Your Guide to Equity Compensation Rights During Divorce

Given the rise of technology industries and the employment changes fueled by the COVID-19 pandemic, many companies have sought innovative ways to attract and retain talent using varied pay structures or equity compensation.

Equity compensation structures create interesting questions in the divorce context as they can impact both property division and support.    

What Is Equity Compensation in Divorce?

Before discussing how equity compensation is treated in divorce, it is important to understand what qualifies as equity compensation. Equity compensation is a form of non-cash compensation that gives an employee a financial and legal interest in the company for which they work.

In essence, instead of offering an employee only traditional forms of compensation, such as wages, salary, or bonus income, the company offers the employee an ownership stake in the company. This ownership stake can be in the form of stock options, restricted stock units (RSUs), employee stock purchase plans, and/or performance shares. This ownership stake, if accrued during the marriage, is considered marital property. 

Equity Compensation As an Asset to Be Divided

Under California law there is a general community property presumption that all assets acquired from the date of marriage until the date of separation are community property and shall be divided equally upon divorce. Equitable compensation is no exception to this general community property presumption, and therefore equity compensation assets are divisible at divorce. This is the case regardless of how the compensation manifests, i.e., whether in the form of stock options, non-qualified stock options, RSUs, or performance shares. 

In order to divide equity compensation in the divorce context, one must generally begin by 1) identifying the type of compensation, 2) determining if the asset is vested or not yet vested, and 3) determining its value either now or in the future. One must also consider whether the compensation is attributable to services rendered before, during, or after the marriage.

Some of the most common forms of equity compensation are stock options and RSUs. Options may be divisible at divorce, whether vested or unvested, despite having no present fair market value. 

Incentive Stock Options (ISO)

Incentive stock options (ISOs) are a corporate benefit that give an employee the right, but not the obligation, to buy shares of company stock at a discounted price with the added benefit of possible tax breaks on the profit. 

In the divorce context, ISOs that have been exercised (purchased) during the marriage are divided equally as community property. Those ISOs which have not yet been exercised, when divided at divorce, may be transferred to the non-employee spouse as non-qualified Stock Options with fewer restrictions. 

Additionally, depending on the exercise status, ISOs may be considered either income or property. To value exercised stock options in divorce, there are several relevant factors which must be considered, such as grant date, grant/exercise price, expiration, and vesting schedule. 

It is also important to note that even nonvested stock options represent a property interest; to the extent these rights derive from employment during marriage (and before separation), they are a community asset subject to division at marriage dissolution.

Employee Stock Purchasing Plans

An Employee Stock Purchasing Plan is a company-run program in which employees can purchase company stock at a discounted price through payroll deductions. With an Employee Stock Purchasing Plan, the employer essentially uses the employee’s wages to directly buy stock in the company on their behalf. The shares are purchased on an after-tax basis such that the employee can purchase a larger number of shares that they may then sell at a higher price in the future. 

In the divorce context, the division of this type of deferred compensation plan requires a calculation which is time-weighted based on the purchase and maturation/vest time period such that the stocks will be divided based on when the option vested and the date of separation.

Restricted Stock Units

Restricted stock Units (RSUs) entitle an employee to receive shares of company stock or payment equivalent to the value of the stock. RSUs are subject to vesting schedules of typically 1 to 5 years and are subject to the employee meeting specific benchmarks and continued employment with the company.

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 resulting from the vesting. 

In the context of a divorce, RSUs that vested during the marital period are considered marital property and subject to the general community property presumption for equal division. However, RSUs that are awarded during the marriage, but vest after the date of separation, are divided pursuant to a time-rule formula and may also be considered for purposes of income available for support, as opposed to solely a property interest subject to division.

Be aware, however, that a time-rule formula will not always be the proper method of allocating interests in equity compensation. Factors suggesting an alternate method of division may come into play.

Performance Stock Units

Like RSUs, performance stock units are subject to a performance-related conditional requirement that must be met by an employee in order to receive the shares. 

In the context of a divorce, it is important to determine why the performance stock units were granted to the employee. For example, was it to attract the employee to the job, as a reward for past performance, or an incentive for continued performance and/or other conditional requirements?

Once the equity compensation is defined, including its vesting schedule and other relevant factors, the court typically uses a time-rule formula to determine which portion of the stock units belong to the employee spouse as their separate property, and which are community property divisible during divorce. The parties may also elect to wait until the stock units have vested, allowing for a more accurate valuation. 

How to Protect Your Equity Compensation Rights

In order to protect your rights to equity compensation, whether you are the employee who was issued this non-cash compensation or the non-employee spouse who acquired an interest during the marriage, it is imperative that you:

1) Prepare and receive accurate disclosures regarding these assets.

2) Propound discovery (if needed) to obtain necessary information if you are the non-employee spouse.

3) Ask the right questions as to the methods being used to define and value the various forms of equity compensation.

4) Understand any reports or calculations prepared by forensic accountants.

5) Understand the tax consequences of any proposed division. 

These assessments are central to determining what, if any, portion of the equity compensation will be considered marital property, how it will be divided in the context of divorce, and what, if any, of the equity compensation is considered income available for support and how that might impact spousal and/or child support.  

Get Your Fair Share of Equity Compensation with Cage & Miles

Equity compensation accrued during the duration of your marriage is subject to equitable division. There are different ways to approach the division of financial equity assets and their impact on issues of support and property, but each type of equity compensation comes with its own legal rules. Hiring a team of expert lawyers can help you protect your equity compensation rights during divorce.

If you or your soon-to-be-ex spouse receive any form of equity compensation and you are going through or anticipating a divorce or support matter, the attorneys at Cage & Miles are here to help.