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The most common type of agreement in a divorce case is a post-nuptial agreement, frequently referred to as a Marital Settlement Agreement (“MSA”) or a property settlement agreement (“PSA”). Such agreements are entered into when the parties have reached an overall comprehensive agreement and frequently include custody and child support terms as well. MSA’s are intended to evidence the terms of the parties agreements on distribution of property, use or sale of the marital residence, the filing of future tax returns, the disposition of past tax refunds, alimony or interim support, how and when pensions will be divided, and any number of other issues that may have arisen in the course of the divorce proceedings.
As in other settlement type agreements (such as prenups and midnups) these agreements require clarity in drafting and full and fair disclosure.
Prenuptial Agreements are intended to alter what would happen in the event of a divorce or a death in absence of the agreement. In other words, without an agreement if a couple divorces they each have their respective rights under the Divorce Code or, if one of them dies, under the Probate Estates and Fiduciaries Code.
A prenuptial agreement can alter those rights and provide a completely different distribution scheme. Such an agreement can eliminate the right of an opposing spouse to seek spousal support, APL or alimony, in fact it can waive all rights under the Divorce Code. Alternatively such an agreement might be used solely to protect a family business that one spouse is likely to inherit or be gifted from claims of the other spouse, but not dealing with any other asset or issue. One is limited only by one’s imagination as to what can be accomplished with a prenuptial agreement.
Post-separation attacks on prenuptial agreements in Pennsylvania are less likely to succeed than in just about any other state because Pennsylvania does not have requirements such as fairness at the time the agreement was entered or fairness at the time the agreement goes into effect, or the requirement that the dependent spouse have representation of an attorney, as many other states do.
In order to be enforceable in Pennsylvania a prenuptial agreement must meet two tests: (1) it must be clearly and specifically drafted i.e., not confusing or ambiguous as to intent; and (2) there must be full and fair financial disclosure which is generally interpreted quite comprehensively i.e., disclosure of income, assets, liabilities and expectancies. In order to prove that such disclosure was provided, prenuptial agreements usually attach the disclosure documents (tax returns, financial statements, etc.) to the prenuptial agreement and reference the financial disclosures specifically in the agreement. Meeting both tests requires very careful attention.
Pennsylvania is referred to as an “equitable distribution” jurisdiction as opposed to a “community property” jurisdiction. Most community property states are west of the Mississippi, California being the most notable. Equitable distribution does not mean equal distribution but rather it means a fair distribution of marital property which requires the court to consider fourteen (14) statutory factors in determining how to divide marital property. These factors include the length of the marriage, the health of the parties, the income and income capacity of the parties including access to perks such as retirement benefits, health insurance, etc., whether or not there are minor children, etc., etc. Marital fault however is not a consideration in the distribution of marital property. Because Pennsylvania allows a divorce on “no-fault grounds” fault is specifically excluded as a factor on which the courts can consider in determining how to divide marital property. (Note however that fault is a relevant factor in determining post-divorce alimony. Pennsylvania law recognizes two categories of property: marital property and separate property. Marital property is subject to being equitably distributed in a divorce case; separate property is not.
Identification of Marital Property
There are basically three steps in the equitable distribution process. The first is to identify the property as marital property. Is it really marital, is it instead separate property, or perhaps it is even property of someone else. Generally speaking all property acquired during the course of the marriage, regardless who “owns” the property is considered marital property (however there are a number of exceptions). So, for example, if a couple buys a house during the marriage even if it is titled only in the Wife’s name, it will be generally considered marital property. A Husband’s pension, even though only in his name, if earned during the course of the marriage, is marital property. The cash surrender value of life insurance acquired during the marriage, even though only in one party’s name, is marital property. On the other hand property inherited by one party, property owned by one party at the time of marriage (and still owned only in that party’s name) are categories of separate property (except for the increase in value during marriage which is marital property) and the separate property component belongs to the owner and cannot be equitably divided or shared with the non-earning spouse.
Valuation of Marital Property
Once the marital property is identified, it must be valued. In most cases the identity of the property is fairly easy but the valuation of the property can present a host of problems. Some types of property are very easy to value, for example a marital bank account. If you look at the amount in the account on the date of valuation, that’s the value. Frequently the parties will agree on the value of assets; the marital residence for example (unless a particularly unique type of dwelling) is not a complex asset to value. If the parties can’t agree on the value real estate appraisers can be employed at relatively low costs to assist the parties in determining value. If they still can’t agree, the experts can testify at the hearing and the court will determine the value. Businesses can present greater problems. What is the fair market value of the ABC Widget Company? In other words, what would a willing buyer pay for a widget company in a hypothetical situation where the owner was a willing seller? Here, the earning spouse may say that no one knows this business as well as I do, nobody is going to pay more than “X” dollars for this business and I am not willing to value it for more than that amount. On the other hand, the non-owning spouse may say that my expert thinks that my spouse’s business is a gold mine, readily saleable, and is worth 4 times “X”. If agreement cannot be reached on the value of the business the litigation to determine the value can be complex, lengthy, and quite expensive.
