It is not uncommon for a privately owned business to be part of the marital estate of divorcing couples. Obtaining a value of a business under these circumstances typically requires a formal business valuation. Business valuations under normal circumstances can be complex, but throw in the concept of “double dipping” in a divorce context and the valuation process becomes even more complicated.
What is “Double Dipping”?
“Double Dipping” is the term used for the act of counting the value of an asset twice: once in the division of property and again as a stream of income connected to the property for the determination of spousal support.
Typically, you come across double dipping when dealing with retirement assets. Retirement assets are often divided as part of the property settlement. Once the plan starts to pay out to the participant at retirement, the individual receiving spousal support will often seek to include the additional income as available for support. However, the learned advisor will correctly point out that the income stream now being received was part of the valuation of the retirement asset when it was split up pursuant to the property settlement. To allow the individual receiving spousal support to seek an increase because of the retirement income is like giving them a “second bite at the apple”, or allowing a “double dip”.
How does the double dipping concept apply to a closely held business?
The answer to this question requires at least a basic understanding of business valuation concepts.
The stream of income generated by a business for its owner is an important component of the overall value of the enterprise under certain valuation methods. When the value of the business is divided pursuant to equitable distribution, the income stream is already part of the overall business value. The double dip occurs when the same stream of income – without an adjustment to recognize its inclusion as a marital asset in equitable distribution – is used to determine spousal support.
It is possible to minimize the danger of double dipping in the valuation of a business by employing methods that place a greater emphasis on components of the business other than the income stream.
By utilizing an asset approach to valuing the business, the fair market value of the business is based on the assumption that a prudent buyer would pay no more than the cost to purchase the assets of the business (both tangible and intangible) at current market prices. This approach requires the valuation of all of business assets and liabilities. Since the focus is on assets and liabilities, the income stream of the business is excluded from the value of the business enterprise. The income stream can now become a factor in determining support without fear of double dipping.
Other valuation methods (income approach, capitalization of earnings, discounted cash flows, market approach) either directly or indirectly involve the cash flow of the business and risk falling into the double-dipping trap.
What are the guidelines for valuations?
To further complicate matters, the guidelines for valuations for divorce purposes are not as clear as they are for valuations prepared for other purposes. For example, valuation guidelines for estate and gift tax typically revolve around the Internal Revenue Code and related regulations. When you approach a valuation for divorce proceedings, you need to consider state law (equitable distribution vs. community property), an accurate valuation date (date of separation, date of the filing of a complaint, trial date, etc.), whether or not some aspects of the business value are subject to stipulations, etc.
Additionally, states vary in their view of double dipping. In Grunfeld v. Grunfeld, 94 N.Y. 2d 696, 731 N.E. 2d 142, 709 N.Y.S. 2d 486 (2000), the New York Court of Appeals held that it was an error in a divorce to base both an equitable distribution award of a business practice, license, or degree and the owner’s obligation to pay maintenance on the same projected earnings. Conversely, court rulings from New Jersey, Michigan, and Ohio (all equitable distribution states) held that, in general, it is appropriate to consider a business’s stream of income for both equitable distribution and spousal support.
As you can see, the value of a business in the context of a divorce requires special attention. As an advocate for your client, it is imperative that you understand the valuation methods employed and make sure any support calculations take into account whether the income has already been included in the asset’s value. In a “Seinfeld” episode, George Costanza found out the hard way that double dipping isn’t good. With a little insight as to the make-up of a business’s value, hopefully your client (or you) won’t suffer the same fate as George!