How to Split Stocks in a Divorce
It is not an easy or straightforward process to determine how to split stocks in a divorce. Stock options are the most challenging to sort out in a divorce. We will be discussing options for stock division in this blog.
Types of Stock Options – it is an important factor in determining how to Split Stocks in a Divorce
Employers usually use the stock options to attract, encourage, and further reimburse employees who perform beyond their original job roles.
Employers also tend to do so in order to make their employees feel a sense of ownership in the company by encouraging employees to either buy the stock immediately or on a later date known as a “strike price”. These options are typically there to make the employee stay with the company long term. Their general premise is to make it clear and to further motivate the employees to make the company succeed. These options are also there as a means of tax-deferring compensation for employees and their contributions towards the company who may be on low paying salaries.
There are two types of employment-related stock options – qualified (statutory) and non-qualified.
Qualified stock can be incentive stock options (ISOs) and options
granted under employee stock purchase plans (ESPPs)
As the name implies, incentive stock options exist to incentivise either potential employees to employment with the company or to encourage and make sure existing employees stay with the company and not leave for a competitor.
ISOs need to meet many statutory requirements. Some of them are:
The stock options should be exercisable within ten years of after they granted. However, the 5-year rule is applicable for someone who owns more than 10% of all voting classes of the options.
The stock owner can leave their stock to someone by will, he cannot transfer the options. The option’s price cannot be dropped below the market value on the day of granting it.
The employee stock purchase plan allows corporate employees to buy the stock at a good discount using payrolls deductions. The deduction accumulated between the day of buying the stock and day of the grant. This allows employer to buy stock on behalf of their employee with the 15% discount of the market price.
The Nelson and Hug formulas are the best for the calculation of how to split stocks in a divorce
In order to determine which formula to use, the attorney should look at the intent of the employer – whether the employer tried to award the employee for their past services or they want to encourage to stay on the job in the future. In the first situation, the Hug formula is used.
In the second situation, Nelson formula is used.
Under Hug, use of the following time-rule calculation: The number of options determined to be community property is a product of a fraction in which the numerator is the period in months between the commencement of the spouse’s employment by the employer and the date of the parties’ separation, and the denominator is the period in months between commencement of employment and the date when each option is first exercisable, multiplied by the number of shares that could be purchased on the date the option is first exercisable. The remaining options are the separate property of the employee.
There are other issue under the Nelson formula also known as “time rule,” the community property in the stock is determined as a fraction, the numerator is the length of service during the marriage and before separation. The denominator is the total length of service by the employee ex-spouse.
Valuation
Under the Family Code 2552, stock options are usually valued during the trial day(s).
The valuation of stocks options depends on the difference between the value of the stock and option. Valuation of the stock turns on a variety of factors, including any restrictions placed on the stock subject to the option. Some factors are placed into consideration in valuation of
the stock options are: How strong is the financial condition of the company, stock’s book value, company’s earning capacity, history of business enterprise, the price of the stock of similar companies on the market, and the capacity of the company to pay dividends.
Stock options will be considered as income for spousal or child support if they can be viewed as an element of a supporting spouse’s compensation package for past, present, or anticipated future services.
If the stock is sold for profit as an exercise of option, the income is realized as very latest for the tax purposes and accordingly to support purposes.
On another hand, the shares of stock which the owner of the company received in connection with the sale of business, but that is unsold, is not income for the tax purposes. Thus, it cannot be counted for support purposes.
Identifying and Classifying Stock Options
The first step in dividing stock options in a divorce is to identify and classify them. This involves determining whether the stock options are qualified or non-qualified and whether they are incentive stock options (ISOs) or options granted under employee stock purchase plans (ESPPs). Understanding the nature of these options is crucial because it impacts how they can be divided and valued.
Community Property vs. Separate Property
In California, stock options acquired during the marriage are generally considered community property and are subject to division. However, stock options awarded before the marriage or after the date of separation are considered separate property. The Hug and Nelson formulas are used to determine the community property portion of the stock options.
The Hug Formula
The Hug formula is applied when the stock options are awarded for past services. The calculation under the Hug formula involves determining the number of options that are community property based on the time period between the commencement of employment and the date of separation relative to the time period from the commencement of employment to the date the options are exercisable.
The Nelson Formula
The Nelson formula, also known as the “time rule,” is used when the stock options are intended to incentivize future services. The calculation involves determining the community property portion based on the length of service during the marriage relative to the total length of service by the employee.
Valuation of Stock Options
The valuation of stock options is governed by Family Code 2552, which specifies that stock options are typically valued as of the trial date. Valuation depends on the difference between the option price and the market value of the stock. Several factors are considered in the valuation process, including:
- The financial condition of the company
- The book value of the stock
- The company’s earning capacity
- The business history of the company
- The market price of similar stocks
- The company’s ability to pay dividends
Dividing Stock Options
Once the stock options have been classified, valued, and the community property portion determined, they must be divided. This can be done in several ways:
- Immediate Division: The stock options can be exercised and the proceeds divided between the spouses.
- Deferred Division: The stock options can be divided when they are exercised in the future. This requires careful drafting of the divorce decree to ensure both parties’ rights and obligations are clearly defined.
- Buyout: One spouse can buy out the other’s interest in the stock options, often by offsetting the value with other marital assets.
Impact on Support Obligations
Stock options can also impact spousal and child support obligations. If stock options are part of the supporting spouse’s compensation package, they may be considered income for support purposes. The income realized from the exercise of stock options or the sale of stock can be used to calculate support payments.
Tax Considerations
Tax implications play a significant role in the division of stock options. The exercise of stock options can result in significant tax liabilities, which must be considered in the divorce settlement. It’s important to consult with a tax professional to understand the tax consequences of dividing and exercising stock options.
Legal and Financial Advice
Given the complexity of dividing stock options in a divorce, it’s essential to seek advice from experienced family law attorneys and financial advisors. They can help you understand your rights, negotiate a fair settlement, and ensure compliance with legal and tax regulations.
By following these steps and seeking professional guidance, you can navigate the challenges of dividing stock options in a divorce and protect your financial interests. For personalized assistance, contact an experienced family law attorney who can provide tailored advice based on your unique circumstances.
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