transfer of stock in divorce

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There has been considerable speculation that one consequence of the Coronavirus will be an increase in the divorce rate resulting from togetherness imposed by the quarantine that pushes marriages already on shaky ground over the brink.  Whether divorces will increase in the future due to Covid-19 remains an open question, but what is certain is that a sizable number of future divorces will involve the transfer of a business ownership interest between spouses as part of the divorce.  To address this situation, this post focuses on key business issues that arise when one spouse (the “Divesting Spouse”) transfers an ownership interest in a business to the other spouse (the “Recipient Spouse”) as part of a divorce settlement.  Addressing these issues will help the Recipient Spouse continue to run the business successfully and also avoid future conflicts with the Divesting Spouse, as well as with future investors and potential buyers of the business.

1. Don’t Rely on Divorce Decree or Settlement Agreement to Document  the Transfer of a Business Ownership Interest Between Spouses

A divorce decree and settlement agreement will document the terms of the divorce and the division of property between spouses, but it is not a good idea to rely on the decree or the divorce settlement to memorialize the transfer of a business interest between spouses.  There are a number of reasons for the Recipient Spouse to insist on securing a stock transfer agreement (or its equivalent), including the fact that the Recipient Spouse will likely be required to show the transfer document to third parties in the future, including banks or other lenders, new investors, company officers or managers, and potential future buyers.  The Recipient Spouse will not want to show the decree or settlement agreement to these third parties, however, because they include private matters unrelated to the business.  This will therefore require the Recipient Spouse to prepare a heavily redacted document for review by third parties.  It is more efficient to simply require a transfer document to be signed that is limited solely to issues related to the business.

Another reason for the use of a transfer document is that it will include many provisions that are not normally part of a settlement agreement.  The decree or settlement agreement will become a very lengthy document if it includes all of the provision that are traditionally set forth in a separate document that covers the transfer of a business interest.

2. Secure a Separate Release of the Divesting Spouse’s Claims Against the Business

After the business is transferred and the divorce becomes final, the Recipient Spouse will not want to defend claims that are brought by the Divesting Spouse against the business.  This requires the Recipient Spouse to secure a broad release of claims against the business from the Divesting Spouse.  This release of the business is separate from and in addition to the release that the Divesting Spouse provides to the Recipient Spouse, individually.

For example, if the Divesting Spouse was an officer, employee, director or manager of the company, the Divesting Spouse’s release needs to include a release of all employment claims, such as claims for unpaid wages/back pay, vacation time, unpaid expenses, and commissions.  The release will also include the Divesting Spouse’s release all claims for wrongful termination, claims related to the distribution of any profits generated by the company and all other business related claims.  The release will also confirm that the Divesting Spouse has resigned from all positions with the company and has no further right or authority to take any action for or make any statements on behalf of the company.

3. Confirm Broad Transfer of All Rights by Divesting Spouse

The provisions that confirm the transfer of ownership in the business by the Divesting Spouse need to be broadly described in the transfer agreement to include all rights, title and interest of every kind related in any way to the business.  This includes all rights of the Divesting Spouse in any and all intellectual property of the company, such as company names, trademarks, trade secrets and patent rights.  This is particularly important if the Divesting Spouse worked in the business, because the Recipient Spouse does not want to be faced with a situation in the future where the Divesting Spouse later claims that he or she developed some software, designs or other intellectual property rights that are not owned by the business, and which are now being used by the Divesting Spouse in direct competition with the company.

4. Consider Requesting Divesting Spouse to Accept Restrictive Covenants

In a normal M&A transaction, a company buyer secures a set of restrictive covenants from the seller as part of the purchase agreement to prevent the seller from competing in any way with the company after the sale takes place.  The buyer will require the seller to provide all of the following restrictive covenants that will last for two to five years:  (i) a covenant not to compete, restricting any involvement by the Divesting Spouse — whether as an owner, employee, consultant, etc., — in a business that is competitive with the subject business for a reasonable period of time within a reasonable geographic area, (ii) an agreement not to interfere with the business’s relationship with its customers and vendors or to solicit customers, or attempt to persuade the business’s customers and vendors to cease doing business with the company, and (iii) an agreement not to hire or solicit the hiring of any of the employees of the business, or otherwise attempt to persuade any of the employees of the business to cease their employment relationship with the company.

If the Recipient Spouse is concerned that the Divesting Spouse may compete in business against the company after the divorce, the Recipient Spouse may want to request the Divesting Spouse to agree to accept some or all of these restrictions.  The Divesting Spouse will not agree to accept these post-divorce restrictions, however, without a corresponding commitment from the Recipient Spouse to provide some amount of additional consideration in the divorce settlement.

5. Request Confidentiality Agreement from Divesting Spouse

Confidentiality agreements are similar to restrictive covenants in that they prevent the person who is subject to the agreement from taking actions that are harmful to the business.  The confidentiality agreement is specific, however, in prohibiting the individual officer or employee from using or transferring any of the company’s confidential information or trade secrets.  All of the company’s officers and employees are subject to a common law duty not to use or misuse any of the company’s confidential information, but a written confidentiality agreement makes this prohibition clearer on the use of confidential information and trade secrets.

If the Divesting Spouse has not already entered into a confidentiality agreement with the company, the Recipient Spouse will want to request the Divesting Spouse to accept and sign a confidentiality agreement to protect the company’s valuable confidential information and trade secrets.  The Recipient Spouse wants to make sure that the company’s confidential information, technology and trade secrets are maintained in strict confidence.

6. Secure “Tail Coverage” of Divesting Spouse From D&O Carrier

  If the company has a directors and officers liability insurance policy (a “D&O Policy”) that provides protection for officers and directors from third party claims, these polices will generally remain for one or two years after the company’s officers and directors are no longer affiliated with the company.  The Recipient Spouse will therefore want to secure “tail coverage” to provide continuing insurance coverage for claims made against the Divesting Spouse.  In this regard, the Recipient Spouse may want to secure a tail policy will extend the D&O coverage over former officers and directors for a total period of five years.

The Recipient Spouse may feel like securing a tail policy that extends coverage for third party claims against the Divesting Spouse is unnecessary because it provides a benefit solely for the Divesting Spouse.  In fact, a tail policy provides insurance protection that protects both the Recipient Spouse and the Divesting Spouse, and it is also a benefit to the company.  If third party claim is made against the Divesting Spouse after the divorce related to the business, the Divesting Spouse will likely demand that the company indemnify him or her.  If the D&O policy is still in place, however, the tail policy will enable the company tender a defense of the claim against the Divesting Spouse, because the D&O carrier will cover all of these legal defense costs.  Fortunately, a tail policy that extends D&O coverage is often not too expensive to secure.

7. Specify Treatment of Future Tax Filings

Dealing with all of the tax issues involved in the transfer of the business is an extensive subject that goes beyond the scope of this post, and spouses engaging in the transfer of a business interest are strongly advised to consult with a tax advisor during their divorce.  But there is one tax issue that the Recipient Spouse should consider addressing up front.  Many businesses held in marriages are structured as pass through entities (i.e., LLC’s partnerships, Sub S corporations), which means that the owners pay the taxes on all profits that are generated by the company.  As a result, in the year following the divorce, Recipient Spouse may be required to issue a K-1 to the Divesting Spouse based on the ownership interest held in the business by the Divesting Spouse during the year in which the divorce took place.

