Washington State Appeals Court Addresses Double-Dipping
Family courts in many jurisdictions recognize that it may be inequitable to consider a spouse’s future income twice: first, when valuing a business interest to include in the marital estate and again, when estimating spousal maintenance payments. This presumed inequity is more commonly known as double-dipping.
When a marital estate includes a private business interest, many jurisdictions limit the amount of value that can be included in the marital estate when the business is valued using income-based methods. A recent case took a different tack: Washington’s Court of Appeals for the Second Division ruled that double-dipping isn’t an issue when the business is a going concern that generates net profits, distinguishing this case from others involving “diminishing” assets.
Based on this subtle interpretation of the law, the appellate court upheld the trial court’s asset allocation, which included a private business, and maintenance payments, which were determined using the husband’s distributions from the business. Here are the details. (Marriage of Cheng, No. 47937-1-II, Wash. App., November 22, 2016)
The Chengs were married in 1996 and separated in July 2013. The two primary assets in their marital estate were a personal residence and the husband’s consulting business, which he started in 2002.
The business has two components: a management consulting service for small business clients and a distance learning company that sells to recent graduates seeking employment in the management consulting industry. The second component, known as “case interview,” makes up the larger part of the business — and the husband has become a recognized expert in that field.
The business’s revenue increased from $275,000 in 2009 to $1.545 million by 2013. The business distributed over $927,000 in income to the husband in 2013, and he expected to receive a similar distribution in 2014.
Both spouses hired valuation experts who used the capitalization of excess earnings method to estimate how much the business was worth. Specifically, value was determined by:
- Projecting future income,
- Subtracting replacement income for the husband, other operating expenses and taxes, and
- Applying a capitalization rate.
The trial court split the difference between the experts’ opinions to arrive at a value of $3.6 million, and the court then allocated the value equally between the spouses. The trial court also noted that the business “has significant goodwill and profits, has experienced significant growth and will, more likely than not, continue to enjoy significant growth in the near future.”
The husband was unable to buy his wife’s interest outright. So, the trial court determined that he should make payments to her over a 15-year period, accruing 6% interest annually.
The court also awarded the wife $640,000 in spousal maintenance, payable over 44 months. The maintenance payments were determined using the husband’s annual distributions from the business.
The husband argued that the maintenance award resulted in double-dipping, because both maintenance and her property distribution of half of the business’s value were based on the business’s future income. The husband’s attorney cited two previous cases tried in Washington to support his argument, involving:
1. A salvage yard, which consisted of real property and scrap metal valued at $200,000 (the business didn’t plan to replace its inventory of salvage materials, so this value decreased with every sale), and
2. A firefighter, who didn’t own a business interest but owned a retirement account worth almost $74,000.
These cases differed from Marriage of Cheng for two key reasons. First, the assets the trial court divided in both of the cited cases were diminishing assets that didn’t generate any significant future income. Second, the only source of funds to pay maintenance in the cited cases was liquidation of the assets that had already been divided between the parties. So, in those two cases, double-dipping had clearly occurred. That is, the wives received a portion of the community asset and then received maintenance paid from the husband’s share of the same asset.
In Marriage of Cheng, the business is a going concern that the trial court believed would continue to grow. The court opined that annual income distributions to the husband wouldn’t diminish the business’s value — and he wouldn’t need to erode the value to pay maintenance.
In addition, the capitalization of excess earnings method that was used to value the business included an adjustment for the husband’s replacement income of $245,000. Although that amount isn’t sufficient to cover the wife’s maintenance payments in this case, the court focused on whether the husband’s actual income (approximately $927,000 in 2013) was enough to cover the maintenance payments. Regardless of the property distribution, the court ruled that the maintenance award was equitable and didn’t result in double-dipping.
The Bottom Line
The concept of double-dipping is frequently a source of disagreement in divorce cases. When a marital estate includes a private business interest and one spouse will receive maintenance payments, it’s important for both sides to understand and consider this issue. Contact your legal and financial experts for more information on how double-dipping is handled in your jurisdiction.
Important note: The rules and legal precedent related to equitable distributions of marital estates and other divorce-related matters vary significantly from state to state. Occasionally, when relevant state laws and legal precedent are limited (or nonexistent), attorneys may look to cases in other jurisdictions for guidance. So it’s important for experts and attorneys to be familiar with cases in other jurisdictions, not just their own. Always consult a legal professional before applying legal concepts from another case to your personal or business situation.
WILLIAM P. ALLEN, CPA/ABV, CFE
Bill is a member of the American Institute of Certified Public Accountants accredited in Business Valuations (ABV); a Certified Fraud Examiner (CFE) accredited by the Association of Certified Fraud Examiners; and the New York State Society of Certified Public Accountants. He has more than 5 years’ experience in public accounting serving both commercial businesses and nonprofit organizations. As a member of the Brisbane team, Bill is responsible for valuation, forensic accounting, and litigation support services. Bill is a graduate of Le Moyne College and has worked with our Firm since graduating in 2006.