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Double Dip and Goodwill Considered by Wisconsin Supreme Court

by bvertz on Aug 15, 2011 • Comments Closed •

Last month the Wisconsin Supreme Court weighed in on two issues that are important to family lawyers and their clients who operate professional practices like physicians, lawyers, dentists and accountants. In Marriage of McReath, the Wisconsin Supreme Court ruled that “saleable” goodwill would be considered marital property, in a case where a dentist argued that “personal” goodwill should not be counted as part of the marital estate. The Court also held that it was not double dipping to include the dentist’s business earnings as part of his income for post-divorce alimony, after dividing the fair market value of the business based on capitalized earnings.

Lawyers, judges and valuation professionals use many different terms – often imprecisely – to describe goodwill, the intangible value of a business that exceeds the value of hard assets like inventory, equipment and receivables. Some courts distinguish between “enterprise” goodwill and “personal” goodwill; other refer to “professioinal” goodwill. As lawyers and judges have advanced along the learning curve, their usage of these terms has improved. Still, the historical record remains a fertile source of confusion.

Wisconsin’s highest court, and the advocate who must have guided the Court’s analysis, Richard J. Auerbach, Esq., of Madison, admirably honed in on the most important aspect of goodwill: whether it is transferable to a buyer. In this case, the husband had purchased two dental offices for a purchase price of more than $900,000. Thirteen years later, Wife’s expert opined that the practice was worth just under $1.1 million and testified that much of the value would be associated with a noncompete clause. While recognizing that some of the saleable goodwill might be fairly characterized as “personal” goodwill, the Supreme Court refused to assume that personal goodwill is necessarily nontransferable. The fact that Husband purchased his practice from another dentist, in a transaction where most of the purchase price was allocated to goodwill, was proof enough that personal goodwill may be transferable.

Unfortunately, the Wisconsin court’s analysis of double dipping was not especially well-reasoned. The Court made little effort to rebut Husband’s argument that it should not include earnings from the dental practice in his income when determining post-divorce alimony, after having divided up the fair market value of the business based on capitalized earnings. The Court cited its own precedent where it cautioned about an inflexible application of the prohibition against double dipping, given the “infinite range of factual situations facing circuit courts in dividing property.” The Supreme Court found that a business is more like an income-producing investment than a pension.

Actually, that analogy does not hold up upon close scrutiny. The value of an investment is equal to the account balance on a particular date, and any interest income generated after that date would be counted as income to the owner of the investment because it can be consumed without decreasing the principal of the investment. If the interest or dividends generated by an investment are counted as income, there is no double dip. On the other hand, a pension is valued by taking the net present value of the future annuity payments. Theoretically, the value of the pension is diminished as payments are received. Therefore, pension payments cannot be counted as income if the pension has been divided as property.

Generally, a business is valued in the same manner as a pension. The value of the business is equal to the net present value of the cash flow or profits that the business generates. A business valuation is a hypothetical sale of the businessin which  the owner sells the business to a hypothetical buyer, who might retain the owner as a employee (paying “reasonable market compensation”) or simply hire a new employee to do the owner’s job. If the business is sold, the owner is not entitled to receive profits, so counting those earnings as income for alimony purposes is clearly double dipping. The Wisconsin court got it wrong.

To get even more sophisticated, the courts might have examined what a dentist like this gentleman was capable of earning as an employee of someone else’s dental practice. Alimony based on earning capacity would not be a double dip. It may be reasonable to believe that a professional could sell his practice and go to work for someone else. The salary that the professional could earn elsewhere might be equal to the “reasonable compensation” that a hypothetical buyer would pay to a replacement employee, or it might be more or less (depending upon the hours, duties and skills that the owner would bring to his new job).

Furthermore, the court might consider the investment return that the owner, having sold his business for cash, would earn on the sales proceeds. That argument might have gotten more traction ten years ago than today (when CD’s pay less than 1%) but it is still worth considering.