If the K-1 issued in the year after the divorce reflects any income that is apportioned to the Divesting Spouse, he or she may expect to receive a cash distribution from the company that is sufficient to cover the Divesting Spouse’s federal tax liability based on this income.  If the company does not issue any distribution to the Divesting Spouse, that would create what is known as “phantom income” because the Divesting Spouse has to pay taxes on this income even though no distribution was issued by the Company.  The issuance of phantom income to the Divesting Spouse is likely to provoke a heated dispute at that point.

The Recipient Spouse will therefore want to address in the divorce settlement how the future K-1 that will be issued to the Divesting Spouse will address any income generated by the business in the year of the divorce.  If the Recipient Spouse is prepared to issue a distribution to the Divesting Spouse, that will take care of the issue.  If the Recipient Spouse has no intention of authorizing the company to issue any distributions in the future to the Divesting Spouse, however, this issue will need to be dealt with by the Recipient Spouse in a manner that will not lead to a future legal dispute with the Divesting Spouse.

The transfer of ownership interests in business is common in divorce settlements.  But if business issues related to the transfer of this type of interest are not considered at the time of the divorce, the parties may find themselves engaging in continuing disputes they did not anticipate.  The Recipient Spouse, in particular, needs to take steps to ensure that the transfer takes place in a manner that allows the business to continue to run successfully, and to head off potential future conflicts with the Divesting Spouse and others after the divorce.

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Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

1. introduction to tax-free transfers of stock options in divorce, 2. understanding section 1041 of the internal revenue code, 3. eligibility criteria for tax-free transfers of stock options, 4. calculating the basis of transferred stock options, 5. reporting requirements for tax-free transfers in divorce, 6. potential tax implications for the receiving spouse, 7. strategies for maximizing tax benefits in stock option transfers, 8. real-life examples of tax-free transfers in divorce, 9. navigating section 1041 for tax-free stock option transfers.

1. tax-Free transfers of Stock Options in Divorce: An Introduction

When it comes to dividing assets in a divorce, stock options can be a complex and often overlooked aspect. However, understanding the tax implications and potential benefits of tax-free transfers of stock options can have a significant impact on the overall financial outcome of a divorce settlement. In this section, we will delve into the introduction of tax-free transfers of stock options in divorce, exploring the various perspectives and providing in-depth information to help you make informed decisions.

2. Taxable vs. Tax-Free Transfers: A Comparison

One of the first considerations when dealing with stock options in a divorce is whether the transfer will be taxable or tax-free. In general, transfers of stock options between spouses incident to a divorce are eligible for tax-free treatment under Section 1041 of the internal Revenue code . This means that the recipient spouse will not incur any immediate tax liability upon receiving the stock options.

However, it is important to note that if the stock options are transferred outside of the divorce process, such as in a post-divorce settlement or as part of a property division agreement, they may be subject to taxation. Therefore, it is crucial to carefully navigate the divorce process to ensure tax-free treatment for stock option transfers.

3. qualified Domestic Relations order (QDRO): An Option Worth Considering

In some cases, utilizing a Qualified domestic Relations order (QDRO) can be an advantageous strategy when transferring stock options in a divorce. A QDRO is a court-issued order that allows for the division of certain retirement plans and benefits without incurring immediate tax consequences. While stock options are not technically considered retirement plans, they can often be included within the scope of a QDRO.

By utilizing a QDRO, the transferring spouse can effectively transfer stock options to the recipient spouse without triggering immediate tax liability. This can be particularly beneficial if the stock options have a substantial value or if their exercise could result in a significant tax burden.

4. Timing Considerations: Pre- or Post-Vesting Transfers

Another important aspect to consider when transferring stock options in a divorce is the timing of the transfer. Stock options can be either vested or unvested, and the timing of the transfer can have implications for both parties involved.

If the stock options are unvested at the time of the divorce, it may be advantageous to delay the transfer until they become vested. By doing so, the recipient spouse can potentially benefit from any future appreciation in the value of the stock options. However, if the transferring spouse is concerned about potential tax liability upon exercise, it may be more prudent to transfer the unvested options immediately.

On the other hand, if the stock options are already vested at the time of the divorce, it may be more straightforward to transfer them directly to the recipient spouse. This eliminates the need to consider future vesting schedules and allows for a cleaner division of assets.

5. seeking Professional guidance : The key to Making informed Decisions

Navigating the complexities of tax-free transfers of stock options in divorce requires careful analysis and consideration. It is highly recommended to seek the guidance of a qualified tax professional or divorce attorney who specializes in complex financial matters. Their expertise can help you understand the specific tax implications, evaluate the best options for your unique circumstances, and ensure compliance with all applicable laws and regulations.

Understanding the intricacies of tax-free transfers of stock options in divorce is essential for maximizing the financial outcomes of a divorce settlement. By comparing taxable and tax-free transfers, exploring options such as QDROs, considering timing considerations, and seeking professional guidance, you can make informed decisions that protect your financial interests and minimize potential tax liabilities.

Introduction to Tax Free Transfers of Stock Options in Divorce - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

Section 1041 of the Internal Revenue Code plays a crucial role in tax-free transfers of stock options in divorce cases. It provides a unique opportunity for divorcing couples to transfer their stock options without triggering any tax consequences. Understanding the intricacies of this section is essential for both parties involved in a divorce settlement, as it can significantly impact their financial situation. Let's delve into Section 1041 and explore its implications from different perspectives.

From the perspective of the spouse receiving the stock options, Section 1041 offers a substantial advantage. It allows them to acquire the stock options without any immediate tax liability. This means that they can defer the tax payment until they exercise the options or sell the underlying stock . By deferring the tax liability, the receiving spouse can potentially minimize their overall tax burden and have more control over their financial planning.

On the other hand, from the perspective of the spouse transferring the stock options, Section 1041 may seem less favorable. The transferor spouse is generally unable to claim any tax deductions or losses on the transfer of stock options. Additionally, they may face potential tax consequences if the receiving spouse exercises the options and sells the stock at a higher value. Therefore, it is crucial for the transferring spouse to carefully evaluate the potential tax implications before deciding to transfer the stock options.

To provide a comprehensive understanding of Section 1041, let's explore some key points through a numbered list:

1. Tax-free transfers: Section 1041 allows stock options to be transferred between spouses without triggering immediate tax consequences. This means that the transfer does not result in any taxable income for either party at the time of the transfer.

2. Carryover basis: The receiving spouse assumes the same basis in the stock options as the transferring spouse. This means that the receiving spouse's basis will be the same as the transferring spouse's basis, which is typically the fair market value of the options at the time of the transfer.

3. Holding period: The receiving spouse's holding period for the stock options includes the transferring spouse's holding period. This is important for determining whether the stock options qualify for long-term capital gains treatment upon exercise and sale.

4. Exercise and sale: When the receiving spouse exercises the stock options and sells the underlying stock, they will be responsible for any resulting tax liability. The tax liability will depend on the difference between the exercise price and the fair market value of the stock at the time of exercise.

5. Alternative options: While section 1041 provides tax-free transfers , it's important to consider alternative options. For example, the transferring spouse could sell the stock options before the divorce is finalized, potentially resulting in a lower tax liability . Alternatively, the couple could agree to divide other assets in a way that offsets the value of the stock options, eliminating the need for a transfer.

6. seeking professional advice : Given the complexities involved in tax-free transfers of stock options, it is highly recommended for both parties to seek professional tax advice. A tax professional can help evaluate the tax implications of various options and determine the most advantageous approach based on the couple's specific circumstances.

Understanding Section 1041 is crucial for divorcing couples navigating the division of stock options. By considering the implications from different perspectives and exploring alternative options , both parties can make informed decisions that minimize their tax liabilities and optimize their financial outcomes.

