Basics of Pennsylvania Law: Double Dip, Part V

This is the last in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

Steneken v. Steneken, 873 A.2d 501 (N.J. 2005).

            Although it is not a Pennsylvania decision, no discussion of double dipping would be complete without Steneken, a 2005 decision of the New Jersey Supreme Court. In this case, the husband was the sole owner of a business which was marital property subject to equitable distribution. The valuation expert performed a normalization of the owner’s compensation in his report, reducing the company’s salary expense and thereby increasing the value of the company. In determining an alimony award, the husband argued that the court should consider his lower, normalized compensation instead of his actual salary (since the excess compensation had been capitalized as part of the business valuation and divided as marital property). The trial court accepted the husband’s argument and used his normalized salary instead of his actual salary.

            An appeal ensued, and the case was remanded to the trial court because the intermediate appellate court held that the record was not fully developed. On remand, the trial court reversed its earlier position and used the husband’s actual salary to determine the proper amount of alimony.

            The intermediate appellate court, reviewing New Jersey’s divorce statute, held that the prohibition on “double dipping” extended only to pensions and affirmed the trial court’s decision. The husband appealed to the New Jersey Supreme Court to extend the principle to double dipping arising from the capitalization of earnings in the context of a business valuation. Since an income capitalization approach had been used by the valuation expert endorsed by the trial court, and was not challenged, the husband argued that he should not have to pay alimony from the excess compensation that had been capitalized and distributed as part of the value of the business.

            The New Jersey Supreme Court disagreed, affirming the trial court’s decision to permit double dipping. Rather than adopting the intermediate court’s rationale, the New Jersey high court attacked the husband’s reasoning.

The logical flaw in defendant’s argument lies at its core. Defendant mistakenly equates the statutory and decisional methodology applied ni the calculation of alimony with a valuation methodology applied for equitable distribution purposes that requires that revenues and expenses, including salaries, be normalized so as to present a fair valuation of a going concern. Simply said, defendant’s charged mischaracterization of the issue here as one of “double counting” both misstakes the issue and ignores the fundamental principles that undergird related yet nonetheless severable alimony and equitable distribution awards.  As our statutory framework and decisional precedent make clear, the proper issue is whether, under the circumstances, the alimony awarded and the equitable distribution made are, both singly and together, fair and consistent with the statutory design. . . . Because we embrace the premise that alimony and equitable distribution calculations, albeit interrelated, are separate, distinct, and not entirely compatible financial exercises, and because asset valuation methodologies applied in the equitable distribution context are not congruent with the factors relevant to alimony considerations, we conclude that the circumstances here present a fair and proper method of both awarding alimony and determining equitable distribution.

 

            The New Jersey court’s opinion is not convincing; other reasons might have been more forceful. For instance, the court might have started with the observation that a business valuation expert ordinarily has no expertise in executive compensation. To identify part of the owner’s salary as excessive is tantamount to saying that the business could hire someone to do the job for less, or conversely, the owner would earn less if he or she sought employment elsewhere. Such determinations are beyond the expertise of most valuation experts, and should not be relied upon to determine the owner’s earning capacity for alimony and support purposes. Yet, if those normalization adjustments are not suitable to determine the owner’s earning capacity, why should we rely on them for the business valuation?

            The New Jersey court noted that if a different valuation methodology had been applied, there might be no normalization adjustment to the owner’s salary. That is true, in the case of an asset approach. However, an asset approach assumes liquidation of the company, not ongoing concern value. The owner’s excess compensation does not get capitalized under the asset approach, so there is no possibility of double dipping. In the market approach, normalization of the income statement or cash flow is performed before applying a multiplier. Therefore, the potential inconsistency perceived by the Court is illusory.

            In a vigorous and well-reasoned dissent, three of the seven Justices enunciated a compromise position: that the trial court need not use normalized compensation when computing the owner’s alimony obligation but should have discretion to adjust the value of the business or the alimony award to alleviate the double dip.

Advertisements

Basics of Pennsylvania Law: Double Dip, Part IV

This is the fourth in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

McFadden v. McFadden, 563 A.2d 180 (Pa.Super.1989).

            McFadden was a post-divorce alimony modification proceeding.  In this case, the husband’s pension annuity benefit was in pay status, and he was receiving the entire pension benefit. Yet, the court found that the husband’s pension had not been identified as marital property at the time of equitable distribution. Therefore, the Superior Court did not reverse the trial court’s calculation of the husband’s income, which included the pension benefit. Most troubling, in dicta, the Superior Court held (per Popovich, J.): “[I]t is equally clear that income from a pension is to be considered when fashioning an alimony award, even if the pension was previously subjected to equitable distribution. See 23 Pa.S.A. § 501(b)(3), (10), (13); Pacella v. Pacella, 342 Pa.Super. 178, 190, 2492 A.2d 707, 711-712 (1985)(court did not err in consideration earlier equitable distribution property in fashioning alimony); Braderman, 488 A.2d at 620 (pension subject to equitable distribution also may be used to calculate alimony award).”

