It is an exciting moment for any skilled future employee of a startup or tech company: The signing of an employment contract and the discussion of how the future employee will be compensated for the work they do for that company.
The discussion of compensation types is of increasing importance in San Diego County and the greater Southern California area. While the world of startup and tech culture is best known as part of Northern California’s Silicon Valley, San Diego has seen a startup and tech renaissance since the beginning of the COVID-19 pandemic in 2020. Even tech giants in the area such as Qualcomm, Amazon, Google, and Apple are increasing their manpower in the area. The question for every potential skilled employee is now: How will I get paid?
What is Compensation?
Let’s go back to basics: What is compensation?
Traditionally, and for many California residents, compensation is limited to a cash salary, paid as W-2 or 10-99 income, and perhaps a small cash bonus around the holidays.
With the increase in demand for skilled workers in California, however, potential employees can now demand a proportional increase in their compensation. But cash flow for a business is not limitless, and the compensation demands are not always in line with a business’s financial bottom line. So companies have needed to become creative in their methods for compensating skilled workers.
In addition to incentive-based cash bonuses, companies have turned to non-cash forms of compensation in the form of equity compensation – discussed herein.
What is Equity Compensation?
Equity compensation is a form of non-cash compensation that gives an employee a financial and legal interest in the company they work for. This equity is in the form of stock shares in the company.
Equity compensation for skilled employees comes in several different forms, but two are of ongoing importance in dissolutions involving spouses who are employees of startups or tech companies: Restricted Stock Units and stock options.
RESTRICTED STOCK UNITS One of the most common forms of non-cash compensation is Restricted Stock Units. Restricted Stock Units (also known as “RSUs”) are granted to an employee as part of their overall compensation package.
RSUs vest over a period – generally four or so years after the initial grant of the RSUs are made, and are contingent on the employee’s continued employment with the company. Until the RSU vests, the employee cannot sell the stock for cash – thus, why this form of stock is called “restricted” stock.
Upon vesting, the employee has the option to sell the stock or hold onto the stock as it increases or decreases in value. Additionally, when RSUs vest, a certain number of the RSUs are automatically liquidated to pay taxes.
STOCK OPTIONS Another form of equity compensation is stock options.
Stock options differ from RSUs in that the employee is given the right, but not the obligation, to purchase a company’s stock at a particular price rather than at the market price. For example, Company “A” may give an employee the option to purchase 100,000 shares of Company “A” stock for .10 cents per share – as opposed to purchasing the stock at market value at $20.00 per share.
Generally stock options are also subject to a vesting period, contingent on the employee’s continued employment with the company. Unlike RSUs, however, the vesting of stock options does not create income – it merely creates the option to purchase the stock.
What Impact Does This Have On My Dissolution or Parentage Matter?
When a Restricted Stock Unit (RSU) vests, a taxable event occurs – meaning that the employee who receives the RSU is taxed on the income he or she receives from the Restricted Stock Unit. This generally shows up on the employee’s paycheck as W-2 income, calculated as the number of RSUs that have vested multiplied by the market value of the RSU at the time of vesting.
Generally speaking, the W-2 income from the vesting of RSUs is income that the Court can consider when addressing child support or spousal. In most circumstances, because this income fluctuates, the Court considers this supplemental income that can be subject to a support “bonus table.”
In the State of California, virtually all assets acquired during marriage are considered community property – and are therefore equally divisible between the Parties as part of the dissolution process. This includes the compensation either party receives from their employer during the marriage.
Equity compensation is no exception to this rule. If the equity compensation was earned during the marriage and exists at the time of separation, the Court must divide that equity compensation as part of the dissolution.
The question does come up, however, when equity compensation is granted during the marriage, but vests after the Parties have already separated. In these circumstances, the Court has the ability to divide the RSUs equitably rather than equally between the Parties, accounting for the employee spouse’s post-separation efforts.
It is important that parties to litigation understand that if an RSU/stock option is adjudicated as a community property asset that this asset cannot also be used as income for determining a support obligation – and vice versa. This is considered an impermissible form of “double dipping”.