ILLINOIS DIVORCE LAW BLOG

Articles Posted in Financial Issues in Divorce

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A “source of funds” rule refers to a legal principle, primarily used in divorce proceedings, that determines whether a property should be classified as marital or separate based on the origin of the funds used to acquire or improve it; essentially, it means that if a spouse contributes premarital funds to purchase a marital asset, they may retain a separate interest in that asset proportional to their contribution. 

The husband filed for dissolution after 18 years of marriage, disputing whether two adjacent lots were marital property. One lot included the marital home, and the other had a barn for the wife’s horse training business. The husband purchased both lots before the marriage, but both were encumbered by loans paid off with a mix of marital and premarital funds. The properties appreciated significantly during the marriage due to market forces. The key issue was whether paying down the loans with marital funds created a marital interest in the properties.

The District Court concluded that the lots were nonmarital property, except for the marital contributions toward the loan principals. The court awarded the husband the properties and the wife a cash equalization payment for half of the marital contributions. The wife appealed, arguing that the properties should be considered marital due to the use of marital funds to pay down the loans.

The Court of Appeals affirmed the district court’s decision regarding the land portions of the lots, finding them nonmarital. However, it reversed the decision regarding the barn and other improvements on one lot, classifying them as marital property due to the joint efforts in their construction and operation. The court modified the equalization payment to the wife accordingly.

The Supreme Court reviewed the case and adopted the “source of funds” rule, which considers the marital estate’s acquisition of equity in the properties through loan paydowns with marital funds. The court reversed the Court of Appeals’ decision regarding the land portions of the lots and remanded the case for a new hearing to determine the equitable division of these properties, considering the source of funds rule. The decision regarding the barn and other improvements was affirmed.
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The issue of cohabitation in Illinois divorce cases is an interesting one.  Sometimes, a spouse that is receiving maintenance support engages in a relationship with a third party after the divorce. The payor spouse many times feels a bit cheated, in that a former spouse (payee)  receives financial support while at the same time dating someone exclusively and sharing their home with him/her.  In Mattson, a former husband felt burned that he was paying support to his ex-wife while she was engaging in a lengthy relationship with a Chicago sportscaster. The former husband hired private investigators to watch the former wife’s house. Former husband brought his case to Court.

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Marriage of Mattson: 2024 IL App (3d) 230307-U

Section 510(c) of the Dissolution Act provides that, “Unless otherwise agreed by the parties ***, the obligation to pay future maintenance is terminated upon the death of either party, or the remarriage of the party receiving maintenance, or if the party receiving maintenance cohabits with another person on a resident, continuing conjugal basis.” 750 ILCS 5/510(c) (West 2022). (Emphasis added.)

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Valuing a small business in a divorce can be complex and often involves several methods. Here are some common approaches:

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  1. Income Approach:
    • Capitalization of Earnings: This method estimates future profits and applies a capitalization rate to determine the business’s value.
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Confusion still reigns with respect to the tax treatment of spousal maintenance for Illinois divorce cases. I still see other law firms discussing online spousal maintenance (support) using the old rules.

In Illinois, spousal maintenance (also known in other states as alimony) is generally not tax-deductible for the payor nor taxable income for the recipient. This change came into effect due to the Tax Cuts and Jobs Act (TCJA) of 2017, which significantly altered the tax treatment of spousal support (maintenance)  nationwide.

Under the TCJA, for divorce or separation agreements executed after December 31, 2018, maintenance payments are no longer deductible by the person paying the maintenance and are not considered taxable income for the person receiving it. This change applies to federal taxes and, in most states including Illinois, state taxes follow federal guidelines on this matter.

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A few years ago, I tried a lengthy case in Will County, Illinois that ended up on appeal on a few key issues. One of these issues is that at trial, I put in evidence and argued that the small company owned by the parties should have its retained earnings considered as marital property, insofar as the practice of this husband and wife company had been to distribute the retained earnings out to themselves as dividend income. While the trial judge held that they were part of the valuation of the marital business, the appellate court agreed with my approach, and ordered that the retained earnings be considered a cash asset of the marriage. This ruling was a significant financial win for my client, and my case ended up clarifying an area of Illinois law and was cited nationally on the following principle: retained earnings in a closely held corporation can be found to be a marital asset (outside of the value of the company itself) subject to distribution in the divorce.

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Retained earnings in a small corporation refer to the portion of the company’s net income that is not distributed to shareholders as dividends but rather kept within the company for reinvestment in its operations or for other purposes. Essentially, it’s the cumulative amount of profits that the company has retained since its inception, minus any dividends paid out to shareholders. Retained earnings are an important asset class in an Illinois divorce with a closely held company.