Understanding Section 1041 of the Internal Revenue Code - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

Section 2: Eligibility Criteria for Tax-Free Transfers of Stock Options

When it comes to dividing assets in a divorce, stock options can often present a complex challenge. However, Section 1041 of the Internal Revenue Code offers a potential solution by allowing tax-free transfers of stock options between spouses in a divorce. This provision can be highly beneficial for both parties involved, as it enables them to divide the assets without incurring immediate tax consequences. However, it is important to understand the eligibility criteria for tax-free transfers of stock options to ensure compliance with the IRS regulations .

1. Marital Settlement Agreement: In order to qualify for tax-free transfers of stock options, the transfer must be made pursuant to a divorce or separation instrument, such as a marital settlement agreement or court order. This agreement should clearly outline the terms of the transfer and specify that it is incident to the divorce.

2. Transfer during Divorce or within One Year: The transfer of stock options must occur either during the divorce or within one year after the marriage ends. It is crucial to complete the transfer within this timeframe to meet the eligibility criteria for tax-free treatment. Any transfers made outside of this window may result in taxable events for both parties.

3. No Additional Consideration: To qualify as a tax-free transfer, the stock options must be transferred without the receipt of any additional consideration. This means that no money or property should be exchanged for the stock options. If any additional consideration is involved, it may trigger taxable consequences.

4. Continuation of Same Terms and Conditions: The transferred stock options must retain the same terms and conditions as originally granted. This includes factors such as exercise price, vesting schedule, and expiration date. Any alteration to these terms could jeopardize the tax-free treatment of the transfer.

5. Reporting Requirements: Although the transfer itself may be tax-free, it is important to note that there are reporting requirements associated with the transfer of stock options in divorce. Both parties must report the transfer on their individual tax returns and provide the necessary documentation to the IRS. Failure to comply with reporting requirements can lead to potential penalties or audits.

To illustrate the eligibility criteria for tax-free transfers of stock options, let's consider an example. Sarah and John are going through a divorce, and as part of their marital settlement agreement, they decide to divide their stock options. Sarah transfers her stock options to John within a year of their divorce, without receiving any additional consideration. The transferred stock options retain the same terms and conditions as originally granted. Both Sarah and John report the transfer on their tax returns and provide the required documentation to the IRS.

In comparing different options for dividing stock options in a divorce, the tax-free transfer option provided by Section 1041 is often the most advantageous. It allows for a seamless division of assets without triggering immediate tax consequences. Other options, such as cash buyouts or dividing the options themselves, may result in taxable events for one or both parties. However, it is essential to consult with a tax professional or financial advisor to determine the best approach based on individual circumstances.

understanding the eligibility criteria for tax-free transfers of stock options is essential when navigating the division of assets in a divorce. By adhering to the requirements outlined in Section 1041, individuals can ensure a smooth transfer process while avoiding unnecessary tax liabilities . It is crucial to carefully consider the options available and seek professional guidance to make informed decisions that align with one's financial goals .

Eligibility Criteria for Tax Free Transfers of Stock Options - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

Calculating the Basis of Transferred Stock Options

When it comes to tax-free transfers of stock options in divorce, understanding how to calculate the basis of transferred stock options is essential. This calculation determines the tax consequences for both parties involved and can greatly impact the overall financial outcome of the divorce settlement. In this section, we will delve into the intricacies of calculating the basis of transferred stock options, exploring different perspectives and providing in-depth information to help navigate this complex process.

1. Understand the concept of basis:

The basis of an asset represents its value for tax purposes. In the context of stock options, the basis refers to the cost or value of the options at the time of transfer. It is crucial to determine the correct basis to accurately calculate any potential capital gains or losses upon subsequent exercise or sale of the options.

2. Consider the different methods for calculating basis:

There are several methods available for calculating the basis of transferred stock options. These methods include:

A. Carryover basis: Under this method, the recipient spouse assumes the same basis as the transferor spouse. The transferred stock options retain their original basis, ensuring no immediate tax consequences upon transfer. However, this method may result in a higher tax liability when the options are eventually exercised or sold.

B. Fair market value (FMV) basis: With this method, the recipient spouse establishes a new basis for the transferred stock options based on their fair market value at the time of transfer. This approach allows for a potential step-up in basis, potentially reducing tax liabilities in the future. However, accurately determining the FMV of stock options can be challenging, and disagreements between the parties may arise.

3. Seek professional valuation assistance:

Given the complexities involved in determining the FMV of transferred stock options, it is advisable to seek professional valuation assistance. Engaging a qualified appraiser or financial expert can help ensure an accurate assessment of the options' value, minimizing the risk of disputes and potential tax complications down the line.

4. Evaluate the tax implications:

It's important to consider the tax implications of each basis calculation method. While carryover basis may provide immediate tax relief, it could result in higher taxes upon exercise or sale of the options. On the other hand, establishing a new basis through FMV may lead to potential tax savings in the future but requires careful valuation and assessment. Evaluating the overall tax consequences, including potential capital gains or losses , can help determine the best approach for calculating the basis of transferred stock options.

5. Consider the specific circumstances:

The best option for calculating the basis of transferred stock options may vary depending on the specific circumstances of the divorce. Factors such as the financial situation of both parties, the nature of the stock options, and the potential future exercise or sale of the options should be taken into account. Consulting with a tax professional or financial advisor who specializes in divorce matters can provide valuable insights tailored to individual circumstances.

Calculating the basis of transferred stock options is a critical aspect of tax-free transfers in divorce . Understanding the different methods available, seeking professional assistance, evaluating the tax implications, and considering the specific circumstances are all crucial steps to ensure an accurate and favorable outcome. By navigating this complex process effectively, divorcing parties can minimize potential tax liabilities and maximize their financial well-being.

Calculating the Basis of Transferred Stock Options - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

Reporting Requirements for Tax-Free Transfers in Divorce

When it comes to dividing assets in a divorce, tax implications are an important consideration. In the context of stock options, Section 1041 of the Internal Revenue Code allows for tax-free transfers between spouses as part of a divorce settlement. However, it is crucial to understand the reporting requirements associated with such transfers to ensure compliance with the tax laws . In this section, we will delve into the reporting requirements for tax-free transfers in divorce, providing insights from different perspectives and offering in-depth information on the topic.

1. Form 1099-B: One of the key reporting requirements for tax-free transfers of stock options in divorce is the issuance of Form 1099-B. This form is used to report the sale or exchange of securities, including stock options. When a spouse transfers stock options to the other spouse as part of a divorce settlement, the transferring spouse is generally responsible for reporting the transaction on Form 1099-B. This form must be furnished to both the internal Revenue service (IRS) and the recipient spouse.

2. Valuation of Stock Options: Another crucial aspect of reporting tax-free transfers in divorce is determining the fair market value (FMV) of the stock options being transferred. The FMV is necessary for accurate reporting on Form 1099-B. There are different methods for valuing stock options, such as the black-Scholes model or professional appraisals. It is essential to consult with a financial expert or tax professional to determine the most appropriate valuation method for your specific situation.

3. Reporting Basis: The basis of the transferred stock options also plays a significant role in reporting requirements. The basis is the original cost of the options, which is used to calculate the gain or loss upon their subsequent sale. In the case of tax-free transfers in divorce, the recipient spouse assumes the basis of the transferring spouse. This means that when the recipient spouse eventually sells the stock options, they will use the transferring spouse's basis to determine their taxable gain or loss.

