Tuesday, July 21, 2020

In re Marriage of Hein (Cal. Ct. App. - July 21, 2020)

You could indeed run a family law system like this.

I just don't know why you would.

The question is what you do with people who are self-employed (or own a business).  In particular, how one treats what the lingo calls "capital assets" -- which is just a fancy term for "the big stuff you buy that let's you do your work."

Let's say you're a professional blogger (so you need to buy a computer), or a driver for UPS (so you need to buy a brown truck).  Without these purchases, you can't make any money.  So you buy it, and start making coin as a result.

But let's say you get divorced.  We've got to figure out how much money you make in order to determine spousal and child support, etc.

The way we usually do that is to just look at your tax returns.  Because, not surprisingly, we've got a fairly sophisticated system when it comes to assessing out how much money people take in order to make sure the government gets its share.  So we largely use that same system in family law cases.

So, on the tax side, we let -- indeed, typically, force -- you to take what's called "depreciation" when you buy a capital asset like your computer or your truck, rather than let you deduct that expense when you incur it.  So, say, in 2018, you buy a $25,000 truck to commence your UPS work, and then use that truck make $25,000 in 2018 and every subsequent year.  As an economic matter, you didn't really "make" any money in 2018, since you spent $25,000 and made $25,000.  But we think that's (1) a bit deceptive, and (2) not the right way to calculate how much money's "available" to you.

So we don't say you made $0 in 2018 (but $25,000 in 2019 and $25,000 in 2020).  Instead, we have you "depreciate" the asset.  Say that we've decided that UPS trucks generally last 5 years; we then let you deduct one-fifth of your $25,000 purchase over each of those five years.  So we treat you as having made a whole $20,000 in 2018 ($25,000 minus $5,000) -- even though you were actually "even" (made $0) in that year in terms of available cash -- and then the same $20,000 in 2019 and 2020 (and the next two years), even though you actually made $25,000.  We're spreading out the deduction because it's more accurate.  After all, yes, in terms of cash, you only "made" $0 in 2018.  But at the end of the year, you also had a $25,000 truck.  Seems silly to say you got "nothing" from your income over that year.

Sorry for the quick, dirty, and somewhat simplistic description of depreciation for those of you already quite familiar with it.  But that's the concept.

So the question is:  Does the same thing make sense in family law court?

The Court of Appeal says:  "No."

Instead, it says that you can't take depreciation.  Since it doesn't accurately reflect the "money" you have available to pay support.  You're not actually "spending" the $5,000 in 2020 (in our example) that depreciation suggests.  So you have it available to pay your former spouse (and/or kids), so we're going to include it in your income.

Again:  You could do that.  It just wouldn't, in my view, make sense.

Because if you're going to ignore tax law (the deduction) in 2020, you've got to do the same thing in 2018.  So if the person in our example gets divorced, under the tax laws, we'll say she has $20,000 of income in 2018, 2019, and 2020, and (in my view) it makes sense to use those same numbers to figure out how much support (if any) she should pay.  She makes money and has a truck.  She's got all that to use to pay her spouse/children.

But the Court of Appeal says, no, you can't use depreciation.  So after today's opinion, she's definitely got $25,000 in "income" in 2019 and 2020 on which to figure support.

But, by the same principle, she also has $0 of income in 2018.  Because if you're not following tax laws for depreciation, you can't follow 'em for 2018 either.  If the Court of Appeal says (as it surely does) that we count the full $25,000 in 2020 because that's actual cash she's got available to pay -- and that that's the family law rule pursuant to statute -- then that same rule means that we've got to view her as having $0 in 2018, because in that year, she didn't have any money to pay support (since she made $25,000 but spent it all on the truck).

So under the Court of Appeal's rule, you should figure "income" of $0, $25,000, then $25,000. Whereas depreciation -- rationally -- smooths that out, and makes it $20,000 every year.  Which I find more accurate, less volatile (obviously), and a better way to determine support.  (Especially since volatility increases transaction cost as parties rush in year-over-year to modify support payments given the ostensible "change" in income.)

There's nothing that forces the Court of Appeal to hold the way it does.  There's a different Court of Appeal opinion that doesn't allow depreciation for real property.  But we could have a different rule for intangible business property like the one at issue here.  Or we could say that the other Court of Appeal opinion seems wrong and that we're not going to follow it.  Either option works.

Today's opinion at least has the value of a bright-line rule and consistency.  But it results in a system that's inefficient and burdensome, as well as not nearly as bright-line as the Court of Appeal might think:

(1) It will result, for sure, in self-employed (and business owners) paying more support in some years since we're now ignoring depreciation, but it will also result (at least if lawyers are smart) in people in such situations arguing (persuasively) that their tax returns similarly overstate their income for years in which they incurred capital expenses but we're allowed to deduct them (and used depreciation instead).  Indeed, for some taxpayers/family law earners, that'll result in them paying less support; for example, if they get divorced (and their support calculated) in a year in which they purchase capital assets, which they can't deduct on their tax returns but can "deduct" in family law court since we're now only looking at "available cash" to pay support.  Of course, the other side can then go to court the next year, when they're not a capital purchase, and argue that now they should get more support, but that just shows the point about transaction cost and uncertainty above.

(2) The Court of Appeal includes a caveat that says that even though you can't count "depreciation" a trial court might nonetheless be able to count it as a "special circumstance" that affects support.  But that's both under- and over-inclusive, and in some ways, is the worst of all possible worlds.  If what a trial court does is to say that capital assets are indeed special circumstances, so we'll go ahead and allow a deduction, great, but (a) we've now wasted time and money to get to the same place we'd have been initially if we'd just taken depreciation into account, and (b) maybe the amount that the trial court counts as "special" isn't the same way that tax law treats it, which isn't awesome, since I suspect the IRS is fairly more informed than a trial judge on, say, the relevant life of various capital assets and how it makes sense to value them over time.  By contrast, the Court of Appeal's general view about what we base support on ("available cash") suggests that trial courts might not find the purchase of a capital asset to be "special" in a given case, in which case we're back to the original problem of distorted support payments -- worse, even, since we've now spent transaction costs on litigating whether something's "special" or not.

So it seems to me that the right rule should just be to follow what the IRS does and allow the depreciation.  At least as the general rule, and directly contrary to what the Court of Appeal does here.

Don't get me wrong; I understand a little bit -- both economically and otherwise -- of where the Court of Appeal may be coming from here.  The "capital asset" that the spouse is depreciating here is an airplane, allegedly used "only for business."  The nature of that asset (a plane) and the fact that he buys flying lessons for his daughter suggests to me that, shock of shocks, this isn't just a business expense with no other purposes at all.  So I get why someone might be somewhat reluctant to say "Oh, you have a half-million dollar plane, so I get why we should use that to reduce the amount you have to pay your ex-wife."

But we can get at that problem by giving a trial court discretion to disallow depreciation (in whole or, probably more accurately, in part) in such "special" circumstances, rather than creating a general rule that depreciation isn't typically allowed.

So I too would create a rule.  It'd just be the opposite one to that followed by the Court of Appeal.