## Double-Dip in Divorce: A Double Misconception

In the July 2015 Edition of BVUpdate, Robert Levis, CPA/ABV, ASA, CFE authored an article, entitled “The Double-Dip Concept is Often a Misconception,” that argued that the concept of the economic “double-dip” in divorce is a “delusion.” In the context of divorce, the double-dip refers to simultaneously requiring the propertied spouse to equitably divide an asset and pay alimony based upon the income derived from the same asset. Mr. Levis argues that the double-dip is a misconception because the double-dip only occurs when the income is paid from a depreciating asset. As he states, “As long as the future income assumed to be generated by the business asset is a return on investment (i.e. “capital”), there is no double counting of the income for property and spousal support purposes.” This argument is completely incorrect. The double-dip concept is not dependent upon whether an asset represents a “return on” or a “return of” the principal of an asset or whether the asset is a depreciation or appreciating. His article fails to consider present value mechanics and fails to consider that the propertied spouse must pay out the present worth of the asset today, which impairs the future ability of the propertied spouse to maintain the level of “return on” the investment.

Mr. Levis provides an example utilizing a bond stating the following:

“Let’s take an example of a one-year bond to illustrate the return of capital/investment. Assume the marital estate owns a $100,000, one-year bond that generates 10% annual interest at the time of the divorce. Assume further that its face value and market value are the same.

At the end of the year following the divorce, the spouse who received the bond will receive $110,000 ($100,000 principal and $10,000 interest). It is doubtful that anyone would say that the $100,000 of the bond principal the spouse receives at the end of Year 1 is income available for spousal maintenance. Most judges or divorce professional would consider it a double count to do so.”

What his example fails to realize, however, is the spouse who received the bond would have to pay the other spouse half of the $100,000 bonds value (i.e. $50,000) in equitable distribution payment on the date of divorce. In order to generate those proceeds, the spouse keeping the bond post-divorce would have to sell half of the $100,000 bond, thereby reducing the available income for distribution from $10,000 to $5,000 on a post-divorce basis. The spouse keeping the bond, therefore, would have to sell $50,000, reducing his portfolio from $100,000 to $50,000, and payout his entire post-equitable distribution payment income of $5,000 in alimony. As such, the propertied spouse receive no income from his post-divorce bonds.

To understand the issue in the context of a business valuation, let’s consider the following example. Suppose the business generates $100,000 in after-tax income and faces a cost of equity capital of 10%. Assume the business has no growth. For simplicity, further assume the only marital asset is the business. Accordingly, the value of the company is $1,000,000 (i.e. $100,000/10% = $1,000,000) and the propertied spouse must pay the non-propertied spouse $500,000 in equitable distribution. However, since the parties have no other assets, the only way in which the propertied spouse can provide the equitable distribution payment to the wife is to monetize the business interest (i.e. either from selling half of the interest in the open market or leveraging half of the business value). For simplicity assume the propertied spouse sells half of the business in order to pay the equitable distribution payment (note that the results would be the same if the business was leveraged). Therefore, on a post-divorce basis the propertied spouse, has only a 50% interest in the company worth $500,000, and is generating income of only $50,000 (i.e. 10% of $500,000). However, the alimony payment is 50% of the pre-divorce income of $100,000. Therefore, the propertied spouse must pay too the wife ALL of the $50,000 in post-divorce business income generated from the asset.

The table below illustrates the outcome:

Pre-Divorce (both parties) | ||||

Busines Value | 1,000,000 | |||

Income | 100,000 | |||

Post-Divorce (Propertied Spouse) | Post-Divorce (Non Propertied Spouse) | |||

Pre-divorce value | 1,000,000 | Pre-Divorce Value | – | |

Less: Sale of 50% of Value (or loan) to generate equitable distirbution payment | (500,000) | Equitable Distribution Payment | 500,000 | |

Post-Divorce Equity Interest in Company: | 500,000 | Post-Divorce Net Worht | 500,000 | |

Income of Remaining 50% Interest in Company | 50,000 | Pre-Divorce Income | – | |

