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Handling Stock Options and Executive Compensation in Divorce

By Nottage and Ward on July 15, 2024

Stock options are complicated. They are subject to intricate and convoluted tax laws, and determining whether stock options are separate or marital property can be difficult. If you are involved in a divorce that’s concerned with stock options, bonuses, preferred compensation, and other complex forms of executive compensation, it’s a really good idea to seek the services of a knowledgeable Chicago high-asset divorce attorney.

Stock Options and Stock-Related Compensation

Stock options are a form of equity compensation that companies may offer to high-value employees. When employers provide stock options, they aren’t giving stock away to employees – instead, they are offering employees the right to buy a set number of company shares at a fixed price. By offering these options to employees, businesses give them the opportunity to benefit from the company’s success by selling the stock if it goes up in value.

Incentive stock options (ISOs) are a type of stock option that offers preferential tax treatment to employees. To qualify for this favorable treatment, ISOs must adhere to specific rules set by the Internal Revenue Service (IRS). Employees who exercise ISOs are not required to pay regular income tax on the difference between the exercise price and the stock’s market value at the time of exercise. Instead, they may be subject to the alternative minimum tax (AMT). If the employee holds the shares for at least one year after exercise and two years from the grant date, any profit made upon selling the shares will be taxed at the lower capital gains rate.

Non-qualified stock options (NSOs) are a type of stock option that does not qualify for the special tax treatments available to Incentive Stock Options (ISOs). NSOs can be granted to employees, directors, contractors, and others, providing more flexibility in terms of who can receive them. When an employee exercises NSOs, the difference between the exercise price and the market value of the stock at the time of exercise is considered ordinary income; it is subject to income tax and payroll taxes.

This immediate tax impact makes NSOs less favorable from a tax perspective compared to ISOs. But they can still be valuable to an employee’s compensation package. In the context of a divorce, it is crucial to accurately assess the value of NSOs and consider their tax implications when dividing assets. Proper documentation and expert valuation are essential to ensure a fair distribution of NSOs between the parties.

Restricted stock units (RSUs) are a form of executive compensation that grants employees the right to receive company stock upon meeting certain conditions, typically based on time or performance. Unlike stock options, RSUs have intrinsic value as soon as they vest, making them an attractive component of compensation packages. The vesting schedule for RSUs often spans several years, and employees are subject to taxes on the market value of the shares once they vest.

Performance shares are a type of executive compensation that is awarded based on achieving specific performance goals. These goals often relate to financial metrics, company milestones, or individual performance targets. Performance shares can be highly variable and are typically subject to vesting schedules similar to RSUs. Legal and financial experts must analyze the performance shares and RSUs to ensure an equitable division.

Valuing Stock Options in a Chicago Divorce

Valuing stock options during divorce proceedings can be complicated due to their contingent nature and various influencing factors. The primary method involves determining the difference between the exercise price and the current market value of the stock. This calculation provides the intrinsic value of the options. Unfortunately, this straightforward approach may not capture the full potential value of the options, especially for those not yet vested.

Another important consideration is the time horizon and the company’s projected performance. A time horizon is the duration one expects to hold an investment. Financial experts often use models like the Black-Scholes model or binomial valuation methods to estimate the fair market value of stock options. These models take into account factors such as stock volatility, time to expiration, and risk-free interest rates.

Vesting schedules play a pivotal role in the valuation and division of stock options during a divorce. A vesting schedule determines when employees can exercise their stock options and gain full ownership. Stock options typically vest over some time, with common schedules being three to five years, often with a one-year cliff followed by monthly or quarterly vesting.

Determining Which Assets Are Marital and Separate Property

Determining whether stock options and executive compensation are considered marital or separate property is critical to divorce proceedings. Marital property generally includes assets acquired during the marriage, regardless of whose name they are in. On the other hand, separate property consists of assets owned prior to the marriage or acquired individually through inheritance or gifts.

The classification of stock options and executive compensation hinges on several factors, such as the timing of the grant and vesting and the purpose of the compensation. Stock options that were granted and vested during the marriage are often deemed marital property, but options granted before the marriage but vesting during it may require a more nuanced analysis.

Speak with a Knowledgeable Chicago High-Asset Divorce Lawyer Today

At Nottage and Ward, LLP, our Chicago divorce attorneys have aggressively represented our clients for over 35 years. We can help protect your assets during a divorce so you can keep the resources that are rightfully yours.

Find out more about how we can help by contacting the experienced Chicago Divorce Lawyers at Nottage and Ward, LLP. Call (312) 332-2915 today to schedule an initial consultation at our firm.