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Hubbard County Health and Human Services, et al. v. Zacher: FAMILY | CORPORATIONS - subchapter S earnings retained for business reasons not child support income; FAMILY | fact Questions

STATE OF MINNESOTA
IN COURT OF APPEALS
A06-2228
Hubbard County Health and Human Services, petitioner,
Respondent,
Beth A. Hadrava, petitioner,
Respondent,
vs.
Shane L. Zacher,
Appellant.
Filed December 11, 2007
Reversed and remanded
Willis, Judge
Hubbard County District Court
File No. FX-06-159
Greg Larson, Hubbard County Attorney, Erika Randall, Assistant County Attorney,
Hubbard County Courthouse, 301 Court Avenue, Park Rapids, MN 56470 (for
respondent Hubbard County Health and Human Services)
Beth A. Hadrava, 40459 Pincherry Trail, Laporte, MN 56461 (pro se respondent)
Allison Maxim, Gary A. Debele, Walling, Berg & Debele, P.A., 121 South Eighth Street,
Suite 1100, Minneapolis, MN 55402 (for appellant)
Considered and decided by Hudson, Presiding Judge; Willis, Judge; and Minge,
Judge .
S Y L L A B U S
1. Undistributed earnings of a Subchapter S corporation that have been
retained for a business reason are not income to a minority shareholder for the purpose of
establishing his child-support obligation.
-2-
2. Whether undistributed earnings of a Subchapter S corporation have been
retained for a business reason is a fact question, which must be decided on a case-by-case
basis.
3. A minority shareholder in a Subchapter S corporation who claims that
undistributed earnings of a Subchapter S corporation should not be included in his
income for the purpose of establishing his child-support obligation has the burden of
showing that the earnings were retained for a business reason.
O P I N I O N
WILLIS, Judge
Appellant challenges the district courts order affirming an order of the childsupport
magistrate establishing appellants child-support obligation, arguing that the
district court erred by including in the determination of appellants income for childsupport
purposes the undistributed earnings of a Subchapter S corporation that appellant
reported on his individual tax returns but did not actually receive. Because we conclude
that additional findings of fact are necessary, we reverse and remand.
FACTS
Appellant Shane L. Zacher and respondent Beth A. Hadrava are the parents of
three children, all of whom live with Hadrava. On November 30, 2005, respondent
Hubbard County Health and Human Services began an action against Zacher to establish
Zachers child-support obligation for the three children. A child-support magistrate
(CSM) heard the matter and, in July 2006, established Zachers child-support obligation.
-3-
Zacher has been employed by Next Innovations, Ltd. since 2002 and became a
shareholder in March 2005. Since January 1, 2005, Next Innovations has been organized
as a Subchapter S corporation. The earnings or losses of a Subchapter S corporation pass
through to its shareholders and are reported by the shareholders on their individual tax
returns.
Zachers brother and father are the other two shareholders of Next Innovations. In
addition to his gross wages during the 2005 tax year, Zacher reported income of ,098
on his individual tax returns as his allocable portion of Next Innovations earnings. Next
Innovations accountant testified that only Zachers father, as the majority shareholder,
has the authority to force a distribution of Next Innovations earnings, and that, between
January 1, 2005, and the June 2006 hearing, Next Innovations had made no distributions
to its shareholders. The accountant further testified that Zacher, therefore, did not
actually receive the ,098 in corporate earnings that he reported on his tax returns.
Zacher testified, and the accountant confirmed, that it was very likely that Next
Innovations would eventually make a distribution to reimburse its shareholders for the
taxes they paid in 2005 on the corporations earnings, although, as of the date of the
hearing, such a distribution had not been made.
In its July 2006 order, the CSM found that because Zacher is a shareholder in Next
Innovations, his share of Next Innovations earnings is a regular source of income . . . .
The CSM explained that Zachers 2005 tax returns were the best available and current
evidence of Zachers gross monthly income and that, [a]lthough his income is subject to
fluctuation, it does appear that the business [Zacher] is engaged in and is shareholder in is
-4-
successful and is experiencing growing revenues. Accordingly, the CSM included
Zachers share of Next Innovations undistributed earnings in his determination of
Zachers net monthly income, and based on that figure, determined that Zacher should
have paid ,400 per month in child support for the period January 1, 2005, through
March 31, 2006, and that, because of the birth of the third child in March 2006, his
ongoing child-support obligation should be ,575 per month, beginning April 1, 2006.
