In many, perhaps most New York business divorce lawsuits, tax documents play a key role.

Equity holder status is essential for standing to sue – including to dissolve, to sue derivatively on behalf of the entity, to sue directly as an owner, or to challenge a merger, consolidation, divestiture, or asset sale.

For entities whose principals decline to follow corporate formalities, like issue stock or membership interest certificates, or adopt written shareholder or operating agreements identifying the owners, Schedules K-1 from the entity’s tax returns identifying the entity’s pro rata owners and their proportionate share of taxable income or losses may be the most important evidence of equity status. Oral general partnerships, in particular, often have no indicia of ownership but Schedules K-1.

Tax records can be important for many other reasons. An owner’s personal tax returns may be necessary to show whether he took funds from the business, distributed income or salary disproportionately, or diverted assets or opportunities to a competing business.

The entity’s income tax returns often contain a wealth of important information about the entity’s financial performance critical for appraisal and valuation.

The list goes on and on.

But to the dismay of many business divorce practitioners and their clients, tax records can be devilishly difficult to get in disclosure.

The Usual Standard for Discoverability

Ordinarily, the standard for disclosure in New York is whether the information sought is “material and necessary,” an exceptionally low standard under which, if there is “any possibility that the information is sought in good faith for possible use as evidence-in-chief or in rebuttal or for cross-examination, it should be considered material” and discoverable (Matter of Grover S., 176 AD3d 828 [2d Dept 2019]).

The Standard for Discoverability of Tax Records

The standard for discoverability of tax returns is much different.

All four Departments of the Appellate Division impose a rather stringent, heightened burden to discover an opponent or non-party’s tax records. The four Departments express this judge-made doctrine in slightly different ways, frequently affirming the denial, and reversing the grant, of disclosure of tax records:

  • Day v Serenity Pharm., LLC, 213 AD3d 488 [1st Dept 2023] [“Plaintiff failed to make the requisite strong showing of necessity for disclosure of the individual defendants’ tax returns. . . . Plaintiff does not identify any information contained in the tax returns that is not available from other sources” [quotations omitted];
  • Cyngiel v Krigsman, 224 AD3d 875 [2d Dept 2024] [“Tax returns generally are not discoverable in the absence of a strong showing that the information is indispensable to the claim and cannot be obtained from other sources . . . The plaintiff failed to make a strong showing that Krigsman’s personal tax returns are indispensable to proving his claims and that evidence cannot be obtained from other sources, such as bank records”] [quotations omitted];
  • Cooke v Greenhouse Hudson, LLC, 230 AD3d 841 [3d Dept 2024] [“[P]ersonal financial records which contain confidential and private information, such as bank statements and tax returns, are only discoverable where the party seeking them shows that they are relevant to issues in the case, indispensable to the claim and unavailable from other sources”] [quotations omitted]; and
  • Matter of Monaco, 117 AD3d 1593 [4th Dept 2014] [“Surrogate’s Court properly denied respondent’s motion, inasmuch as respondent has not made a sufficiently strong showing that the information contained in petitioner’s income tax records were indispensable to this litigation and unavailable from other sources, such as other financial or business records”] [citation and quotations omitted].

Sharp readers will notice another devilish complication: some appeals courts extend the heightened burden of discoverability to “bank” records (e.g. Cooke), while others do not (e.g. Cyngiel).

Surprisingly, New York’s highest court, the Court of Appeals, has never considered whether the common-law, heightened burden for discoverability of tax records adopted by all four Departments of the Appellate Division is consistent with the liberal disclosure standards of Article 31 of the CPLR. There are certainly plenty of arguments against it. For one, if tax returns contain sensitive information, an easy solution is a confidentiality order, not wholesale denial of disclosure.

Unless or until the Court of Appeals chooses consider this issue, litigants have no choice but to grapple with the two-part “indispensability” and “unavailability” standard.

A Case Study

A recent decision by New York County Commercial Division Justice Robert R. Reed highlights the difficulty some business divorce litigants face trying to discover an adversary’s tax records.

Slabakis v Olympos Trading Corp. (84 Misc 3d 1231 (A) [Sup Ct, NY County Nov. 20, 2024]), involved alleged breach of a “buyout agreement” between three owners of several corporations in the Manhattan commercial real estate business.

