Business Valuation

Apr 2023 : Holder’s Interest Value to the Owner Cuts Both Ways

Posted by Joseph W. Cunningham, JD, CPA

View / Download April 2023 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal

The Michigan Court of Appeals has ruled in a number of cases that, if is a business providing personal services is worth more to the owner than the price at which it could be sold, the value for divorce purposes is value to the owner – sometimes called “holder’s interest value” – on a going concern premise unless there is reason to believe the enterprise will be sold or discontinued.

But what about the reverse situation – the sale value – that is, fair market value (FMV) – is higher than the value to the owner?

Premise of Value to Owner

If there is no intent to sell or discontinue a business or professional practice, it should be valued for divorce based on its intrinsic value to the owner on a going concern basis. The financial benefits from that value are what have been conferred on the family while intact and will be conferred solely on the owner post-divorce.

Support – Kowalesky, 148 Mich App 151 (1986) and several other Court of Appeals (COA) cases.

Logic – If there is no intent to sell, under what rationale should any value other than the value based on current financial benefits provided by the business be used in a divorce settlement?

No other value is relevant to this family or, hence, to this divorce.

However, Value to Owner Cuts Both Ways

Value to Owner Higher than FMV – The value of a neurosurgeon’s practice – dependent solely on established referral sources to this particular doctor – is worth much more assuming the doctor will continue the practice than to sell it. According to the COA, the higher value applies in divorce if there is no reason to believe the practice will be sold or discontinued.

FMV Higher than Value to Owner – Several years ago consolidators were “rolling up” funeral homes to add value via economies of scale – synergistic value. But, if a family-owned funeral home intended to remain as such and had no intention of “going corporate”, would it make any sense to use the higher potential sale value which is, essentially, irrelevant to this family, this divorce?

Logic – What possibly supports applying value to owner if higher, but not if lower? Either way, should not the value to this particular family be used?

Clawback Provision

If potential sale value is significantly higher than value to owner, the non-owner can be protected by use of a clawback provision which provides that, in the event of sale within a certain time frame, the non-owner will receive some percentage of net sale proceeds in excess of the value used in the divorce.

Depending on the circumstances, a declining percentage may be appropriate – e.g. 50% of the excess if the sale occurs within a year of divorce, 40% within two years, and so on.

Such a provision should be considered particularly if there is reason to believe a sale may occur in the near term.

It is not a failsafe method for safeguarding the non-owner, but does afford some measure of protection.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Holder’s Interest Value to the Owner Cuts Both Ways”
View / Download April 2023 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “Apr 2023 : Holder’s Interest Value to the Owner Cuts Both Ways”

Oct 2022 : Division of Federal Income Tax Debt — Lezotte v. Lezotte, Unpublished per curiam opinion of the Court of Appeals, issued July 28, 2022 (Docket #360244)

Posted by Joseph W. Cunningham, JD, CPA

View / Download October 2022 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal

Facts

  • During most of their twenty-two year marriage, H & W owned a McDonald’s franchise which provided them a relatively high standard of living.
  • They sold the franchise in 2015 and netted approximately $850,000. However, rather than using the money to pay income tax due on the sale, the funds were invested in various business ventures all of which failed.
  • H and W filed for bankruptcy which was concluded in July 2020.
  • Regarding the federal tax debt remaining after bankruptcy, W claimed (1) that H had “hid financial circumstances from her” and (2) that H “controlled the finances and she had little input on” the disposition of the sale proceeds.
  • Further, it was acknowledged that H often signed W’s name – with her consent – on various documents including income tax returns.
  • The trial court divided the income tax on the gain from the McDonald’s sale equally between H & W in pertinent part because W “had enjoyed the financial benefits of the business during the marriage, including trips, jewelry, and clothing.”
  • W appealed.

Court of Appeals Decision

  • The Court upheld the trial court decision.
  • The Court noted that H had brought documents for W to sign and, further, that she had attended a meeting related to the bankruptcy proceedings.
  • Thus, the Court ruled, “the trial court’s division of marital debt was fair and equitable.”

