Last year I had the privilege of attending the BVR/Morningstar Summit on Best Practices in Business Valuation in Divorce, which will be held this month in Chicago. Unfortunately I have to miss it this year as I will be visiting my new niece in San Diego. They will be discussing the latest developments in business valuation and complex financial issues in divorce, including the following summary of a double-dipping decision from California, which I am posting verbatim from the BVWire blast email:

In re Marriage of Blazer, (August 25, 2009) (partially unpublished)
The California Court of Appeal considered two issues of first impression: whether an owner’s capital account in a small, closely held company should count toward his income for determining spousal support; and whether the ultimate support award, when combined with the disposition and division of the business as a going concern, constitutes an impermissible “double dip” into the income stream of the business and of the owner-spouse.

Profitable produce company. The husband owned a brokerage fruit company in California, focusing primarily on the strawberry market. The trial court valued the closely held business at $5.6 million. Although each party presented expert testimony, the record did not reveal their respective methodologies or the trial court’s determination, except to note that it used the “capitalization of excess earnings method.” It ultimately awarded the entire business to the husband and all remaining asserts to the wife, plus a $1.34 million equalization payment.

In determining the wife’s request for permanent support, the trial court also considered whether the husband’s contribution of roughly $1.4 million from his capital account to expand and integrate the company was a reasonable business expense. Due to changes in the produce industry, the “buyer-broker” entity was being phased out, the husband testified, and unless the company moved into the farming and distribution markets, it would “not exist, it will be gone.” The husband’s expert, a CPA, noted that the company was “very thinly capitalized,” and that the funds were the husband’s to invest and should not be credited as income for purposes of spousal support. The wife’s expert agreed that the business could be better capitalized, but declined to express any “legal” opinion regarding the nature of the husband’s contributions, conceding only that capital withdrawals were generally not taxable as income.

Based on this evidence, the trial court excluded the funds used to expand the business from its award of spousal support. “The need to maintain higher capitalization in the company and the need to diversify the company’s work are reasonable expenses that should not be charged against [the husband’s] income,” it said, “but rather should be taken out of the company before assessing what his reasonable income is for purposes of support.”

As a final matter, it awarded the wife $20,000 per month in permanent support—and both parties appealed. The wife claimed the trial court should have accounted for all of the husband’s income, including the funds in his capital account, before awarding maintenance, while the husband claimed the award unfairly permitted the wife to “double dip” into his business’s income stream. In other words, because the court awarded the wife half of the business’s goodwill value in the property division, which was measured by the excess earnings method, it should not have considered those same earnings in assessing his ability to pay her support.

Both arguments lack direct legal authority. The appellate court tackled the wife’s arguments first, finding nothing in California precedent directly on point. The wife offered two cases, one that permitted a trial court to consider future income from a husband’s bonuses in its award of spousal and child support; and a second case that permitted consideration of income from the future exercise of stock options. But as the husband pointed out, in those cases, the supporting spouse was an employee, not a business owner. Accordingly, the appellate court found them apposite to the current case. However, the record provided substantial support for the trial court’s factual findings regarding the nature of the business and its expenses, including testimony from the husband and his expert. Moreover, the applicable California statute requires courts to consider the “earned and unearned income and the assets of the supporting party,” the appellate court pointed out, with emphasis. Thus, the trial court acted well within its discretion by attributing the reinvested funds to the business instead of the husband, and the appellate court confirmed its alimony award.

In considering the issue of the double-dip, the court found no direct support in California case law. The husband offered cases from other jurisdictions, including New York, which prohibits courts from double-counting the income from professional licenses.  “Once a court converts a specific income stream into an asset, that income may no longer be calculated into the maintenance formula and payout,” the court noted, citing Grunfeld v. Grunfeld 709 N.Y.S.2d 486 (Ct. App. 2000) (available at BVLaw™). At the same time, “there is no double counting to the extent that maintenance is based [on] spousal income which is not capitalized and then converted into and distributed as marital property,” the Grunfeld court held.

California courts have addressed the argument against double-dipping when dividing pension funds and determining support—but they have rejected its “superficial appeal,” this court observed. In one case, the award of spousal support extended only three years after the divorce, but in all cases, when “one spouse receives permanent . . . support from the other spouse, the source is from the separate property of the paying spouse, including . . . earnings or property which were once the community property of both spouses,” the court said (quoting a 1979 California Supreme Court opinion). Thus, it rejected the legal basis for the husband’s argument against double-dipping in divorce.

The appellate court also found no factual basis for it in the record. Unfortunately, the trial court’s orders did not explicitly identify the intangibles it valued when applying the capitalized excess earnings method to the business. Nor did it appear to have valued the business using a stream of future income belonging to the husband, the appellate court noted.  Despite testimony from the husband’s expert that “the excess earnings method of valuing goodwill in a professional corporation . . . is not far removed from a prediction about future earnings,” the court rejected the notion that this valuation method “compels a determination that [the business’s] goodwill value is tied to the husband’s future efforts.”

