Case Studies and Answers to Frequently Asked Questions

• What happens to my stock options when I get divorced?
• Can I transfer my stock options in a divorce?
• Are stock grants considered in determining child support and alimony?

Splitting assets in a divorce can be complicated, particularly when stock based compensation is a significant part of your salary. Understanding these critical issues and the legal trends in your state could have a big impact on your property settlement and child support agreement.

Once all your assets have been identified, it is inevitable questions regarding the nature and value of your stock options will come up. You will need to determine whether your vested and unvested options are classified as marital, separate or hybrid property.

Vested stock options that were granted during your marriage are considered a marital asset. State laws will often dictate how to classify options granted before a marriage that vest during the marriage. These options could be considered marital, separate or hybrid property depending on where you live.

Unvested options pose the biggest challenge. Unfortunately, there is no clear trend that exists among the majority of the courts. If a case goes to trial, several factors are likely to be considered when classifying the property:

• Is the future vesting of the option a contingency that distinguishes compensation earned during the marriage from that earned after the marriage?
• Was the option award granted for job performance that occurred during the marriage or an incentive for future effort?

Understanding these issues will great help you or the courts decide how to classify these very valuable assets in your divorce.

Review your company plan documents and grant agreements for language for the transferability of options. Some plans let options be transferred to or exercised by former spouses. Other plans are silent on this point or preclude the division of stock options. If you are unsure, always ask to speak to your stock-plan administrator.

Generally speaking, incentive stock options (ISOs) are not transferable in a divorce. Any attempt to assign them will disqualify the options from their favorable tax treatment. Non-qualified stock options (NQSOs) may be transferred, however it is important to understand the tax consequences to avoid any surprises.

The courts often want the division of assets to be final, but that is not always possible. When circumstances do not allow for this, the following methods to divide the marital interest in the stock option may be used:

1. Deferred distribution – this method divides the stock or sale proceeds from the option exercise "if, as and when" the option is exercised.

2. Tenants in Common – the ownership of the option is not transferred, but the parties are deemed "tenants in common" in the future vesting of the stock options. This method gives the non-employee spouse a right to exercise his or her interest through the employee-spouse.

3. Constructive Trust – the ownership of the options is not transferred, but when an exercise occurs, the non-employee spouse receives their interest in the following ways; 1) the net proceeds from the exercise and sale of the stock or 2) after the exercise of the options, the resulting stock is transferred into the non-employee spouses name. It is important the tax considerations of using this option are in the divorce decree.

When a divorce involves an executive with options that are a significant portion of his or her salary, a growing number of courts are looking at the exercise of options as a source of deferred income. Future grants of stock options, restricted stock, or other equity based compensation not divided as assets during the divorce are being treated as income for the purposes of awarding child support and alimony.

In addition to cash based compensation, vested and exercised options with the underlying stock sold are the simplest means for calculating additional income for support purposes. Vested and exercised options with the underlying stock not sold can also be used. Since the stock could easily be converted to cash it is possible to calculate the income. Unvested options are generally not considered in the definition of income.

Unlike property settlements, child support payments can be re-examined at the courts discretion. For example, if a support paying parent’s income has substantially increased due to stock option income. To avoid any future complications, always make sure your separation agreement mentions this valuable source of income is to be included for the purposes of support payments.