The district court affirmed the CSMs determination of child support, and Zacher
appeals.
ISSUE
Did the district court err by including the undistributed earnings of a Subchapter S
corporation as income to a minority shareholder for the purpose of determining his childsupport
obligation?
ANALYSIS
A district court has broad discretion to provide for the support of the parties
children, and that decision will only be reversed if the district court abused its discretion.
Rutten v. Rutten, 347 N.W.2d 47, 50 (Minn. 1984). Thus, we review a district courts
decision confirming a CSMs order under an abuse-of-discretion standard. Davis v.
Davis, 631 N.W.2d 822, 825 (Minn. App. 2001). A district court abuses its discretion
when it establishes a child-support obligation in a manner that is against logic and the
facts in the record or when it misapplies the law. See Rutten, 347 N.W.2d at 50 (holding
that the district court abuses its discretion when it sets support in a manner that is against
logic and the facts in the record); Ver Kuilen v. Ver Kuilen, 578 N.W.2d 790, 792 (Minn.
-5-
App. 1998) (explaining that [a]n abuse of discretion occurs when the [district court]
improperly applies the law to the facts).
A presumptively appropriate child-support obligation is calculated by multiplying
an obligors net monthly income by the percentage applicable to that income in the
statutory guidelines table. See Minn. Stat. 518.551, subd. 5(b) (2004).1 Income is
defined as any form of periodic payment to an individual . . . . Minn. Stat. 518.54,
subd. 6 (2004). See also Duffney v. Duffney, 625 N.W.2d 839, 843 (Minn. App. 2001)
(Generally, if a payment is periodic it is income.). And the designation of a particular
source of funds as income for child-support purposes is a question of law, which we
review de novo. Sherburne County Soc. Servs. v. Riedle, 481 N.W.2d 111, 112 (Minn.
App. 1992).
The CSMs order explains that the decision to include Zachers share of Next
Innovations earnings in the determination of his income was based on Zachers status as
a shareholder. Zacher contends that his share of Next Innovations earnings is not
income within the meaning of section 518.54, subdivision 6, because he did not
actually receive his share of those earnings.
The question of whether undistributed earnings of a Subchapter S corporation
should be included as income to a minority shareholder for the purpose of establishing his
1 The legislature amended and renumbered section 518.551, subdivision 5(b), as well as
the other provisions in chapter 518 dealing with child support in 2005. See 2005 Minn.
Laws ch. 164, 29, at 1924. In 2006, the legislature provided that the 2005 amendments
to the provisions relating to the calculation of child support would apply only to actions
or motions filed after January 1, 2007. See 2006 Minn. Laws ch. 280, 44, at 1145.
Because this action was filed before the effective date of the 2005 amendments, we
review the decision under the 2004 statute.
-6-
child-support obligation is a matter of first impression in Minnesota. But the issue has
been addressed in other jurisdictions. For example, in Florida, the undistributed earnings
of a Subchapter S corporation are not income to a minority shareholder if they have been
retained for corporate purposes but are income when they have been retained to enable
a shareholder to avoid a child-support obligation. Zold v. Zold, 911 So.2d 1222, 1231-33
(Fla. 2005). Similarly, in Indiana, undistributed earnings of a Subchapter S corporation
are not income to a minority shareholder unless there is a finding that the corporation is
being used to shield income. Tebbe v. Tebbe, 815 N.E.2d 180, 184 (Ind. Ct. App. 2004).
And in Kansas, undistributed earnings of a Subchapter S corporation also are not income
to a minority shareholder when it has not been established that the corporate earnings had
been manipulated or that the shareholder acted in any way to shield income. In re
Marriage of Brand, 44 P.3d 321, 327-28 (Kan. 2002).
