In re Marriage of Brand

• Citation: 273 Kan. 346,44 P.3d 321
• Decision Date: 19 April 2002
• Docket Number: No. 86,273.,86,273.
• Parties: IN THE MATTER OF THE MARRIAGE OF MARY JO BRAND, Appellant, and MICHAEL JOSEPH BRAND, Appellee.
• Court: United States State Supreme Court of Kansas

273 Kan. 346

44 P.3d 321

IN THE MATTER OF THE MARRIAGE OF MARY JO BRAND, Appellant, and MICHAEL JOSEPH BRAND, Appellee.

No. 86,273.

Supreme Court of Kansas.

Opinion filed April 19, 2002.

Ross D. Alexander, of Alexander, Floodman & Casey, Chtd., of Wichita, argued the cause and was on the brief for appellant.

Stephen J. Blaylock, of Blaylock & Cleous, Chartered, of Wichita, argued the cause, and Joan M. Bowen, of the same firm, was with him on the brief for appellee.

The opinion of the court was delivered by

LOCKETT, J.:

Petitioner Mary Brand filed a motion to modify child support, claiming that respondent Michael Brand's distributions from several Subchapter S corporations in which he was a minority stockholder should be included as income for purposes of calculating child support. The district court determined that the distributions were not income received as defined in the Kansas Child Support Guidelines. Petitioner appeals.

On November 19, 1996, a decree of divorce was granted to petitioner, and respondent. Spousal maintenance of $1,200 per month was awarded until January 1, 2000. The parties were granted joint custody over their three children and petitioner was granted primary residential custody of the two youngest children. Respondent was ordered to pay $800 per month in support and maintenance for the children. As a part of the property division, respondent was awarded the interest in a corporation owned by members of respondent's family, Brand Plumbing, Inc. (Brand Plumbing). Respondent was also granted the interest in several other Subchapter S corporations, including B&E Investments, BBBR Corporation (BBBR), and 3 A.H., Inc. After the divorce, respondent also had ownership interest in Wichita West Development, Inc., a Subchapter S Corporation, and Quail Crossing, L.L.C.

Child support was based on respondent's salary from Brand Plumbing. No self-employment income or distributions from the Subchapter S corporations were included in the income computation for support.

In April 1997, the oldest child resumed living with petitioner. Child support was increased to $1,232 per month until the oldest child's graduation from high school, when support would reduce to $1,155 per month.

In 1998, Brand Plumbing converted to Subchapter S status, and the taxes due on income of the corporation were then "passed through" to respondent as a shareholder responsible for paying the taxes. Respondent could not elect to take distributions of corporate assets independently and the shareholders did not always make distributions in the amount respondent requested. Respondent received a distribution from Brand Plumbing in 1999 for $42,350 to pay his share of the 1998 and a portion of his share of the 1999 income taxes owed on the corporate income. The amount of the distribution was based upon an accountant's recommendation to the shareholders and a decision by respondent and the other shareholders, respondent's brothers. In 2000, Brand Plumbing distributed $39,500 for respondent to pay 1999 taxes.

Not all the income from Brand Plumbing was distributed in any given year. Sufficient operating capital was retained so that the corporation could continue to purchase material, purchase vehicles, and finance a possible relocation. Brand Plumbing had assets of $458,000 in 1998, $469,000 in 1999, and $409,000 in 2000. The corporation had historically retained such amounts. Since becoming a Subchapter S corporation, Brand Plumbing had not made distributions in excess of the amount necessary to reimburse its shareholders, including the respondent, for their share of the corporation's tax liability.

In 1999, respondent sold approximately 10 percent of his stock in Brand Plumbing to pay petitioner the final installment payment under the divorce property division settlement. Petitioner did not assert the value of that sale should be included in calculating support because it was a sale of an asset that was awarded to the respondent in the divorce.

Respondent held a 25 percent ownership interest in BBBR. Respondent's brothers owned the other shares. Capital gains taxes were paid in 1999 as a result of BBBR's sale of a tract of land. No distributions were made by the corporation to its shareholders.

Respondent and his brothers owned minority interests in the other entities and were considered passive investors. Two friends of the respondent owned the majority interests. Respondent routinely received a distribution from these entities equal to the amount of his tax obligation on the business' income. Income was reinvested in each of the businesses and applied to reduce the debt held by each entity. Reducing the debt increased "the interest" of the interest holders.

During the marriage, respondent received no distribution in excess of his tax obligations from any of the entities that would have been available to share with his wife and children. After the marriage, he had also received no distributions in excess of his share of entities' tax obligations.