4. reporting Capital gains : If the recipient spouse sells the stock options received in the divorce settlement, they may have a taxable capital gain or loss . It is crucial to report such transactions accurately on Schedule D of Form 1040, which is used to report capital gains and losses . The recipient spouse should consult with a tax professional to ensure proper reporting and to explore any available deductions or strategies to minimize the tax impact .

5. Alternative Reporting Options: While Form 1099-B is the standard reporting method for tax-free transfers of stock options in divorce, there are alternative options available. For instance, some divorcing couples may choose to report the transfer on Form 8275, Disclosure Statement, to disclose any positions that may be contrary to the tax rules. This approach provides an extra layer of transparency to the IRS, potentially reducing the risk of an audit or further scrutiny.

understanding the reporting requirements for tax-free transfers in divorce is essential to ensure compliance with the tax laws and avoid potential penalties or audits. By following the guidelines outlined above and consulting with professionals, divorcing couples can navigate the complexities of reporting stock option transfers accurately. Ultimately, the best reporting option will depend on individual circumstances, and seeking expert advice is crucial to make informed decisions and optimize tax outcomes.

Reporting Requirements for Tax Free Transfers in Divorce - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

Potential Tax Implications for the Receiving Spouse

When it comes to the division of assets in a divorce, stock options can become a complex matter. In our previous blog post, we explored the tax-free transfers of stock options under section 1041 of the Internal Revenue Code. While this provision allows for tax-free transfers between spouses during divorce, it is important to consider the potential tax implications for the receiving spouse. In this section, we will delve into the various tax considerations that the receiving spouse should keep in mind.

1. Basis Adjustment: One significant tax implication for the receiving spouse is the basis adjustment of the transferred stock options. In a tax-free transfer, the receiving spouse assumes the same basis as the transferring spouse. This means that if the transferring spouse had a low basis in the stock options, the receiving spouse will also have a low basis. Consequently, if the receiving spouse later sells the stock options, they may face a higher capital gains tax liability .

2. Alternative Minimum Tax (AMT): Another crucial consideration is the potential impact of the Alternative Minimum tax (AMT) on the receiving spouse. The AMT is a separate tax system that limits certain deductions and exemptions, potentially resulting in a higher tax liability. In the case of stock options, exercising them may trigger an AMT liability for the receiving spouse. It is essential for the receiving spouse to understand the potential AMT consequences and plan accordingly.

3. Timing of Exercise: The timing of exercising stock options can also affect the tax implications for the receiving spouse. If the receiving spouse chooses to exercise the stock options immediately after the transfer, they may face a higher tax liability due to ordinary income tax rates. On the other hand, if the receiving spouse waits to exercise the stock options and sells them as long-term capital assets, they may benefit from lower capital gains tax rates . The decision of when to exercise the options should be carefully evaluated based on the current tax laws and the receiving spouse's financial situation.

4. Holding Period: The duration for which the receiving spouse holds the stock options before selling them can have a significant impact on the tax consequences. If the receiving spouse holds the options for at least one year after exercise and two years after the grant date, any resulting gain will be considered long-term capital gain . This can result in a lower tax rate compared to short-term capital gains , which are taxed at ordinary income rates. The receiving spouse should consider the potential tax savings associated with holding the stock options for a longer period before selling.

5. Consideration of Other Assets: When evaluating the tax implications of receiving stock options in a divorce, it is crucial to consider the overall division of assets. The receiving spouse should assess the tax consequences of the stock options in conjunction with other assets received in the divorce settlement. For example, if the receiving spouse also receives significant retirement assets, the tax implications of the stock options may be offset by the potential tax advantages of the retirement accounts. A comprehensive analysis of all assets is essential to make an informed decision.

While tax-free transfers of stock options under Section 1041 can provide a valuable option for divorcing couples, it is vital for the receiving spouse to carefully consider the potential tax implications. Understanding the basis adjustment, AMT implications, timing of exercise, holding period, and overall asset division can help the receiving spouse make informed decisions to minimize their tax liability . Seeking the guidance of a qualified tax professional or financial advisor is highly recommended to navigate the complexities of tax considerations in divorce.

Potential Tax Implications for the Receiving Spouse - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

1. Understanding the Different Types of Stock Options:

When it comes to maximizing tax benefits in stock option transfers, it is crucial to have a solid understanding of the different types of stock options. Broadly speaking, there are two main types: non-qualified stock options (NSOs) and incentive stock options (ISOs). NSOs are typically granted to employees and can be exercised at any time, whereas ISOs are granted to key employees and have specific tax advantages. It is essential to differentiate between these options as the tax implications can vary significantly.

2. Timing is Key: Exercising Options at the Right Time:

Timing plays a crucial role in maximizing tax benefits in stock option transfers. It is important to consider the tax implications of exercising options at different times. For NSOs, exercising them at the earliest opportunity may be beneficial, as it starts the clock for long-term capital gains treatment. On the other hand, ISOs have specific holding period requirements to qualify for favorable tax treatment. Understanding these timing considerations can help individuals strategize when to exercise their options for maximum tax benefits.

3. Utilizing the 1041 Election:

Section 1041 of the Internal Revenue Code provides an opportunity for tax-free transfers of stock options in divorce. By making a 1041 election, divorcing spouses can transfer stock options between themselves without triggering any immediate tax consequences. This can be an advantageous strategy, as it allows for the division of assets without incurring unnecessary taxes. However, it is important to note that the transferor's basis in the stock options carries over to the transferee, potentially affecting future tax implications.

4. Evaluating the Option to Exercise Prior to Transfer:

Another strategy to consider is exercising stock options prior to the transfer in a divorce. By doing so, the transferor can potentially reduce the future tax burden for both parties. This approach allows the transferor to take advantage of any built-in gains and reset the cost basis for the transferee. However, it is crucial to carefully evaluate the financial implications of exercising options, considering factors such as exercise price, market conditions, and potential alternative investment opportunities .

5. Weighing the Benefits of Stock Option Buyouts:

In some cases, a buyout of stock options may be the most favorable option for both parties. A buyout involves one spouse compensating the other for their share of the stock options, effectively transferring ownership. This strategy allows for a clean break and avoids potential future complications. However, it is important to carefully assess the financial implications of a buyout, including any immediate tax consequences and the potential for future growth in the value of the options.

6. Seeking Professional Advice:

Navigating the complexities of tax benefits in stock option transfers can be challenging, especially during a divorce. Seeking professional advice from a tax expert or financial planner is highly recommended. They can provide personalized guidance based on your specific situation, helping you make informed decisions that maximize tax benefits while considering your long-term financial goals .

Maximizing tax benefits in stock option transfers requires careful consideration of the different types of stock options, timing considerations, the utilization of Section 1041, evaluating the option to exercise prior to transfer, weighing the benefits of stock option buyouts, and seeking professional advice. By strategizing effectively, individuals can minimize tax liabilities and ensure a smooth transition of stock options during a divorce.

Strategies for Maximizing Tax Benefits in Stock Option Transfers - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

1. Tax-Free Transfer of Stock Options: A real-Life Case study

In this section, we will explore a real-life case study that exemplifies the tax-free transfer of stock options in a divorce. By delving into the intricacies of this scenario, we can gain valuable insights and understand the various perspectives involved.

Imagine a couple, Sarah and John, who are undergoing a divorce. Sarah holds stock options in a company where she works, and they have appreciated significantly over the years. As they navigate the division of assets, Sarah and John are faced with the challenge of determining how to handle these stock options in a tax-efficient manner.