First, testimony by the husband’s expert—even though it was uncontradicted, was not conclusive proof of such a finding. Second, and more importantly, “an entity’s future earnings do not always correspond with the owner’s contribution of labor,” the court found. The case law has long recognized that “goodwill may exist separate and apart from the services of the person who created it.” Although goodwill and earnings may arise from the personal talents, skills, and reputation of an individual employee, their value may attach to and continue with the business even after that employee departs.

Despite lapses in the record, it sufficiently showed that the trial court valued the husband’s business without including any of his potential or continuing income, the appellate court concluded. Further, nothing in the applicable statute precluded the trial court from recognizing the husband’s future earnings as income available for spousal support, even though such income was undoubtedly his separate property; the trial court also considered the wife’s future investment earnings from her award of marital assets to determine her reasonable needs.  “To sum up, Calfornia authority offerns no basis for treating husband’s earnings from his ongoing business differently fvrom income generated by other assets divided at dissolution, for purposes of determining spousal support,” the court held, and declined to adopt any prohibition against the double-dip in divorce.

This summary suggests that California jurisprudence remains relatively unsophisticated on this important issue, which I might explain in the following way: a business valuation is a hypothetical sale of the business. If the business were sold in conjunction with the divorce, the business owner would receive a price equal to the fair market value yielded by the business valuation. That price is the marital asset that is divided in equitable distribution. The former owner of the business might then have to get a job, where he or she might earn a salary equal to the “reasonable compensation” element of the business valuation. Any future support obligation might be based on the reasonable compensation figure, but must not be based on excess salary and/or business profits that the owner might have received prior to the hypothetical sale, because the owner is no longer receiving such benefits after the “sale.”  The divorce court must not consider the business owner’s actual compensation and profits when calculating post-divorce support obligations. On the other hand, any support obligations imposed prior to the divorce (i.e., prior to the hypothetical sale) may be based on the owner’s entire compensation and profits because the double dip does not occur until the business is “sold.” The court in Blazer seemed to miss this concept in its analysis.

One of my colleagues believes that there is a flaw in the double dipping argument when applied to business valuation because the business may continue to generate profits in the distant future.  Mathematically, a business valuation is a net present value calculation, derived from the sum of the profits generated by the business year after year into infinity. Valuation is not based upon profits for a limited period of time; it is unlimited. By viewing the valuation as a hypothetical sale, this concept is easier to understand. A business owner will not receive profits at any future time period after selling the business.

Blazer demonstrates the importance of building a record at the trial court level and explaining valuation concepts in concrete terms. It is easy for a court to misconstrue esoteric terms like “goodwill,” but it seems unlikely that an expert could deny that fair market value implies a hypothetical sale, or that valuation is the net present value of an infinite series of annual profits.

My firm PBKG LLC is proud to announce that five of our partners (David Pollock, Todd Begg, Candice Komar, Dan Glasser and Brian Vertz) have been named to the 2011 edition of The Best Lawyers in America.

Since its inception in 1983, Best Lawyers has become universally regarded as the definitive guide to legal excellence. Because Best Lawyers is based on an exhaustive peer-review survey in which more than 39,000 leading attorneys cast almost 3.1 million votes on the legal abilities of other lawyers in their practice areas, and because lawyers are not required or allowed to pay a fee to be listed, inclusion in Best Lawyers is considered a singular honor. Corporate Counsel magazine has called Best Lawyers “the most respected referral list of attorneys in practice.”

It is important to note that the lawyers listed in Best Lawyers have no say in deciding which practice areas they are included in. They are voted into practice areas entirely as a result of the votes they receive from their peers. 

This is the second consecutive year that I have been voted into The Best Lawyers in America.  The Best Lawyers in America® 2011 (Copyright 2010 by Woodward/White, Inc., of Aiken, S.C.).

In Balicki v. Balicki, 2010 PA Super. 134 (July 30, 2010), the Superior Court considered the husband’s argument that the alimony order provided more income to his ex-wife than she could spend (as shown by her budgetary expenses). The trial court in its opinion justified the alimony award by noting that the wife would pay income tax on her alimony award, thereby reducing the after-tax dollars available to her. The trial court presented a seemingly reverse-engineered analysis of available income sources to prove that the income nearly matched wife’s claimed budgetary needs, thereby vindicating the result.

An important element of the trial court’s opinion was its calculation of the ex-wife’s income tax liability arising from her alimony award. The trial court held, and the Superior Court agreed, that a tax “gross-up” may be warranted under 23 Pa.C.S. § 3701(b)(15), one of the 17 statutory criteria for judging alimony claims. The trial court’s tax gross-up was triple the provision recommended by the master, but the trial court also disapproved the master’s inflated budget. These two adjustments offset each other, and the trial court affirmed the result reached by the master on different grounds.

The husband argued that the trial court had no right to reconsider the tax gross-up since neither party raised the issue in their exceptions from the master’s report. The Superior Court agreed that the trial court was not limited to the issues specifically raised on exceptions. Ironically, the Superior Court dismissed all of the husband’s allegations of error pertaining to specific items on wife’s budget, holding that they were waived because they were not specifically identified in the § 1925 statement.

