You cannot draw from a finite pot of money and expect it to be full every time.
By Bruce M. Berger, CPA/ABV, CVA, CFF and Alfred Zeiler, AIBA (Florida)
We’ve all heard about double dipping in some form or another. From celery sticks to government accounting, everybody seems to be in on it. So, are matrimonial judges immune to this? Well, I think that largely depends on us.
In the situation where the alimony-paying spouse owns a business, the income that is used to pay alimony is also used to develop the value of the business, which becomes part of the equitable distribution. In other words, the income is now in the form of business value, of which the alimony-receiving spouse receives half. Now we use that same income stream to determine a level of alimony to be paid. So we’re using the same income twice. Regardless of which side you’re on, that doesn’t quite seem fair, does it? But that’s what is happening in many states.
If the income was used to determine the value of the business, and half the value is given to the alimony-receiving spouse, the amount of money to pay alimony has been reduced. You simply cannot draw from a finite pot of money and expect it to be full every time. This is why so many business-owner spouses feel like they’re getting treated unfairly in their divorces. And in essence, they are.
Without going into the numerous different scenarios, the simplified answer is to subtract the alimony payment from the income that is used as part of determining the value of the business. Since the amount of alimony to be paid is based on the net income plus the officer’s compensation (plus add backs in many instances), subtracting the alimony from the net income reduces the value of the business and, as such, avoids double dipping.
Let’s work through a simplified example using the capitalization of earnings method.
|Income for capitalization||257,500|
|Equitable Distribution Amount||715,000|
Let’s assume that alimony is $3,000 per month, or $36,000 annually into perpetuity (paying alimony into perpetuity is unlikely, but then again, the likelihood of a business continuing into perpetuity is equally unlikely. We are assuming that no other contingencies exist that would change the continued payment of alimony). If the alimony-paying spouse has to pay this $36,000 from the business net income of $250,000, then the value of the business should not be based on the full $250,000. In our example, if we subtract the $36,000 from the $250,000, we are left with business net income of $214,000. This changes the value as follows:
|Net Income less Alimony||214,000|
|Income for capitalization||220,420|
|Equitable Distribution Amount||610,000|
The difference in value in this example is $105,000. In other words, if the alimony-receiving spouse wants to receive $3,000 in monthly alimony, he/she should be prepared to give up $105,000 on equitable distribution.
If we use our same income figures above and reduce monthly alimony from $3,000 to $1,500, the difference in equitable distribution reduces from $105,000 to $50,000. In other words, the alimony-receiving spouse receives an additional $55,000 in equitable distribution by reducing monthly alimony to $1,500. Doing it this way gives the alimony-receiving spouse some options. Does he/she want more money up front, or a larger monthly amount? In either case, following the logic shown in our example allows for this without penalizing the alimony-paying, business-owner spouse.
What about alimony that is paid only for a specific number of years? In that case, the income stream can be discounted back to present value using the same discount rate that was used in the business valuation. This present value amount would be subtracted from the value of the business. This will also work for alimony amounts that change over the years. Since alimony is usually based on total income (salary + business net income + add backs), the risk of alimony continuing is directly related to the risk of the continuing business income stream. As such, the same discount rate should be used for both the valuation and determining the present value of the alimony. I’m sure an argument can be made to use a different discount rate for the alimony payments, but it would not be any easier to support than the discount rate used in the valuation.
For lump-sum alimony, the value of the business is simply reduced by the amount of the lump-sum amount.
This same logic can also be applied to values reached using the market approach, since multiples are typically applied to income streams. However, this logic will not work with the asset approach, since income is not a part of this approach.
The excess earnings method is considered a hybrid method, because it uses both assets and an income stream. As such, the logic applied above can also be applied to this method.
Now that we know what the issue is and how to overcome it, what’s next? Well, we need to have the courage to start presenting this in court and helping the judges understand the real parity reached using this logic. The opposite of courage is conformity. And it is this conformity that got us here in the first place. We should have the courage to do what is right, regardless of who our client is.
Bruce M. Berger, CPA/ABV, CVA, CFF is the managing partner at Bruce M. Berger and Company, P.A., and has been providing accounting services since 1982. In 1992, Mr. Berger, along with a handful of other Certified Public Accountants, pioneered the entry of CPA’s into the litigation process as part of an additional range of services provided by accounting professionals. Over the years, Mr. Berger’s firm has expanded its capabilities to offer a full range of services in the area of forensic and investigative accounting. Mr. Berger has been accepted as an expert witness throughout South Florida in the areas of divorce, insurance, partnership disputes and shareholder dissolution.
Alfred Zeiler, AIBA, is the valuation manager at Bruce M. Berger and Company, P.A. Mr. Zeiler’s business valuation and economic damage experience includes a variety of assignments, including closely-held businesses, professional practices and thinly traded public companies. Mr. Zeiler’s services have been rendered for a variety of purposes including (but not limited to) family law matters, business damages, shareholder litigation, estate and gift tax matters, buying and selling businesses, and breach of contract. Mr. Zeiler also has in-depth forensic accounting, restructuring, and turn around experience.