Comments on the Case

  • It is not uncommon for one spouse to handle a couple’s finances, including income tax matters.
  • In many such instances the other spouse simply signs tax returns and other documents without reading and/or understanding what is being signed.
  • Sometimes, such a spouse may qualify for innocent spouse status and, thereby, avoid responsibility for joint tax liabilities.
  • But, one of the qualifying factors for innocent spouse status is that the spouse seeking such status did not significantly benefit from the unpaid tax.
  • In the Lezotte case, Ms. Lezotte did not in fact benefit from the unpaid taxes since the investments of the net sale proceeds all failed.
  • Rather the trial court appeared to rely on the fact that she “enjoyed the fruits of marital business decisions for seventeen years” and cannot “disavow herself from the debt that comes from those same business decisions.”
  • It was not indicated in the decision whether Ms. Lezotte had applied for innocent spouse protection.
  • Because there were virtually no assets to divide, the result to Ms. Lezotte was harsh.
  • The case serves as a reminder of how important it is for both spouses to have some level of understanding of their finances, including taxes, affecting them.
  • Also, in a divorce action in circumstances where that did not happen, innocent spouse status should certainly be considered regarding federal income tax debt.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Division of Federal Income Tax Debt — Lezotte v. Lezotte, Unpublished per curiam opinion of the Court of Appeals, issued July 28, 2022 (Docket #360244)”
View / Download October 2022 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “Oct 2022 : Division of Federal Income Tax Debt — Lezotte v. Lezotte, Unpublished per curiam opinion of the Court of Appeals, issued July 28, 2022 (Docket #360244)”

Nov 2021 : Court of Appeals Rules on Double-Dipping Issue Fort v Fort, Mich App No. 351568 (4/22/21) – Unpublished

Posted by Joseph W. Cunningham, JD, CPA

View / Download November 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal

Facts

H and W were divorced in 2019 after 14 years of marriage and three children.

  • Per their agreement, W was a stay-at-home mom.
  • H owned and worked at a business (Company), which was valued for the divorce settlement.
  • The trial court used the appraised value of the Company and ordered H to pay W spousal support.
  • H appealed, claiming that the property award and spousal support award, taken together, “constitute an impermissible “double-dip” that results in an inequitable outcome.”

Court of Appeals Decision (Unpublished)

  • The Court of Appeals (Court) noted that “double-dipping” – or tapping the same dollars twice – refers to situations where a business or professional practice is valued by capitalizing its income, some or all of which is also treated as income for spousal support.
  • The Court referred to the published Loutts case (Loutts v Loutts, 298 Mich App 21 (2012), in which the Court stated “[s]pousal support does not follow a strict formula” and “there is no room for the application of any rigid and arbitrary formulas when determining the appropriate amount of spousal support.”
  • Thus, the Court in Loutts “declined to adopt a bright-line rule” with respect to double-dipping.
  • The Loutts decision is consistent with preceding Court of Appeals cases on the issue.
  • However, the Court in Loutts indicated that if an appropriate spousal support award can be made without double-dipping, then such should be done.
  • The Court in the Fort case stated that it was unclear whether the trial court engaged in an inequitable “double-dip” because it did explain how it calculated spousal support.
  • Thus, the Court remanded the case so that the trial court could make factual findings concerning the relevant factors in a determination of spousal support.

Comments on the Case

  • The Court once again affirmed that spousal support is the be determined based on the factors set forth in Sparks v Sparks, 440 Mich App 141, (1992) and in Olson v Olson, 256 Mich App 619 (2003).
  • In doing so, income used in valuing a business or professional practice should not automatically be excluded from income for spousal support to avoid double-dipping.
  • However, if a proper balancing of the parties’ needs and income, taking all relevant circumstances into account, can be achieved without double-dipping, then such should be done in determining spousal support.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Court of Appeals Rules on Double-Dipping Issue Fort v Fort, Mich App No. 351568 (4/22/21) – Unpublished”
View / Download November 2021 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “Nov 2021 : Court of Appeals Rules on Double-Dipping Issue Fort v Fort, Mich App No. 351568 (4/22/21) – Unpublished”

Aug/Sep 2021 : Thoughts on Start-Up Companies in Divorce Settlements

Posted by Joseph W. Cunningham, JD, CPA

View / Download Aug/Sept 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal

Intro

Start-up companies require considerable thought in divorce settlements. Some reasons:

  1. Some will go great guns and become quite valuable.
  2. Others will fizzle and flop.
  3. And, since we do not have crystal balls, it is often impossible to know how a particular new company will fare.
  4. A considerable investment of time and/or finances may have been made during marriage, by one or both parties.
  5. Experience a party has had during marriage may equip him/her with a set of skills & and/or specialized knowledge that will be advantageously brought to bear on the new enterprise.
  6. Some start-ups have projections – often required to obtain financing – while many do not.

Methods for Handling in a Divorce Settlement

Postema Equitable Award Approach

If a considerable amount of funds has been expended in preparing the launch of the new enterprise, repaying the non-owner spouse half the amount spent may be satisfactory in some instances.

  • This is somewhat akin to the Postema1 reimbursement approach to establishing an equitable award for a spouse who made sacrifices, efforts, and contributions to enable the other to attain an advanced degree and certifications, as the case may be.
  • As with a Postema award, however, it is appropriate to consider non-financial sacrifices, efforts, and contributions made by a spouse to the establishment of the other’s start-up business.

