§ 3.02 PARTICULAR ASSETS

• Jurisdiction: Washington

§ 3.02 PARTICULAR ASSETS

Characterization issues arise when the courts must determine whether a particular item of property is community or separate property. This section discusses the characterization of a wide range of property types—real and personal, tangible and intangible, vested and contingent, and others.

[1] Earnings

A spouse's earnings arising from services performed during marriage are community property. Nothing could be more basic to the community property system: earnings during marriage are generally understood to be the quintessential form of community property. The Washington Supreme Court has stated two reasons for this general rule. First, it is the duty of each spouse to contribute his or her industry, energy, and intelligence to the marriage, so that each spouse's employment efforts generate community assets. And second, earnings are neither a gift, devise, or bequest and therefore fall into the residual category of community property. RCW 26.16.030; Abbott v. Wetherby, 6 Wash. 507, 33 P. 1070 (1893). The rule reflects the preference for community property.

Employment benefits represent accumulated earnings and are characterized by marital status when accumulated. Vested accumulated sick leave benefits were held to contain elements of both deferred compensation and future earnings replacement in In re Marriage of Nuss, 65 Wn. App. 334, 343-44, 828 P.2d 627 (1992). The deferred compensation benefit element constitutes an asset subject to distribution at marriage dissolution. The value must be reduced to adjust for income and Social Security taxes. Sheffer v. Sheffer, 60 Wn. App. 51, 802 P.2d 817 (1990). Likewise, accumulated vacation pay must be valued, adjusted, and distributed as community property. Hurd v. Hurd, 69 Wn. App. 38, 848 P.2d 185, review denied, 122 Wn.2d 1020 (1993), overruled in part on other grounds in In re Estate of Borghi, 167 Wn.2d 480, 219 P.3d 932 (2009). Similarly, bonuses should be characterized based on the time period during which they were earned. In re Marriage of Griswold, 112 Wn. App. 333, 48 P.3d 1018 (2002), review denied, 148 Wn.2d 1023 (2003).

These rules may conflict when a spouse's services are performed for a business in which the spouse owned a separate property interest prior to marriage. In both incorporated and unincorporated businesses owned as separate property, the problem the courts face is the reconciliation of the statutory mandate that the rents, issues, and profits of separate property are separate property with the equally strong rule that earnings from a spouse's labor are community property.

An increase in the value of the business occurring after marriage may be either community or separate property, depending upon whether the source of the increase is deemed to arise from a spouse's services or from rents, issues, and profits from the assets of the separate business. The problems are discussed further in § 3.03, below.

The rule that earnings are community property may be overcome upon showing a gift by the other spouse or that the spouses agreed to make a spouse's earnings separate property. The court found an agreement to give the wife's personal earnings to her as her separate property in Yake v. Pugh, 13 Wash. 78, 42 P. 528 (1895). An action was brought by community creditors, and the court found that the money in question had been received by the wife from boarders and for her work done as a dressmaker. Before she agreed to work, her husband had promised her that if she worked her earnings would be her separate property, had made statements about the agreement to others, and had paid his wife for his own board. The court held that the agreement operated as a gift to the wife of her earnings as separate property.

Merely depositing a spouse's earnings into a separate bank account is insufficient to establish that the earnings have been transformed from community into separate property. In Plath v. Mullins, 87 Wash. 403, the wife had earned money operating a restaurant when the husband was out of the country. She had placed the money in a separate account. The administrator of the husband's estate brought an action to establish an equitable interest for the benefit of creditors in land purchased from those earnings and that account. The court held that there was no gift and concluded that the evidence was not sufficiently clear and convincing to rebut the community property presumption. In Jones v. Duke, 151 Wash. 108, a car was purchased with money from the wife's bank account and title was held in her name. The car purchased was held to be community property. The car was used as a family car and the cost of its operation was paid by the community funds.