Retained earnings can be distributed to the shareholder(s) as a 1099 dividend, and many owners of small companies use retained earnings for this purpose. These dollars can also serve as a source of funding for various activities such as business expansion, research and development, debt reduction, or building up cash reserves. They are an important indicator of a company’s financial health and its ability to reinvest in itself for future growth.

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One aspect of my practice is to deliver high level legal skill to my clients, while at the same time optimizing their outcomes in a cost-effective manner. Divorces don’t need to cost an “arm and a leg.”

Divorce can be emotionally and financially taxing for all parties involved. While the emotional aspect might be harder to mitigate, there are several strategies to save on the cost of divorce:

  1. Mediation: Consider opting for mediation instead of litigation. Mediation involves a neutral third party who assists in facilitating discussions and negotiations between spouses to reach mutually acceptable agreements. It’s often faster, less adversarial, and less expensive than going to court.
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In my practice, much of the emphasis on this blog is placed on complex child custody litigation, and how to manage these difficult issues with child custody litigation.  Yet, in some of my cases along with child custody issues there can be significant financial issues and division of property issues. One issue that sometimes arises is the valuation of a family owned business, or the valuation of a percentage share in a corporation our group of companies.

With certain exceptions  all property acquired during marriage through the time, skill and efforts of either spouse is considered marital property. The disposition of property is governed by Section 503 of the Illinois Marriage and Dissolution of Marriage Act (IMDMA). Under Illinois law, all property acquired by either spouse during a marriage is presumed to be marital property.

A business begun by one spouse after the date of marriage and before physical separation will need to be divided in a dissolution proceeding, and if you and your spouse cannot agree on its value it may need to be evaluated by an expert.  Under the IMDMA the Court can appoint its own expert to advise it about financial issues in a case, but more typically each arty will retain a CPA-level expert to determine values in the business and property interests, and then be available to testify at trial (if necessary) regarding the values that the Court should determine in a marital estate.

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For the decades that I have been practicing Family Law/Divorce/Child Custody, I have always endeavored to deliver good value for the money spent on legal fees. Aside from keeping my hourly rates at a moderate level so that they are affordable for all clients, I also have some pride in the fact that my Firm really works to manage the cases aggressively and at the same time, cost effectively.  With this in mind, I thought I’d post some suggestions on how clients can help keep legal costs down in a contentious divorce:

Here are 7 ways to save on divorce costs:
1.  Try to maintain some measure of BIFF (Brief, Informational, Firm and Friendly) communication with your spouse over children’s issues. Use Our Family Wizard or similar platform. When all communications go through lawyers, the costs go up.
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I can say that most of the calls to my firm involve significant and complex child custody issues, many involving psychological issues or parental alienation concerns. Yet, it is still very important for my practice to focus on financial issues in divorce, as well.  Issues concerning support calculations, and valuation issues of real estate and/or business are an important and essential part of the practice.  I spent a few years, along with my law school training, in MBA school as well. These years of the study of accounting and finance have proven beneficial in the practice of Illinois Divorce Law.
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A case I tried some years ago made its way to the Appellate Court in Illinois. The case was ultimately brought to the Illinois Supreme Court, which decided not to address the Third District Appellate Court’s decision in Marriage of Liszka.  I tried the Liszka case before a Will County judge, and it was a barnburner, involving both child custody issues and financial issues including the valuation of a closely held business worth in the millions of dollars.
Part of my approach with the trial court in that case was to ask the Court to not only value the retained earnings in the business as marital property, but as these retained earnings had not been part of the valuation of the business, that the Court should distribute the marital earnings to the parties as a cash distribution of marital property.  The trial court declined to do so. Fortunately, because the case was tried with some expectation that the court might make some mistakes in its judgment of the case, I tried the case with an eye that the decision of the court would be appealed.
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Reading up today on divorce planning, the reminder was made that the summer is often the time that many people postpone thoughts of divorce. The reasons for this are many. Business during the summer with activities takes the attention away from difficult subjects like divorce. For many parents, it’s just enough making sure that the kids are having a good summer, and that summer trips or vacations are being taken before the kids go back to school.

Even if you are already decided that you wish to file for divorce, there are a number of things that you can do to make the eventual decision easier. None of these steps are disruptive, and the you and the children will enjoy the summer without thoughts of disruption or change. Here are a few themes to focus on during the summer:

1. Understand your financial position. It’s important to have access to financial records during the divorce process. It can be helpful to try to assemble as much of this information as is possible, so that when you meet with our office. we can have a general discussion of financial planning in the divorce process. Take a look at http://www.illinoiscourts.gov/forms/approved/divorce/financial_affidavit.asp in order to review the form that is now universally used in Illinois divorce cases as a guide for the lawyers and judges is assessing the financial condition of the parties.
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