Homeschooling Children Does Not Justify Alimony, says Superior Court

by bvertz on Mar 19, 2011 • Comments Closed • , , , , ,

In Kent v. Kent (March 18, 2011), the Superior Court of Pennsylvania rejected a parent’s argument that she should be entitled to collect alimony for a period of eleven years so that she could continue to homeschool the parties’ minor children. It was undisputed in this case that the mother had withdrawn from the workforce five years earlier in order to home-school the parties’ children, which she continued to do up to the date of trial. The wife had resigned her position as a teacher and began to collect a reduced public pension in order to supplement the family’s finances. The husband argued that homeschooling was not a joint decision and did not require so much of wife’s time as to prevent her from working. The trial court awarded alimony to wife for a period of three years rather than the requested eleven years.

On appeal, the Superior Court cited the paucity of controlling case law. The Court observed that a body of law concerning the payment of private school tuition (Fitzgerald, Gibbons, et al) did not control, since those cases were governed by the child support guidelines, not the statutory alimony criteria (where a spouse’s ability to become self-supporting through appropriate employment is paramount). Instead, the Court relied upon a decision of the Arkansas Supreme Court, holding that alimony was appropriate where the homeschooling parent had no employable skills, education or experience.

Examining the wife’s work history in this case, the Superior Court affirmed the trial court’s finding that the homeschooling wife was capable of returning to work within three years. The Court also endorsed the husband’s reasoning that economic decisions made during coverture might no longer be viable when an intact family breaks into two separate households. The Court emphasized that its decision was not motivated by a policy against homeschooling, but a simple affirmance of the trial court’s application of statutory criteria.

What’s the Hullabaloo about Balicki?

by bvertz on Dec 12, 2010 • Comments Closed •

In Balicki v. Balicki, 2010 Pa.Super.134 (2010), the Superior Court affirmed the trial court’s decision to discount the value of an insurance business, based on the hypothetical income taxes that would be incurred by its owner upon sale of the business. The trial court’s decision was itself a reversal of the master’s report, in which the master found that the tax discount was inappropriate because the owner would not likely sell the business (which had been in the family for more than two generations).

The decision is based on the 2005 amendments to the Pennsylvania Divorce Code (specifically, § 3502(a)(10.1) and (10.2)), which require the divorce court to consider tax consequences and costs of sale associated with marital assets, even if those taxes and costs are not imminent or certain. Balicki is also the result of an “abuse of discretion” standard of appellate review in Pennsylvania divorce cases, which affirms the trial court’s decision unless it is manifestly unreasonable.

In the September/October 2010 edition of The Value Examiner, the magazine of the National Association of Certified Valuation Analysts (NACVA), authors Meg Holland and Maureen Thomas proclaim that Balicki will affect divorce cases across the United States. In their article, the authors draw a parallel that may be difficult for some (even me, an experienced divorce lawyer and accredited valuation analyst) to follow.  Balicki, they say, is the antithesis of Bernier, a 2007 Massachusetts Supreme Court decision that established “fair value” (as opposed to fair market value) as the value standard in Massachusetts divorces.

Balicki is no Bernier, however. First, Balicki is an intermediate appellate court decision, the opinion of three out of the fifteen Superior Court judges, not a Supreme Court decision. Second, Balicki does not change the value standard in Pennsylvania (not that Holland and Thomas are saying that; they aren’t). Sure, Balicki has been interpreted in some outposts as the death knell for the argument that tax discounts may be ignored in cases where the owners never intend to sell. Yet, many of us read Balicki as a decision that stands on its own factual and evidentiary record. The panel in Balicki specifically found insufficient evidence to prove that the owner of the insurance business would never sell. In spite of Balicki, I still maintain that tax and sales cost discounts are not mandatory in every business valuation case.

I would also venture to guess that the wife’s camp did not argue strongly enough that the taxes and expenses were already considered as part of the marketability discount in the business valuation. Had that argument been made cogently at the master’s level, it is possible that the master and trial court would have adopted that position, and the Superior Court under an abuse of discretion would have affirmed.