Earnings of the spouses while living separate and apart are separate property. RCW 2.16.140; Togliatti v. Robertson, 29 Wn.2d 844, 190 P.2d 575 (1948); In re Marriage of Griswold, 112 Wn. App. 333. The court in Rustad v. Rustad, 61 Wn.2d 176, 377 P.2d 414 (1963), held that a mere physical separation will not make a spouse's earnings separate property. There must be a more permanent separation. Moreover, there must be a recognition by both spouses that the marriage is over for the statute to apply. Seizer v. Sessions, 132 Wn.2d 642, 659, 940 P.2d 261 (1997); In re Marriage of Short, 125 Wn.2d 865, 871, 890 P.2d 12 (1995). Acquisitions while living separate and apart are discussed more fully in § 3.03[3], below. See also Harry M. Cross, The Community Property Law in Washington (Revised 1985), 61 WASH. L. REV. 13, 23-35 (1986).

Compensation paid a spouse for services rendered prior to the marriage is the separate property of that spouse. RCW 26.16.010, .020. Thus, property purchased during marriage with such premarital earnings is separate property. Merrick v. Appenzeller, 115 Wash. 181, 196 P. 629 (1921). An award for loss of future earnings that would have been earned after death of the other spouse is separate property. Vail v. Toftness, 51 Wn. App. 318, 753 P.2d 553 (1988). Severance pay is not deferred compensation but is, instead, intended to soften the blow of dismissal. Accordingly, it is to be characterized on a replacement theory. If it was received prior to dissolution of the marriage and it was intended to soften the blow on a spouse while married, it would be community property. See In re Marriage of Bishop, 46 Wn. App. 198, 729 P.2d 647 (1986). But if and to the extent that the pay was intended to soften the economic impact of dismissal after dissolution, it is the dismissed spouse's separate property. Id.

Occasionally, a person may be compensated for not working. This is the situation when a person is paid in return for a promise not to compete. If the compensation received for such a promise is intended to replace potential community earnings, then the community should have some legal interest in it. In In re Marriage of Gillespie, 89 Wn. App. 390, 948 P.2d 1338 (1997), the Court of Appeals held that $80,000 paid for such a noncompete covenant was the separate property of the spouse making the covenant, reasoning that the promise not to compete did not in fact impact the covenanter's earnings during the subsequent marriage. Indeed, he earned more in an alternative occupation than he had in the occupation in which he was not allowed to compete. The court left for another day how such a covenant should be characterized if it did impact marital earnings.

The treatment of partially earned contingent fees had not been considered in Washington until the decision in In re Marriage of Estes, 84 Wn. App. 586, 929 P.2d 500 (1997). In Estes, the trial court, citing the difficulty of valuation, valued the lawyer husband's contingency fee cases at zero and awarded them to him. The Court of Appeals reversed, stating that the difficulty of valuing the fees could be resolved by awarding them to both husband and wife:

The proceeds of any contingency fee agreements obtained during the marriage in the conduct of the community's business should be awarded to both parties and divided between them, when received, "based upon the percentage of the number of hours worked during the marriage bears to the total number of hours worked in earning the fee"

Id. at 592 (citations omitted). The court concluded that this was the approach taken by most courts that had considered the matter. Interestingly, the court concluded that the division of contingent fees on an "as received" basis did not run afoul of RPC 5.4(a), which prohibits the splitting of fees between lawyers and nonlawyers, any more than it would violate the rule for an attorney and spouse to share the fees when they are received as community property. Id.

The problem of how to apportion a contingent fee arose again in In re Marriage of Mitlyng, No. 525-05-1-I, 2004 Wash. App. LEXIS 2131, 122 Wn. App. 1017 (Wash. Ct. App. July 6, 2004) (unpublished). The lawyer wife testified that she had done 50 percent of the work on the case prior to separation and 50 percent of it after separation. But she conceded that she, like other contingent fee lawyers, did not keep time records and so this was just an estimate. The court chose not to use her testimony as the basis for its division: "in light of Linda's failure to keep any hourly billing records or any type of documentation, the 'reasonable' solution would be to compute the time according to the number of months spent on the case." Id. at *9-10. The court did so, using a ratio of "preseparation" months as against total months spent, beginning with the date the case came in and ending when it was settled. This yielded a 77 percent community property share of the $70,000 fee. The appeals court affirmed the ruling as within the trial court's discretion.

The assignment of contingent fees does not, however, necessarily relieve the assignor spouse of the income tax liability on these fees. In Kochansky v. Commissioner, 92 F.3d 957 (9th Cir. 1996), the parties to a divorce...