Less: 50% of Pre-Divorce Income (Alimony) | (50,000) | Alimony Payment | 50,000 | |

Net Cash Flow to Propertied Spouse | – | Net Cash flow to Non-Propertied Spouse | 50,000 |

Therefore, on a post-divorce basis, the propertied spouse is left with no income, while the non-propertied spouse receives $50,000. Moreover, in order to pay the equitable distribution payment to the the non-propertied the propertied spouse must keep the the $500,000 in post marital value “locked-up” in an business or another investment of similar risk, otherwise there is no income to provide the alimony payment. The non-propertied spouse, however, may invest the $500,000 in cash received as equitable distribution payment to further increase income available to the non-propertied spouse. In fact, if you eliminate the annual income and simply accrue the economic equivalent of the alimony payments as an asset for lump sum alimony (using the business cost of capital as the discount) rate, the following shows that the propertied spouse has no economic assets remaining:

Propertied Spouse | Non-Propertied Spouse | |||

Present Value of 50% Interest in Business | $500,000 | Cash/Equitable Distribution Payment | $500,000 | |

Present Value of Alimony Payments (Assuming Perpetual Alimony) | (500,000) | Present Value of Alimony Payments (Assuming Perpetual Alimony) | 500,000 | |

Economic Assets | – | Economic Assets | $1,000,000 |

As shown, the propertied spouse has no economic assets, while the non-propertied spouse is allocated the entire marital net worth. It’s important to note that I have assumed (for illustration) perpetual alimony payments in the above schedule. In reality, alimony payments are no perpetual. Therefore, there would not be a full transference of the entire marital net worth from the propertied spouse to the non-propertied spouse. This can be easily adjusted, however, by reducing the alimony payment by an appropriate probability weighted actuarial adjustment factor to reflect the length of alimony and probability of termination.

In any event, the non-propertied spouse receives a substantial economic windfall when alimony is awarded and the asset generating the income is equitably divided. We can understand this further in terms of future values. For example, assume the non-propertied spouse invests the $500,000 cash equitable distribution payment in the stock market to generate a return of 10% (same as business cost of capital). Further assume, the non-propertied spouse invests the $50,000/year alimony in the market at the same rate. The propertied spouse, however, has no income to invest. Furthermore, the asset is no growth so it has no appreciate. Assume alimony continues for 10 years, at which time alimony stops, and the propertied spouse can sell the business asset supporting the alimony payments (recall this asset will not appreciate because it all of the return is being paid to the non-propertied spouse in terms of alimony). At the end of 10 years, the future net worth of the parties would look as follows:

Propertied Spouse | Non-Propertied Spouse | |||

Future Value of 50% Business Interest | 500,000 | Future Value of $500,000 Invested @ 10% | 1,296,871.23 | |

Future Value of Income Invested (no income available for investment) | – | Future Value of $50,000 alimony invested @ 10% | 796,871.23 | |

Total Future Net Worth | 500,000 | Total Future Net Worth | 2,093,742.46 |

As shown above, a significant economic injustice is created because, with the non-propertied spouse amassing over $2 million within 10 years. The propertied spouse holds an asset worth $500,000. Now contrasts this economic result to the case with no alimony and simply an award of half the business value. In this case, the propertied spouse retains a business worth $500,000 (recall the propertied spouse must sell or leverage 50% of the business value of $1 million to finance the equitable distribution payment) and can reinvest business cash flows at the business cost of capital of 10%. The non-propertied spouse holds cash of $500,000 which can be reinvested in an asset of comparable risk. Thus, in 10 years time, both parties have the same equitable value of $1,296,871.23. Assets have been equitably divided.

As such, the “Double-Dip” does not depend upon the nature of the asset or whether the asset is amortizing or appreciating. Simply put, requiring the propertied spouse to pay alimony AND pay out the present worth of the asset that is generating the income to support alimony payments, results in a significant economic injustice. Mr. Robert Levis Misconception is really the double misconception.

JA