Financial Experts in Divorce Litigation: Providing Peace of Mind in More Ways Than One

Financial Experts in Divorce Litigation: Providing Peace of Mind in More Ways Than One
Town Topics of Princeton, September 21, 2011

Many divorce matters require financial experts.  These experts are often certified public accountants, but quite frequently are also accredited in business valuations.  They work closely with counsel and the client to lend their expertise to the issues at hand.  The most common situations are the subject of this article and will be discussed below. 

Three common areas in which financial experts are used in divorce litigation are the following:  (1) Providing an analysis of the parties’ lifestyle during the marriage; (2) Analyzing the tax impact of alimony, both to the payor and the payee; and (3) Evaluating any business interests the parties may have.  In all three areas, a financial expert can be a real asset to your divorce litigation.

Lifestyle Analysis

When parties are involved in divorce litigation, alimony can be a hotly contested issue.  Child support, in some circumstances, involves a mathematical formula that incorporates the parties’ respective incomes and provides an appropriate number.  However, in arriving at an appropriate alimony amount, attorneys are only guided by a series of factors provided by the state law.  Among these factors are the actual need for alimony, the ability of one party to pay alimony, the length of the marriage, the age and health of the parties, and, the standard of living established during the marriage. 

If the parties cannot agree on the marital lifestyle as a gauge of support, and they often cannot, a financial expert can be retained to provide an analysis.  Such an analysis provides a snapshot of the standard of living for a given period of time.  Often, financial experts will look at several years of the parties’ spending (normally the last three to five years of a marriage to get a representative sample) in which they take into consideration the parties tax returns as well as all of their expenditures.  These expenditures will include checking accounts, credit cards and even ATM withdrawals.  After analyzing the money coming in and the money going out, you are left with a clearer picture of how the parties spent their money during the marriage.  The attorneys will be able to use the analysis completed by the financial expert to allocate the income of the parties so that each can come as reasonably close to the lifestyle they enjoyed during the marriage and as may be appropriate based on the other factors.
Impact of Alimony

In arriving at alimony and child support amounts, it is often helpful to have a financial expert provide an analysis of the tax consequences for the payor and the payee.  Unless stipulated otherwise, alimony is tax deductible for the payor and is taxable income for the payee.  Child support is not tax deductible, nor is it includable in the recipient’s income for tax purposes.  Therefore, for the payor, a tax analysis can be completed to not only show that particular party how much income he will be left with after meeting his support obligation every month, but the expert can also provide a projection as to what his tax liability will be at the end of the year.  In turn, the recipient can understand how much income he or she will have to meet his or her expenses and to budget for tax payments due on the support and any other income received.

Business Evaluations

When one or both of the parties in a divorce owns a closely held business or is a shareholder in one, and the parties cannot agree on a value of that business or share interest, that business must be evaluated in order to give it a fair value.  There are three approaches commonly used by financial experts when evaluating a business:  (1) the Income Approach; (2) the Market Approach and (3) the Asset Approach;

Income Approach

The income approach essentially estimates what someone would pay today (or as of the effective valuation date) for some expected stream of future economic income.  The basic concept is a simple one – with an assumed income level, what would a seller be willing to accept and what would a buyer be willing to pay to acquire that income stream.  There are various methods within the income approach, but they all operate under the assumption that the value of a business can be determined in relationship to its income, however that income may be defined.  The usual income that is considered is either stated as income or earnings (which mean the same thing), or cash flow – which can be the same as income, but usually has some differences. 

Market Approach

The concept of the market approach is that valuation “guidance” can be found in transactions involving similar companies.  It is a comparable theory to appraising the value of a home by analyzing sales of similar houses.  Often when using this method, a financial expert will look to a comparable public company for guidance as to how to value the non-public business interest in dispute.  Public company comparables are used because there usually is a great deal of information available on these companies.  However, comparables often must be adjusted and in some cases even disregarded as indicators of value for reasons including:  (1) public companies are much larger than the companies being valued; (2) public companies are often more dispersed with more locations, thereby giving them a broader market; and (3) public companies usually have multiple products and lines of sale whereas privately held companies are generally more limited.


Asset Approach

The asset approach, also known as the cost approach, is conceptually the simplest approach.  However, it is not commonly used when dealing with profitable operating businesses.  The reason is that the asset approach assumes the value of the business is best expressed by taking the underlying tangible values of various assets, subtracting therefrom the liabilities, with the net result being the value.  No recognition would be given to intangibles such as good will, customer lists, etc.  For this reason, the asset approach is not the most probative method of determining the value of going business concerns. 

As can be seen above, financial experts can be useful in a number of ways.  Any party to a divorce action should not be reluctant to retain such experts in matters that include the issues outlined above.  Not only will experts provide critical information that will help the matter come to an equitable resolution, but they will deliver peace of mind to individuals seeking the start of a new life.