Til death or (or divorce) do you part

By Cheri G. David, CPA, CVA

“With this hug, I thee wed.”

Marriage is an emotional and financial investment for couples, often beginning with a sunny paradise and sometimes ending with an unplanned tsunami. Whether your clients are Katie Holmes, Paul McCartney or not famous at all, value-added proactive advice can help your clients negotiate the elements of both pre- and post-nuptial life-changing events.

The ‘three-way hug’

So what really is a “three-way hug?” Notwithstanding that there are both spiritual and sometimes not so spiritual bonds that bind couples, a three-way hug is the first two infinite hugs between the newly wed individuals, and the third is with the government. The government hug includes both federal and state jurisdictions. What this means is that if the happy couple becomes not so happy, then all of the acquired stuff during the marriage will be divided pursuant to state statutes.

State laws are further divided into equitable distribution and community property division states. The distinction between an equitable state, such as Virginia, likely does not really mean “equitable” or “fair.” Equitable just means that if the couples proceed with a divorce, then the courts have more liberties to split the assets differently than 50/50. In a community property state, such as California, courts are more inclined to essentially split assets and liabilities 50/50.

Understanding the federal and state implications of marriage can help you better advise your clients when they choose to enter into a marriage contract.

Baby boomers vs. millennials

Baby boomers are still divorcing at an increasing rate. According to May 30, 2017, article in MarketWatch, the divorce rate has doubled since 1990 among adults ages 50 and older. And for second timers the divorce rate is nearly 75 percent. The economics of divorce are generally pretty simple: It will significantly change the couple’s economic status. Then, add in layers of litigation and hurt feelings. Now you potentially have financial ruin for a once-happy, now no-so-happy couple.

Millennials, however, are paving a somewhat new path. They are just simply putting off marriage. It may be because of shaky finances, student loan debt, late career starts or a newer online dating culture. Whatever the reason, if millennials are waiting later in life to get married, they also have had more opportunities to acquire a few more things (house, retirement accounts) pre-marriage, contrasting with baby boomers, who acquires these things during the marriage. In the post-boomer divorce generation, a modern CPA will need to recognize these demographic changes to understand why premarital financial agreements should be standard along with premarital counseling.

Premarital counseling and the financial contract

CPAs can be proactive in reshaping the stigma associated with prenuptial agreements. After all, the soon-to-be-wed are surely not going to visit a lawyer first; they may, however, have a CPA they are willing to talk openly. As part of their premarital counseling, couples discuss how they want to raise kids, where they want to live and who walks the dog.  Those are all important, but with money issues as one of the top causes for divorce, financial discussions and agreements prior to marriage should also be a required step. Such discussions are critical and can positively impact the emotional and financial success of the couple. How the couple chooses and agrees to maintain their finances provides insight on how successfully they will navigate difficult situations.

Couples generally start off with the best of intentions, believing they can resolve everything through their undying “love” for one another. But statistics indicate that idea is true only about 50 percent of the time. Advance financial planning before the marriage may seem unromantic at the time – after all, couples do not enter into a marriage intending to be divorced. In this prenuptial period though, while the couple is still on the same side and negotiating money management, it is much easier to discuss financial agreements than after the fact or in court! A CPA is in a unique position to promote healthy discussions with the couple on the importance of coming to financial agreements, whether simple or complex, that may outlive the marriage. This can be a great value-added service to clients.

Prior to my personal journey in Virginia Supreme Court case David v. David 287 VA. 231 (2014) (more on that below), I would have stated that love is love and that is that. No way was I going to sign a contract for divorce (a premarital financial agreement or pre-nup) before getting married. Frankly, I was appalled at the idea. However, times have certainly changed. After my experiences in all four Virginia court systems (Juvenile, Circuit, Appellate and Supreme), I advise soon-to-be wed couples, young and old, to outline their financial goals and agreements before walking down the aisle.

Debunking the stigma

Remember the ‘three-way hug” – marriage in and of itself is a contract with each other as well as a legally binding contract with state laws. Prenuptial agreements are also legal contracts that can help bring couples closer to realizing their financial goals. Money issues rank among the top causes for divorce. CPAs an be of great counsel in offering sound advice and encouragement for the couple to outline their financial goals at a minimum. If the couple is willing to listen, share with them that prenuptial financial contracts are not just for the rich. A prenuptial agreement doesn’t need to be ugly, or written as a contract for divorce.

