Valuing Licenses and Degrees, New York Style

Editor's Note: New York often serves as a leading venue for concepts in matrimonial law. Although states differ widely on valuation issues such as personal and organizational goodwill, the concept of value to a professional license or degree has a certain amount of differentiation to the marital pot.

A Case Study

Jim and Sally were in love. They knew they were meant to be from the moment they first met. They married during their junior year in college; Sally was a pre-law student, Jim, pre-med. Alas, the fairy tale didn't last. In order to make ends meet, Sally dropped out of college and worked as a waitress to put Jim through college and med school, and to survive financially during his internship and residency. Shortly after Dr. Jim finished his fellowship in vascular surgery and set up his practice in the pricey Upper East Side of Manhattan, he announced to Sally he was starting a new fairy tale with his nurse'

This fairy tale-turned soap opera 'and maybe more like General Hospital for those involved in similar matrimonial litigation in New York ' is the pretend analogy to a real-life case.

O'Brien v. O'Brien

O'Brien v. O'Brien, 66 N.Y. 2d 576 (1985) (wherein Willard Da Silva, the Chairman of this newsletter's Board of Editors, represented Mr. O'Brien), was a pivotal case. In that 1980s litigation, Mrs. O'Brien's counsel was able to argue successfully before the courts that Mrs. O'Brien had given up her career aspirations so as to benefit and support her husband's career aspirations as a surgeon, fully expecting to share and enjoy the enhanced earnings he was expected to derive from his medical career. How was it equitable, her attorney argued before the justices, that she should pay the 'cost' of his earnings enhancement, but not reap the benefit of her investment? The courts agreed.

But, how to measure what Dr. O'Brien should share with his soon-to-be-ex in this equitable distribution state? Simple, argued Mrs. O'Brien's expert witness. Just calculate the present value of Mr. O'Brien's lifetime earnings enhancement associated with his medical license, which Mrs. O'Brien helped make possible through her many years of work, at the expense of her own career dreams.

Thus the valuation of licenses and degrees as a marital asset was established in New York. O'Brien and its progeny have created a framework in an attempt to apply valuation tools to measure enhanced earnings capacity. In O'Brien, the debate as to if a license or degree can be valued was won by those who argue that it can be independently valued. (Never mind that a transaction for value cannot be affected: a license or degree cannot be sold. Nor is it relevant that some of the measurement structures are artificially established.) In New York, much of the continued litigation in this area relates either to the factual issues surrounding the calculation of the present value of the enhanced earnings or the equitable distribution of that present value. Regarding the latter, the mere fact that a spouse obtained a license, certification or degree during the marriage does not by itself entitle the other spouse to an award of the enhanced earnings. The spouse must show that he/she made a contribution toward the acquisition of that license, certification or degree as cited in Small v. Small, 227 App.Div. 2d 949 (4th Dept. 1996).

Calculating Enhanced Earnings Capacity

To calculate the present value of enhanced earnings capacity, a valuation professional estimates the earnings differential due to the enhanced capacity, estimates the remaining tenure of the enhanced earnings and calculates the present value of that inflation-adjusted, enhanced earnings stream. To do so, there are at least six factual issues that must be determined in order to measure enhanced earnings capacity:

License/Degree That Enhanced Earnings

Since O'Brien, the New York courts have been enlarging the concept of 'marital property' to include any license or skill that enhances future earning capacity. College degrees enhance earnings. Even attending college but not earning a degree enhances earnings. In fact, nearly all licenses enhance earnings: doctors, nurses, teachers, school administrators, CPAs, and, yes, even attorneys. Professional practices have also been held to be marital property subject to equitable distribution [Cohen v. Cohen, 104 App.Div. 2d 841 (2nd Dept. 1984) (accounting practices); Litman v. Litman, 61 N.Y.2d 918 (1984) (law practices); Sweeney v. Sweeney, 118 App.Div. 2d 774 (2nd Dept. 1986) (medical practices)].

