California is a community property state. All property acquired and income earned during marriage is community property. All property acquired prior to marriage or by way of gift or inheritance is separate property. In California, husbands and wives, and domestic partners as of January 2005, each own a one-half interest in all of the community property assets giving them the privilege to share in the management and control of the property. They are equally responsible for the community property debts and liabilities. When parties divorce, courts divide community property and debts equally between the parties.
Sometimes complications arise as to the character of property. That is to say that property that started off in the marriage as separate property may have been partially transformed into community property. For example, Henry purchased a house just a few months prior to his marriage to Whitney. Henry’s house was considered his separate property because it was acquired before his marriage to Whitney. However, Henry had a mortgage on the house. After his marriage to Whitney, he used community property assets, namely his income from his job, to make mortgage payments. Although the house is considered his separate property, the community has an interest in the house in relation to the payments that were made using Henry’s income from his job which is considered community property.
If an owner of separate property wants to remain the separate owner of that property for divorce purposes, then he/she must keep that separate property apart from the community property. When separate property is not kept apart from community property, then separate property can become commingled with community property. The courts may treat the property as belonging to the community.
When separate property is commingled with community property, the person alleging that a piece of property is separate must show that the property is separate or that the property is derived from separate property assets. Proof to establish that a piece of property is separate requires a tracing of property to show its separate property source. Tracing is a mechanism to allow the owner of separate property to show that a certain piece of property is in fact separate property and not community property.
For example, Whitney had a bank account with $10,000 prior to her marriage to Henry. After their marriage, Whitney continued to deposit her check into her bank account. Whitney wrote checks in the amount of $5,000 from that account to purchase household furniture. When Whitney and Henry file for divorce, Whitney assumes that the furniture is her separate property as it came from her separate bank account. Henry assumes that the furniture belongs to the community because some of the money in her bank account was from Whitney’s income and income earned during the marriage is community property. In order for Whitney to establish that the furniture is in fact separate property, Whitney must trace the source of the funds used to purchase the furniture to her separate property. The problem for her is that her separate property bank account was commingled with community property funds, her income from work. However, the court has stated that if Whitney can show that separate property funds were available at the time the furniture was purchased, then she may claim that the furniture is her separate property.
Quasi-community property acquired during the marriage located in a state that does not recognize community property may. In that case, California courts will treat such out of state property as community property and label it quasi-community property. For example, Henry and Whitney use community property funds to purchase a condo in New York, a non community property state. Although New York is not a community property state, California will treat the condo as if it is community property.
If the business has been formed during the marriage, then it is community property. However, if it was originally created prior to marriage and continued on during marriage, then the community has an interest in the business.
Some assets found in a business are tangible items such as office furniture, computers, machines, etc. Other business assets are intangible such as copyrights, trademarks, trade secrets, and goodwill.
Goodwill is the value that a business has in retaining and attracting business customers due to the reputation of a person. For instance, Whitney is a lawyer in a solo practice. Clients go to her practice because she has a great reputation. Henry will want to value her business not just based on her tangible assets, but on her intangible assets as well, such as her goodwill or ability to attract clients based on her reputation.
Intangible assets are difficult to value. Normally, business appraisers or evaluators are employed to determine the value of a business and its assets.
Pension or retirement plans are a form of ‘earned income’ for past services rendered. For that reason, such plans are treated as community property. Generally, the community’s interest in the plan is based on the length of marriage.
Courts have a couple of ways to divide the interest in a pension plan. Courts may make a cash-out distribution or they may order an in-kind division of the pension plan to the non-employee spouse. In a cash-out distribution, courts allow the employee spouse to keep the entire pension/retirement plan interest and award the non-employee spouse an offsetting community property award equivalent to the community property interest of the non-employee spouse. When an in-kind distribution is made, the non-employee spouse receives payment once the employee spouse retires and begins drawing from the pension/retirement plan. In an in-kind distribution situation, courts maintain jurisdiction of the plan to see that the non-employee spouse receives money owed
There are two basic types of pension/retirement plans: one is a defined contribution plan and the other is a defined benefit plan.
A defined contribution plan is created in a way that each participant has a separate account. Normally, a participant’s benefits in the plan are based on the amount of money he or she contributed to the account. An example of a defined contribution plan is a 401 (k) plan. Courts almost always divide these accounts at dissolution of marriage (divorce) and issue a cash-out distribution because they are easy to value. One way to value this type of account is to simply call the bank and ask for a particular account’s value.
A defined benefit plan is an employer funded plan. Complicated methods are used to determine the expected benefits one may receive at retirement. Due to the complexities of determining the expected benefits at retirement and determine the community property of the expected benefit, courts generally make an in-kind distribution and reserve jurisdiction. This means that the court uses evidence from actuarial accounts to assess the present interest of the community property in the defined benefit plan and gives the non-employee spouse half of the interest of the community property. The non-employee spouse receives disbursement checks once the employee spouse retires and receives such checks. The court reserves jurisdiction to ensure that the non-employee spouse receives the money owed from the defined benefit plan.
Sometimes the employee spouse’s interested in the retirement plan has vested, yet the employee spouse does not want to retire. In this case, the court will enable the non-employee spouse to make a ‘Gillmore Election.’ If this election is made, the court may establish the community interest as if payments had been made to the employee spouse, and order the half that amount to the non-employee spouse. This can be a tricky election as it may affect the non-employee spousal support amount.
The federal government established the Employee Retirement Income Security Act of 1974 (ERISA) with the intent to protect pension plans. ERISA has two prohibition clauses; the anti-alienation clause and the anti-assignment clause, to prevent the transfer of interests in a plan that normally would be transferred under state community property laws. Federal law preempts state law and so state community property laws must abide by the federal laws that are in effect. Nevertheless, the use of a qualified domestic relations order (QDRO) is an exception to the ERISA prohibition. A QDRO is a document that protects the alternative payee spouse, the non-employee spouse. Use of a QDRO enables the state court to distribute spousal interests in retirement benefits by allowing the employee spouse to keep his or her retirement plan and gives the non-employee spouse his or her proper portion of those benefits.
There are many other community property and separate property issues that have not been addressed in this section.