Valuation / Litigation Consultants, PLC

Attorneys must know the “replacement value” of a life in order to formulate a damage claim in personal injury, wrongful death and wrongful termination litigation. Forensic accountants calculate life worth based on the remaining work capacity that is lost after the damaging event in order to illustrate to a jury that a damage claim was formed in economic reality. A case can pivot on the calculation alone. This article explains some of the basic concepts of economic damages for individuals and illustrates a quick method to figure life worth.

Damages are generally considered to be a lump-sum amount for judgment or settlement purposes. The losses are typically calculated from the date of the damaging event and compounded with interest to the present date, then projected into the future and discounted back to present value. Individuals that can continue to work in a limited fashion produce mitigating dollars that are subtracted from a total loss.

How does one cram a lifetime of lost earning potential into a neat, single figure? The general answer includes:

1) Projecting the expected yearly future earning capacity, over the work life expectancy. The earnings can be based on the working status at the time of the damaging event, or, if the situation warrants, based on reasonable alternatives such as allowing for job promotions and attainment of higher education.

2) Estimating associated employer-provided fringe benefits, over the work life expectancy. Lost benefits can represent a large portion of the damages suffered. A recent U.S. Chamber of Commerce study reports that Social Security taxes, paid holidays and vacations, medical insurance and 401(k) plan (typical large company benefits) can be worth up to 26% of earnings.

3) Figuring the yearly value of household services that can no longer be performed over the life expectancy. The services include the unpaid tasks that maintain and enhance the lives of those that occupy the household, such as food preparation, laundry, cleaning, auto and yard maintenance, and child care. The loss of the production, even though not directly compensated like regular employment, has value to the household nonetheless since the tasks will: a) not be done at all or not as often, b) be done by someone else in the household (at the expense of other things the "someone else" might have been doing), or c) require outside assistance which may have to be compensated. Since most individuals do not keep hourly logs, published studies, like “The Dollar Value of a Day,” help to quantify the hours that typical Americans spend performing the unpaid household tasks and present an hourly rate to measure the value. This loss category is usually considered in a personal injury and wrongful death case and applies to the employed, the unemployed and homemakers.

4) Discounting the annual sums for earnings, benefits, and services to a single present value for the desired lump-sum number.

Many analysts grow the earnings figures each year to account for merit raises using a “real” wage growth rate of around 1% and discount to present value using a “true” interest rate of around 3%. Why such low rates? A method accepted by the U.S. Supreme Court known as “constant-dollar” is often used by analysts to estimate future lost earnings and interest by removing inflation from current rates. Removing inflation, which has hovered around 3% in recent history, eliminates the nearly impossible task of predicting future inflation rates and gives the dollars to be received in the future the same average purchasing power as dollars received today.

The concepts discussed can be best explained with an illustration. In order to simplify the calculations, the earnings are not grown for merit raises and only the future damages are considered. The merit raise growth is accomplished, however, by using a 2% discount rate derived from subtracting the real wage growth rate of 1% from the true interest discount rate of 3%. The Tables referenced allow the reader to calculate his or her own life worth and can be downloaded from www.valuationlitigation.com/downloads.asp.

Sarah, a forty-year old, white, female engineer is permanently injured in a car accident and will be unable to work on the job and perform regular household chores and family duties for her husband and two children. She was earning $80,000 annually at the time of injury and enjoyed all of the fringe benefits listed above at 26% of pay, or $20,800 annually (no Table to download for fringe benefits, so use between 20-26% for your own calculation). Sarah’s pre-injury life expectancy (see Table 1) is 42 years, thus she would have statistically been expected to live until age 82. Her pre-injury work life expectancy (see Table 2a) is 21 years, thus she would have statistically been expected to work until age 61. Since Sarah did not keep records of time spent with household chores (and who does?), Table 3 shows that someone with Sarah’s family makeup would typically have worked 32.5 hours per week in the household, valued at $9.97 per hour, or $16,849 annually.

The goal is to figure the yearly future losses and discount them to present value. Table 4 lists factors for the 2% discount rate that will transform an annual payment into a single, lump-sum present value figure. Add together Sarah’s lost earnings and benefits for a total of $100,800. Multiply that figure by the present value factor of 17.011 found in the 21 year row of Table 4 to equal $1,714,708. Multiply Sarah’s lost household services of $16,849 by the present value factor of 28.235 found in the 42 year row to equal $475,731. Add the two figures together to arrive at the total economic damages for Sarah’s lost earning and production capacity of $2,190,439. If you have a financial calculator, solve for present value by entering a payment of $100,800 at 2% for 21 periods, then a payment of $16,849 at 2% for 42 periods. What’s your life worth? Using the Tables, find your own life and work life expectancies, household service hours and rate, and present value factors, then plug your numbers into the “formula” found in the illustration.

Fair or not, the “replacement value” of some individuals is worth more than others due to the loss of a greater working capacity. No one can state with absolute certainty that an individual would have earned “X” amount of dollars for “Y” amount of years, however, if a person is unable to fully work or has died, a forensic accountant can reasonably estimate the life worth by using known facts, statistical estimates and professional judgment.

Why would anyone have a need for Creatively Searching for Income on a tax return? Everyone is always honest and straightforward in a business acquisition, loan application, divorce or lost profits lawsuit – aren’t they? Forensic CPA work may not be as exciting as watching the team on Crime Scene Investigation solve a murder, but we can often find the missing piece of the puzzle that solidifies your decision-making process or proves your case. The forensic CPA can assist the buyer, seller or litigant in proving or disproving the existence of income, validating claims of separate property, determining disposable income, verifying the standard of living and identifying transmuted property.

This article will focus on techniques used by forensic CPAs to identifying income using the form 1040, U.S. Individual Income Tax Return as the starting point. The 1040, however, is not always a completely accurate reflection of a subject’s true income. The individual may legitimately report a lesser amount of taxable income and draw a considerably larger amount of cash than that reported. I have used the following tax return CSI methods on many forensic engagements, but they can be used by anyone trying to make sense of facts and figures in common business and litigation situations.

The starting point for most forensic investigations involving individuals begins with reviewing several years of the 1040 in order to gauge the level and consistency of income and deductions. Income miraculously tends to fall in the periods preceding an event like a divorce, and income tends to rise in those preceding a business sale or major loan application.