“Structured Settlement”

  • Provide for the owner spouse to receive an agreed on reasonable compensation for his/her efforts.
  • Then pay a portion of what the company earns after paying the compensation – that is, profit – to the non-owner spouse, usually, on a declining scale basis.
  • For example – 50% in the first 2 years, then 40% for a year or two, then 30% for a year.
  • The declining scale takes into account that, as time goes by, less of the profit is attributable to the marriage and more to post-divorce efforts.

Defer the Valuation

On rare occasions, it may be best to provide that the business value will be determined at a set time after the divorce.

  • This approach provides the valuable benefit of hindsight.
  • But, it is not often used because (1) it leaves a part of the settlement unresolved and (2) it will be problematic to determine the portion of the value attributable to postdivorce efforts.
  • Another negative is that it often involves the non-owner spouse “looking over the shoulder” of his/her ex to ensure everything is on the up and up.
  • But, in some instances – particularly where there is sufficient trust and/or the lack of ability to manipulate operating results – it may be a good fit.

Case Specific Approach

As the above indicates, it is clear that – like so many aspects of divorce – dealing with a start-up company in divorce is a case-specific proposition.

All relevant circumstances should be considered in fashioning an appropriate provision in the settlement.

Endnote

1 Postema v Postema, 189 Mich App 89; 471 NW 912 (1991).

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Thoughts on Start-Up Companies in Divorce Settlements”
View / Download Aug/Sept 2021 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “Aug/Sep 2021 : Thoughts on Start-Up Companies in Divorce Settlements”

May 2021 : Court of Appeals Reverses Trial Court Ruling on the “Marital/Separate” Property Character of a Business Interest Received by Gift before Marriage Wolcott v Wolcott, Mich App No. 351918 (March 11, 2021) Unpublished

Posted by Joseph W. Cunningham, JD, CPA

View / Download May 2021 Article – PDF File

Tax Trends and Developments Column – Michigan Family Law Journal

Facts

  • In July 1999, W’s father gave her a 10% interest in a closely-held business (Company) at which she was not employed.
  • The parties married a month later in August 1999.
  • During the entire marriage, the parties maintained separate bank accounts.
  • W deposited any distributions she received from the Company into her separate bank account.
  • The trial court ruled that W’s interest in the Company was her separate property.
  • H appealed.

Court of Appeals Decision

  • In an unpublished decision, the Court reversed the trial court’s ruling.
  • In doing so, the Court noted that the distributions W received from the Company – though deposited into her separate bank account – were commingled with her marital income deposited into the same account.
  • Further, the Court stated that W had testified that she used some of the distributions from the Company to pay marital expenses and household bills.
  • The Court ruled that W’s conduct with regard to distributions from the Company indicates that her interest in the Company was marital property.

Comments on the Case

  • The Court’s decision seems unfair to W.
  • The parties evidently, from the outset of their marriage, intended to keep their respective property interests separate, including the distributions W received from the Company.
  • That the distributions were incidentally “commingled” with marital funds does not necessarily indicate an intent to convert them – and certainly not the Company – to marital property, nor does use of some of the funds to pay marital expenses – particularly if other funds were temporarily insufficient.
  • The Court used these two factors to convert a pre-marital gift into marital property.
  • Treating the commingled distributions as marital seems reasonable. But, to treat the entire value of W’s interest in the Company as marital seems excessive.
  • The obvious upshot of the case is, if a party wants to keep separate property separate, then such party:
    1. Should deposit any income from such property in a separate account into which no marital funds are deposited; and,
    2. Should not use such funds to pay marital expenses. If such is necessary because marital funds are insufficient, make a documented loan of the separate funds to pay the expenses, and be sure that the loan is repaid.

About the Author

Joe Cunningham has over 25 years of experience specializing in financial and tax aspects of divorce, including business valuation, valuing and dividing retirement benefits, and developing settlement proposals. He has lectured extensively for ICLE, the Family Law Section, and the MACPA. Joe is also the author of numerous journal articles and chapters in family law treatises. His office is in Troy, though his practice is statewide.

Download the PDF file below… “Court of Appeals Reverses Trial Court Ruling on the “Marital/Separate” Property Character of a Business Interest Received by Gift before Marriage Wolcott v Wolcott, Mich App No. 351918 (March 11, 2021) Unpublished”
View / Download May 2021 Article – PDF File

Complete Michigan Family Law Journal available at: Michigan Bar website – Family Law Section (subscription required)

Read More “May 2021 : Court of Appeals Reverses Trial Court Ruling on the “Marital/Separate” Property Character of a Business Interest Received by Gift before Marriage Wolcott v Wolcott, Mich App No. 351918 (March 11, 2021) Unpublished”