Enhanced (or Topline) Earnings

While it may appear that acquiring an estimate of enhanced earnings may be a simple matter, the fact is, enhanced earnings are often difficult to measure. What if the titled spouse works part time, or works overtime or two jobs? What if the titled spouse is not working in the field in which the subject degree/license relates, such as a teacher who left teaching to run his/her own business? What about the self employed professional? What portion of his/her income relates to profits of the professional practice and earnings as a professional? Or suppose the professional is just starting out his/her career and hasn't yet realized the potential enhanced earnings, as was the case in O'Brien. Evaluated on a case-by-case basis, the base of the enhanced earnings should match the base of earnings used in the unenhanced earnings. If the unenhanced earnings estimate is for individuals employed full time, the full time equivalent top line earnings should be applied. Also, look to the market for what similar individuals earn. If valuing a nursing degree/license for an individual who just graduated, look to see what nurses earn on average in the marketplace. Of course, this begs the question: 'Are average earnings appropriate for this individual?'

Unenhanced (or Baseline) Earnings

What would an individual earn if he/she did not obtain his/her degree and/or license? If the subject of the calculation is a 37-year-old male, who married right after high school and now has an accounting degree and his CPA, what would his likely earnings be if he was a 37-year-old high school graduate with nearly 20 years of work experience? Experts will often look to U.S. Census Bureau data, (Data can be found at the U.S. Census Bureau's Web Site for various years at http://www.census.gov/hhes/www.income.html), which provides income statistics by various socio-economic categories. For example, the total average earnings for all 35- to 39-year-old males who worked full time, and had a high school degree (and no college) was $42,893 in 2004. The countervailing argument for using average generally addresses whether or not the individual is 'average' or not; an argument also made, often with more effort, for topline earnings.

Remaining Worklife

How much longer, from the time of the calculation (typically the end of the economic union, often measured by the date of filing for divorce) will the individual continue to receive the enhanced earnings? How much longer will the 37-year-old male continue to work? Experts generally use, and the courts have accepted, a series of studies prepared by Dr. A.M. Gamboa (The New Worklife Expec-tancy Tables: by Gender, Level of Educational Attainment, and Level of Disability, A.M. Gamboa, Jr., PhD, MBA, Vocational Econometrics, Inc., Louisville, KY; 2002), which estimates remaining worklife for individuals based upon age, gender, education, and level of disability. The advantage of this analysis is that it takes into account life expectancies and workforce participation rates. According to Gamboa, our 37-year-old male is expected to work an additional 24.7 years. Arguments to deviate from the worklife tables include fact-specific circumstances that affect worklife, such as forced military retirement at a younger age and typical early retirement of teachers that shorten the worklife.

Inflation Adjustment

Experts adjust the earnings differential over the assumed worklife by an assumed rate of inflation, usually the rate of inflation as measured by the CPI (Consumer Price Index) as published by the Federal government as of the calculation date.

Discount Rate (or Present Value Factor)

To convert the inflation-adjusted worklife earnings enhancement to present value, experts discount the projected earnings enhancement over time to today's dollars by applying a discount rate. Another area where valuation theory and courts diverge in opinion, the courts have deemed that the discount rate should be a 'riskless rate.' Experts therefore often use a long-term Treasury bond yield, the life of which closely matches the expected worklife term, as an appropriate discount rate. The argument for a riskless rate says that most risks are captured in the worklife tables, including the likelihood of the individual's living long enough and not becoming disabled, or otherwise not participating in the workforce. The arguments against the use of a riskless rate include case-specific facts that create different levels of risk, such as particular dangers in certain jobs. Obviously the state of the interest yield curve can dramatically affect the value outcome, all other facts remaining constant. Therefore, some courts have required a shortcut to this analysis, by requiring the assumption of a simple 3% discount rate to non-inflation adjusted earnings.

Coverture

Up to this point, we have assumed that the entire earnings enhancement occurred during the marriage and is part of the marital estate. In fact, often earnings enhancement occurs both inside and outside the term of the marriage; therefore, only a portion of the enhancement should be included in the marital estate. If a portion of the license/degree was obtained outside the marriage, experts apply a coverture calculation to allocate the portion of the enhanced earnings capacity properly to the marital estate. For example, if our 37-year-old male had earned his bachelor's degree during the marriage, but he and his wife married between semesters of his junior year in college, he attended college for three of his eight semesters during the marriage. A coverture calculation would apply three-eighths (or 37.5%) of the earnings enhancement to the marital estate.