Form W-2 Examine the Line 1 “Wages” and Line 5 “Medicare Wages” for a difference. Observe the box 13 check boxes for “Retirement Plan.” If this box is checked or a difference exists between Lines 1 and 5, then the employee probably has a retirement or 401(k) plan or other salary reduction benefit. State income taxes withheld in excess of 6-8%, or by a person who does not live or work in that state, or federal income taxes withheld in a larger percentage than the tax bracket the person would likely fall within, may indicate this person is intentionally over withholding and parking funds to hide from the lawsuit. Another related hiding technique involves overpaying estimated taxes, which is reported on the second page of the 1040. This transgression is not obvious and would require direct information from the IRS or examination of bank records.

You should not always necessarily assume that the W-2 is prepared correctly since many errors and omissions occur on them. I have been told many times that a divorcing spouse is “in cahoots” with the business owner, or the subject prepares the W-2s himself. Try to obtain corroborating information like a paystub or payroll summary from the employer if the information seems suspect.

Schedule A (Itemized Deductions) An astute individual can hide assets (cash) in prepayments for his future benefit. These prepayments can often be detected on Schedule A. Analyze the property taxes that should be due annually to see if substantially more is deducted than in the past. Prepayment of a year or two of taxes can add up. Perform the same check on mortgage interest. An increase in interest deduction from one year to the next could indicate prepayment of a few mortgage payments, and, conversely, a large decrease in deduction could indicate a refinancing or large principal pay-down. Payments of an unusual or extraordinary nature can usually be found by examining the bank records, but can often be lost in the maze of bank accounts or check volume.

Schedule B (Interest and Dividends) If interest and dividends are reported, then an investment asset is generating the income. If the person owns growth stocks or other non-dividend producing assets, then little or no income will be reported. Although nontaxable municipal interest is supposed to be reported, many filers omit this since tax-exempt income is not reported to the IRS. Be aware that assets may be transferred to a child through an UGMA, to another person by “gift”, to a trust or to a corporation. The IRS reporting is on that other entity’s SSN or EIN, thus disguised.

Schedule C (Sole Proprietorship) A sole proprietor does not have to keep a balanced, double-entry accounting system, i.e., many owners keep their records in a coffee-stained spiral notebook. Since the income statement and balance sheet are not required to be reported and reconciled together on the return, as is the case with a corporation, partnership or LLC, manipulation can occur. Most Schedules C are reported on the cash basis, thus receivables and inventory may exist but are not recorded anywhere. If possible, inspect sales tax returns, customer invoices or cash register tapes to ensure that all income is reported and not pocketed. Watch for excessive vehicle, travel, meals and miscellaneous expenses. Depreciation can be manipulated legitimately for tax reporting by writing off the full value of assets under IRC Sec. 179 and other newer expensing provisions. These artificially high depreciation deductions allow write-offs that distort the true income picture of a business.

Schedule E, (Rental, Partnership/LLC and S Corporation) A common, legitimate tax dodge allows small business owners to pay themselves rent for buildings they own in lieu of a larger salary or draw. The rent expense is deducted on the business return, but the reportable income is sometimes mysteriously absent on the individual’s 1040 rental income Schedule E, thus tracing is required.

Profit or loss for a partner, LLC member or S corporation owner is reported to them in the form of a Schedule K-1, which is an attachment to a business tax return. A partner or LLC member should not receive a W-2 to report his income since he is not a legal employee, and an S corporation owner should receive a W-2. When inspecting the partnership/LLC and S corporation income section on page 2 of Schedule E, scrutinize the income/loss reported. This does not necessarily reflect the actual income received by this owner. An S corporation owner will commonly take compensation in the form of “S corporation draws”, which is essentially a non-reported return of capital likened to a dividend, in place of or in addition to his W-2. If the K-1 is correct, the draw figure will appear on the second page. If not reported there, check the corporate tax return balance sheet on page 4 for the distributions. In a recent divorce case, I observed an owner’s S corporation K-1 that reported income of $49,250. The owner took no W-2, but rather took all of his compensation, $78,500, as an S corporation draw (which is against IRS rulings because it avoids payroll taxes). The K-1 was in error and did not report this draw, but found it on the corporate tax return.

The partner/LLC member receives most of his compensation by taking draws, not “payroll” per se. The draws should be reported on the K-1 and on the business return, form 1065, page 4. Be aware that both LLCs and partnerships file on form 1065, the partnership tax return. Another form of compensation, likened to a salary, is called a “guaranteed payment” and should be reported on that partner’s/member’s K-1. A common error (or deception) is the failure to report the guaranteed payment (salary) on the K-1 and bypass paying tax on it. Once again, income reported on the K-1 does not necessarily reflect the owner’s actual income received.

Another aspect to consider is the amount of capital or loans a small business owner may invest in or loan to his company, thus parking cash out of the way of prying eyes. Owners can easily bury capital on a tax return. Track the retained earnings or partners equity from year to year. The basic formula is beginning (prior year) balance plus net income earned less draws equals ending balance. Analyze the total capital and owner-related loans. If these balances seem high for the type of business, ask yourself if this business needs a large amount of accumulated capital to operate.

Dead men don’t talk, and sometimes tax returns don’t either. Forensic CPAs will often be called upon to conduct an “autopsy” to determine the cause of discrepancy in income claimed versus reality. Assuming no personal or business financial statements are available and the tax returns are silent, then where do you look? Five basic methods are available to prove unreported income: the Transaction Method, Net Worth Method, Expenditures Method, Bank Deposit Method and Percentage Method.

Transaction Method This is the easiest method to employ since it involves identifying a specific item or transaction that was not properly reported on a tax return such as a real estate sale or securities sale. Most financial transactions and earnings are reported to the IRS on some type of form, like a 1099. An individual may fail to identify to the court or report on the tax return items that are recorded on a 1099-S, from a real estate sale, or 1099-B, from a broker sale of securities. This is discussed as a general concept above in relation to erroneous K-1 reporting. A business might also inflate inventory values or create fictitious payables in order to depress reportable income. In this case, a thorough fraud audit may need to be conducted on the business’ books.

Net Worth Method Many civil and criminal tax cases use this method to determine unreported income and to support findings from other methods employed. The concept is simple - if an individual’s net worth from one year to the next increases beyond the reported income, then unreported income probably exists. Outside of a form 1040, records of assets can be obtained from county assessors, bank and brokerage accounts, federal estate and gift tax returns and loan/credit card applications. After an unsubstantiated increase in net worth is established, a likely source for this income must be determined other than from accumulated cash, loans, inheritances, gifts, insurance proceeds, etc. If the individual claims the likely source was from accumulated cash, you need to establish the unreasonableness of this by searching for checks returned for insufficient funds, bankrupt filings, offers in compromise or installment agreements with the IRS, Social Security and employer records showing low income, deposition answers about cash on hand, etc.

