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General Asset Valuation in Divorce


This article, like all of my articles, was written for my own, Eric Roy's, benefit as I find this material interesting. I use it as a personal reference and a reference for my attorney staff members. If you are really seeking to gain a strong understanding of this material I suggest you purchase one of the numerous books which have been written on the subject.

Assets of the marriage, and debt, must be valued before they can be distributed amongst the parties. Without proper valuation property distribution will inherently be unequal. Thus you need to know how to go about valuing different assets. Often times you will first need to understand what a certain asset is or how it functions before you can value it. Basic assets to be valued in most divorces include real and personal property. You are of course looking for equity here. Thus you need list the fair market value as well as all debt including first and second mortgages and lines of credit attached to these properties. You can always hire an appraiser or go online at one of the many websites that will give you a general appraisal value of a particular property. For personal property you will likely be relying on your client's testimony as to value. The reason for this is simply that appraisal costs can often overshadow the value of the property. Thus, for a lot of personal property just have your client testify as to the value.

One of the more daunting assets to value within the divorce is the pension benefit. Defined pension benefit plans pay out a monthly annuity over a period of time, generally until the recipient dies. The difficulty in valuing these assets is that this valuation requires estimation of many factors. For instance, a pension typically doesn't mature until a certain date which may or may not have arrived. At that maturity date the annuity payout will depend on factors such as the highest income achieved over a certain period of time. Often times this period of time which the ultimate valuation relies has yet to occur. To complicate things further we can only guess at when the plan participant will die. To do these valuations a mortality tables can be used by actuaries. Discount rates can be applied to reduce the value to account for circumstances such as the employees retiring prior to vesting or early death of the participant. When dealing with pensions you as divorce counsel need to get your hands on the summary plan description early on. You can make this request to the plan administrator. If you do not represent the participant spouse then simply have the non-employee spouse sign off on a release which they will typically do, otherwise you can have the court order the participant to sign off on this release. Otherwise you can subpoena the plan summary from the plan administrator directly.

Please see my other articles on distribution of pensions and valuations of pensions for information on the various factors to consider when dividing a pension. The bottom line is that if the parties want a full separation now then there must be a present value calculation. Present value is the current value of a future stream of payments or a future lump sum payment. To do a present value calculation you will need to consider interest rates, inflation, and discount rates. You will likely need to have your forensic accountant weigh in on this valuation. If your opponent calls an expert to the stand to opine on the subject and you wish to counter that opinion then you must have an expert. Your client has no credibility to speak on the subject against an expert. Ultimately you will need to understand that your client's property interest will be calculated using a coverture fraction taking into account years of employment which coincide with marriage as your numerator over total years of marriage. This number will then be multiplied by 50% to determine the non-employee spouse's interest in the retirement.

Bonus packages can present a unique problem for divorce counsel. The reason for this in part comes down to the fact that it is sometimes difficult to determine for what period of time a bonus is earned. As counsel you should try to get ahold of any compensation packages. For larger companies these compensation packages will typically be in writing. The documents themselves may tie the bonus to a particular metric such as gross sales for instance. The reason why this is important is because if you can show that a bonus to be received in the following year is a direct result of services rendered during the marriage then you need to be arguing that the bonus, though not yet received, is in fact community property. Know that if the employee spouse is chummy with his boss he may request that his bonus be deferred until a later year, a year after which the divorce has concluded. If you end up deposing the opposing parties' management be sure to find out about bonuses. Find out when bonuses are set to occur in the future and what metric such bonuses rely on. This of course is important for alimony claims as well.

Stock options are similar to bonuses in that they are often given for service which may have occurred at different times. For instance, a stock option may be granted for retention purposes, so as to retain the valuable employee for the future. Stock options may have been granted for the employees past achievements. Look to when the stock option was earned. This is important and you need to know if the stock option was earned during the marriage for purposes of arguing community or separate property. Remember that stock options are typically not assignable. This means that you will not be able to divide the stock options at divorce. Rather a buyout will be in order. To effectuate this buy out or off set you will need to be able to value the stock option currently. Early on in the divorce process ask the employee spouse for a copy of the stock option plan as well as a description of the stock options which have been granted thus far. You can issue a subpoena to the employer if need be to obtain these stock option grants and agreements. As a very basic method a stock option can be valued by looking at the difference between the current share price and the exercise price. Understand that if the current share price is below the exercise price the stock option will be underwater. That being said, with time the stock option may become valuable, far exceeding the exercise price. There are other more complicated methods for valuing stock options which are referred to as the Black-Scholes or Binomial models. These methods are more complex. When you are dealing with stock options keep your eyes open for reload provisions. These reload provisions allow the employee to exercise his options not by cashing them in but rather by obtaining new stock options in exchange for the existing options.

When dealing with stock options, and other retirement instruments for that matter, understand the tax implications related to those instruments. When you are dealing with stock options you should know that incentive stock options (ISOs) are quite valuable because they result in no taxable income for the employee spouse. This is contrary to the non-qualified stock option (NQSO) which do result in tax consequences to the employee spouse upon being exercised. Understand that similar to pensions the parties can agree to a "wait and see" approach. Using this approach there is no immediate buy out or set off for the current value of the stock options. Since the stock options can't be assigned the employee spouse simply holds onto the option until such time as it matures and then at that time the stock can be sold off or valued and bought out by the employee spouse to the non-employee spouse.

