By Jason Bogniard, MBA, ASA, CVA, EA | Principal, Business Valuation
The concept of “Double Dipping” in divorce litigation is a fervently debated and quickly evolving issue in domestic relations courts across the State of Ohio, and the nation for that matter. So, what is double dipping and why should you care? Double dipping is only an issue in domestic relations litigation when one or both spouses are business owners and earn compensation or a return on their investment in the form of owner draws or shareholder dividends.
Double dipping occurs when the same stream of earnings is used by a business appraiser to determine the value of a business and then used again for purposes of establishing the income of the business owner when calculating the amount of spousal support to be paid.
Business appraisers employ three different valuation approaches in determining the value of a business enterprise including, the income, market, and cost (asset) approaches. No matter which approach an appraiser chooses, all valuation theory centers around the critical tenant that the value of a business enterprise is derived by estimating the future income stream of the business and then discounting that income stream back to a present value. Of the three valuation approaches, the most common approach that is affected by the double dipping concept is the income approach. Simply put, the income approach has two key inputs. The first variable is the estimated future sustainable earnings of the business. The second impact is the risk-adjusted rate of return an investor would require as compensation to invest in the business. Then the sustainable earnings stream is divided by the risk-adjusted rate of return to produce a value estimate for the company. Double dipping can occur in the market approach depending on the valuation multiple and income stream to which the multiple is applied. It is rare to find the double dip concept applying to the cost approach unless considerable intangible assets are valued under a derivative of the income approach.
A key element of any business valuation is the valuator’s determination of reasonable compensation of the business owner(s). Often, based upon independent evidence, a business valuation professional will find a company’s historical earnings need to be adjusted higher or lower to reflect a more reasonable level of owner compensation as compared to what the business actually paid. After an adjustment for reasonable owner compensation, the earnings above that amount are typically used in the valuation process. When owner compensation, distributions and other benefits paid on an owner’s behalf are included in the spouse’s income for spousal support calculations then a double dipping of those sources of income has occurred, once in the valuation of the business as an asset to be divided as marital property and then as income to be shared as alimony payments. From the business owner’s point of view, this is an unfair double counting of a single income stream. The non-owner spouse points to Ohio statute which states that for purposes of calculating support payments income “from all sources”[1] shall be considered by the court in awarding spousal support.
An illustration of the double dip in action in the income approach will help to underscore the potential impact on marital property and spousal support payments. For the below illustration, assume the business generates income before deducting owner compensation of $500,000, that the owner is paid out all business profit in the form of wages and distributions annually and that for valuation purposes, the business appraiser finds that a normalized owner wage is $350,000.
| IMPACT OF DOUBLE DIP ILLUSTRATION | ||
| With Double Dip | Without Double Dip | |
| Income Before Owner Wages | 500,000 | 500,000 |
| Normalized Owner Wages | (350,000) | (350,000) |
| Excess Business Earnings | 150,000 | 150,000 |
| Rate of Return | ÷ 20% | ÷ 20% |
| Business Value | 750,000 | 750,000 |
| Income Considered for Support | 500,000 | 350,000 |
| Income Double Counted | 150,000 | 0 |
Although the concept of double dipping has been around for many years, the first appeals court to address the issue head-on in Ohio was the Tenth District Court of Appeals in Heller v. Heller[2]. The Tenth District’s opinion in the first Heller v. Heller (there were two subsequent appeals on the issue of spousal support) the appeals court found:
“Trial courts may treat a spouse’s future business profits either as a marital asset subject to division, or as a stream of income for spousal support purposes, but not both.”2
There have been many other appeals court cases in the state of Ohio, including in the Tenth District, which has refined the original conclusions in Heller v. Heller. In the Ohio appeals court opinions that followed the majority opinions centered on the methods used in valuing the marital business asset, the concept of equity in divorce proceedings, the relative earning ability of the parties, the length of the marriage and that Ohio statute requires the consideration of income from all sources when establishing spousal support, to name just a few. The elements required to be considered by a trial court in awarding spousal support are beyond the scope of this article, but the reader can review the factors by referencing Ohio Revised Code 3105.18 (c) (1).
The most commonly cited Ohio appeals cases dealing with the issue of double dipping include the following:
| OHIO DOUBLE DIP CASES | ||
| Appellate Case | Valuation Approach | Double Dip Allowed |
| Heller v. Heller – 10th District | Income | No |
| Hetta v. Hetta – 5th District | Unknown | Yes |
| Ulliman v. Ulliman – 2nd District | Income | No |
| Bohme v. Bohme – 2nd District | Income | Yes |
| Eddington V. Eddington – 10th District | Asset | Yes |
| Gallo v. Gallo – 10th District | Income | Yes |
| Sieber v. Sieber – 12th District | Income/Asset | Yes |
| Potter v. Potter – 12th District | Market | Yes/Not in Record |
| Kellam v. Bakewell – 6th District | Market | Yes |
| Corwin v. Corwin – 12th District | Income | No |
| Settele v. Settele – 10th District | Asset | Yes |
| Bagnola v. Bagnola – 5th District | Unknown | Yes |
| Rossi v. Rossi – 8th District | Income | Yes |
Despite the conclusive tone of the first Heller appeals court opinion, there have been many other trial and appeals cases that followed, which offered conflicting conclusions on the permissibility and/or prohibition of double dipping. A layperson view of the subsequent opinions boils down to essentially that Ohio courts recognize that doubling dipping can occur when income and some market approaches to valuation are utilized in establishing the value of marital property, but that trial courts have wide latitude to accept or reject the use of excess business earnings in the calculation of spousal support based on the facts and circumstances of each matter.
[1] Ohio Revised Code Section 3105.8(c) (1) (a)
[2] Heller v. Heller, 2008-Ohio-32196, 2008WL2588064 (Ohio Ct. Appl 10th Dist. Franklin County 2008)