We conclude that the primary question that a district court must resolve in
deciding whether the undistributed earnings of a Subchapter S corporation are income to
a minority shareholder who is a child-support obligor is whether the corporation retained
the earnings for a business reason or retained them to enable the obligor to shield
income or manipulate the amount of money he receives in order to reduce or avoid his
child-support obligation. In a case involving an issue similar to that here, this court has
noted concern for the possibility that a shareholder might manipulate the earnings of a
Subchapter S corporation to reduce his child-support obligation. Williams v. Williams,
635 N.W.2d 99, 103 (Minn. App. 2001). In Williams, which involved a dispute over
whether to include distributions of a Subchapter S corporation as other compensation
-7-
of the shareholder for purposes of determining child support, this court recognized the
potential for the employee-shareholder [of a Subchapter S corporation] to manipulate
income of a Subchapter S corporation to avoid or reduce child-support obligations . . . .
Id. at 103.
Determining whether undistributed earnings of a Subchapter S corporation were
retained for a business reason or retained to manipulate a shareholders income is a fact
question. We therefore reject Zachers argument that Next Innovations undistributed
earnings are not income as a matter of law because he did not actually receive payment
and because he is a minority shareholder who has no authority to force a distribution of
the earnings. We conclude instead that the question of whether the undistributed earnings
of a Subchapter S corporation are income to a minority shareholder for child-support
purposes must be determined on a case-by-case basis. The degree of control that Zacher
has over corporate operations is certainly relevant, but the fact that he is a minority
shareholder and did not actually receive his portion of the earnings is not alone
determinative.
The district court made no findings regarding whether the undistributed earnings
of Next Innovations were retained for a business reason. Therefore, additional findings
are necessary to determine whether Zachers share of the undistributed earnings of Next
Innovations should be considered to be income to him.
We note that some jurisdictions put the burden of establishing that there is a
business reason for retaining earnings on the shareholder if he is in a position to control
the retention and disbursement of earningsfor example, when he is a majority
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shareholderbut on the child-support obligee if the obligor shareholder has a minority
interest and thereby less ability to control the retention and distribution of corporate
profits. See Brand, 44 P.3d at 328; Fennel v. Fennel, 753 A.2d 866, 869 (Pa. Super. Ct.
2000). Other jurisdictions put the burden on even a minority shareholder. See Zold, 911
So.2d at 1233 (holding that a minority shareholder of a Subchapter S corporation must
prove that undistributed earnings were retained for corporate purposes rather than
impermissibly retained to avoid . . . child support . . . .); Walker v. Grow, 907 A.2d 255,
270 (Md. Ct. Spec. App. 2006) (holding that the burden is on a minority shareholder
seeking to exclude the undistributed earnings to prove that the earnings are not available
for child-support purposes). The Florida Supreme Court has explained that the burden is
properly on even a minority shareholder because he or she has the ability to obtain
information to establish the propriety of the corporations actions. Zold, 911 So.2d at
1233. We think this is the better rule. Because Zacher has the ability to obtain
information relating to whether there is a business reason for Next Innovations to retain
its earnings, he bears the burden of proof on that issue.
But resolving the question of whether the undistributed earnings of Next
Innovations should be considered to be income to Zacher for child-support purposes does
not necessarily end the inquiry. The ultimate determination of a child-support obligation
is based on the obligors ability to pay. Strandberg v. Strandberg, 664 N.W.2d 887, 889
(Minn. App. 2003). And the statute allows the district court to consider all . . . resources
of the parents in deciding whether to deviate from the guidelines. Minn. Stat. 518.551,
subd. 5(c)(1) (2004). Therefore, even if the district court determines that there is a
-9-
business reason for Next Innovations to retain earnings, and therefore the undistributed
earnings are not income to Zacher for purposes of child support, the district court must
then consider whether Zachers interest in Next Innovations is a resource that should be
taken into consideration in determining his ability to pay child support. On remand, the
district court may in its discretion reopen the record.
D E C I S I O N
We conclude that further findings of fact are necessary to determine whether the
undistributed earnings of Next Innovations are income to Zacher for child-support
purposes or whether his interest in Next Innovations is a resource for the purpose of
child-support. We therefore reverse the district courts order setting Zachers childsupport
obligation and remand for further proceedings consistent with this opinion.
Reversed and remanded.
 

 
 
 

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