Common Errors in Enhanced Earnings Calculations

Challenges can be made to attack the theoretical problems with en-hanced earnings calculations. Often the courts have crafted solutions to these problems for the application of the analysis to measuring the value of the marital estate. Ensure that your experts know and understand the analytical or assumptive errors in their calculations. For example:

• Including total individual earnings in topline earnings, rather than earnings associated with the degree/license. For example, a teacher may earn additional compensation for coaching a scholastic sport, which does not require a teaching certificate.
• Double counting income to value both a license and a valuation practice. This error was highlighted in McSparron v. McSparron, 87 N.Y.2d 275 (1995), and illustrates that experts need to take care in allocating income to value assets. If a law practice generates $500,000 in profits to its sole practitioner, those profits should not be used to value both the practice in a business valuation, and the enhanced earnings. The expert needs to establish a basis for allocating a portion of those profits to the attorney as a practitioner (enhanced earnings) and the attorney as a business owner (profits).
• Not tax-affecting baseline and topline earnings. In New York, at least, the enhanced earnings calculation on an after-tax basis and the difference between pre-tax and after-tax can be significant.
• Differing earnings base between baseline and topline earnings. If baseline earnings are established based on data for full time earnings, topline earnings should be estimated on the same basis. Part-time earnings may need to be converted to full-time earnings, or overtime earnings may need to be disregarded.

Two other issues associated with enhanced earnings calculations are worth noting, though they are matters of fact, typically outside the scope of the expert's role:

• The issue of double dipping is the use of the same income to value a marital asset and establish maintenance (or income) awards. To the extent one uses income to value a marital asset, and then awards a portion of that income as maintenance, the income has been allocated twice to the non-titled spouse.
• The issue of spousal contribution to the enhanced earnings addresses the allocation of this asset between the spouses. The extent to which the non-titled spouse provided economic support to the union and the attainment of the enhanced earnings vehicle, is the extent to which the non-titled spouse is entitled to share in the enhanced earnings. Unlike the facts in O'Brien, a professional couple, each independently working towards his and her professional credentials, and both contributing to the economic union, would likely not share in each other's enhanced earnings upon divorce.

Enhanced Earnings Associated With Celebrity Status

It is also interesting to note how the enhanced earnings capacity is being applied outside the arena of degrees and licenses. In Golub v. Golub (139 Misc.2d 440, Sup. Ct. New York County 1988), the court held that the skills of an actor and model are marital assets because those skills represent en-hanced earning capacity. In Elkus v. Elkus (169 App. Div. 2d 134 (1st Dept. 1991), the Appellate Division held that the enhanced value of the plaintiff's career and/or celebrity status is a marital asset subject to equitable distribution. The plaintiff in Elkus was an opera singer (Frederica von Stade) and the defendant was her voice teacher and coach. During the marriage, the plaintiff's income increased and she became a well-known celebrity.

Poor Joe Piscopo. In a classic 'what's wrong with this theory' case, the court awarded his wife a portion of his valued celebrity status. The problem was that he divorced during the height of his entertainment career, and his enhanced earnings were based on the assumptions that that level of celebrity status would remain. Piscopo v. Piscopo, 231 N.J. Super. 576 (Ch. Div. 1988).

Moral: Matrimonial attorneys need to recognize the valuation theories underscoring arguments of earnings capacity. Depending upon the applicable state's case law, these theories will impact your next case.

William Quackenbush, MBA, ASA, CBA, managing director of Advent Valuation Advisors (www.adventvalue.com), is a credentialed business appraiser, with offices in New York City and the Hudson Valley area of New York. He is the author of a credentialing course and text in valuation, and is a member of the American Society of Appraisers' Business Valuation Committee. He teaches valuation courses internationally and lectures on valuation issues to the legal, accounting, and appraisal communities.