Expenditures Method This method is very simple to understand and apply and is useful when the individual spends most of his income and does not save much. Establish annual expenses through affidavits, checkbooks, bank statements, canceled checks, etc. If the expenses exceed the reported income and it can be established that the gap was not bridged with accumulated cash, loans, inheritances, gifts or insurance proceeds, you probably have found unreported income.

Bank Deposits Method The IRS commonly uses this method to catch tax cheats. All deposits recorded in all banks and other institutions are totaled, cash received by the individual that was not deposited and used to pay expenses is added, deposits that do not represent already reported and known taxable income are subtracted and business expenses paid by check or cash are subtracted. Finally, the standard or itemized deductions and exemptions, as reported in the 1040, are deducted to arrive at taxable income. If more taxable income is found with this formula than was reported on the 1040, the individual probably has unreported income.

Percentage Method Not used as often, but this is a good method for supporting findings from other methods when investigating a business. An established and reliable profit percentage, typical of that business, is multiplied by a reported income base, such as sales or gross profit, to determine net income. The formula net income is compared to that reported on tax returns or financial statements to establish an underreporting of income.

I used a variation of this method combined with the business valuation method of capitalized returns a few years ago in a divorce. The case involved a family that owned the local cable company and several other businesses in the small town. The husband owned a separate property minority share of the businesses and had successfully stalled producing financial statements and tax returns, but we did have all of the 1040s for the duration of the marriage. The attorney that employed me had been assigned this case a few days before trial and needed me to very quickly establish an increase in value of the separate property since an antinuptial agreement was signed. I established a value of the businesses in each year of the marriage by taking his minority reported income on the 1040s and “grossing it up” to a full value using his ownership percentage and a reasonable rate of return. This gross up provided me with a figure for goodwill, which I added to the “hard assets” he had reported on an affidavit. Together, the goodwill and hard assets established a value that the wife was able to show had increased substantially during the marriage. The judge approved the easy-to-understand methodology and awarded a decent property settlement, despite the antinuptial agreement.

Conclusion Hiding income and assets is routine and seemingly easy for a litigant. The transfer of income between an individual’s 1040 and his business return, and visa versa, is easily manipulated and can go undetected without the proper scrutiny. Tax returns are often the first, best shot at Creatively Searching for Income, so hire an experienced CPA to read between the lines and keep an eye on the cash flow. Forensic accounting isn’t flashy and fancy, but it is often as important to a lawsuit as the CSI team is to a murder investigation.

Surely You Jest While I Vest

Pension Valuation In A Tennessee Divorce

By Robert Vance, CPA, CVA, CFP

A pension plan can be the most significant asset that accumulates during a marriage. Couples often forego other forms of savings while vesting in an employer-sponsored plan since it is a “free” fringe benefit. The term, vested, means, “the degree to which an employee-participant owns the benefits which have been accrued on his or her behalf.”(1) It stands to reason that a pension, whether vested or not, should always be considered a valuable marital asset in a divorce. The Court of Appeals of Tennessee at Knoxville agrees with this premise. The Court ruled April 23, 2002 on the divorce case of Curtis Michael Daniels v. Mary Freels Daniels. The parties appealed several issues, one of which was whether the Trial Court erred in failing to award Mrs. Daniels any share of Mr. Daniels’ pension benefits. This article will focus on the Daniels decision and the methods the Court restates are to be used in valuing vested and unvested (or undetermined) defined benefit pensions in Tennessee divorces, however, different cases and circumstances may require different methods and techniques.

Daniels v. Daniels

As of the trial date, Mr. Daniels had been an employee of the Tennessee Valley Authority (TVA) for over twenty years. At trial, an affidavit from Robert J. Vaughn, manager of Retirement Services at TVA, was presented stating that if Mr. Daniels retires from TVA after five or more years of creditable TVA service, he may be eligible to receive a pension based solely on TVA’s contributions. He also stated, “the amount of any pension to which Mr. Daniels may become eligible has not been determined by TVARS and is not contained in any record maintained by Retirement Services.” The Trial Court apparently took this statement to mean that the pension was unvested and even used that particular term in describing the pension. This case, however, appears to center around undetermined benefits, not unvested.

In researching this article, I spoke with Mr. Vaughn at TVA. He issues the pension affidavits almost daily and assures me that in a situation as seen in this case, a TVA employee with twenty years of creditable service would be vested in the TVARS pension. He said that any vested employee could easily obtain a statement from TVARS estimating his monthly retirement benefit based on service already performed. TVA’s standard affidavit states that an employee’s eligible pension has not been determined and TVA does not maintain a record of it. Mrs. Selma Paty, attorney for Mrs. Daniels, told me this is technically true since TVA outsources the generation of the statements to a private firm and does not actually keep copies in their files. She agrees that the pension benefit information could have been easily obtained, but the Trial Court would not compel Mr. Daniels or TVA to produce the document.

In the appeal, Mrs. Daniels argued that the TVA pension is marital property pursuant to T.C.A. §36-4-121(b)(1)(B), which states:

“Marital property” includes income from, and any increase in value during the marriage of, property determined to be separate property in accordance with subdivision (b)(2) if each party substantially contributed to its preservation and appreciation, and the value of vested and unvested pension, vested or unvested stock option rights, retirement or other fringe benefit rights relating to employment that accrued during the period of the marriage.

Mrs. Daniels also asserted and that the Trial Court abused its discretion in failing to award her any portion of the TVA pension that accrued during her husband’s twenty year career with TVA. Mr. Daniels argued that his potential collection of the unvested pension is based upon a number of future events and that Mrs. Daniels failed to produce any evidence as to the value of the pension or that he will even receive the pension. Mrs. Paty asserts that many attempts were made to produce the evidence of value, but Mr. Daniels would not cooperate and the Trial Court did not compel him to do so.