Defining the terms of the agreement can be a hallmark of building trust before the marriage. Couples should have open, honest discussions about how each person feels about spending, how they envision their financial future and how they view other financial matters. How many CPAs have seen couples have such different financial habits that they end up in absolute distrust of one another? Let your clients know that prenuptial agreements can be for all couples getting married and can be as simple or complex as the situation dictates. Prenuptial agreements could address some or all of the following issues:

• Will the couple maintain separate or joint accounts?
• Will household expenses be paid equally from each spouse’s earnings?
• Will both spouses work and contribute financially, or will one spouse stay home after having kids?
• Does one spouse have student debt or other debts? If so, are both spouses agreeing to take on the responsibility, or will the debt remain the responsibility of the debt-ridden spouse?
• How does the couple feel about taking on debt?
• Does either spouse have pending tax liabilities?
• Considerations of spousal support or alimony in the event of divorce.

Whether it’s the clients’ first, second or third marriage, CPAs should actively engage them in the discussion of prenuptial financial agreements – an invaluable piece of financial responsibility in the marriage.  

Separate, marital, hybrid (mine, yours and ours)

If the happy couple didn’t take your advice on having a prenuptial agreement, and the now not-so-happy-couple decides to divorce, they will quickly learn that if they don’t sort out their financial affairs, they are bound to split things up according to state law. State statutes will dictate equitable or non-equitable – and equitable may not mean fair or even 50/50.

The first order of business for the court is to determine whether the assets are titled jointly or separately. The second is to determine what is separately owned (property owned before marriage and titled to one spouse) and what is marital owned (property acquired during the marriage generally titled in both spouse’s names). Sounds simple, doesn’t it? Not so fast. There is also hybrid property – that which is part separate and part marital property. Normally this would happen if a spouse owned property before the marriage, then sometime during the marriage, either spouse worked to increase the value of that property.

A simplified example of hybrid property is a rental house owned prior to marriage. If both spouses put in effort to maintain the property, refinance it, add on, etc., then the court may consider whether or not those efforts equated to an increase in the value of property.

Burden of proof

Va. Code 20-107.3(A)(3) is the guideline statue in Virginia that outlines how Virginia courts define martial, separate and hybrid property. The court’s decision in the David case reiterated that personal effort by either spouse is “any” effort by either party. Translation for CPAs is that the effort does not have to be non-passive or include material participation to be considered personal effort by the courts.

In David, at issue was a separate stock account owned by the husband prior to marriage (separate property). The husband, a financial advisor of 25 years, told the court he was not a day trader but a long-term investor. During the eight-year marriage, he made a total of 35 trades and the account grew considerably from $200,000 to nearly $900,000. The wife testified that the account’s growth was due to his investment strategies and years of knowledge as a financial advisor. The court determined that decisions of whether to buy, sell or hold are, by nature, a personal effort. According to Va. Code 20-107.3(A)(3), after the wife proved the increase and demonstrated it was due to personal effort, it was up to the husband to prove that it was not due to his effort.

While stock investing is a passive activity, the courts found that husband’s efforts during the marriage caused the increase. The wife did not have access to the account, nor did wife initiative trades on the account; all of her activities were passive. In David, however, the courts determined that husband did not meet his burden to disprove that his efforts did not cause the increase, and therefore the court awarded wife half the value of the increase.

Years ago, CPAs and lawyers would advise their clients to merely keep the assets solely titled in the owning spouse’s name to protect the premarital asset. But the David verdict shows that advice would now be flawed. One of the best things for a CPA to do is advise clients to have a prenuptial agreement not only outlining the simple agreement about how they will handle their finances but, at minimum, what the value of separate assets were prior to marriage. If the couple is willing to go the extra mile, they would be doing themselves a favor by also adding into that agreement how any increase in value would be shared.

Post-nuptial considerations

If premarital financial agreements were not made, there is always the post-nuptial agreement option. If the couple later realizes that it would have been a good idea to engage in premarital financial agreement, they have the option of entering into a post-nuptial agreement. It is likely safe to say that if a couple is just beginning to get to this place after the marital union, there may be trouble in paradise. Courts are familiar with the types of situations that cause a couple to enter into post-nuptial agreements. In these instances, the courts will determine if there is duress or fraud at play; as a result, the post-nuptial financial agreement can be disregarded.

It is strongly recommended that if your client is entering into this type of arrangement, they consult a lawyer.

CPA advice for the modern marriage

CPAs who advocate for prenuptial financial agreements are not giving legal advice. Rather, they recognize financial literacy is a part of a sound financial plan for the modern marriage. Offering this is a value-added service to help clients navigate potential financial issues that lie ahead in a marriage, and, sometimes, divorce. While no one entering into a marital union starts off thinking it will end, a well-advised client has the opportunity to be educated by their most trust advisor. Hopefully that advice will be a positive foundation of financial trust with each other from this day forward and into infinity.

Cheri G. David, CPA, CVA, has nearly 20 years of experience in tax, financial and small business consulting. She is an owner and managing partner at Clarkson David, CPA, and is also a partner at Valuation One, LLC, a firm specializing in expert witness testimony and divorce litigation matters. She is a member of the Disclosures Editorial Task Force.