1.1 Sarah's Perspective

From Sarah's point of view, she wants to ensure that she can transfer her stock options to John without triggering any tax consequences. She is aware that under Section 1041 of the Internal Revenue Code, transfers of property between spouses incident to divorce are generally tax-free. However, she also knows that stock options have unique characteristics that require careful consideration.

1.2 John's Perspective

John, on the other hand, is concerned about the potential tax implications of receiving Sarah's stock options. He wants to explore the most advantageous options available to him, both in terms of immediate tax consequences and future financial gains. John is particularly interested in understanding the tax basis of the stock options and the potential impact on capital gains taxes upon exercise or sale.

1.3 Evaluating the Options

To address their concerns, Sarah and John consult with their respective tax advisors and family law attorneys. After careful analysis, they consider the following options:

1.3.1 Option 1: Direct Transfer of Stock Options

One option is for Sarah to transfer her stock options directly to John. This transfer would be made incident to the divorce, thereby qualifying for tax-free treatment under Section 1041. However, it is important to note that the tax basis of the stock options would carry over to John. This means that any future gains upon exercise or sale of the options would be subject to capital gains taxes .

1.3.2 Option 2: Cash Equalization

Another possibility is for Sarah to retain the stock options and compensate John with other assets of equal value, such as cash or property. By doing so, Sarah can maintain control over the stock options and potentially benefit from any future appreciation without triggering immediate tax consequences for either party.

1.3.3 Option 3: Deferred Distribution

Alternatively, Sarah and John could agree to defer the division of the stock options until a later date, such as when they are exercised or sold. This approach allows them to delay the tax consequences and potentially take advantage of more favorable tax rates in the future. However, it is essential to establish clear guidelines and mechanisms for the eventual division of the proceeds.

1.4 The Best Option

Ultimately, the best option for Sarah and John depends on their unique circumstances, financial goals, and risk tolerance. It is crucial for them to carefully evaluate the tax implications, future potential gains, and their individual preferences before making a decision.

By examining this real-life case study, we gain valuable insights into the complexities and considerations involved in tax-free transfers of stock options in divorce. Each option presents its advantages and potential drawbacks, emphasizing the importance of seeking professional advice and taking a comprehensive approach to asset division.

Navigating Section 1041 for Tax-Free Stock Option Transfers

When it comes to the division of assets in a divorce, stock options can present a unique challenge. These financial instruments, often granted by employers as a form of compensation, can hold significant value. However, the tax implications of transferring stock options can complicate matters even further. In this section, we will explore Section 1041 of the Internal Revenue Code, which provides guidelines for tax-free transfers of stock options in divorce cases.

1. Understanding Section 1041: Section 1041 allows for the tax-free transfer of property between spouses or former spouses incident to a divorce. This means that the transfer of stock options from one spouse to another in a divorce settlement may be exempt from capital gains tax. However, it is important to note that this tax advantage only applies to transfers that occur as part of the divorce settlement and within one year of the divorce. Any subsequent transfers may be subject to capital gains tax.

2. Requirements for Tax-Free Transfers: To qualify for tax-free treatment under Section 1041, certain requirements must be met. Firstly, the transfer must be made between spouses or former spouses as a result of a divorce or separation agreement. Secondly, the transfer must be incident to the divorce, meaning it is related to the ending of the marriage. Lastly, the transfer must occur within one year of the divorce. It is crucial to meet these requirements to ensure the tax-free status of the stock option transfer.

3. Valuing Stock Options: Determining the value of stock options is a crucial step in the division of assets during a divorce. The value of stock options can fluctuate greatly, depending on various factors such as the current market price, the strike price, and the expiration date. It is advisable to consult with a financial expert or a valuation specialist to accurately assess the value of stock options. This will help ensure a fair and equitable distribution of assets between spouses.

4. Different Approaches to Stock Option Transfers: There are several approaches to consider when transferring stock options in a divorce settlement. One option is for the recipient spouse to assume the stock options entirely. This means that they will take over the rights and obligations associated with the options. Another approach is to divide the options between both spouses, allowing each party to retain a portion of the options. Alternatively, the options can be sold, and the proceeds divided between the spouses. The best approach will depend on the specific circumstances of the divorce and the financial goals of each party involved.

5. Tax Considerations: While Section 1041 allows for tax-free transfers of stock options, it is essential to consider other tax implications that may arise. For example, if the stock options are exercised after the transfer, any resulting capital gains or losses will be attributed to the recipient spouse. Additionally, if the transferred options are subject to restrictions or vesting requirements, the recipient spouse may be subject to ordinary income tax upon their eventual exercise. It is crucial to consult with a tax professional to fully understand the potential tax consequences of stock option transfers.

Navigating Section 1041 for tax-free stock option transfers in divorce cases requires careful consideration of the requirements, valuation, and various approaches available. By understanding the implications and seeking professional guidance, couples can effectively divide stock options while minimizing tax consequences . Each case is unique, and the best option will depend on the specific circumstances and goals of the parties involved.

Navigating Section 1041 for Tax Free Stock Option Transfers - Tax Free Transfers of Stock Options in Divorce: A Look at Section 1041

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Dividing Stocks in a Divorce Protect Your Investments

Last updated: may 11, 2023 • 10 min read.

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Divorce can be an emotionally challenging and financially complex process. One of the critical aspects is dividing assets, such as stocks. Understanding how to split stocks in a divorce can be a daunting task, but with the right guidance, you can make informed decisions. In this article, we'll explore the steps you need to take to ensure a fair and equitable distribution of your stock holdings during a divorce.

Determining Marital Assets

Before diving into the process of dividing stocks, it is essential to have a clear understanding of the assets that will be subject to division in a divorce. Identifying and classifying marital assets can be a complex task, as it involves determining which assets were acquired during the marriage and which ones are considered separate property. This step is crucial, as it sets the foundation for an equitable division of stocks and other assets, ensuring both parties receive their fair share.

Separate property includes assets acquired before marriage or as gifts or inheritance during the marriage. Marital property, on the other hand, refers to assets acquired during the marriage. In most cases, only marital property is subject to division in a divorce.

Community Property State vs. Equitable Division States

The division of assets is determined by the state laws where you reside. In a community property state such as California, spouses have equal ownership of marital assets, requiring a 50-50 split. In equitable division states, assets are divided based on what is fair and equitable, which may not always be equal.

Dividing Stock Holdings

When it comes to dividing stock holdings, the goal should be to achieve a fair and equitable distribution that reflects each spouse's contribution to the marriage and considers their future financial needs. This process may require careful negotiation, compromise, and an in-depth understanding of the intricacies of the stock market. By approaching the division of stock holdings with a clear objective and a willingness to work together, both parties can pave the way for a smooth asset division and a more amicable divorce process.

1. Determine the Value of the Stocks

To divide your stocks, first establish the current value and monetary value of your stock holdings. Consider the stock market fluctuations and past performance of the shares. Consulting a financial advisor or forensic accountant with years of experience can help you determine an accurate valuation.

2. Assess Tax Implications

Dividing stocks can have tax consequences. Consider the capital gains taxes that may arise when selling or transferring stocks. A financial professional can guide you through the potential tax implications and help you make the best decision.

3. Evaluate Vesting Schedules and Unvested Stocks

Unvested stocks or stock options are those that have not yet met the vesting schedule set by the employer. These may be divided differently from vested stocks. Check with a legal professional to determine the best way to address these in your divorce agreement.

