New Case - Fuller v. Fuller - Intangible Trail Income Stream is a Marital Asset, But Not Income for Support; Includes Comment from Robert Vance
December 21st, 2016
Erin Alford Fuller (“Mother”) v. Roger Darnell Fuller (“Father”)
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Case Number: E2016-00243-COA-R3-CV
Appeal from the Chancery Court for Bradley County
Trial Judge: Chancellor Jerry S. Bryant
Date Filed: Wednesday, December 21, 2016
An interesting new case was filed on December 21, 2016 that involves valuing a sole proprietorship and the concept of double-dipping the income stream for support purposes. The trial court found that the “trail” income from the father’s financial planning business was a divisible marital asset, valuing it according to the evidence presented. The trial court set child support and alimony based on its determination of the father’s income as an average of the prior two years’ gross revenues from his business. The Eastern Section of the COA determined that the trial court properly classified and valued the father’s trail income from his business; however, erred by including the amount of the trail income distributed as a marital asset in the father’s income available for payment of child support and alimony purposes. The COA vacated the trial court’s determination regarding the amount of child support and alimony to be paid by the father and remanded for a proper determination of father’s income, as well as an appropriate calculation of child support and alimony.
Fuller Case Facts: Asset That Can Be Sold is Divisible
Father asserted that the trial court erred in classifying his sole proprietorship, Legacy Investments, as a marital asset subject to equitable division by claiming that the business depends solely on his efforts to generate income. Father argued that the business had no value aside from goodwill, noting that the COA has repeatedly held that professional goodwill in a sole proprietorship is an intangible asset that is not divisible as marital property upon divorce because it is personal to the proprietor. See, e.g., Hartline v. Hartline, No. E2012-02593-COA-R3-CV, 2014 WL 103801, at *13 (Tenn. Ct. App. Jan. 13, 2014); Eberting v. Eberting, No. E2010-02471-COA-R3-CV, 2012 WL 605512, at *19 (Tenn. Ct. App. Feb. 27, 2012). Mother contended that the trial court properly valued the trail income from the business as a marital asset, upon determining that the trail income constituted an asset separate from goodwill.
Father is a CFP, certified financial planner, and is employed by his own sole proprietorship practice, Legacy Investments. Mr. Fuller typically receives two types of income from his employment: direct commissions from the sale of financial products and income from financial products that he had previously sold and continued to manage, a recurring income stream commonly referred to as “trail” income. Father admitted that his total revenue from Legacy in 2014 was $270,000, which was comprised of $50,000 in direct commissions and $220,000 in trail income.
Father contended that the trail income could be sold for two times its annual value (i.e., 200%). The parties stipulated to an expert who was familiar with the recognized guidelines in the trade for valuing the sale of a financial planning practice which he testified was “two times a year’s trail, plus . . . one times the [direct] commission.” The COA determined that Father’s trail income was a divisible marital asset separate and apart from any goodwill of the business and valued this asset at $400,000, awarding Mother a judgment for one-half of that amount. The undisputed evidence demonstrated that Father’s trail income could be sold or assigned and that a recognized methodology existed within the industry for valuing the income as property that could be sold. The salability aspect was determined by the Court to be the controlling factor in distinguishing its nature from the concept of goodwill.
I am confused by this ruling of the Eastern Section COA in terms of their logic that the trail income is a divisible marital asset when compared to other recent rulings. The ruling stated that the salability aspect of the trail income was the controlling factor in distinguishing its nature from the concept of the intangible asset: goodwill. The ruling states “In contrast to professional goodwill, Father’s trail income could be sold separately.” The terminology is important as it appears that the Eastern Section COA uses the term “professional” which I interpret to be also known as “personal” in the valuation profession. The courts in Tennessee have consistently ruled that personal or professional goodwill is not a divisible marital asset, but have inconsistently ruled on the divisibility of enterprise or business goodwill. Enterprise goodwill has generally been determined to be divisible by the Tennessee COA, but not if the business or professional practice is a sole proprietorship according to the Eastern Section of the COA, as in Hartline cited above and in Lunn v. Lunn, No. E2014-00865-COA-R3-CV (Tenn. Ct. App. June 29, 2015). Drs. Hartline and Lunn were sole practitioner dentists from the Chattanooga area. In my opinion, from a financial forensic and business valuation analytical standpoint, the form of organization as a sole proprietorship, LLC or corporation should not matter as to whether or not a business can sell its intangible asset of goodwill. Either the business can sell and transfer the asset or it cannot.