In 1999, respondent reported income on his Schedule K-1 of approximately $200,000 and received approximately $70,000 in distributions. We note respondent reported no income or received no distributions as a result of his interest in Quail Crossing, L.L.C., thus, income and distributions were only as a result of his interest in Subchapter S Corporations. The majority owners of the entities did not expect future distribution amounts to be more than the amount needed by each individual to cover his or her share of the business' taxes.

After her spousal maintenance terminated, petitioner filed a motion to increase child support to $3,300 per month. At that time, respondent's salary from Brand Plumbing was between $4,500 and $5,300 per month after taxes. The $3,300 child support amount requested by petitioner was equal to 60 to 65 percent of respondent's net income.

On September 13, 2000, the district court heard the motion to increase child support. The district judge determined that respondent's income as reported on his tax returns was not income "received" under Kansas Child Support Guidelines, because: (1) the income was not the taxpayer's income but corporate income; (2) the shareholder could have elected to pay taxes at the corporate level; (3) the income had not been historically considered by these parties in child support calculations; (4) the issue was raised after spousal maintenance ended; (5) some income was the result of a sale of corporate assets; and (6) the funds would not have been available to the parties for support when the family was intact prior to divorce. The district court then set child support at $1,414 per month based on respondent's salary from Brand Plumbing. A timely notice of appeal was filed. This court has jurisdiction over the appeal pursuant to K.S.A. 20-3018(c).

We note that the district court's finding that the shareholder could elect to pay taxes at the corporate level was erroneous. Although it is true that a corporation elects Subchapter S status, thereby passing through taxable income to the shareholders and avoiding duplicate taxation at the corporate level, such an election, once made, does not allow the shareholder to opt to have the earnings taxed at the corporate level from time to time. However, this finding is not important to our decision.

Standard of Review.

Interpretation of the child support guidelines is a question of law. In re Marriage of Burton, 29 Kan. App.2d 449, 28 P.3d 427, 430 (2001). However, review of an order setting child support is limited to determining whether there is substantial competent evidence to support the trial court's findings. See In re Marriage of Hendrick, 21 Kan. App.2d 964, 968, 911 P.2d 192 (1996). "Substantial evidence is evidence which possesses both relevance and substance so as to form a basis of fact from which the issues can be reasonably resolved." Dalmasso v. Dalmasso, 269 Kan. 752, 758, 9 P.3d 551 (2000).

Taxation and Income of Subshapter S Corporations.

The tax treatment of corporate distributions is controlled by state law. K.S.A. 79-32,139, which governs taxation of Subchapter S corporate income, states:

"A corporation having an election in effect under subchapter S of the internal revenue code shall not be subject to the Kansas income tax on corporations, and the shareholders of such corporation shall include in their taxable incomes their proportionate part of such corporation's federal taxable income, subject to the modifications as set forth in K.S.A. 79-32,117, and amendments thereto, in the same manner and to the same extent as provided by the internal revenue code." Although a Subchapter S corporation may distribute income, it is not required to do so. Thomas v. Thomas, 738 S.W.2d 342, 344 (Tex. App. 1987). Earnings are owned by the corporation, not by the shareholders. 738 S.W.2d at 344. Subchapter S corporations may accumulate profits, referred to as "retained earnings." Retained earnings are the net sum of a corporation's yearly profits and losses. See Rohrer v. Rohrer, 715 A.2d 463, 464 n.2 (Pa. Super. 1998).

Subchapter S status provides an alternate method of taxing a corporation's income. Thomas, 738 S.W.2d at 344. In a Subchapter S corporation, income tax is paid by the shareholders rather than by the corporation itself. Greely Gas Co. v. Kansas Corporation Commission, 15 Kan. App.2d 285, 286, 807 P.2d 167 (1991) (citing 26 U.S.C. §§ 1361-78 [1988]). When the tax is paid by the individual, the corporation avoids income tax liability. Thomas, 738 S.W.2d at 344 (citing 26 U.S.C. § 1371 et seq. [1982]).

A Subchapter S corporation allocates various items of income to shareholders based upon the shareholder's proportionate ownership of stock. Rohrer, 715 A.2d at 464 n.2 (citing, e.g., 26 U.S.C. 163[d][5][A]). Allocations are itemized on an individual shareholder's Schedule K-1. See Miller v. Director, Div. of Taxation, 19 N.J. Tax 522, 528 (2001).

Petitione...