All of the ex-wife’s issues on appeal, most of which seemed to be calculated to counter-balance husband’s appeals, were dismissed by the Superior Court, which affirmed the rationale of the trial court.

The Supreme Judicial Court of Massachusetts ruled recently that agreements between spouses who plan to continue their marriage but wish to define their legal rights and obligations in the event of divorce are enforceable in that state. Some states (notably Ohio) do not permit spouses to execute agreements waiving their marital rights unless they are actually pursuing divorce, and the law of many states is unsettled. In its recent decision, the highest court of Massachusetts joined the ranks of states (including Pennsylvania) where such “post-nuptial” agreements are permissible.

Post-nuptial agreements may combine certain elements of prenuptial agreements with features of marital settlement agreements. Post-nuptial agreements may divide marital property between spouses, protect their separate property, and establish or restrict spousal support and alimony, like settlement agreements. Post-nuptial agreements can also protect family businesses, inheritance, and other separate property to be acquired in the future, just as prenuptial agreements do.

In Ansin v. Ansin-Cravin, 457 Mass. 283, 929 N.E.2d 955 (2010), the husband and wife entered into a post-nuptial agreement two years before their eventual divorce. The post-nuptial agreement in that case gave the parties a chance to attempt marital reconciliation while removing the financial risk of taking “one last chance”. The couple had been married for nineteen years at the time of their agreement. At that point, the husband separated from his wife and advised her that he would not return unless she would sign an agreement. She hired legal counsel, investigated the nature and value of their assets, and negotiated the terms of the agreement.

Having signed the agreement, the husband and wife reconciled for nearly two years. Ultimately the reconciliation did not last, but the parties were able to avoid the stress and expense of protracted divorce litigation by having an agreement in place (at least, they would have avoid those pitfalls if the wife had not challenged the validity of the agreement). The Massachusetts court applied the same standards to post-nuptial agreements as many states employ when judging the validity of prenuptial agreements and settlement agreements: (1) availability of independent legal counsel; (2) full and fair disclosure of financial resources; (3) absence of fraud or duress; and (4) reasonableness of the provisions for each spouse.

Pennsylvania has long recognized post-nuptial agreements, and for good reason. When entering into a post-nuptial agreement, full and fair disclosure is an essential element; and it may be important to engage legal counsel. While formbooks and software programs may contain “boilerplate” prenuptial agreements, post-nuptial agreements are very different and require the skill of an experienced family law attorney.

News stories were posted today on CNN.com and VanityFair.com claiming that a growing number of people are using Facebook to cheat on their spouses…. and getting caught! Divorce lawyers have discovered that many careless cheaters leave obvious evidence of their infidelity on social networking sites, where anyone can find it. In fact, a site called FacebookCheating.com has recently popped up to hype this phenomena. According to CNN, “a recent survey by the American Academy of Matrimonial Lawyers found that 81 percent of divorce attorneys have seen an increase in the number of cases using social networking evidence during the past five years. More than 66 percent of those attorneys said the No. 1 site most often used as evidence is Facebook with its 400 million registered users.”

So if this internet evidence of cheating is out there, how can it be useful in a court where most divorces proceed under the no-fault laws? In my experience, Facebook and other social networking sites can be gold mines of useful evidence that can help parents to win custody cases. Too many people post pictures and stories of their drunken or bawdy behavior on their profiles. Facebook evidence can prompt a judge to question a parent’s ability to observe appropriate values and boundaries with their children. Evidence of cheating is not necessarily relevant to the economic aspects of most no-fault divorces, but it can be a defense to spousal support or alimony under some circumstances. If you discover a spouse’s Facebook profile with damaging evidence of cheating, contact your family lawyer immediately to find out what to do next.

My friends at Crawford Ellenbogen LLC  know a lot about taxes. One of their principals, Victor Dozzi CPA, recently sent me a great tip about kids who are earning income from summer jobs, and I asked him if I could share it with you. He agreed, so here it is:

Are your children working at summer jobs this year?  If so, here are some tax reminders.

* If a child did not owe any income tax last year and doesn’t expect to owe any this year, the child can claim “exempt” when completing the federal withholding allowance form (Form W-4). This will eliminate having federal income tax withheld from his or her paychecks.

* For 2010, your child can earn as much as $5,700 without owing federal income tax. There will still be withholding from your child’s paycheck for a number of other taxes, including: social security, Medicare, PA, PA UC & perhaps local.

* As long as you provide more than half of your child’s support, you can still claim the child as an exemption on your 2010 tax return.

* Earnings from a summer job will qualify a child to contribute to an IRA – up to $5,000 or the child’s 2010 earnings, whichever is less. If your child would rather spend his earnings than save for retirement, you could gift all the cash, or agree to match what your child saves. As long as the amount put into the IRA doesn’t exceed the child’s wages (or the $5,000 limit), it doesn’t matter where the cash comes from.

The principals of Crawford Ellenbogen (Joan, Victor, and Barb) can provide great advice and personalized service – it’s just a phone call away.

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In accordance with IRS’ Circular 230 we are required to advise you that any written advice we provide to you cannot be used for the purpose of avoiding penalties under the Internal Revenue Code.