The Holland and Thomas article leads to some interesting topics for reflection, such as: how do you calculate the hypothetical taxes that a seller would incur when selling an equipment-intensive business whose equipment was fully or greatly depreciated? The depreciation recapture analysis would seem to require a good equipment appraisal.

The Valuation Examiner article also contains an outright mistake: the authors state incorrectly that § 3502(a)(10.1) and (10.2)  were enacted in 1988, prior to the Pennsylania Supreme Court’s decision in Hovis (1988), which held that tax consequences could not be considered unless imminent and certain. (Actually, those statutes were enacted in 2005. The 1988 recodification of the Divorce Code was silent on the tax issue.)  The authors go on to say that three subsequent divorce decisions, including two out-of-state Supreme Court decisions, were incorrectly decided in reliance on Hovis, which the authors mistakenly regard as bad law.

Of course, Hovis was the law of Pennsylvania until the Pennsylvania Legislature enacted § 3502(a)(10.1) and (10.2) in 2005. During our discussion at the 14th Annual Family Law Update (November 2010), it was the consensus of four leading divorce lawyers that Balicki was an unremarkable decision.  It just means that the next lawyer who wants to argue that tax discounts should not be applied must work that much harder. Still, let’s see what happens in January 2011, when the PBA Family Law Section devotes an entire 90 minute seminar to this case.

10 Cash Flow Rules In Divorce (Part I)

by bvertz on Sep 28, 2010 • Comments Closed • , , , , , , , , ,

In business, they say, cash flow rules. The same principle is true, I find, in divorce. I have been brainstorming a set of cash flow “rules” for divorcing spouses. Here is part one:

1.  Never run out of cash. My #1 divorce rule is the as Inc Magazine‘s #1 business rule. In divorce, there is a period of time immediately following separation when a divorcing spouse’s cash flow may be particularly vulnerable. Spouses who are not working need to know that litigation might drag on for weeks before the support payments will begin. In order to meet routine financial obligations (bills, loans, credit cards), divorcing spouses should be sure to have a two months’ supply of cash before separating.

2. When it is impossible to increase income, reduce spending. Some divorcing spouses expect to preserve the standard of living they have always enjoyed, but it is just not possible.  In fact, the law does not guarantee it.  Our judges know that two households cannot be run as cheaply as one, so it is necessary to cut corners. Many families are living beyond their means or just scraping by. Divorce did not create the problem and cannot solve it. If your cash flow is not enough to pay the expenses, you must reduce expenses.

3. House-poor or pension-poor is just plain poor. Liquidity is a valuable resource. Some divorcing spouses insist on keeping a house or pension instead of assets that can be converted to cash more easily. Kids can’t eat a house. A pension won’t pay the light bill if you are 45 years old. Even though you may have worked your whole life to earn that pension or create a great home for your kids, you might be better off trading it away or selling it to generate cash that will pay the bills. You will sleep better at night.

4.  Credit borrowing does not equal cash flow. Loans and credit cards are temporary – and very expensive – ways of dealing with inadequate cash flow. By borrowing, you may be digging a deeper financial hole for your future. Do not borrow unless you have a sure means of paying off the loan or credit card within a year or less.

5.  Build earning capacity. We have all heard the story about the father who is refusing overtime at work so that he will not have to pay more child support or the mother who is waiting until the divorce is concluded before she returns to college. It might seem like an attractive strategy, but it always backfires. The sooner that you enhance your cash flow, the sooner you will restore your financial stability.

Alimony Tax Gross-Up Approved

by bvertz on Aug 9, 2010 • Comments Closed • , , ,

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.

Pennsylvania: Alimony Factors

by bvertz on Feb 3, 2010 • Comments Closed • , , , , , , , , ,

What factors inflence a spouse’s eligibility for alimony after divorce under Pennsylvania law?