Retirement Accounts and Stock Units

Dividing retirement accounts like 401(k)s, IRAs, or pension plans can be complicated. You may need a Qualified Domestic Relations Order (QDRO), a court order that grants a non-employee spouse the right to a portion of the employee's retirement benefits.

Stock Units in Retirement Plans

Employee stock units or employee stock options within retirement plans should be considered when dividing assets. The division of these types of assets should also be addressed in the divorce settlement.

Working with Professionals

It's essential to seek legal advice when dividing stocks in a divorce. A family law attorney with extensive experience in handling high-asset divorces can help you navigate the complicated process and ensure your best interests are represented. They can offer invaluable insights into state-specific laws, regulations, and precedents that may affect the division of your stocks. Furthermore, they can assist in negotiating settlements, drafting agreements, and representing your interests in court, if necessary.

Financial Expertise

In addition to legal counsel, enlisting the help of a financial expert or financial institution is crucial in successfully managing the division of stocks in a divorce. These professionals can provide guidance on valuing and dividing stocks, considering factors such as market conditions, company performance, and future growth potential. Their expertise can help ensure a fair and accurate valuation of your stock assets.

Moreover, financial experts can assist you in understanding and managing the tax implications of dividing stocks. They can help you devise strategies to minimize potential tax liabilities and ensure compliance with relevant tax laws and regulations.

Considerations and Strategies

One spouse may choose to buy out the other's share of the stocks by providing cash value or other assets of equal value. This can be a suitable option if both parties agree and there is enough liquidity to facilitate the buyout.

Another strategy is to offset the value of the stocks with other marital assets like real estate, investment accounts, or bank accounts. This allows each spouse to retain assets of similar value without the need to sell or transfer shares.

Co-Ownership

In some cases, spouses may choose to maintain co-ownership of the stocks, particularly if they believe in the future performance of the company. This approach may require continued cooperation between the former spouses, but it can potentially lead to greater financial gain.

Selling Stocks and Dividing Proceeds

If both parties agree, selling the stocks and dividing the proceeds can be an option. This approach simplifies the division process but may trigger capital gains taxes and depends on the stock's fair market value at the time of sale.

Special Considerations

Dividing unvested RSUs (restricted stock units) and stock options can be complex, as they are typically tied to future work or performance. The Hug formula or time rule is often used to determine the division of these assets, factoring in the grant date, vesting schedule, and date of separation. Consult a family law attorney or financial professional to address these unique assets.

Child Support and Spousal Support

The division of stocks may impact child support and spousal support obligations. It's essential to consider these factors when determining the best way to divide assets, ensuring a fair outcome for all parties involved.

Tips for Navigating Stock Division in a Divorce

• Keeping emotions in check. Divorce is an emotionally taxing experience, and it's essential to separate emotions from financial decisions. Focus on making rational choices that protect your financial future and prioritize your best interests.
• Updating beneficiary designations. After dividing stocks in a divorce, don't forget to update beneficiary designations on your investment and retirement accounts. This ensures that your assets will be distributed according to your wishes in the event of your death.
• Rebuilding your financial future. Once your divorce is finalized and your stocks have been divided, it's essential to focus on rebuilding your financial future. Create a new budget, adjust your financial goals, and seek professional advice to help you get back on track.
• Record-keeping and documentation. Maintaining thorough records and documentation throughout the divorce process is crucial. Keep track of all stock transactions, account statements, and valuations to ensure a transparent and fair division of assets. Proper record-keeping can also help you avoid potential disputes or complications in the future.
• Seeking a free consultation. Many family law attorneys and financial professionals offer free consultations to discuss your unique situation. Take advantage of these opportunities to gain valuable insight and understand your options when it comes to dividing stocks in a divorce.

When dividing stock options, it's important to consider the past work and future work associated with the options. Stock options granted as a reward for past services during the marriage might be considered marital property, while those granted for future performance may be treated differently. A legal professional can help you determine how these factors impact the division of stock options.

Impact of Divorce on Stock Portfolio

The division of stocks in a divorce can significantly impact your investment strategy and risk tolerance. As your financial situation changes following the separation, it becomes essential to reevaluate your stock portfolio and align it with your new financial goals and circumstances.

Post-divorce, you may need to shift your investment focus and adjust your strategies to ensure they align with your updated financial objectives. This might involve diversifying your portfolio to minimize risks, adjusting your stock holdings to optimize returns, or considering new investment opportunities that were previously overlooked.

As your financial stability and future income potential may be affected by the divorce, it's important to reevaluate your risk tolerance. Consider how much risk you are willing to take with your investments and adjust your stock portfolio accordingly. For example, you might choose to invest more conservatively or take on additional risk, depending on your new financial situation and goals.

Following the division of stocks, it's crucial to rebalance your portfolio to ensure it maintains a well-diversified and risk-appropriate composition. Rebalancing involves selling or buying stocks to achieve your desired asset allocation, which can help minimize risk and maximize returns.

Prenuptial and Postnuptial Agreements

A prenuptial agreement established before the marriage or a postnuptial agreement created during the marriage can be a valuable tool in addressing the division of stocks in a divorce. These legally binding agreements can outline how stocks and other assets will be divided, simplifying the process and reducing potential conflicts. If you have a prenuptial or postnuptial agreement in place, consult with a family law attorney to understand its implications for your stock division.

Divorce Mediation

Divorce mediation can be a cost-effective and less adversarial approach to dividing stocks and other assets. In mediation, a neutral third-party mediator facilitates negotiations between spouses, helping them reach a mutually agreeable settlement. This process can lead to a more amicable resolution, allowing both parties to maintain control over the division of their assets, including stocks.

Liquidation vs. Transfer of Stocks

When dividing stocks, you may have the option to either liquidate or transfer the stocks to your former spouse. Liquidation involves selling the stocks and dividing the proceeds, while a transfer maintains the stock ownership but changes the name on the account. Each option has its pros and cons, and you should consult with a financial professional to determine the best choice for your situation.

Post-Divorce Financial Planning

After your divorce is finalized, it's important to revisit your financial plan and make adjustments based on your new circumstances. This may include revising your budget, updating your estate plan, and reevaluating your investment strategy. Working with a financial advisor can help you develop a comprehensive plan to achieve your financial goals post-divorce.

By considering these additional points, you can further ensure a smooth and fair division of stocks during your divorce, while also preparing yourself for a strong financial future.

The process of dividing stocks in a divorce is multifaceted and requires careful consideration of various factors. By exploring different approaches, seeking professional guidance, and staying informed about the potential implications of your decisions, you can work towards a fair and equitable division of stocks that sets you up for financial success in your post-divorce life.

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Restricted Stock Units (RSUs) and Divorce: What You Need to Know

Jason Crowley, CFA, CFP, CDFA

In this guide, I’m going to walk you through how to handle Restricted Stock Units (RSUs) in a divorce.

So if you or your spouse has RSUs, you’ll find the answers to your questions here.

Let’s get started.

• How RSUs work
• RSUs and taxes

An example of how RSUs work

Understanding the basics of rsus in a divorce.

• How to calculate the marital (community) portion of RSUs
• Looking at a few different RSU divorce scenarios
• How to value or divide RSUs in divorce
• How RSUs impact alimony and child support

How Restricted Stock Units (RSUs) work

Before we get too far into the details of how to divide RSUs in a divorce, let’s cover the basics.

Restricted Stock Units (RSUs) are a type of stock-based compensation used to attract and retain employees. Like stock options and phantom stock, RSUs are one of many ways that your employer can provide you with an opportunity to share in the success of the company.