Editor's Note: New York often serves as a leading venue for concepts in matrimonial law. Although states differ widely on valuation issues such as personal and organizational goodwill, the concept of value to a professional license or degree has a certain amount of differentiation to the marital pot.

A Case Study

Jim and Sally were in love. They knew they were meant to be from the moment they first met. They married during their junior year in college; Sally was a pre-law student, Jim, pre-med. Alas, the fairy tale didn't last. In order to make ends meet, Sally dropped out of college and worked as a waitress to put Jim through college and med school, and to survive financially during his internship and residency. Shortly after Dr. Jim finished his fellowship in vascular surgery and set up his practice in the pricey Upper East Side of Manhattan, he announced to Sally he was starting a new fairy tale with his nurse'

This fairy tale-turned soap opera 'and maybe more like General Hospital for those involved in similar matrimonial litigation in New York ' is the pretend analogy to a real-life case.

O'Brien v. O'Brien

O'Brien v. O'Brien , 66 N.Y. 2d 576 (1985) (wherein Willard Da Silva, the Chairman of this newsletter's Board of Editors, represented Mr. O'Brien), was a pivotal case. In that 1980s litigation, Mrs. O'Brien's counsel was able to argue successfully before the courts that Mrs. O'Brien had given up her career aspirations so as to benefit and support her husband's career aspirations as a surgeon, fully expecting to share and enjoy the enhanced earnings he was expected to derive from his medical career. How was it equitable, her attorney argued before the justices, that she should pay the 'cost' of his earnings enhancement, but not reap the benefit of her investment? The courts agreed.

But, how to measure what Dr. O'Brien should share with his soon-to-be-ex in this equitable distribution state? Simple, argued Mrs. O'Brien's expert witness. Just calculate the present value of Mr. O'Brien's lifetime earnings enhancement associated with his medical license, which Mrs. O'Brien helped make possible through her many years of work, at the expense of her own career dreams.

Thus the valuation of licenses and degrees as a marital asset was established in New York. O'Brien and its progeny have created a framework in an attempt to apply valuation tools to measure enhanced earnings capacity. In O'Brien, the debate as to if a license or degree can be valued was won by those who argue that it can be independently valued. (Never mind that a transaction for value cannot be affected: a license or degree cannot be sold. Nor is it relevant that some of the measurement structures are artificially established.) In New York, much of the continued litigation in this area relates either to the factual issues surrounding the calculation of the present value of the enhanced earnings or the equitable distribution of that present value. Regarding the latter, the mere fact that a spouse obtained a license, certification or degree during the marriage does not by itself entitle the other spouse to an award of the enhanced earnings. The spouse must show that he/she made a contribution toward the acquisition of that license, certification or degree as cited in Small v. Small, 227 App.Div. 2d 949 (4th Dept. 1996).

Calculating Enhanced Earnings Capacity

To calculate the present value of enhanced earnings capacity, a valuation professional estimates the earnings differential due to the enhanced capacity, estimates the remaining tenure of the enhanced earnings and calculates the present value of that inflation-adjusted, enhanced earnings stream. To do so, there are at least six factual issues that must be determined in order to measure enhanced earnings capacity:

License/Degree That Enhanced Earnings

Since O'Brien, the New York courts have been enlarging the concept of 'marital property' to include any license or skill that enhances future earning capacity. College degrees enhance earnings. Even attending college but not earning a degree enhances earnings. In fact, nearly all licenses enhance earnings: doctors, nurses, teachers, school administrators, CPAs, and, yes, even attorneys. Professional practices have also been held to be marital property subject to equitable distribution [ Cohen v. Cohen , 104 App.Div. 2d 841 (2nd Dept. 1984) (accounting practices); Litman v. Litman , 61 N.Y.2d 918 (1984) (law practices); Sweeney v. Sweeney , 118 App.Div. 2d 774 (2nd Dept. 1986) (medical practices)].