Under Pennsylvania law, post-divorce alimony “is a secondary remedy . . . available only where economic justice and the reasonable needs of a party cannot be achieved by way of an equitable distribution award and development of an appropriate employable skill.” These are the well-known words of the Superior Court of Pennsylvania in its Opinion in Nemoto v. Nemoto, 620 A.2d 1216 (Pa.Super.1993). Most of the important concepts in alimony jurisprudence are covered in this sentence. First, the trial courts must attempt to divide marital property in a way that avoids the need for post-divorce alimony. Why? Because the courts encourage a complete cessation of financial ties between divorcing spouses. If enough property (particuarly income-generating property) can be conveyed to a divorcing spouse, then that property can fulfill all of the spouse’s economic needs without the financial “umbilical cord” of alimony.

  • The value of the assets and liabilities distributed to each of the parties must be considered before awarding alimony. 23 Pa.C.S. § 3701(b)(10), (16); Fee v. Fee, 496 A.2d 793 (Pa.Super. 1985).
  • In its determination of alimony, the trial court must consider the income generated by a spouse’s marital and nonmarital assets. Ressler v. Ressler, 644 A.2d 753 (Pa.Super. 1994).

Second, our Courts encourage spouses to maximize their earning capacity and income potential through appropriate employment. In the first decade of the Divorce Code, enacted in 1980, the law provided that alimony could be awarded only for rehabilitative purposes, such as paying for college or vocational training. Alimony was not permitted in Pennsylvania prior to 1980, and the legislators who enacted the  Divorce Code worried that spouses would lose their incentive to become self-supporting if they could easily receive post-divorce alimony. The alimony law has been revised since 1980, allowing alimony for other reasons, such as meeting the budgetary shortfall of a spouse who is incapable of self-support. Still, the old law remains a strong influence among judges and lawyers in Pennsylvania. Several attempts to modernize the alimony law have failed, primarily because they might reduce a spouse’s incentive to go back to work. 23 Pa.C.S. § 3701(b)(1), (9), (17).

  • The Court imputed an earning capacity to a dependent spouse who devoted her time to an unproductive start-up business instead of seeking gainful employment. Thomson v. Thomson, 519 A.2d 483 (Pa.Super.1986).
  • An award of alimony for ten years was deemed excessive when a college education leading to a self-supporting job would require just four years. Barrett v. Barrett, 614 A.2d 299 (Pa.Super.1992).
  • In cases where there is no evidence of an impediment that would prevent a spouse from becoming self-supporting, the court is authorized to limit an alimony award. Adelstein v. Adelstein, 553 A.2d 436 (Pa.Super.1989).
  • In cases where a spouse’s earning capacity was limited by a medical disability or the disability of a custodial chid, Soncini v. Soncini, 612 A.2d 998 (Pa.Super.1992), the court may decline to impose a full time earning capacity upon a dependent spouse, justifying an award of alimony.

Finally, the law looks to the reasonable needs of a spouse. After a divorce, each spouse must have sufficient cash flow to meet his/her monthly household expenses. Yet, judges realize that two households cannot exist as cheaply as one combined household. The marital standard of living is just one of the seventeen statutory criteria for alimony awards, and in practice, it is one of the least influential. The expenses associated with custody of a child is more influential in an ex-spouse’s request for alimony. Just as important is the ability of a dependent spouse to become self-supporting through appropriate employment and the financial hardship that alimony may cause to the payor. When determining the amount and duration of an alimony award, the courts scrutinize the budget of a spouse seeking alimony carefully. 23 Pa.C.S. § 3701(b)(7), (8), (13).

  • The Court will not allow an award of alimony that would divert twice as much income to the alimony recipient as the payor, which would allow her to enjoy a better standard of living than she had enjoyed during the marriage Ressler v. Ressler, 644 A.2d 753 (Pa.Super.1994).

Marital misconduct is just one of the seventeen factors in awarding alimony, and it has remained one of the least influential since the enactment of the Divorce Code. 23 Pa.C.S. § 3701(b)(14); Nuttal v. Nuttal, 562 A.2d 841 (Pa.Super.1989).