Basics of Pennsylvania Law: Double Dip, Part III

This is the third in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

Miller v. Miller, 783 A.2d 832 (Pa. Super. 2001)

In Miller, the parties settled their division of property, and Wife subsequently sought a modification of child support based on the income that Husband derived from the sale of his share of marital assets. The Superior Court held that the proceeds from the sale of assets were not “income” within the statutory definition. The Superior Court affirmed the trial court’s refusal to modify child support when the payor received proceeds from the sale of marital assets after the divorce and division of property. The double dip in Miller was another reason for the Court’s decision.

Rohrer v. Rohrer, 715 A.2d 463, 465 (Pa. Super. 1998).

            Rohrer was the first published decision to prohibit double dipping in Pennsylvania. (Interestingly, the opinion was written by Judge Popovich, who had held in McFadden that double dipping was permitted.) In Rohrer, the husband was an owner of a business organized as a Subchapter “S” corporation. At an early stage of the proceedings, the pass-through earnings of the business were included in the husband’s income when calculating his support obligations. At equitable distribution, the husband asked the master to exclude retained earnings from the value of the business, in order to avoid double dipping. Husband’s request was granted by the master, but only to the extent that retained earnings from the date of the support order forward into the future were excluded. The retained earnings that accrued prior to the support order were counted as part of the value of the business.

            The trial court reversed the master’s decision and excluded all of the retained earnings. On appeal, the Superior Court reversed and adopted the master’s finding. The Superior Court held that “money included in an individual’s income for the purpose of calculating support payments may not also be labeled as a marital asset subject to equitable distribution.” Rohrer, at 465.

Basics of Pennsylvania Law: Double Dip, Part II

This is the second in a series of posts containing summaries of Pennsylvania case law on the issue of double dipping in divorce. “Double dipping” occurs when an income-producing asset (such as a pension or business) is counted as marital property subject to equitable distribution, as well as income subject to an alimony or child support obligation.

Cerny v. Cerny, 656 A.2d 507 (Pa.Super.1995).

            Prior to separation, the husband received a cash severance payment, which was counted as income in determining his support obligation. The severance payment was excluded (in a prior, unpublished Superior Court decision) from the marital estate to avoid double dipping. Subsequently, the IRS issued a tax refund to the husband, as the severance payment was not taxable income. The trial court held that the tax refund should be counted as marital property. On appeal, the Superior Court reversed, holding that the tax refund retained the same nonmarital nature as the income from which it was derived. The opinion does not reveal whether the tax was deducted from the payor’s income when determining his support obligation, but if so, then the result may have been inequitable.

Basics of Pennsylvania Law: Double Dip, Part I

The concept of a “double dip” is logical and intuitive. If an income-producing asset has been awarded to a party in equitable distribution, the same asset cannot be counted as a source of income from which alimony may be paid. For instance, a pension in pay status cannot be counted as income for alimony purposes if it was also a marital asset that has been divided in equitable distribution. This concept has been recognized and adopted by the Pennsylvania courts at the trial and appellate levels. Butler v. Butler, 541 Pa. 364, 663 A.2d 148, 156 (1995)(professional goodwill); Diament v. Diament, 816 A.2d 256, 277 (Pa.Super.2003)(advance of marital assets); Miller v. Miller, 783 A.2d 832 (Pa.Super. 2001)(proceeds from sale of marital property); Rohrer v. Rohrer, 715 A.2d 463 (Pa.Super. 1998)(retained earnings of a business); Kokolis v. Kokolis, 83 Pa.D. & C.4th 214 (Ally. 2006)(pension in pay status), affirmed, 927 A.2d 663 (Pa.Super. 2007); cf. McFadden v. McFadden, 563 A.2d 180 (Pa.Super.1989)(pension in pay status).

This post is the first of a series describing Pennsylvania case law concerning the double dip.

Berry v. Berry, 898 A.2d 110 (Pa.Super.2006).

The husband in this case was terminated from his employment as a partner in an accounting firm just weeks after the commencement of a support claim within a divorce action. Upon his termination, the husband received a distribution of his partnership capital account plus a cash severance payment equal to seven months’ base salary. The wife argued at the trial court level that neither of these items should be included in the husband’s income when determining his child support obligation. (The husband had secured other employment paying a salary sufficient to justify a Melzer analysis.) The trial court held that the capital account distribution and cash severance were income for support purposes. The wife appealed, prompting the Superior Court to vacate and remand the case.

The Superior Court held that the partnership capital account was marital property which should not have been included in the husband’s income because doing so would constitute a double dip.  On the other hand, the Superior Court held that the cash severance payment was strictly income. In its decision, the Court distinguished between money earned prior to the marital separation (in this case, a partnership capital account) and money acquired after separation (in this case, a severance payment). Since the partnership capital account was acquired prior to separation, it fell within the statutory definition of marital property. The cash severance acquired after separation did not.  The Superior Court held that the capital account was marital property while the severance payment was income. In both of its findings, the Superior Court refused to double dip.

