## Facts

- Ira Lee Thomas (husband) and Martha S. Thomas (wife) married in 1968; the wife filed for divorce in 1983.
- During the marriage, the husband acquired about 16% of the stock of a closely held family corporation by gift and inheritance; the stock was undisputedly his separate property.
- The corporation operated as a Subchapter S corporation, so its income was taxed to shareholders personally; the community estate paid tax on the husband’s proportional share whether the corporation distributed the earnings or retained them.
- The corporation distributed dividends during the marriage but did not distribute all earnings; some earnings were retained by the corporation.
- A jury found $146,000 in retained corporate income earned during the marriage was attributable to the husband’s shares.
- The divorce decree ordered the husband to pay the wife one-half of any future sums he received from the corporation for his share of earnings until $73,000 was paid, and appointed him trustee for the wife as to those payments.
- The husband appealed, arguing the decree improperly awarded the wife corporate retained earnings (corporate assets) rather than dividing the marital estate.

## Issues

1. Whether retained earnings of a Subchapter S corporation attributable to a spouse’s separate-property stock are community property subject to division on divorce.
2. Whether, absent an alter-ego finding, a divorce court may order payments to the non-shareholder spouse directly tied to future distributions of retained corporate earnings.

## Decision

- The court held retained earnings of the Subchapter S corporation were not community property subject to division on divorce.
- The court held the trial court erred by awarding the wife a share of retained earnings through an order tied to future corporate payments and a trustee arrangement.
- The court reversed the portion of the decree awarding the wife $73,000 from future corporate earnings distributions and remanded for a proper division consistent with its holding.

## Legal Principles

- Absent proof and a finding that a corporation is a spouse’s alter ego, a divorce court may divide only the spouse’s shares of stock, not corporate assets.
- Retained earnings belong to the corporation until distributed; shareholders (and the marital community) do not own retained earnings as property solely because they are taxed on pass-through income.
- Subchapter S pass-through taxation affects federal tax liability but does not change state-law characterization of property interests for divorce division purposes.
- Dividends actually received during marriage may be treated as marital property, but undistributed corporate earnings remain corporate property.

## Conclusion

The appellate court ruled that a divorce decree cannot award a non-shareholder spouse an interest in a corporation’s retained earnings where the shareholder spouse’s stock is separate property and there is no alter-ego finding; retained earnings remain corporate property until distributed, so the remedy lies in dividing marital assets (including the stock’s value), not in reaching corporate accounts through the decree.


Thomas v. Thomas, 738 S.W.2d 342 (Tex. App.—Houston [1st Dist.] 1987)