They became more popular as an alternative to stock options after accounting scandals involving companies like Enron and WorldCom.

Until that time, stock options were the vehicle of choice.  But after a Financial Accounting Standards Board ruling in 2004 which changed the corporate accounting rules for stock options, companies began shifting away from stock options in favor of RSUs.

Like stock options, RSUs provide an incentive to remain with the company (until the shares vest) and help it perform well so that the stock price increases in value.

So, what are RSUs exactly?

RSUs are a promise to issue shares of employer stock once certain conditions have been met. 

The shares are “restricted” because they are subject to a  vesting schedule based on length of employment or performance goals. The shares may also be subject to further restrictions such as limitations on the ability to sell or transfer shares. These other restrictions are more common in private companies.

RSUs are similar to stock options in that you can receive shares of company stock, but there are some important differences to note as well.  For example, if the stock price declines significantly, a stock option can lose all practical value as the options become “underwater” and the exercise price is higher than the stock price. This effectively eliminates any incentive to remain with the company since your stock options are now worthless.

That is not the case with RSUs.  Even if the share price falls after you are granted shares, the RSUs always have some value (unless the stock price falls to $0).

The catch is that you must remain employed at your company until vesting for the RSUs to have any value to you.  If you leave the company, any unvested RSUs are usually forfeited.

Exceptions may take place in certain situations.  For instance, vesting may be allowed to continue or is accelerated due to specific agreements or life changes built into the RSU agreement (e.g., death, disability, or retirement, depending on the plan and grant agreement).

RSUs and Taxes

With RSUs, you are taxed when the shares vest (not when they’re granted). Your taxable income is based on the value of the shares at vesting.

Example: 100 shares vest at $10/share. Your taxable income is $1,000.

This compensation income is subject to federal taxes, state taxes, and payroll taxes ( Social Security , Medicare). Like other W-2 income, the company is required to withhold taxes.

An employer may offer several ways to pay taxes at vesting, or it may use a single mandatory method. The most common practice is withholding some of the vested shares to cover the withholding taxes.

The stock price at vest becomes your cost basis and the vest date is the start of your holding period (if you don’t sell the shares immediately). If you hold the shares for more than one year after vest, any increase in stock price from the value at vest to the sale price is taxable as long-term capital gains. If you hold for less than one year, it’s taxable as short-term capital gains.

Let’s look at an example of how all this works.

You are granted 10,000 RSUs (shares of company stock) that vest at a rate of 25% a year.  The market price at the time the shares are granted is $20.

• At Grant: The total pre-tax value of the RSUs is $200,000. However, you have no taxable income to report when the shares are granted.
• The stock price is $25 at the time of vesting. You have $62,500 of taxable income to report. (2,500 shares x $25/share)
• Share prices rise to $30 at the time of vesting. Your taxable income is $75,000 (2,500 shares x $30/share)
• Share prices fall to $10/share. Your taxable income is $25,000 (2,500 shares x $10/share)
• The stock price at vest is $40/share. Your taxable income is $100,000 (2,500 shares x $40/share)

The overall total value of the vested shares at vest is $262,500.

The above example is a “graded” vesting schedule because the shares are vested in portions over time.

By contrast, companies can also use “cliff” vesting.  That takes place when 100% of the shares are vested all at once after completing a stated period of service or specific performance goals.

Graded vesting can take place at regular intervals, or there can be varying intervals between vesting dates.

It’s not uncommon to have a combination of cliff and graded vesting. For instance, you might have 25% of the shares vest after 1 year, then have the remaining shares vest monthly for the next 36 months.

Regardless of the vesting schedule, each block of shares is taxable upon vesting.

As part of the divorce process, you and your spouse will be required to complete financial disclosures. The idea is to ensure that you both have an understanding of the entire financial picture.

The financial disclosures include providing details on all assets and compensation. That includes any RSU grants.

RSUs and other forms of stock-based compensation can be valuable assets that need to be addressed in a divorce.

Seeking stock options and RSUs as compensation during a divorce can be challenging, mainly because the value will change over time.

Stock prices change all the time.  As a result, the value of the stocks will not become fixed until a spouse decides to exercise his or her options and cash out or until the RSUs vest.

There are two main ways to divide RSUs.

• Option 1: The employee spouse can keep the RSUs and buy out the other spouse’s interest based on the current value.
• Option 2:  Deferred division. With this approach, the employee spouse continues to hold the unvested RSUs in his/her name until the RSUs are released. At that time, the non-employee spouse would receive their share of the vested RSUs.

Both methods carry their advantages and disadvantages.

If your spouse cuts you a check for the value of the RSUs now, you could miss out on future gains, especially if the company is still in the start-up phase.

But by getting the value of the options up front, you are also eliminating the risk of future drops in value.

If a spouse received RSUs while you were married, they will likely be considered as marital property (at least in part).  This means you are entitled to a portion as part of your divorce settlement, depending on the divorce laws of your state.

Before a proper division can take place, there will need to be a determination of what part of the RSUs is marital property vs. separate property.

How to determine the marital (community) portion of RSUs in divorce

Laws will vary from state to state, but no matter where you live, determining the marital portion of RSUs can be complicated.

Part of this depends on the property division laws in your state.  Some states, such as California, are community property states, and all marital assets are divided equally.  In equitable distribution states, which encompass the vast majority of states, assets are divided fairly but not always equally.

Determining what part of RSUs are community property is influenced by several factors:

• When was the RSU award granted?
• What is the vesting schedule?
• What is the vesting criteria? In other words, do the RSUs vest over time or is vesting contingent on meeting certain performance metrics?
• Why was the RSU awarded? Employees can be granted RSUs as rewards for past performance or as an incentive for future performance. If the RSU was granted for past performance, it means a spouse may receive RSUs after separation as a bonus for work that took place during the marriage.
• Most RSUs do not allow an employee to transfer ownership of restricted shares to their spouse.

If RSUs are granted and vest during a marriage, then determining the characterization (marital vs. separate) is relatively simple.  If the employee wants to keep the RSUs, then they can negotiate an equitable trade-off based on the current value of the RSUs.  The other option is the split the present value of the stock, and sell half, which is given to the non-employee spouse.

Time Rule Formulas

Dividing RSUs after a divorce is especially relevant in California. Many Silicon Valley tech companies, particularly start-ups, offer employees RSUs as a form of deferred compensation.

When RSUs are granted during a marriage but not yet vested, a division becomes more complicated.  Often in California divorces, The Hug Formula or the Nelson Formula are used to sort things out.

Hug  and  Nelson  refer to California Appellate cases that further defined the division of stock options and RSUs in a divorce. Both of these are variations of the  time rule. 

The time rule essentially looks at the total earning period and what portion of the total earning period occurred during marriage. That ratio is the marital percentage.

Keep in mind, vesting is contingent on the employee spouse staying with the company for several years.  If the employee leaves or terminates, those RSU grants have no value.

The Hug Formula for Calculating the Marital Portion of RSUs

Using the Hug Formula , the shares owed to the non-employee spouse are calculated by thinking of an RSU as deferred compensation for past performance. The formula calculates the percentage of community interest as follows:

(Period of Time Between Start Date at Company and End of Marriage) /

(Period of Time Between Start Date at Company and Vesting)

The community interest is multiplied by the total shares harvested.  That number is divided in half. That total is the non-employee’s portion of the vested shares.