Remember that if you represent the non-employee spouse you will need to keep in mind that the employee spouse could quit or be terminated prior to the maturity date of the stock option. You as counsel need to be smart and build in some language which protects your client in case of this event. Bottom line is the employee spouse needs to compensate your client if he quits or is terminated for cause. Come up with a fair value for this and insert it within your marital settlement agreement. Also keep in mind that the employee spouse will always try to convince you or the court that the value of the stock option is less than what it is. This spouse will argue that the company is not going to be so prosperous and that the future is grim for the company. To counter this you should employ your forensic accountant to prepare a written report. Bring this report ahead of the settlement conference and if need be have your expert testify to this fact at trial. When you do end up drafting provisions in your marital settlement agreement for future distribution of stock options or other deferred receipt assets be sure to describe the intent of the parties. In this way, if there is some uncertainty down the road as to what was written the court can simply look to the intent of the parties. Then go on further to write a provision that directs the court to look to the intent of the parties in the instance there are any uncertainties or ambiguities with regard to the plain language of the marital settlement agreement.

As a divorce attorney you need to have at least a basic understanding of the various retirement instruments. You should understand the difference between defined benefit plans and defined contribution plans. You should understand 401(k)s, 403(b)s, deferred compensation, money purchase plans, employee stock ownership plans, IRA's and the like. A pension is a type of retirement that you will almost always see when you represent government employees. If they are state employees they will receive benefits under the public employees retirement plan (PERS). Federal employees qualify for the federal counterpart of PERS which is FERS the federal employees' retirement system. Each of these plans provide for a pension benefit assuming the employee works long enough to vest in the companies' retirement program. A pension provides for a series of definite payments upon eligibility and actual retirement of the employee. These benefits typically continue until death. Pension benefits fall under the label of defined benefit plans. These plans are more difficult to value as outlined above. An annuity is similar to a pension in that it pays a specific sum of money in regular intervals for a certain period of time. Annuities can differ in structure according to the annuity's terms and conditions.

In opposite to defined benefit plans are the defined contribution plans. These plans are sometimes called "cash plans". These plans are typically easier to deal with as their value can be easily quantified. This means they can be divided with greater ease and sometimes do not require a qualified domestic relations order to divide. Defined contribution plans maintain all the funds which can be paid out as a lump sum. These plans are financed by payments by the employer. However there are plans in which the employee may also contribute to the contribution plan. One of the most common cash plans you will come across as divorce counsel is the 401(k). Under these 401(k) plans the employee can elect to have part of his income deferred into the 401(k) plan. The employer may have a matching program where they match the employee's contribution up to a specific level. These monies which are diverted into the cash plan are tax deferred. This means that the employee will not have to pay federal income taxes on this income at the time of receipt into the plan. However, when the employee eventually liquidates his 401(k) in the future then these distributions will be taxed at that time.

403(b) plans are similar to 401(k) plans in that they allow the employee to defer some of his or her income into the plan as opposed to direct receipt as taxable income. These plans are available for employees of public schools and some other tax-exempt organizations. These annuity plans are tax deferred until receipt just as a 401(k) plan is. Similar to the 403(b) plan is the 457 deferred compensation plan. This deferred compensation plan is for employees of state or local government or other tax exempt organizations. These plans also provide for exempt deferrals until actual distribution at a later date. Know that there are "simple" 401(k) plans as well, which are a benefit for smaller businesses as they are cheaper and easier to administer than the complex 401(k) plans. These plans are available to employers who have less than 100 employees.

Profit sharing plans are plans which are sponsored entirely by the employer. Profit sharing plans again receive this tax deferred special treatment. Federal tax law does limit the contribution limits into these types of plans. Annual contribution limits also apply the same to money purchase plans. Money purchase plans are similar to profit sharing plans except for the fact that they are sponsored by both employer and employee. In these money purchase plans the amount of employer contribution is known in advance and typically can be found in the plan documents.

Employee Stock Ownership Plans (ESOPs) allow for employees to own a share of the business. In these plans employees automatically obtain ownership of company stock after certain conditions are met, namely continued employment in the company. This is useful as it allows the company to reduce its direct salary payout to employees and at the same time incentivizes employees to work for the benefit of the company. Under these ESOPs it may also be the case that at some point in time the employee is allowed to purchase corporate stock under favorable terms. It is not unusual for some organizations to be owned entirely by their employees.

One of the most common investments that you will come across as divorce counsel is the IRA. These investments are not sponsored by employers. To find evidence of an IRA you will need to look at brokerage statements or tax returns. IRAs are cash plans. These investments are held in trust by a bank or other entity approved by the IRS. These investments have specific annual contribution limits. There are two types of IRAs the practitioner should be familiar with. The difference in these IRA plans is the tax implications incurred by each. Under a traditional IRA contributions can be fully or partially deducted. Under the traditional IRA the recipient will not be taxed on income from the IRA until actual distribution at retirement. The Roth IRA differs in that the contributions are not tax deductible. The benefit of the Roth IRA is that the income ultimately received from distribution including appreciation will be received tax free upon retirement.

Financial statements prepared for creditors by the employee spouse can be your best friend as divorce counsel. These statements will reflect the financial circumstances in a favorable light for the non-employee spouse as they tend to be over-inclusive of assets and income. Thus in addition to tax returns always get your hands on financial statements. These are valuable as tax returns may not show all taxable income. For instance, 401(k) contributions and other tax deferred retirement contributions must not be shown on a tax return. These assets will be listed on financial statements as borrowers attempt to appeal to lenders for favorable interests rates. Also, in most states it is a crime to produce false financial statements. Thus if you can show a discrepancy between financial statements and what has been provided in opposing counsel's initial disclosures you can demonstrate a fraud. This of course destroys the opposing parties' credibility in the courtroom.

For more information on this subject I direct you to Miles Mason, Sr.'s work. He is a JD and a CPA and has written thoroughly on these subjects. Most of my learning, such as the information provided above. comes from his mastery and writing on the subject matter.

Categories: Family Law