Dividing Stock Options in a Divorce
How are stock options treated if you decide to dissolve your marriage?
The first thing to consider is whether the stock options are vested or not vested, granted in California they will still be treated as a piece of property and they need to be appropriately divided.
Basically stock options are commonly used to attract or retain key employees with incentives outside of their basic salary structure. Dividing stock options can be tricky, sometimes we utilize the benefit of a forensic accountant to help with this process and there are different cases that talk about the division of stock options. These cases contained within them certain formulas that we can utilize to divide the stock options.
For instance there are 3 cases we can recall: In Rey Marriage of Hug, then there is Harrison and there is Nelson.
The idea here is that we we would start with determining when the stock options were earned. For instance if they were earned after the Date of Marriage but before the Date of Separation then they are clearly going to be treated as Community Property. But then the question becomes when are the benefits earned and to determine if a stock option was earned by an employee sometimes you need to look at their employment contract, sometimes you might need to depose their boss, sometimes you might need to look at the letter the employer often writes out with a note of “Congratulations we are granting you with stock options. Here’s how much they are…” Looking at it from the point of view of the boss or the person receiving or another perspective helps us determine when this benefit we were calling a stock option was in fact earned.
Now you would wonder if it is earned before the Date of Separation why is it not clearly community property?Recall what we said: if it’s earned after the marriage but before the Date of Separation then it would be treated as community property.
What if it was earned before the Date of Separation however the employee who got the stocks worked for that company before the Date of Marriage and therefore earned them before the Date of Separation. But then again what does earn mean? Did the employer give the stock option to that employee in part because of what the employee did before they got married since they’ve been working for that employer before the Date of Marriage. For instance let’s say it’s a 4 year marriage and “employee” has worked for “employer” 8 years and then right before the Date of Separation, say 6 months before, employer gives stock options to employee. They were given to the employee before the separation, i.e. they earned it before the Date of Separation. Again it depends. We need to look at the intent of the employer. Is the employer compensating the employee for work that was done only during the marriage, or are they compensating in part for the work that was done before the marriage, or are they also compensating the employee and because sometimes stock options are given to retain an employee is it a forward looking grant? Meaning “even though we’re giving you the stock options today before the Date of Separation, we’re doing so in part based upon your future work and only if you stay with us five more years will you be able to exercise the stock options.” Then what? What if you get them after the Date of Marriage and before the Date of Separation but if you read the fine prints you determine that it is the expectation of the employer for employee to work 5 more years before they get a dime, before they get to exercise those stock options. Now what? Are the stock options community or separate property because it’s based on future work you’re going to do as a separated individual? Are they a mixed asset, a hybrid, with some of it going to be community and the rest separate property?That’s what we called the time rule.
The time rule is a very basic concept. We often use it for retirement accounts but it is also applicable to stocks. Imagine a retirement account where you are firefighter and you worked as a firefighter for the city of Yorba Linda for 20 years, but you were only married 5 out of 20 years and you’ve been contributing to your retirement account for 20 years. The time rule would dictate that the community’s interest in that retirement account is 5/20. Numerator would be the total number of years during which you make contributions when you were married, denominator would be the total number of years you’ve made contribution since you’ve started that retirement plan. That is a simplified way to look at the time rule as a way to proportionally divide an asset that has been earned over different periods of time. Now the difference when it comes to the retirement account is there is prospective look at it. It is not like the employer is saying “You must work 5 more years with us to be entitled to your retirement account” as opposed to stock options where sometimes it is based upon future work.
So these cases we reference like Hug, Harrison, and Nelson cover different types of scenarios where a different application of the time rule is being applied to determine what percentage of the stock option if any is community and what percentage is a separate property.
Now what if you have a stock option earned during the marriage but vets afterwards. Is that community, separate, or hybrid? Typically stock options that are earned during the marriage but vest afterwards are treated like a deferred compensation plans similarly to certain types of pensions. Usually an employee is granted the right to buy stock now or in the future at a fixed price. That’s what a stock option is, you’re being given the right to own some percentage of the company through a stock and what the benefit the employer is giving you is that they’re essentially telling you “we’re going to sell this stock to you at a discounted price,” there are fixing for you essentially the price of the stock. Sometimes they give you different awards of stock starting from now and into the future. So you have a choice if you want to exercise those options you’re essentially saying “I want to buy into the company this many stocks you guys have awarded me at a discounted price of x.”
We must then look again at the award. What if the terms of the stock options are that you have to sell back your stock to the company if you ever leave? That would changes things.
What controls whether the options are separate or community property is when they were granted and when they vest. Those are the two key factors. Again vesting goes typically into the time, effort, labor the employee is putting into the company. Therefore if the stocks are fully vested by the Date of Separation and they were acquired during the marriage that’s pretty much all community property.
But again if they vest 5 years after the Date of Separation because you’re required to continue working then it’s possible that only a proportion of that stock option is community and the rest of it is separate property.
What if they do not vest at all? There are circumstances under which there is a minimum number of years of service which you’re required to put in and you never do. Then it is not a property interest because it never vested. In that case it becomes like an expectation that never matured.
In cases where you have to work many years for the company for the stocks to vest, assuming you’re still at the company and you’re still working but you separate before it’s vested then typically the options are going to be both community and separate property and we’ll need to do an apportionment between what is community and what is separate which would bring us back to the time rule.
Now what if stock options are granted after the Date of Separation. Those usually would be the separate property of the recipient even if some of the reason the employer gave it to them is because of their prior work. Now we would still look at what the intent of the employer was but in cases like that where your employer knows you’re going through a divorce and they’ve given you stocks or granted them to you after the Date of Separation and they know what the law requires, they’re going to come in and probably support the employee and provide that their intention in giving the stock was to retain the employee for the future and therefore it is not based upon the work that the employee did before the Date of Separation.