The Appeals Court found the pension to be a marital asset because of T.C.A. §36-4-121(b)(1)(B). The Court stated that, while Mr. Daniels’s pension is contingent upon several factors including but not limited to his retirement from TVA, the pension is a valuable marital asset assuming he qualifies for it upon retirement. They further found that the Trial Court did not divide the pension and it erred in failing to award Mrs. Daniels any portion of it. Although the Trial Court referred to the pension as unvested, it is actually undetermined since it apparently is vested based upon TVA parameters, but was simply left unvalued at trial.

The Appeals Court cited Cohen v. Cohen, 937 S.W.2d 823, 830-832 (Tenn. 1996). In Cohen, the Supreme Court stated that the difficulty in determining the value of pension or retirement benefits should not affect the classification of the property. Having held that unvested retirement benefits are marital property under the Tennessee statute, the Court in Cohen listed principles that may assist trial judges in valuing these benefits. The Court then went on to cite observations made by the Court of Appeals in Kendrick v. Kendrick, 902 S.W. 2d 918, 922 (Tenn. App. 1994) as follows:

1. Only the portion of retirement benefits accrued during the marriage are marital property subject to equitable division,

2. Retirement benefits accrued during the marriage are marital property subject to equitable division even though the non-employee spouse did not contribute to the increase in their value,

3. The value of retirement benefits must be determined at a date as near as possible to the date of the divorce.

Cohen v. Cohen specifically directs the Trial Courts as to possible methods of dividing an unvested or undetermined pension.

Vested "The first approach, known as the present cash value method, requires the trial court to place a present value on the retirement benefit as of the date of the final decree…To determine the present cash value, the anticipated number of months the employee spouse will collect the benefits (based on life expectancy) is multiplied by the current retirement benefit payable under the plan…This gross benefit figure is then discounted to present value allowing for various factors such as mortality, interest, inflation, and any applicable taxes…Once the present cash value is calculated, the court may award the retirement benefits to the employee‑spouse and offset that award by distributing to the other spouse some portion of the marital estate that is equivalent to the spouse's share of the retirement interest…The present cash value method is preferable if the employee‑spouse's retirement benefits can be accurately valued, if retirement is likely to occur in the near future, and if the marital estate includes sufficient assets to offset the award."(2)

Unvested/Undetermined "In other circumstances in which the vesting or maturation is uncertain or in which the retirement benefit is the parties' greatest or only economic asset, courts have used the "deferred distribution" or "retained jurisdiction" method to distribute unvested retirement benefits. This method has distinct advantages when the risk of forfeiture is great…Under such an approach, it is unnecessary to determine the present value of the retirement benefit. Rather, the court may determine the formula for dividing the monthly benefit at the time of the decree, but delay the actual distribution until the benefits become payable…The marital property interest is often expressed as a fraction or a percentage of the employee spouse's monthly benefit. The percentage may be derived by dividing the number of months of the marriage during which the benefits accrued by the total number of months during which the retirement benefits accumulate before being paid. One advantage to the deferred distribution method is that it allows an equitable division without requiring present payment for a benefit not yet realized and potentially never obtained… Another advantage to the approach is that it equally apportions any risk of forfeiture…While the parties are entitled to an equitable division of their marital property, that division need not be mathematically precise…It must, however, reflect essential fairness in light of the facts of the case."(3)

The Daniels Appeals Court stated that both the Supreme Court in Cohen v. Cohen and their Court in Kendrick v. Kendrick had already addressed the unvested pension issue in both cases. The Court therefore remand to the Trial Court to choose one of the two aforementioned methods of valuation found in Cohen in order to obtain an equitable division.

Using the Present Value Method To Value An Interest In A Defined Benefit

Pension Plan (Vested Benefits)

Many businesses, large and small, sponsor retirement plans that can be classified into generic categories as defined by the retirement plan industry and the Internal Revenue Code (IRC) as defined contribution plans and defined benefit plans. Participants in defined contribution plans (including IRA, 401(k), and Keogh accounts) usually receive periodic statements of their accounts that detail vested and non-vested balances. It is usually a simple matter to determine the values of investments in such plans since these are contributory accounts having a definite dollar figure “deposited” or contributed to the account owned by the employee.

A more challenging endeavor is determining the value of an employee's interest in a defined benefit plan since the value of the participant’s interest in such a plan must be calculated by determining the present value of the expected future monthly pension payments, as prescribed in Cohen. The concept of present value must be understood in order to appreciate the pension valuation process. Present value embodies the concept that a dollar in hand today is worth more than a dollar a year from now, or many years from now. One would rather receive a lump sum of money now rather than waiting for it to be paid over a period of months or years. This preference lies in the time value of money, and, in order to receive a lump sum now rather than throughout the future, one must be willing to receive a reduced or “discounted” amount. The future benefits are discounted back to the present value using a number of variables that include a time period (the participant’s life expectancy) and an assumed rate of return on the money (the discount rate).

1. Establish the vested monthly retirement benefit as close to the Divorce Date as possible,

4. Calculate the present value of the future benefit payments at the Retirement Date,

5. Discount the present value of future benefits at the Retirement Date (as computed in Step 4) back to the Divorce Date (a.k.a. valuation date),

6. Determine what percentage of the computed pension value qualifies as marital property.

Pension Plan Valuation Timeline

Step 1 - Establish the vested monthly retirement benefit as close to the divorce date as possible

Most companies have an in-house pension administrator or outside administration firm that can readily calculate the expected monthly or annual benefit a participant will receive upon retirement, based on the benefit formulas established by the company. As previously stated, the value of a participant’s interest in a pension plan is determined, for divorce purposes, by calculating the present value of the expected future monthly pension payments based on a life expectancy assumption. Quite often the benefit will be presented on a company-generated form as a dollar figure to be received monthly upon retirement at a normal retirement age and sometimes as a reduced amount upon early retirement (if that is an option in the plan). The statement may further break down the figures as a single life annuity (payments for the employee’s life only) and a joint life annuity (payments for the lives of both spouses). For divorce purposes, only the single life option is used since a divorce is imminent and the joint life option will not be relevant (at least not for this spouse).

Step 2 - Determine the age and life expectancy of the participant

The participant’s life expectancy is a figure in years that is calculated generically based on national statistics. The figures can be obtained from many sources. A commonly used source is the National Vital Statistics Report, from the Centers for Disease Control and Prevention. This application is quite simple. For example, a white male the age of 46 today, can be expected to live another 31 years to age 77, according to the tables. If he is to retire at age 65, the payout period is assumed/estimated to be 12 years (77-65) and the Deferral Period would be 19 years (65-46), for a span of 31 years (12+19).