Some businesses involve elements of personal services; professional practices (lawyers, accountants, doctors, etc.) are prime examples. Businesses frequently have a component of the value identified as “good will.” If the “good will” is dependent upon the personal reputation and personal skill of one of the parties (the Husband or the Wife) that type of good will is referred to as personal good will and is not divisible in a divorce case. On the other hand, institutional good will, or traditional business good will, is an asset which is very much divisible between the parties. There are a host of issues that must be considered in valuing businesses.
Other Issues
The law also requires the court to consider the tax implications and costs of sale in valuing marital assets. By way of simple example, $100,000 in cash sitting in a bank account is not the same as a house that is worth $100,000. In order to realize the value of the house it must be sold and a real estate commission of (for example) 6% and a 1% transfer tax will have to be paid. In some circumstances there might be a capital gain tax (although this is rare for a marital residence). Thus, even if only considering the cost of sale, right away the house is only worth $93,000. In valuing businesses one must also consider the costs of sale, potential tax consequences, and other possible discounts such as a marketability discount (how long would the business have to stay on the market before it could be sold) and minority discounts (Wife only owns 1/3 of the ABC Widget Company and therefore any willing buyer is going to demand a discount for her 1/3 ownership because she does not have control of the business).
Distribution
The third step in equitable distribution after identifying the asset and valuing the asset is the actual distribution of the asset of itself. This is when the various factors come into play. Should the asset be divided 50/50 or should the Wife get 60% of the value of the assets and the Husband 40%. The law does not require that all assets be sold and converted into cash in order to be divided. For example, in a simple case, assume that there is a marital residence that has a marital value of $100,000 and the Husband’s pension that has a marital value of $200,000. Assume further that the court has determined that a fair (“or equitable”) means of distributing all of the assets would require the Wife to get 55% of the assets or $165,000. The court will not require the house to be sold in order to create cash but rather award the house to Wife along with $65,000 from the Husband’s pension leaving the Husband with $135,000 of his pension or 45% of the estate. Nor does the law require that all assets be distributed in the same percentage. For example, a court could distribute all the bank accounts 50/50 but distribute a different asset (or group of assets) 60% to one party and 40% to the other.
In Pennsylvania, child support is determined by the Child Support Guidelines established by the Pennsylvania Supreme Court. Federal law requires each state to adopt guidelines to be uniformally applied throughout the state. Pennsylvania’s guidelines are based upon the net incomes of the parties. While there are limited circumstances under which the courts can deviate from the guideline amounts, from a practical standpoint, the guidelines are pretty rigidly applied. Thus, once the net incomes of the parties are known, an attorney can generally get a reasonably accurate handle on what the courts would award as child support. The difficulty in this area, if there is any, is determining the net income. What most people think of as their “take home” pay is not what the support law uses for net income. Deductions from gross income to reach net income are limited to actual taxes owed on the income (not necessarily what one has withheld from each pay check) necessary and legitimate business expenses (generally applicable when dealing with a business owner rather than a salaried employee) and mandatory pension contributions (many government pensions are mandatory, virtually all private pensions are voluntary and therefore not deductible from gross income). While it is generally fairly easy to determine net income for a salaried employee, even highly paid individuals, it can sometimes be quite complex to determine the net income of a business owner. All types of income are considered including interest, dividends, rental income, lottery winnings, etc.
Once net income is determined, it is a relatively straightforward matter of plugging mother’s and father’s incomes into the guideline formula and determining the basic child support award for the number of children involved.
Until recently there was a means of checks and balances in determining child support in very high income situations (when the net incomes of the parties exceed a combined total of $30,000 per month). Recent changes in the support guidelines are now intended to apply to all income levels even if the actual needs of the child are far less than the guideline amount.
To some extent, the amount of child support is dependent upon the amount of the custody time that the payor parent enjoys with the children. If that parent has more than 40% custody, child support will be reduced on a sliding scale up until the obligor has equal 50/50 custody time. Sometimes this reductions can be substantial. A common misconception is that parties who share custody equally do not owe any child support. This is true only when the parties share custody equally and the parties net incomes are also fairly equal. Otherwise, the higher earning spouse will pay child support to the lesser earning spouse, albeit at a somewhat reduced level because of the adjustment for having custody more than 40% of the time. In determining the amount of custody a parent has, Pennsylvania law counts overnights only .
For tax treatment of child support see the article on Taxability of Support Orders.
The tax treatment of support orders depends upon the type of support being paid. Generally, child support orders are tax free to the recipient parent and non-deductible to the payor parent. On the other hand, payments for the support of the other parent (which can be spousal support, alimony pendente lite (APL for short) and post-divorce alimony) are fully taxable to the recipient and fully deductible to the payor. The tax treatment of payments to a spouse, particularly post-divorce alimony payments is a very complex area which deals not only with Pennsylvania support law but with federal income tax law. One should always consult competent counsel for advice when considering the deductibility of any support payments.