Double Dipping … again

At the Pennsylvania Bar Association Family Law Section Winter Meeting 2009, which took place at the William Penn Hotel in Pittsburgh this weekend, a panel of judges, lawyers and CPAs discussed hot topics in family law and business valuation. One of the hot topics, presented by Pittsburgh valuation professional Richard F. Brabender, was double dipping. Specifically, this seminar discussed the theoretical/academic argument (which I have advocated in this blog) that a double dip exists where capitalized income which has been divided between the spouses as marital property is also counted as income for child support or alimony purposes.

Clearly, if there is a pension in pay status which is valued on the date of trial, and the pension annuity benefit is counted as income for calculating post-divorce alimony, the court has divided the same stream of income twice – a “double dip.” This same problem exists where business profits have been capitalized as part of the valuation process and also included in the business owner’s net income for child support and alimony purposes.

The twist that Dick Brabender brought to light in his presentation was the double dip that may occur during the separation, where the owner’s compensation substantially exceeds a market salary. For instance, if a business owner is drawing $500,000 per year from the business, but could hired a newly-minted MBA (because we all know how they can improve any business) to do the owner’s job for $70,000 a year, then the owner is receiving excessive compensation of $430,000 per year. Why shouldn’t the business owner’s spouse get 50% of the excess compensation during the separation period as an advance against his or her share of the marital property (assuming the business is entirely marital), subject to re-allocation at the time of trial? (The excess compensation would then be excluded from both spouses’ incomes for support purposes.) This is the likely result if there were a marital pension in pay status, which could be divided 50/50 during the pendency of litigation as an advance of marital property.

In order to accomplish this interim division of the business income stream, the court would have to conduct a hearing to determine that the owner’s compensation were excessive, something the court is unlikely to decide in motions court. Moreover, the excess compensation hearing would have to occur prior to the support or maintenance hearing so that there were no inconsistencies between the support order and the property advance. One of the panelists, eastern Pennsylvania lawyer Mark Ashton, suggested that the court would also have to look at whether the rents being paid by the business to the owner were consistent with market levels, whether the owner were working more than 40 hours a week, etc. Suddenly a simple hearing to determine a property advance has become a multi-day trial with multiple expert witnesses!

Another panelist, Jay Blechman, suggested an alternative: a lookback at the time of the final property division trial. In other words, if it were proven at the end of the case that the owner’s compensation during the pendency of litigation was above-market, then the court could re-designate the excessive income as marital property and award an incremental amount to the owner’s spouse. In Pennsylvania, a business owner’s spouse without children would receive 40% of the income stream as support or maintenance, but if the excess compensation were marital property, the spouse might 50%, 55% or more. So, Jay Blechman suggested that the business owner’s spouse could get 40% during the pendency of the case, and an additional 10%, 15% or more of the excessive compensation at the end of the case.

No case law supports this idea yet.

Variations on a Double Dip Theme: The Moore Case

The Tennessee Court of Appeals issued a decision in May 2006 that addresses the lingering question of whether gains from the sale of marital property may be included in income for child support purposes: the old “double dip” dilemma. In Moore (2006), the partial owner of a cycle shop settled his divorce in 1991, retaining his interest in the business as part of his equitable distribution. Child support was set at the time of the divorce, and modified later based on an increase in the owner’s salary.

Years later, the business owner sold his interest in the cycle shop to his sister, who was the other owner. In exchange for his interest and a non-compete clause, the seller received 20% of the sales proceeds up front and a five year note in monthly installments with interest. When the former wife of the seller filed a petition for modification of child support, alleging an increase in the father’s income due to the sale of the business, the trial court determined that the sales proceeds should not be included in his income for support purposes.

On appeal, the Tennessee Court of Appeals noted that the statutory definition of income in that state includes “capital gains.” Yet, the father in this case relied upon a Tennessee precedent that excludes “isolated capital gains” from income. Moreover, Father cited a Tennessee law which provides that “assets distributed as marital property will not be considered as income for child support or alimony purposes, except to the extent that asset will create additional income after the division.”

The Tennessee Court of Appeals remanded to determine what portion of the proceeds received by the husband from the sale of his business interest could be considered “additional income” under Tennessee law. At first blush, it appeared that the Tennessee court blurred the distinction between the net income or profits generated by a business (which are included in the value to be divided in an equitable distribution proceeding) and passive income such as interest, dividends and capital gains on marketable securities (which are truly “created” after the division of property).

Yet, the Moore opinion set forth a methodology which intentionally or unintentionally measures the portion of the sales proceeds that were not divided in equitable distribution. The appellate court held that the difference between the actual sales proceeds and the value used in equitable distribution should be divided pro rata over the five year payback period as “additional income.” In essence, the Tennessee court pro-rated the margin of error between the valuation and the actual sale price. That seems to be an appropriate way of capturing the difference between theory and practice.