The question really is: What is the intangible, enterprise goodwill, and can it be sold? Very simply stated, enterprise goodwill is the present value of future cash flows available to the owner, over and above a normal owner compensation, the total value of which exceeds the “hard” assets like cash, receivables and equipment. For example, a professional practice is valued, or sells, for $100,000 which includes cash, receivables and equipment collectively valued at $40,000. The implication is that enterprise goodwill is $60,000. Enterprise goodwill is sold every year in this country by thousands of sole practitioner dentists, accountants, engineers, architects, financial planners, etc. The goodwill or intangible value that is sold by these professionals is based in part on the future cash flow expectation of recurring revenue streams generated from patient lists, client lists, tax return preparation revenue, related building projects and, yes, trail income. I personally sold the goodwill from my sole practitioner CPA practice in 2003 in the form of the recurring revenue stream from the client list and files. We based the sale on a multiple of the gross revenue.
In Fuller, the Father is a financial planning professional practice organized as a sole proprietorship. The Eastern Section COA was able to separate the future cash flow of the trail income (an intangible asset) from the sole proprietor simply due to the salability of the recurring revenue and the existence of a recognized valuation methodology. Did the dentists Drs. Hartline and Lunn have intangible assets to sell that could be valued? Answer: Yes; a patient list, known location used by a dentist, equipment operating in place and a trained and assembled workforce (i.e., recurring revenue or enterprise goodwill). Do dentists have an industry-recognized valuation methodology? Answer: Yes; usually some factor or percentage of gross revenue that can typically range from 60-65%. Fuller used a selling factor of 200% of annual gross revenue. What is the difference between Fuller, Hartline and Lunn based upon the facts of those cases as stated in the appellate decisions? All three had recurring revenue that could be sold and all three are sole proprietors/sole practitioners.
Fuller Case Facts: Divisible Asset Cannot Also Be Income
The trial court calculated Father’s income based on the average of his past two years’ revenues and set child support according to the guidelines. Father asserted that the trial court erred in determining the amount of his income for the purpose of setting child support by failing to deduct the “ordinary and reasonable expenses of self-employment necessary to produce income” pursuant to the Tennessee Child Support Guidelines. The trial court utilized the annual income amount of $200,000 which appeared to be the gross revenue of Legacy without any deduction for expenses. The COA also noted that in basing Father’s income amount on the total revenue from Legacy, the trial court appeared to have included the trail income that was also divided as a marital asset, i.e., the trial court “double-dipped”. Citing TCA § 36-4-121(b)(1)(E) (Supp. 2016) “. . . assets distributed as marital property will not be considered as income for child support or alimony purposes, except to the extent the asset will create additional income after the division . . .”
As a result, the COA concluded that the trial court’s determination regarding Father’s income and his resultant child support and alimony obligations must be vacated and remanded so that the trial court could make a determination regarding Father’s income by deducting (1) any ordinary and reasonable expenses of self-employment necessary to produce income, and (2) the amount of the trail income distributed as a marital asset. The COA ruled that the trial court should also consider any additional income generated by the trail income asset after the division.
I agree that the ordinary and reasonable expenses should be deducted from the gross revenues to determine a net income available to draw by the proprietor which in turn is his income available for support. I do not agree in this case that Father’s income should be determined by deducting the amount of the trail income distributed as a marital asset since I do not see the double-dip. The trail income is an intangible, future-income concept that would only be realized upon the sale or assignment of the client list or trail income residuals to another CFP. Apparently, the trail income asset was figured as the present value of only two years of gross revenue; however, that revenue source is presumably many years away from being realized as Mr. Fuller does not appear to be near retirement age and of course death or disability cannot be reasonably predicted. The income available to the obligor for child support and alimony purposes is immediate and current and would seemingly not be the same income stream that would be realized upon the sale of the future trail income that could be years into the future. In my opinion, based upon the facts in the Fuller decision, the intangible asset known as trail income and the income available for support do not appear be the same income stream and therefore no double-dip has occurred.