In Seinfeld, when George Costanza double dips his chip while attending a wake, he is getting two servings of dip using just the one chip. This creates an unpleasant situation for others, as it’s “like putting your whole mouth right in the dip”. In divorce cases, double dipping works the same way, except the dip is now money and one spouse is receiving two payouts based on the same asset. In both cases, double dipping represents a scenario that is unfair to everyone else involved, except for the double dipper themselves of course.
For an asset such as a pension, double dipping is easy to understand. If a party acquired a pension during the marriage, their spouse may be entitled to half of the pension’s value at the time of divorce. If the receiving spouse were to later request additional compensation once the pension starts paying out, that would be considered double dipping. Since the future payout was included in the pension valuation at the time of divorce, the receiving spouse would have already received fair compensation at that time.
Unfortunately, when the asset is a business, things become more complicated. In such circumstances, a double dip will occur when the same income stream is used both for marital distribution purposes as well as for spousal support calculation. Double dipping in this regard results from the very nature of the business valuation process which will often include factoring in the spouse’s compensation as part of the valuation of the business itself.
A common misconception of business valuations is that the value of a business is based on past performance. The truth is, while past performance is often used, it is done as a historical reference to assist in determining the present value of future performance. There are several approaches and methods for valuing a business including the asset, income, and market approaches (see our article on the Elements of a Business Valuation ) Most of these methodologies utilize the revenue stream and owners compensation, at least in some part, in determining value. When the appraised value is used, without appropriate adjustments, in determining both the marital distribution and spousal support, double dipping may occur.
Let’s consider a business that generates $250,000 per year in net cash flow with a fair market value of $1,250,000 capitalized at 20%. The owning spouse receives $150,000 per year in salary (with no other distributions),but the market rate of compensation is only $100,000. Adjusting the business value for the difference in compensation yields a fair market value (FMV) of $1,500,000. As such, the non-owning spouse is entitled to $750,000 for a 50% distribution. The problem here arises when using the owner’s actual annual compensation amount of $150,000 to determine spousal support. In doing so, this would mean that the non-owning spouse would be entitled to $75,000 a year in spousal support (the present value amount or lump sum value of support at 20% being $375,000). Using this scenario, the non-owning spouse would receive $1,125,000 in total value. This is double dipping since the owner’s salary is being counted twice, once during the valuation of the business and once for support purposes.
There are two options that eliminate the double dip:
Adjust the business value for compensation and base the spousal support on the owner’s compensation at the market rate:
Do not adjust the business value for compensation and base the spousal support on the owner’s actual compensation:
While the concept of double dipping appears logical, not all states have the same rules or have addressed the issue. Take a lesson from George; to avoid ending up in a divorce proceeding equivalent to a fist fight at a wake, make sure that you consult with your business valuator to ensure that the correct methodologies and adjustments are used for your specific jurisdiction.