Step 3 - Determine the Appropriate Discount Rate To Be Applied

In determining the appropriate discount rate, the following two components are considered:

2. An additional percentage of return intended to compensate the “investor” for risk over and above the risk-free investments, if any, associated with the specific pension plan being valued.

The risk-free rate refers to the investment return on a “perfectly safe” investment under current market conditions. This return and its underlying investment are based on the current yield of long-term U.S. Government bonds as of the valuation date. The maturity of the bonds should approximately match the total period over which benefits will be discounted (the combined deferral and payout periods previously discussed).

Additional Risk Component

Many pensions are considered to be risk-free based on the size and success of the sponsor company, and those of the U.S. Government. The valuer may believe, however, that a risk may exist that the promised future benefits could be less than expected. The higher the perceived risk that payments will not be paid in full, the higher the discount rate should be. In other words, if more risk were involved with the cash flow being discounted, one would require a higher rate of return on the money to compensate for the potential default. As the discount rate goes up with the risk assessment, the present value will go down. The inverse effect occurs because one is “trading” away the risk into the future by “receiving” a lump sum now. The primary factors to consider in assessing the additional risk for a particular plan are as follows:

1. Is the plan covered under the Employee Retirement Income Security Act of 1974 (ERISA)?

2. Is the plan over or under-funded by the company based on the projected future obligations?

Step 4 - Calculate the present value of the future benefit payments at the Retirement Date

Review the timeline presented above once more. The discounting of the present value of the future benefit payments begins to the right, in the Payout Period. The payments to be received monthly during this time period are to be calculated into a single lump-sum figure at the Retirement Date using a computer program. The future payments to the right are “pulled back” to the left closer to present day.

Step 5 - Discount the present value of future benefits at the Retirement Date (as computed in Step 4) back to the Divorce Date

After discounting the monthly payments into a single, lump-sum payment at the Retirement Date, the figure is then discounted to the Divorce Date to account for that time delay and the time value of money during the Deferral Period. After this figure is calculated, compare that value to any known contributions the participant may have made himself, plus earnings on those contributions. The larger of the two should be used as the present value of the pension.

Step 6 - Determine what percentage of the computed pension value qualifies as marital property

T.C.A. §36-4-121(b)(1)(B) defines marital property in part, as “the retirement or other fringe benefit rights relating to employment that accrued during the period of the marriage.” An easily understood approach to the calculating the portion of the pension that accrued during the period of the marriage is to calculate the ratio of the years of the marriage to the years of participation in the plan. For example, if the marriage lasted 10 years and the employee participated in the pension plan for 15 years, the value derived in Step 5 would be multiplied by 66.7% (10 / 15) to extract the marital value.

Mr. Smith, age 47, who has worked for the ABC Widget Company for 17 years (since age 30), is divorcing his wife of 10 years. He has been eligible and has participated in the company’s defined benefit pension plan for the last 15 years. During discovery, a pension benefit estimate is obtained from ABC that states Mr. Smith is fully vested in the plan and will receive $680 per month upon retirement at age 65. The figure is based on the company’s pension formula using variables known as of today with no assumptions of future service or salary projections.

Using the appropriate table in the National Vital Statistics Report, it is determined that Mr. Smith has a life expectancy of 31 years (i.e. he is expected statistically to live until age 77). The Payout Period to use is 12 years (77-65) and the Deferral Period is 19 years (65-46). The current interest rate quoted on 30-year U.S. Government bonds (the risk-free rate) is 5.5%. After analysis of the ABC Widget Company, it is determined that their plan is covered under ERISA, the plan is slightly under-funded and the company is experiencing some lean financial times according to the latest annual report. An additional risk of 1% is determined to be appropriate under the circumstances, for a total 6.5% discount rate.

The current expected payout of $680 per month through the Payout Period is discounted to the Retirement Date using 144 payments (12 years x 12 per year) at 6.5%. The resulting figure is then discounted through the Deferral Period to the Divorce Date using a period of 19 years at 6.5% to arrive at a present value of $20,513. The plan is non-contributory, so $20,513 is used as the figure to multiply by 66.7% (10 / 15) to extract the marital value of $13,682. This value now sits on Mr. Smith’s martial balance sheet as an asset of his to be offset with other assets that his wife will receive.

Using the Deferred Distribution Method To Value An Interest In A Defined

Benefit Pension Plan (Unvested Benefits)

The deferred distribution method, by definition, delays the determination of the amount the ex-spouse will receive in the divorce. Per Cohen, “the court may determine the formula for dividing the monthly benefit at the time of the decree, but delay the actual distribution until the benefits become payable.” Thus, no actual present value or single, lump-sum figure is calculated, rather a percentage of the monthly benefit, once drawn, is to be paid to the ex-spouse. The variables used to determine the percentage should be those in effect at the time of divorce.

This method is best illustrated with an example. Mr. Smith, age 47, who has worked for the ABC Widget Company for 17 years (since age 30), is divorcing his wife of 10 years. He is not vested in the pension plan and will not be until age 50 when he has completed 20 years of service. No estimate is given or available as to the expected monthly benefit upon retirement. The pension is not valued at date of divorce, but the pension is a valuable asset of the marriage. According to Cohen, a deferred distribution could be ordered that provided for a percentage of the pension to go to Mrs. Smith, if and when paid to Mr. Smith.

The ratio for unvested pensions is slightly different than that used to figure the vested pension that accrued during the marriage. Under Cohen, an unvested pension is calculated using the ratio of the years of the marriage to the years of the vesting period required in the plan. In this example, the percentage of the pension subject to marital property division is 50% (10 year marriage / 20 year vesting). The court would then decide as to what percentage of the 50% Mrs. Smith would receive once Mr. Smith began drawing.

The Tennessee courts have decided many times over that vested and unvested pension benefits are subject to equitable division in a divorce. The courts have even set forth prescribed methods to execute the valuation or division of the benefits. The present value and deferred distribution methods are specifically mentioned in Cohen and several other cases as acceptable and understandable procedures for valuation. Other, more complicated methods are available, with some considered more accurate than those described in this article, however, the bottom line is that the value or percentage derived must be reasonable and explainable to the court.

(1) Slimmon, Robert F., Successful Pension Design For Small to Medium-Sized Businesses, (Englewood Cliffs, N.J.: Prentice-Hall, 1987), p. 25.

