"Double dipping”: More than poor table manners in divorce

When divorcing spouses own a business, that business is often the biggest — and most contentious — marital asset. One ongoing debate in divorce courts is: How do you balance spousal support payments with distributions of private business interests? Across the country, little consensus exists regarding the overlap of these payments.

This was the case in Steneken v. Steneken, a controversial 2005 New Jersey Supreme Court ruling that has raised eyebrows among family law practitioners and valuation professionals. In fact, three of the seven New Jersey Supreme Court justices dissented from the final ruling.

Whether or not you agree with this contentious decision, you cannot turn a blind eye. Judges commonly look outside their jurisdictions for guidance on this complex issue. So this high-profile case is relevant to divorce cases everywhere in the United States.

Double dipping - The term “double dipping” refers to a situation in which a spouse receives double-payment for a single asset. The double-counting concept is commonly applied to pension funds. Courts generally don’t permit a spouse to receive both an equitable distribution of pension assets and alimony based on pension income.

This issue is less clear when applied to business interests. For instance, courts in many jurisdictions have extended the double-dipping logic to a company’s goodwill. Depending on the state in which the divorcing spouses reside, some (or all) of the company’s goodwill may be excluded from the marital estate if the nonmonied spouse receives alimony.

In Steneken, the husband unsuccessfully asserted that his business’s future income was double counted by:

1. Increasing his business’s value to reflect salary normalization adjustments, and

2. Computing alimony based on his actual above-market compensation.

In addressing this issue, the court differentiated between the structural purposes of alimony and equitable distributions, based on New Jersey state law.

The purpose of alimony - The court found that the goal of alimony is to award the nonmonied spouse sufficient income to maintain a lifestyle reasonably comparable to the one enjoyed during the marriage.

The Stenekens enjoyed a lavish lifestyle that included a large house, frequent vacations and luxury vehicles. The court concluded that alimony based on the husband’s actual take-home pay — rather than a lesser amount based on the husband’s replacement compensation — would allow the wife to maintain her marital lifestyle.

The purpose of equitable distributions - According to Steneken, equitable distributions seek to fairly divide marital assets. They are intended to be additions to, not substitutes for, spousal support payments.

Understanding an asset’s fair market value is paramount to making equitable distributions. Normalization adjustments are customary when valuing a controlling interest in a private business using the income or market approach. For example, a company’s historic income stream might be adjusted for revenues and expenses that are nonrecurring, unusual, or recorded at above- or below-market rates.

In a footnote to the Steneken ruling, the court noted, “Nothing in this opinion restricts the parties’ later right to seek modification of the alimony award based on changed circumstances, including salary deferrals designed to fund needed capital improvements in [the business].”

In other words, Steneken did not preclude a monied spouse from challenging alimony awards based on above-market salaries that unduly drained business resources, thereby compromising the company’s value.

The lessons learned - Steneken doesn’t prohibit divorcing spouses from using replacement compensation for both business valuations and alimony computations. Instead, fairness should be the overriding objective. To achieve fair outcomes, courts consider the unique facts and circumstances of each divorce case.

When divvying up a private business, the nonmonied spouse often receives less than half of the business interest’s value. For instance, in Steneken, the wife received only 35% of the business’s value. Possible factors affecting this percentage include:

• Whether normalization adjustments were made for excess owner compensation and perks,
• How long the parties were married,
• When the business interest was acquired,
• How each spouse contributed to the business during the marriage,
• If the business were sold, whether it would incur significant built-in capital gains taxes,
• Whether the monied spouse’s compensation — or, indirectly, his or her marital lifestyle — adversely impacts the value of the business via forgone investment opportunities or neglected capital improvements, and
• Whether the business’s value includes personal or business goodwill.
• Finally, the business valuation discounts, such as lack of control, lack of marketability or key person discounts, can affect the percentage of the business the nonmonied spouse receives.

Uncertainty rules - As Steneken demonstrates, courts generally refrain from imposing rigid rules prohibiting double dipping in cases involving closely held businesses. Instead, they are more likely to adopt a flexible approach to handling the overlap between alimony and equitable distributions. In fact, court rulings vary widely.