Enhanced (or Topline) Earnings

While it may appear that acquiring an estimate of enhanced earnings may be a simple matter, the fact is, enhanced earnings are often difficult to measure. What if the titled spouse works part time, or works overtime or two jobs? What if the titled spouse is not working in the field in which the subject degree/license relates, such as a teacher who left teaching to run his/her own business? What about the self employed professional? What portion of his/her income relates to profits of the professional practice and earnings as a professional? Or suppose the professional is just starting out his/her career and hasn't yet realized the potential enhanced earnings, as was the case in O'Brien. Evaluated on a case-by-case basis, the base of the enhanced earnings should match the base of earnings used in the unenhanced earnings. If the unenhanced earnings estimate is for individuals employed full time, the full time equivalent top line earnings should be applied. Also, look to the market for what similar individuals earn. If valuing a nursing degree/license for an individual who just graduated, look to see what nurses earn on average in the marketplace. Of course, this begs the question: 'Are average earnings appropriate for this individual?'

Unenhanced (or Baseline) Earnings

What would an individual earn if he/she did not obtain his/her degree and/or license? If the subject of the calculation is a 37-year-old male, who married right after high school and now has an accounting degree and his CPA, what would his likely earnings be if he was a 37-year-old high school graduate with nearly 20 years of work experience? Experts will often look to U.S. Census Bureau data, (Data can be found at the U.S. Census Bureau's Web Site for various years at http://www.census.gov/hhes/www.income.html), which provides income statistics by various socio-economic categories. For example, the total average earnings for all 35- to 39-year-old males who worked full time, and had a high school degree (and no college) was $42,893 in 2004. The countervailing argument for using average generally addresses whether or not the individual is 'average' or not; an argument also made, often with more effort, for topline earnings.

Remaining Worklife

How much longer, from the time of the calculation (typically the end of the economic union, often measured by the date of filing for divorce) will the individual continue to receive the enhanced earnings? How much longer will the 37-year-old male continue to work? Experts generally use, and the courts have accepted, a series of studies prepared by Dr. A.M. Gamboa (The New Worklife Expec-tancy Tables: by Gender, Level of Educational Attainment, and Level of Disability, A.M. Gamboa, Jr., PhD, MBA, Vocational Econometrics, Inc., Louisville, KY; 2002), which estimates remaining worklife for individuals based upon age, gender, education, and level of disability. The advantage of this analysis is that it takes into account life expectancies and workforce participation rates. According to Gamboa, our 37-year-old male is expected to work an additional 24.7 years. Arguments to deviate from the worklife tables include fact-specific circumstances that affect worklife, such as forced military retirement at a younger age and typical early retirement of teachers that shorten the worklife.

Inflation Adjustment

Experts adjust the earnings differential over the assumed worklife by an assumed rate of inflation, usually the rate of inflation as measured by the CPI (Consumer Price Index) as published by the Federal government as of the calculation date.

Discount Rate (or Present Value Factor)

To convert the inflation-adjusted worklife earnings enhancement to present value, experts discount the projected earnings enhancement over time to today's dollars by applying a discount rate. Another area where valuation theory and courts diverge in opinion, the courts have deemed that the discount rate should be a 'riskless rate.' Experts therefore often use a long-term Treasury bond yield, the life of which closely matches the expected worklife term, as an appropriate discount rate. The argument for a riskless rate says that most risks are captured in the worklife tables, including the likelihood of the individual's living long enough and not becoming disabled, or otherwise not participating in the workforce. The arguments against the use of a riskless rate include case-specific facts that create different levels of risk, such as particular dangers in certain jobs. Obviously the state of the interest yield curve can dramatically affect the value outcome, all other facts remaining constant. Therefore, some courts have required a shortcut to this analysis, by requiring the assumption of a simple 3% discount rate to non-inflation adjusted earnings.

Coverture

Up to this point, we have assumed that the entire earnings enhancement occurred during the marriage and is part of the marital estate. In fact, often earnings enhancement occurs both inside and outside the term of the marriage; therefore, only a portion of the enhancement should be included in the marital estate. If a portion of the license/degree was obtained outside the marriage, experts apply a coverture calculation to allocate the portion of the enhanced earnings capacity properly to the marital estate. For example, if our 37-year-old male had earned his bachelor's degree during the marriage, but he and his wife married between semesters of his junior year in college, he attended college for three of his eight semesters during the marriage. A coverture calculation would apply three-eighths (or 37.5%) of the earnings enhancement to the marital estate.