(2) Cohen v. Cohen, 937 S.W.2d 823, 830-832 (Tenn. 1996).

(3) Ibid.

(4) Meltzer, Stanton L., et al., Guide to Divorce Engagements, (Fort Worth, TX: Practitioners Publishing Co., 1997), p. 5-63.

The IRS form W-2, Wage and Tax Statement, can often prove to be a simple roadmap for determining an employee’s income for Tennessee Child Support Guidelines purposes. However, don’t be fooled by its apparent simplicity. The W-2, if not read correctly, does not always reveal the unknown and known sources of employment “income” as defined by the Guidelines. Per the Guidelines, the definition of “income” is:

Gross income shall include all income from any source (before taxes and other deductions), whether earned or unearned, and includes but is not limited to, the following: wages, salaries, commissions, bonuses, overtime payments, dividends, severance pay, pensions, interest, trust income, annuities, capital gains, benefits received from the Social Security Administration, i.e., Title II Social Security benefits, workers’ compensation benefits whether temporary or permanent, judgments recovered for personal injuries, unemployment insurance benefits, gifts, prizes, lottery winnings, alimony or maintenance and income from self-employment. Income from self-employment includes income from business operations and rental properties, etc., less reasonable expenses necessary to produce such income. Depreciation, home offices, excessive promotional, excessive travel, excessive car expenses, or excessive personal expenses, etc., should not be considered reasonable expenses. “In kind” remuneration must also be imputed as income, i.e., fringe benefits such as a company car, the value of on-base lodging and meals in lieu of BAQ and BAS for a military member, etc. (1)

“All income from any source (before taxes and other deductions),” would seem to be a no-brainer - an all-encompassing definition of a person’s cash inflow. But, the term “income” can mean one thing to a CPA and W-2 preparer and another to an attorney trying to interpret the document in order to set child support. Income is conventionally thought by CPAs to be taxable compensation or earnings of some type. Attorneys and the Guidelines generally consider the term “income” to be cash flows available to the employee regardless of the purpose for payment. W-2’s report gross income in one of it’s boxes, and can document other payments made to the employee for items like business expense reimbursements and moving costs.

Practice Tip -Because the W-2 is a much more complex reporting document than it appears, understand that employers or their accountants in preparation make many unintentional errors. Do not necessarily rely upon the form as presented. For employees with a more complex compensation structure, an attorney should discover the expense reimbursement policies and retirement plans available to the employee, then trace those items to the W-2.

Start your analysis with the most commonly used items on the W-2 – Boxes 1, 3 and 5, Wages Tips and Other Compensation, Social Security Wages and Medicare Wages, respectively. Box 1 reports the taxable wages, salary, commissions, certain expense reimbursements, etc. (hereinafter wages) the employee will be required to report on his form 1040 as income for that year. It will not include any amounts for elective salary deferrals, (i.e. pre-tax deductions.) The most common examples of elective salary deferrals are contributions to 401(k) or Simple IRA plans. Note that most companies match some percentage of an employee’s pay or contribution to a retirement plan and deposits the cash or company stock into the employee’s separate account. This type of fringe benefit does not have to be reported on the W-2, although it may appear in Box 14. The match could also be considered Guideline income since it is a monetary balance the employee can access usually after a vesting period.

Practice Tip – Social Security Tax (6.2% rate) and Medicare Tax (1.45% rate) are collectively known as FICA (total rate of 7.65%), not one or the other separately. These taxes are deducted from an employee’s pay at these rates, subject to certain limits as explained below. An employer matches the withheld tax dollar-for-dollar for a total tax paid in of 15.3%. The W-2 will only report the employee’s withheld portion.

Box 3 reports the wages subject to Social Security Tax withholding at the 6.2% rate, up to the maximum wage base. For 2001, the wage base is $80,400 for a maximum tax of $4,984.80; for 2002, the base is $84,900 for a maximum tax of $5,263.80. Generally, Box 3 reports all of the items found in Box 1, but does not deduct the elective salary deferrals. Note that certain government employees and clergy are not subject to Social Security tax and will not have an amount reported in Box 3.

Box 5 reports the wages subject to Medicare Tax withholding, which are generally the same as those in Box 3, without the maximum wage base. The elective salary deferrals are not deducted from Box 5 and, since there is no maximum Medicare wage base, Box 5 is the most accurate of the three boxes in determining the employee’s gross income from employment. An employee’s Box 5 will be higher than Box 3 and possibly Box 1 if his wages exceed the maximum wage base and he participates in a 401(k)-type plan.

A simple example will illustrate all of these points. An employee, Joseph Jones, earned $140,000 in 2002 and elects to have $5,000 deducted and contributed to his 401(k) plan. He has no federal tax withheld (he lives dangerously.) No fringe benefits.

In this example, Joseph’s net “take home” pay is $127,706.20 ($140,000.00-5,263.80-2,030.00-5,000.00); the Guideline income is $140,000. The elective salary deferrals should be considered part of Mr. Jones’ gross income since the deduction was elective and would have been included in gross taxable income if Congress had not decided to make this particular paycheck deduction a pre-tax item.

Practice Tip –Photocopy both sides of a W-2. The backside may include instructions and explanations of any codes that might appear in Box 12. These codes can provide a wealth of information about income, reimbursements, deductions and fringe benefits that may or may not be included in Boxes 1, 3 and 5.

An employee fringe benefit increasing in popularity is the §125 “Cafeteria Plan.” This IRS-qualified paycheck deduction allows for a pre-tax deduction from income for particular personal expenses that would probably otherwise not be tax deductible to the employee. A typical cafeteria plan deduction is medical insurance, which could add up to several thousand dollars. The amount of the Plan deducted from pay will generally not be found in Boxes 1, 3 or 5, (or anywhere else for that matter) and could be considered Guideline income since it is also elective.

Employer expense reimbursements and allowances can also be a source of income for Guideline purposes. An employee’s out-of-pocket business expenses and employer paid moving expenses may be reported in Boxes 1, 3 and 5, however, the payments may qualify for non-reporting on the W-2 depending on the method of payment and documentation. In most circumstances, the obligee spouse will know if the obligor makes a “profit” on expense reimbursements.

Practice Tip-The reporting of expense reimbursements and allowances is a source of confusion, thus many employers fail to include them properly on the W-2. A quick call or a subpoena issued to the company’s benefits department will reveal their reimbursement and W-2 reporting policies.

