Should Non-Operating Assets
Be Reflected by the Business?

Forensic-1Should it matter to the divorcing parties if non-performing business assets appear on the business’ balance sheet? You better believe it should! Let me explain. Business value may be apportioned to divorcing parties differently than other marital assets owned outside of the business. This is due primarily in consideration of double dipping issues.

Several months ago, a valuation report letter was issued by a neutral appraiser to conclude on the fair market value of a business pursuant to a contested matrimonial action filed. The business was formed during the marriage and therefore considered to be marital property subject to valuation for equitable distribution purposes pursuant to the laws of the State of New York.

As of the valuation date, the valuation report reflected a cash balance retained by the business of $2,000,000. Per the neutral appraiser’s expert report, the excess cash balance represented $1,600,000 above what the neutral appraiser’s determination of the business’ working capital requirements were, which is considered excess assets or non-operating assets in valuation parlance. The business value was increased by the amount of the excess assets at the valuation date. The neutral valuation appraisal expert concluded the business’ fair market value was $1,000,000, exclusive of any cash/excess working capital. An addition to the aforementioned $1,000,000 business value was $1,600,000 representing the excess cash retained from undistributed cash earnings by the business, which had been reported by the spouses in their personal joint tax returns filed in the years so accumulated with the taxes paid on those earnings from jointly held marital assets. Total business appraised value was concluded to be $2,600,000.

The Neutral’s valuation report clearly indicated the larger component of the business value resulted from a subjective non-business decision to retain unnecessary/excess funds which were treated for tax purposes as earned and personally taxed to the couple when flowing through to their personal income tax  returns. The excess cash is greater than the normalized expected business cash flows to be earned from its operations having absolutely no economic relevance to its fair market business value.

Pursuant to a divorce, equitable distribution and division of business value in New York does not necessarily equate to the same amount. The final division of assets is based on facts and circumstances of each particular case. Those factors may be related to relative contributions of the parties, conduct of the parties, length of marriage, among other issues. One of those other factors deals with the issue of double dipping. Accordingly, the non-titled spouse is not awarded a 50% equitable distribution of the fair market value of the business in order to mitigate the effect of having the valued business asset counted twice both for equitable distribution purposes, and again as required maintenance payments (child support is not considered subject to double dipping consideration in NYS divorces). This may result in a substantial yet unintended benefit to the titled spouse for excess funds held by the business that could have been distributed as after tax marital property outside of the business structure. In this matter, had the Plaintiff spouse known about this accumulation, such funds may very well have, in fact, been distributed.

The annual cash distributions after all operating expenses, was solely the decision of the moneyed spouse. The non-monied spouse had no knowledge whatsoever, about the existence of the excess cash accumulated over the years by the monied spouse and the non-monied spouse was unaware of its existence.

Dennis B. Kremer, CPA/ABV/CFF/CGMA, CVA