When you go through a divorce, property division can be complex and highly contentious. In a high-net-worth divorce, in addition to having more to divide overall, there may also be types of property that are more complicated to split. Stock options, for example—an increasingly common feature of employee compensation packages, especially in young, growing Silicon Valley companies—present a particular challenge.
What are stock options?
Stock options give an employee the right to buy shares in the company at a future date at a specified fixed price. Typically, the options become vested (fully available for the employee to own or sell) over a few years, usually two to five. Unvested stock options have no present market value but have the potential for enormous worth down the line.
The employer’s vesting schedule can be based on various factors. Some stock options are offered to draw talent to a company or reward past service. In other cases, stock options function as compensation for future work and, as such, are an incentive to stay with the company for an extended period.
Why are stock options challenging to divide in a divorce?
In California, any asset acquired while you’re married (from the date of marriage to the date of separation) is considered community property and will be split 50/50 in a divorce. Anything brought to the marriage by the individual partners or acquired after separation is separate property.
This is where stock options become tricky. While it is relatively straightforward to divide the value of the vacation home, car, or boat you owned together as a married couple, stock options are more challenging for numerous reasons, including:
- You may have some options that fall under community property and some under a separate property.
- You may have a mix of vested and unvested stock options
- Valuation of unvested stock options is complex as they have no concrete market worth at present but may be extremely valuable in the future.
- The date of separation plays a key role here: it refers to the date that one of the spouses declared intent to end the marriage and took an active step in pursuing divorce, such as moving out.
Here’s a typical example: suppose one spouse gets a new job at an up-and-coming technology company during the marriage and receives stock options in the hiring package. Then the couple initiates a divorce before the options are fully vested. Since the employee spouse acquired the stock option during the marriage, it is considered community property. A portion of the eventually mature stock may be awarded to the non-employee spouse even though the couple is no longer together.
In such cases, California courts will apply one of several formulas or “time rules” to determine what percentage belongs to the non-employee spouse. The two main formulas are known as the Hug formula and the Nelson formula. These calculations help the court balance several pivotal factors:
- The intention of the employer—to reward past services (Hug) or future performance (Nelson)
- Date of vesting
- Number of exercisable shares
- Date of separation
There are other formula options, and the court has broad discretion regarding which, if any, to use and how to apply them in dividing the options.
Typically, the further the vesting date from the date of separation, the smaller the portion of options that will be considered community property. For example, if stock options were acquired during the marriage and vested only a few months after the split, the non-employee spouse would be entitled to a higher percentage than if the stock options acquired during the marriage remained unvested for several years after the couple separated.
It’s also essential for divorcing couples to realize that the sale of vested stock options can have significant tax implications. Exercised stock options are taxable income, considered capital gains (or losses) based on the difference between the purchase price and actual exercise proceeds. The transfer of these matured stocks can impact both ex-spouses’ taxes.
There are numerous approaches to determining the stock options deemed community property. So, whether you come to a settlement or leave it to the court when you’re going through a high-asset divorce and dealing with issues surrounding deferred compensation, you need a skilled attorney who understands the nuances of this thorny and volatile area of family law. At SFLG, we are experienced in representing both employee and non-employee spouses. We work with various financial experts to prepare a persuasive case for how vested and unvested stock options should be characterized to achieve a favorable result for our client.
By Debra Schoenberg