October 1, 2013
Stock options were a popular form of compensation in the 1990’s and 2000’s, especially with tech companies, as a way to compensate employees and also keep them at the company. Since the options were often not exercisable for years the employee had an incentive to stay with the employer and help the company grow, so that the options would grow in value.
These days stock options are much less popular, but we still see them show up on the asset list. Valuing and dividing them can be tricky.
There are no tax consequences on the grant of statutory options, or incentive stock options (ISO’s), to the employee. To recognize their full value all stock options, no matter the type, must be exercised and the resulting stock eventually sold. This can be done on the same day, or the options can be exercised and sold at a later date. Without getting too technical, when an ISO is exercised there is no tax consequence, but when it is sold part of the proceeds will be taxed as ordinary income, and part will be taxed as capital gain, provided certain holding periods are met.
ISOs, before they are exercised, cannot be divided in a divorce and keep their favorable tax status. If they are transferred to the non-employee spouse they become non-qualified options (see below). However the employee can exercise the option and then transfer the stock to the spouse.
Non-qualified options (NQSO’s) have fewer restrictions than ISO’s as far as when they can be exercised. When the employee exercises the option the difference between the grant price of the option and the exercise price is considered compensation, thus he pays ordinary income tax as well as FICA and Medicare tax. The stock acquired is then taxed as a short-term or long-term capital gain, depending on how long the employee holds it.
Valuing stock options in a divorce is tricky. There are no hard and fast rules, but generally options that are granted before the separation date are considered marital property. However options that are granted in the near future after the separation date – that may have been granted based on performance during the marriage – could be argued to have marital property status.
Vested options that are unexercised have been treated differently in different states. Some judges have categorized vested, unexercised options as gross income that can be used to determine support payments. Other courts have said they can be considered as both income (for support) and property (for division.)
An option that is both unexercised and unvested is even more unclear. While they have no current value, they could be very valuable in the future.
Various methods have been used to deal with options. Sometimes they are transferred, although they may lose their favorable tax status as mentioned under the ISO discussion above.
Another possibility is to hold them jointly and share the proceeds when exercised and sold. Or the employee spouse could continue to hold them but be required to exercise and sell them on a schedule and share the proceeds. Finally a present value can be assigned to the options and other marital property then given to the non-employee spouse to offset the value.
Feeling confused? You’re not alone! Stock options are complicated and must be dealt with carefully. They will probably require some discussion and agreement as to their current value and how best to work them into the divorce agreement.