Common Errors in Enhanced Earnings Calculations

Challenges can be made to attack the theoretical problems with en-hanced earnings calculations. Often the courts have crafted solutions to these problems for the application of the analysis to measuring the value of the marital estate. Ensure that your experts know and understand the analytical or assumptive errors in their calculations. For example:

• Including total individual earnings in topline earnings, rather than earnings associated with the degree/license. For example, a teacher may earn additional compensation for coaching a scholastic sport, which does not require a teaching certificate.
• Double counting income to value both a license and a valuation practice. This error was highlighted in McSparron v. McSparron, 87 N.Y.2d 275 (1995), and illustrates that experts need to take care in allocating income to value assets. If a law practice generates $500,000 in profits to its sole practitioner, those profits should not be used to value both the practice in a business valuation, and the enhanced earnings. The expert needs to establish a basis for allocating a portion of those profits to the attorney as a practitioner (enhanced earnings) and the attorney as a business owner (profits).
• Not tax-affecting baseline and topline earnings. In New York, at least, the enhanced earnings calculation on an after-tax basis and the difference between pre-tax and after-tax can be significant.
• Differing earnings base between baseline and topline earnings. If baseline earnings are established based on data for full time earnings, topline earnings should be estimated on the same basis. Part-time earnings may need to be converted to full-time earnings, or overtime earnings may need to be disregarded.

Two other issues associated with enhanced earnings calculations are worth noting, though they are matters of fact, typically outside the scope of the expert's role:

• The issue of double dipping is the use of the same income to value a marital asset and establish maintenance (or income) awards. To the extent one uses income to value a marital asset, and then awards a portion of that income as maintenance, the income has been allocated twice to the non-titled spouse.
• The issue of spousal contribution to the enhanced earnings addresses the allocation of this asset between the spouses. The extent to which the non-titled spouse provided economic support to the union and the attainment of the enhanced earnings vehicle, is the extent to which the non-titled spouse is entitled to share in the enhanced earnings. Unlike the facts in O'Brien, a professional couple, each independently working towards his and her professional credentials, and both contributing to the economic union, would likely not share in each other's enhanced earnings upon divorce.

Enhanced Earnings Associated With Celebrity Status

It is also interesting to note how the enhanced earnings capacity is being applied outside the arena of degrees and licenses. In Golub v. Golub (139 Misc.2d 440, Sup. Ct. New York County 1988), the court held that the skills of an actor and model are marital assets because those skills represent en-hanced earning capacity. In Elkus v. Elkus (169 App. Div. 2d 134 (1st Dept. 1991), the Appellate Division held that the enhanced value of the plaintiff's career and/or celebrity status is a marital asset subject to equitable distribution. The plaintiff in Elkus was an opera singer (Frederica von Stade) and the defendant was her voice teacher and coach. During the marriage, the plaintiff's income increased and she became a well-known celebrity.

Poor Joe Piscopo. In a classic 'what's wrong with this theory' case, the court awarded his wife a portion of his valued celebrity status. The problem was that he divorced during the height of his entertainment career, and his enhanced earnings were based on the assumptions that that level of celebrity status would remain. Piscopo v. Piscopo, 231 N.J. Super. 576 (Ch. Div. 1988).

Moral: Matrimonial attorneys need to recognize the valuation theories underscoring arguments of earnings capacity. Depending upon the applicable state's case law, these theories will impact your next case.

William Quackenbush, MBA, ASA, CBA, managing director of Advent Valuation Advisors (www.adventvalue.com), is a credentialed business appraiser, with offices in New York City and the Hudson Valley area of New York. He is the author of a credentialing course and text in valuation, and is a member of the American Society of Appraisers' Business Valuation Committee. He teaches valuation courses internationally and lectures on valuation issues to the legal, accounting, and appraisal communities.