Many business owners pay themselves a regular salary. This is not only a good business practice, but it is useful should they need to ascertain the value of their business in a divorce.
The income approach is a popular method of business valuation when a business owner divorces. As the name implies, the income approach uses the business owner’s income as part of its calculations. However, using the income approach to value a business risks the potential of double-dipping.
Double-dipping in a divorce
Double-dipping occurs when the amount of the owner-spouse’s salary used in the valuation process differs from the salary used when determining alimony. Generally, double-dipping arises when the owner-spouse’s real-life income is greater than the market rate for that position. The appraiser, when valuing the business, will make sure the owner’s salary for valuation purposes matches its fair market value, even if in real life, it is greater. Any surplus between the two is considered business profits, and ultimately, increases the fair market value of the business.
The fair market value of the business, as calculated using the income method in this case, is used in the property division process. The business, like other marital assets, is split between the spouses through equitable distribution. The value of the business is bumped up by the difference between the owner’s real-life salary and the fair market value salary for that position. This increases the value of the business.
Thus, the spouse or spouses awarded a share in the business walk away with more than they would have if the owner-spouse’s real-life salary was used in the valuation process. But if the owner-spouse’s real-life salary, rather than the fair market value salary, is used when determining alimony, double-dipping has occurred. This is because the difference between the owner’s higher real-life salary and lesser fair market value salary was awarded twice.
It was awarded once during the property division process where the difference was considered business profits increasing the value of the business. And it was awarded again in the alimony award since the alimony award was based on the owner-spouse’s real-life salary. Business valuation can be complex, but so can the divorce process. A mistake made either way can lead to an unfair result.