Reimbursements could also satisfy the “all income from any source” Guideline criteria. Under certain conditions, the IRS considers these payments to be taxable income includable on the W-2 depending on the discretion the employee has over the use of the funds. Since the dollars are paid to the employee to reimburse him for ordinary and necessary business expenses or for moving, which could be quasi-business related, many practitioners might not consider them as income. To illustrate, a salesman may use her car to travel from customer to customer and she is reimbursed for the mileage costs, but does an attorney usually receive a stipend for his expensive business suits or commuting costs to and from home? All are necessary to conduct business. All persons that work incur some sort of personal expense as a condition of employment. Will the attorney be hit for support on income that he ultimately will use to buy a new suit and tie? Yes. Should the salesman be hit for support on reimbursed mileage payments she will ultimately use to buy gas? Perhaps.

The W-2 can be an effective roadmap that summarizes income for Tennessee Child Support Guideline purposes and other important measures in a divorce – but you can make a wrong turn and end up in a bad neighborhood if you read it incorrectly. Of course, there is no substitute for a thorough interview and full financial analysis of the subject, along with a little common sense. The W-2 is a roadmap that can lead the attorney to the right side of the tracks, but it also contains alleys and side streets just waiting for a missed turn.

(1) Rules of Tennessee Department of Human Services Child Support Services Division, Chapter 1240-2-4 Child Support Guidelines, ¶1240-2-4-.03 (3)(a), Oct. 1989 (Revised)

Professional Practice Valuation in a Tennessee Divorce
As Published in Tennessee CPA Journal, June 2001
A Publication of the Tennessee Society of CPAs

The process of valuing a business is more art than science and depends on the circumstance or event causing the valuation. The fundamental concept common to most business valuations is that the value of an entity is equal to the present worth of the future benefits of ownership at a single point in time. Economic benefits to an owner ultimately must be derived from the generation of ongoing income from operations or investments, liquidation of the underlying assets or sale of the entity. Fair market value (FMV) is the value standard to be used in most cases, with a few notable exceptions, such as in some divorces or dissenting shareholder lawsuits. FMV is defined as the amount at which the property would change hands between a willing buyer and a willing seller, neither under compulsion to buy or sell, with both parties having reasonable knowledge of relevant facts. Believe it or not, the Internal Revenue Service created this definition in 1959 in Revenue Ruling 59-60, which, even today, is still considered a bedrock of valuation text.

In a divorce, an actual transfer of the business to a third party is not usually planned or even possible, thus does not involve a willing buyer and willing seller in an arm's length deal (i.e., no FMV). Jurisdictions, like the State of Tennessee, often impose further limitations or restrictions based on their belief that, in certain cases, the expectation of future earnings is not an asset for property division. The following article focuses on three divorce cases decided in the Tennessee Court of Appeals. These cases highlight three situations commonly argued when professionals divorce - existence of goodwill for a sole practitioner, existence of goodwill in a large practice and binding valuation formulas found in buy-sell agreements. All three cases deal with medical practices, although the same theories apply to other professions.

In a Tennessee divorce, a sole practitioner licensed professional, such as a physician, dentist, accountant, attorney, engineer, etc., would generally not be subject to having the practice valued at FMV. Only the value of the net assets could be considered with no allowance for an expectation of future earnings (i.e. goodwill), such as in Hazard v. Hazard, 833 S.W. 2d 911 (Tenn. App. 1991). Net Assets is defined as the total non-intangible assets (cash, accounts receivable, work in progress, inventory, equipment) less the payables and debts. Professionals with larger practices that do not depend on the sole reputation or efforts of the individual have often been likened to going concern, closely held corporations, such as in Witt v. Witt, 17 TAM 15-6 (M.S., Tenn. App. 1992). The valuation allowed in Witt more closely resembles FMV and did allow for goodwill. Another interesting twist was decided in Harmon v. Harmon, 25 TAM 15-22 (W.S., Tenn. App. 2000). Harmon established that a spouse, who is not a party to a buy-sell agreement, is not bound to the artificially low valuation method specified in the agreement.

Sole Practitioner (No Goodwill)
In Hazard, the Western Section of the Tennessee Court of Appeals affirmed that a sole practitioner professional practice is to be valued using the "net tangible assets with ascertainable value." The court stated that goodwill, which is usually based on some function of future, potential income, is not to be considered based on the personal nature of a professional practice and the speculative nature of future income which may or may not materialize. Dr. Hazard was a physician in his final year of fellowship training in pulmonary medicine. He established a private practice that employed one associate physician, two nurses and two other employees. The court found the value of the practice to be based upon a total of the cash on hand, accounts receivable, equipment, fixtures, supplies and medical charts. No provision for goodwill was allowed. The wife argued that the practice was a going concern, separate entity, and should be valued accordingly. The court determined that the practice was highly specialized and, apparently, very dependent upon the services of Dr. Hazard.

In Smith v. Smith, 709 S.W. 2d 588 (Tenn. App. 1985), the…Court, in dealing with a law practice, said:

The next question is what elements of a profession are taken into account in arriving at the value of that profession for purposes of making an equitable division. The physical assets, of course, such as the furniture, buildings, library, etc., are things that have an ascertainable value and should be taken into account. The accounts receivable, properly weighted, should have a definite value. The most troublesome question involves the goodwill of the firm. Is that an asset that can be considered part of the marital property? Other states are split on the question, although a clear majority hold that the goodwill of the firm should be considered and evaluated in making a division of the marital property.

We are not persuaded, however, that this state should adopt the rule that professional goodwill is a part of the marital estate. We find the position taken by the Wisconsin Court of Appeals in Holbrook v. Holbrook, (Wis. App. 1981) to be persuasive. The court said:

The concept of professional goodwill evanesces when one attempts to distinguish it from future earning capacity. Although a professional business's good reputation, which is essentially what its goodwill consists of, is certainly a thing of value, we do not believe that it bestows on those who have an ownership interest in the business, an actual, separate property interest. The reputation of a law firm or some other professional business is valuable to its individual owners to the extent that it assures continued substantial earnings in the future. It cannot be separately sold or pledged by the individual owners. The goodwill or reputation of such a business accrues to the benefit of the owners only through increased salary.

There is a disturbing inequity of compelling a professional practitioner to pay a spouse a share of intangible assets at a judicially determined value that could not be realized by a sale or another method of liquidating value.

The Holbrook opinion is one of the most often cited involving professional goodwill (or the lack thereof).

