court discussed the problem of dealing with Subchapter S corporations and the undistributed income produced by them in dealing with alimony and child support issues in Tuckman v. Tuckman, 308 Conn 194, 61 A 3d 449 (2013).   Relying on a Massachusetts case, the court quoted directly from that decision:[T]he better reasoned decisions require a case-specific, factual inquiry and determination ․ We follow the lead of these cases, and similarly conclude that a determination whether and to what extent the undistributed earnings of an S corporation should be deemed available income to meet a child support obligation must be made based on the particular circumstances presented in each case.   Such a fact-based inquiry is necessary to balance, inter alia, the considerations that a well-managed corporation may be required to retain a portion of its earnings to maintain corporate operations and survive fluctuations in income, but corporate structures should not be used to shield available income that could and should serve as available sources of child support funds.(Internal quotation marks omitted.)  Id., 210–11.Although, the instant case is evaluated based on the agreement of the parties, this case is supportive of the court's decision not to simply accept the shareholder's representation of what business income is available for alimony purposes.

FN5. He also testified that in his opinion the inclusion or exclusion would make little difference m the outcome as both parties had the obligation and it would be mostly a “wash.”.  FN5. He also testified that in his opinion the inclusion or exclusion would make little difference m the outcome as both parties had the obligation and it would be mostly a “wash.”

Adelman, Gerard I., J.