“Double Dipping” Considerations in a Divorce When a Business Interest is at Issue

This Week’s Blog by Andrew M. Eliot.

“Double Dipping” Considerations in a Divorce When a Business Interest is at Issue

In some divorce cases, a business (or an interest in a business) that is owned by one spouse, and from which he or she receives income, also constitutes an asset to which a value must be ascribed so that the asset can be distributed between the parties in some manner as part of an overall division of property. In instances where both the value of a business interest must be divided, and an award of alimony in favor of the non-titled spouse might also be appropriate, the concept of “double dipping” must be carefully considered in order to avoid potential inequities that could otherwise result when resolving the two separate, but sometimes interrelated issues, of property distribution and spousal support.

What is Double Dipping Generally

Generally speaking, the concept of “double-dipping” refers to a situation in which one spouse is unfairly paid twice for a single asset; once in the context of property division and a second time as part of a spousal support award.

How Can Double Dipping Occur when a Business Interest is Being Divided?

When the value of a business interest must be divided in a divorce, there are a variety of valuation methodologies that can be employed to determine the value of the interest for property distribution purposes. While an exploration into the various valuation methodologies is beyond the scope of this article, one common valuation approach that is employed in the divorce context (and stated in very simplistic terms) is for the value of the business interest to be calculated as a function of the entity’s future stream of expected income.   It is in this context that “double-dipping” issues are most likely to arise.

Specifically, double dipping concerns can arise if the same cash flows that are used to determine the overall value of a spouse’s business interest are also considered a component of that spouse’s income for purposes of calculating spousal support. Stated differently, when a business is valued based upon the entity’s expected income stream, it would constitute double dipping to both distribute the value of the business and then also base spousal support on the full amount of income the business produces.

How Can Double Dipping be Avoided

While there is a variety of ways to address double dipping concerns that may arise when a business interest is being valued and divided, one common methodology is for a “reasonable compensation” or “replacement compensation,” figure to be attributed to the business owning spouse. This figure represents the hypothetical amount that the business would pay to an unrelated person to perform the same function as the business owning spouse. Then, in determining what amount of income earned by that spouse is available for spousal support purposes, only the “reasonable compensation” amount utilized, which would necessarily be some amount less than the business owning spouse’s total earnings. Relatedly, in determining a value for the business interest, the “reasonable compensation” amount is subtracted out from the business cash flows that are used to determine the overall value of a spouse’s business interest. As a result of this process (commonly referred to as “normalizing income”), the higher the reasonable compensation figure attributed to the business-owning spouse is, the lower the value of the business will be for distribution purposes and, conversely, the lower the reasonable compensation figure attributed to the business-owning spouse is, the higher the value of the business will be for distribution purposes.

Are Forensic Experts Utilized Where Double Dipping Issues Might Arise

Yes. In cases where business valuation and/or potential double dipping issues arise, it is crucial to involve a business valuation expert with expertise in these areas. Such experts can assist clients and attorneys in wading through and understanding these often complex and thorny issues.

Cases involving distribution of business interests and double dipping concerns are often complex and, in order to be handled properly, require a great deal of expertise and attention. At Broder & Orland LLC, we have extensive experience handling matters involving these issues and are poised to help clients achieve favorable and fair results when these issues arise.