However, Pennsylvania Support Guidelines do recognize one of the important provisions of the federal income tax code that permits payments which would otherwise be non-deductible child support to be deductible to the payor and taxable to the recipient when those payments are combined with support payments for the spouse (such as spousal support or APL) and those payments are not specifically “allocated” to either child support or spousal support. While the amounts of child support and spousal support are determined independently under Pennsylvania Support Guidelines, the ultimate award is the total of those two amounts. When that total is “unallocated” it is deemed to be family support under the Internal Revenue Code and therefore completely deductible to the payor and fully taxable to the recipient. Pennsylvania Support Guidelines presume that such orders are unallocated and therefore fully deductible to the payor and fully taxable to the recipient. If your marginal tax bracket approaches 35%, the ability to deduct otherwise non-deductible child support payments, which can easily be several thousands of dollars per month in higher income cases, can be quite important. Again, this is a complex area of law and there are a variety of other tests and circumstances which must be considered in determining the ultimate tax treatment and readers are advised to obtain the advice of competent counsel.
The Pennsylvania Divorce Code specifically recognizes agreements entered into “before, during and after” the marriage. A mid-nuptial agreement is entered during the marriage but is otherwise similar in effect to a prenuptial agreement. Because a mid-nuptial agreement is entered after the marriage occurred, it technically is and is sometimes referred to as, a post-nuptial agreement. Generally speaking however a post-nuptial agreement is thought of as a final settlement agreement and is often referred to as a marital settlement agreement or a property settlement agreement.
Mid-nuptial agreements are not anywhere near as common as prenups or postnups. Sometimes they are entered because a parent is intending to make a large gift, perhaps in the context of estate planning, to the Husband or Wife, such as an interest in a business or a piece of real estate, and there is a desire to keep that asset “in the family.” In this limited type of agreement a spouse will be asked to give up all rights in that particular asset but will not be asked to give up rights in any other marital assets such as rights to alimony or equitable distribution of other assets, etc.
The other circumstance that gives rise to consideration of a mid-nuptial agreement is when a couple may be having marital difficulties but neither party has decided to proceed with the divorce and both parties want to try and make efforts to save the marriage. However, they don’t want to be emotionally burdened with might happen to their assets if they fail to reconcile and so they decide up front that in the event they subsequently break up (six weeks, six months or six years later) the agreement will set forth how the economic issues will be resolved. While one hopes that both parties enter into the negotiations for such an agreement in good faith, the private motivations of any individual can never be ascertained with certainty. Nevertheless, mid-nuptial agreements still require, for enforceability purposes, the same formality and tests as a prenuptial agreement i.e. clarity in drafting and full and fair financial disclosure. There is one additional requirement for an enforceable mid-nuptial agreement. While a prenuptial agreement does not require any extra consideration other than the occurrence of the marriage itself, a mid-nuptial agreement, being entered into after the marriage has already occurred, requires separate and real consideration to be given to the spouse who may be surrendering certain rights. A discussion of the type of consideration is beyond the scope of this blog.
Some people just want to live together without the benefit of marriage or would like to get married but can’t because of legal prohibitions such as Pennsylvania’s refusal to recognize same sex marriages. Such couples often have as sophisticated and complex financial interrelations as do many married couples.
Similar to a prenuptial agreement, a cohabitation agreement can set forth what will happen to jointly owned real estate, bank accounts, and other assets and can, in some instances, deal with issues of child custody and support whether the couple has had a child naturally or by adoption.
One thing no agreement can do, whether it be a cohabitation agreement, post-nup, mid-nup or a prenup, is eliminate or reduce a parent’s obligation to financially support a child or significantly alter a parent’s custodial rights. However, in some relationships such rights do not exist in the first instance, such as step-parents, some surrogacy situations, etc. One parent may be a natural or adoptive parent but the other half of the couple may have no otherwise legally cognizable rights.
A cohabitation agreement can at least establish the intentions of the parties and the desires of the parties in such situations at a time when the parties had an amicable relationship rather than first trying to establish what those intentions were, perhaps years ago, in the midst of a hostile dispute when there may be strong motives to deny original intentions.
The vast majority of disputes in any family law matter are settled by an agreement. This doesn’t mean there won’t be any litigation, but ultimately most issues in the majority of cases get resolved by an agreement, whether it be a custody agreement, a child support agreement, an agreement on the interim and exclusive use of the marital residence, an agreement for advance partial distribution of assets, or an overall comprehensive property settlement agreement (often referred to as a marital settlement agreement or a postnuptial agreement which generally encompasses many issues, all of which have been ultimately agreed upon and reduced to a written agreement).
Other types of agreements are entered into not because the alternative is litigation but in order to avoid future disagreements. The most well known of this type of agreement is a prenuptial agreement which is entered into before a marriage and is intended to set forth in advance how economic issues will be resolved in the event of a divorce or in the event of death of one of the parties. A midnuptial agreement is similar in many respects to a prenuptial agreement however it is entered during the marriage and can serve similar purposes to a prenuptial agreement. Finally, Pennsylvania recognizes cohabitation agreements which are entered into by couples who do not intend to get married or are prohibited by law from getting married (for example same sex couples) but who wish to establish their rights, for example in real estate they intend to purchase together or that one party intends to purchase for both of the parties to live in, in the event the couple later breaks up.
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