Plaintiff Angelo Slabakis (“Slabakis”), Defendant Theodore Samourkas (“Samourkas), and non-party John Moshaklaidis (“Moshaklaidis”) founded the venture in 1977. In 1984, after Slabakis and Samourkas’s relationship soured, Samourkas offered to acquire Slabakis’s interest in the business, yielding the “buyout agreement.”

Under the agreement, Samourkas allegedly agreed to purchase Slabakis’s equity “for a total compensation consisting of a down payment of One Million One Hundred Thousand Dollars ($1,100,000) plus Ten Million Dollars or twenty percent of the profits” from the eventual sales of the entities’ real estate assets, “whichever was greater, to be paid when the last of the properties was sold.”

According to this New York Post article, in 2021, the last of the last of the venture’s properties, a commercial building at 576 Fifth Avenue, New York, New York, sold for slightly more than $100 million.

About a month before the sale, Slabakis sued Samourkas’s estate, his daughter, and several entities associated with the decades-old buyout agreement, alleging in his complaint claims for breach of contract, fraudulent conveyance, unjust enrichment, constructive trust, and a shareholder derivative claim.

A year and a half into the litigation, Slabakis moved to compel a broad array of documents and deposition disclosure, including the corporate tax returns for 11 entities “that owned properties in which plaintiff alleges an ownership interest.”

Slabakis explained, “The requested information is relevant to establish ownership of the subject properties,” and “the information in said returns could lead to relevant and admissible evidence” concerning “the allegations of ownership in the case at bar.” Little more was said on the subject, a rather threadbare showing of necessity defendants justifiably criticized as falling far short of showing “indispensable need.” Justice Reed agreed.

The Court wrote:

To justify the mandatory disclosure of corporate tax returns, a party must establish that the information contained within the tax return is indispensable to the litigation and unavailable from other sources, [meaning that] the proponent must

[1] identify the particular information the return will contain and its relevance,

[2] explain why other possible sources of the information sought are inaccessible or likely to be unproductive, and

[3] limit examination of the return to relevant material through redaction of extraneous information.

(quotations omitted).

Applying this stringent standard, the Court held that Slabakis “has not met his burden of establishing necessity,” ruling that he “merely asserts that the tax returns would help establish ownership of the corporations, but does not explain why that information cannot be gained through other means.”

“Indeed,” wrote Justice Reed, “defendants have produced numerous documents demonstrating the corporate designation and ownership of these entities — and testimony by defendants and their law firm . . . has been offered on this issue.”

So after almost two years of discovery motion practice over discoverability of corporate tax returns, Slabakis came up empty handed.

The Takeaway

The lesson of Slabakis, like so many other cases before it: to obtain disclosure of corporate or personal income tax returns, general allegations of “relevance” that might suffice for disclosure of other kinds of business records may not come close to satisfying the exacting standard for discoverability of tax returns. Instead, be prepared to make a very strong showing of necessity of the information to the case, and the unavailability of the information from any other source of disclosure, including depositions.

Returning to the introduction of this article, the silver lining is that tax returns are often so important in business divorce litigation that litigants in this area often enjoy a greater degree of success than in other areas of the law. Sometimes, for example, tax records are so obviously important that opponents do not contest their production. But when they do, business owners and their counsel will need to carefully articulate a pressing need for disclosure of tax records, failure of which will often result in denial of disclosure.

Subpoenas are Not a Solution

Can one use subpoenas to accountants or government taxation agencies as an end-run around the indispensability and unavailability standard?

Unfortunately, no. With limited exceptions, federal and New York State law both prohibit government disclosure of tax returns, in reliance upon which the IRS and New York Department of Taxation and Finance outright reject and refuse to comply with civil subpoenas for tax records (see 26 U.S.C. § 6103 and New York Tax Law § 697 [e] [1] and [2]).

It is comparatively easier to get tax records from accountants, but the law restricts disclosure from professionals involved in tax preparation services as well (see 26 U.S.C. § 7216). And a person or entity whose returns are in possession of accountants or an attorney has standing to move to quash the subpoena, or for a protective order, based upon the same indispensability and unavailability standards governing party disclosure of tax records.

So when seeking tax records, bring your A game, prepared to explain to the Court with specificity why lack of disclosure of tax information would incurably prejudice your ability to prosecute or defend the case. Without such a showing, expect to be disappointed.