Closely Held Corporation (With Goodwill)
Exceptions do apply to the "no goodwill," net asset value divorce rule. For example, in Witt, the court found that Dr. Witt's outpatient diagnostic clinic had a value over and above the net asset value (i.e. it had goodwill.) The court said:

We are convinced, however, that excluding the professional goodwill, (Husband's) practice has a value over and above the net asset value. The clinic employs eight people providing CT scans and MRI examinations. (Husband) works a full day at the VA Hospital and then goes to the clinic to apply his expertise to the work performed during the day by technicians. (Husband's) professional fees are billed separately from the technical fees generated by the technicians....The trial judge found that the net asset value of the clinic amounted to $950,000. The evidence does not preponderate against that finding....The trial judge set a value on the medical practice at $1,300,000, i.e., $350,000 over and above the net asset value. We think the part of the business that does not include (Husband's) professional goodwill has a substantial value and that the trial judge's valuation of $350,000 for that portion of the business is supported by the evidence.

In other words, the clinic was found to have separate goodwill that was not directly related to the Husband's professional or personal goodwill, and thus the overall value was increased accordingly to include the intangible value.

Spouse Not Bound to Buy-Sell Agreement
In Harmon, the wife was not bound to the valuation method (formula) mandated in the buy-sell agreement in effect in her physician-husband's medical practice. The wife was not a party to the agreement and had not signed it.

Husband owned 10 shares (1.17%) of stock in the Jackson Clinic (Clinic), a very large, multi-location medical association. He had signed an employment contract that contained a non-compete clause, which further subjected him to a buy-sell agreement. The agreement bound him to a predetermined formula for valuation of the shares if he were to attempt to sell them. The formula specified that no allowance could be made for goodwill, supplies or accounts receivable, except upon dissolution.

Prior to trial, the parties stipulated that the current net asset value of Husband's interest in the Clinic at that time was $250,000. At trial, Wife asserted that the trial court should use the parties' stipulated net asset values. She argued that Husband's buy-sell agreements with the Clinic were designed to discourage physicians from leaving the clinic, and therefore set an artificially low price per share. She asserted that the share price set by the clinic did not reflect the actual value of Husband's interest because it did not include the accounts receivable or the inventory. Husband argued that the clinic should be valued in accordance with the buy-sell agreement because he would be bound to that price if he sold his shares. The trial court found the stipulated value of the Clinic was the value to be used if the practice liquidated. Since there was no plan to liquidate, the trial court stated that Wife was bound to the value set by Husband's buy-sell agreement.

Upon appeal, Wife first argued that appropriate value was the net asset value of $250,000 as stipulated by the parties. She stated that this value looks to the net assets of the practice as a going concern, taking into account the value for items such as accounts receivable and supplies. Even though Wife argued that net asset value was the FMV, she did not request a provision for goodwill, which would have been closer to the true FMV. She noted that she was not a party to the buy-sell agreements, and disputes the trial court's legal conclusion that she was bound by the value set in the agreements. Husband argued that the trial court's valuation of his interest in the Clinic is correct because his interest cannot be valued at more than the price he would receive for the sale of his shares.

The Harmon appellate court noted that both Smith and Hazard involved professional practices in which the value as a going concern and its business reputation was inseparable from the professional reputation of the practitioners. The court stated that, in a larger professional setting that does not depend on the reputation or services of a single practitioner, such as in Witt, Tennessee courts have not limited the valuation to the physical assets and the accounts receivable and have included goodwill.

In Harmon, the court relied upon a 1992 case, York v. York 17 TAM 34-1 (M.S., Tenn. App. 1992). In York, the Court discussed at length the method for valuation of a divorcing spouse's interest in a large professional practice. In York, the husband owned an interest in a multi-employee, specialty medical group. The York Court found the husband's medical practice to be more similar to the practice in Witt than to a traditional solo medical practice. The trial court in York likened the professional association to a closely held corporation and indicated that, while future income projections would not be considered, other factors such as corporate goodwill and the price at which other physicians had purchased stock would factor into the valuation of the husband's interest.

The Harmon court's research revealed no Tennessee cases addressing the issue of whether Wife was bound by the value stated in the buy-sell agreement. The clear majority of courts from other jurisdictions held that the value established in the buy-sell agreement of a closely held corporation, not signed by the non-shareholder spouse, is not binding on that spouse, but is considered, along with other factors, in valuing the interest. The court found that the majority view is more consistent with the valuation approach outlined in Tennessee decisions such as in York. The York court rejected the notion of mathematical formulas for such a valuation and emphasized that valuation of a professional corporation, such as Husband's, is "a factually driven inquiry that requires the trial court to weigh and evaluate all relevant evidence regarding value."

The Harmon court adopted the view that buy-sell agreements may be considered along with any other relevant evidence on valuation, but are not controlling, thus reversed the trial court's holding on this issue. The cause was remanded to the trial court for valuation of Husband's interest after consideration of all relevant evidence, including, but not limited to, the parties' stipulated net asset value and the values set forth in the buy-sell agreements. The trial court was told it may consider how closely the factors for valuation in the buy-sell agreements correlate with the factors mentioned in York and other applicable case law. The buy-sell agreement of the Clinic specifically excluded items such as intangible assets, accounts receivable and supplies. As in York and Witt, Husband's medical practice is an incorporated medical group that does not depend solely on his professional reputation for its value as a going concern. In fact, Husband's medical group in this case dwarfs in size those considered in York and Witt. The court found that since Husband will continue to experience the benefits of being a shareholder and an employee, factors such as those deleted from the valuation in the buy-sell agreement are pertinent to the valuation of Husband's interests for purposes of the division of marital property. The issue is not the value the shareholder spouse would receive if he sold his shares, but rather the current value to the shareholder of his interest in the corporation.

Conclusion
The final chapter of the valuation of professional practices in Tennessee divorces has certainly not been written. The courts are continuing to grapple with the concept of professional versus practice goodwill and the point at which the line is crossed and the practice becomes diverse enough to separate itself from the professional. This article addressed three valuation issues commonly found when professionals divorce - the non-existence of goodwill for a sole practitioner in Hazard, the existence of goodwill for a large practice in Witt, and not binding a non-party spouse to artificially low-yielding valuation formulas found in a buy-sell agreement in Harmon. The courts are becoming more sophisticated in their understanding of business valuation as evidenced in these cases, but they continue to depart from many traditional valuation methods.