The Nelson Formula for Calculating the Community Portion of RSUs

The  Nelson Formula considers the stock as primarily future incentives for performance. The community interest under the Nelson Formula is:

(Time worked between the date of the grant and the date of separation) /

(The date of the grant and the date the option is first exercisable)

Community interest is multiplied by the number of shares that have vested and divided in half. That amount is the non-employee’s portion of the vested shares.

Both formulas are applicable but do have some differences to note . After weighing these differences, the choice of which one to use is typically determined by both spouses.

In some cases, RSUs are considered marital property on the date the RSU was granted.  If the RSU is not vested by is deemed marital property, the parties will need to negotiate the value of the RSUs and compensate the non-employee with a payment.

Another option is for both parties to agree to wait until the RSUs vest in the future when they can be sold, creating a more accurate valuation.  Most divorcing couples do not go this route, instead preferring a clean financial break from their partners.

Looking at a few different scenarios for RSUs and divorce

Depending on your situation, dividing RSUs in a divorce can be relatively easy to determine, or it can be just the opposite.

Let’s take a closer look at a few scenarios:

• RSUs granted during marriage that vest during marriage: These are generally considered as marital or community property and would be divided according to the division of asset laws for your state.
• RSUs granted after a separation or a divorce are generally considered separate property.
• RSUs granted during a marriage that vest after separation: There is usually a marital portion and a separate portion. This is calculated using one of the time rule formulas discussed above.
• RSUs granted before marriage that vest during marriage: This falls in the same category as RSUs granted during marriage that vest after separation. There’s a marital portion and a separate portion.

How to Value or Divide RSUs in Divorce

Ok, so now you’ve figured out the marital portion of the RSUs.

What’s next?

Decision time…

Do you want to divide the RSUs or do a buyout?

Let’s look at how both of these options work.

Dividing RSUs in Divorce

With this option, you and your spouse will split the marital (or community) property RSUs.

Unvested RSUs can’t be transferred on the books. Luckily, there’s a workaround.

The employee spouse can hold the other spouse’s RSUs in constructive trust. Don’t worry, you don’t actually have to create a trust. All this means is that the employee spouse essentially becomes the broker for the other spouse’s RSUs. The employee spouse will transfer the other spouse’s shares to them once  the RSUs vest.

The shares can be transferred (not the unvested RSUs).

Dealing with the taxes is where things can get a little complicated.

In a nutshell, the income and withholdings are all reported in the employee’s name. You can allocate the spouse’s portion of the income and withholdings to the spouse on your tax returns. If you’re going this route, be sure to work with a CPA.

The alternative to allocating income and withholdings is to simply have the employee pay the taxes and only deal with the net shares released.

The drawback here is that the shares withheld are often not enough to cover the taxes owed. Sometimes, the employee spouse gets the short end of the stick with this approach.

How to Value RSUs for Offset in a Divorce

The other option for dealing with RSUs is to value them for offset. This means you’re going to place a value on the RSUs that you’re keeping and your spouse will get other assets or cash in exchange.

If the company is publicly traded, this approach is actually pretty simple.

Step 1: Calculate the marital (community) property portion.

Step 2: Multiply the number of unvested community property RSUs by the current stock price. This gives you the pre-tax community value.

Step 3: Apply a tax discount. This can be a little tricky, but the idea is to estimate the taxes that you would pay on the RSUs.

Step 4: Divide by 2 to calculate each spouse’s portion.

Let’s look at how this works with an example.

Let’s say there are 200 total unvested RSUs and 100 of them are community property . The stock price is $10 per share.

100 community shares x $10/sh = $1,000 pre-tax community value

Let’s assume the tax rate is 25%.

Tax discount = $1,000 x 25% = $250

After-tax marital (community) value = $1,000 – $250 – $750

After-tax value for each spouse = $750 / 2 = $375

In this example, you would owe $375 to buy out your spouse’s interest in the community RSUs.

Keep in mind there’s a risk that the unvested RSUs are forfeited if the employee leaves the company prior to vesting.

That’s why it’s unusual for the non-employee spouse to consider doing a buyout.

It’s not all or nothing

So far, we’ve talked about either doing a buyout or splitting the RSUs.

It’s not all or nothing. You could consider doing a partial buyout, where one spouse buys out a portion of the other’s RSUs and you split the rest of the RSUs.

This can be a good solution in situations where you have a lot of RSUs and one spouse wants to trade for other assets like the marital home or a pension.

How RSUs Impact Alimony and Child Support

In most states, a big part of calculating child support and alimony payments is based on the income of both parties.  Generally speaking, guidelines are in place to consider all sources of income.

Compensation, in general, has gotten more complex than ever before.  RSUs are one form of this more complicated compensation issue. Bonuses, commissions, deferred compensation, stock options, and other sources of income can all impact the amount of income parents make and must report for child support purposes.

The tricky part is that these forms of compensation are not always paid out regularly.  That is true for RSUs awarded on a cliff schedule (all at once), and sometimes on a graded schedule if the intervals are not spaced consistently.

The IRS does not treat the initial grant of the restricted stock as income for income tax purposes.

However, for purposes of calculating child or spousal support, a court might treat the vesting of the right to exercise the option as income. The current value minus the purchase price will determine the amount of income.

The IRS allows an 83(b) election if the employee wants to be taxed as ordinary income before vesting, or before the lapse of restrictions. Any increase in value is taxed at capital gains rates, which are almost always less than ordinary income rates. Note that an 83(b) election is only allowed for restricted stock – not for RSUs.

Ultimately, when the stock is sold, any profit will be income available for purposes of calculating alimony or child support, regardless of whether it is ordinary income or capital gains income.

In some cases, these non-salaried forms of compensation may be much higher than an employee’s regular paycheck.  Predicting their amounts for child support can be difficult as a result.

Offsetting this is that in some states, the amount of income used to determine child support is capped.  The thinking is that at some point, child support will cross a line of being too high because the parent’s income is so high, resulting in an amount that is far and above what a child needs.

(I’ve had cases where child support was set at almost $100,000 per month!)

But that may not be the case in some states which don’t have a cap.

It can make for interesting negotiations between parents and their attorneys.  When a disagreement can’t be resolved, parents may need to resort to mediation, or the court will step in and resolve the matter instead.

More Frequently Asked Questions about RSUs

What is the withholding rate on rsus.

RSUs are considered as supplemental wages (like bonuses) and are subject to statutory withholding requirements. Here’s a breakdown:

• Federal: 22% on supplemental wages up to $1M, 37% on supplemental wages in excess of $1M
• Social Security: 6.2% (on annual wages up to $132,900)
• Medicare: 1.45% regular plus 0.9% on wages in excess of $200,000
• State: varies based on your state

One of the common misconceptions is that bonuses are taxed at higher rates the regular pay. That’s simply not the case. Keep in mind that these are the withholding rates, which is just an approximation of your actual taxes. The withholding might be different, but your total taxes are the same at the end of the day.

Do you receive dividends on RSUs?

You will have voting and dividend rights only after you are vested (because technically you don’t own the shares until they’re vested).

Companies sometimes pay dividend equivalent payouts for unvested RSUs which may be reported on a W-2 as wages in some circumstances. These dividend equivalents that can be moved into an escrow account to help offset withholding taxes.  They can also be reinvested through the purchase of additional shares.

How can I tell if my spouse has RSUs?

There are a couple ways to tell if your spouse has RSUs.

First, you could have your attorney subpoena the company that your spouse works for. This is the most surefire way to get the details on your spouse’s compensation package.

The drawback to this apprach is that it can be challenging to keep things amicable if you’re issuing subpoenas.

Fortunately, there are a couple of other alternatives.

Ask for your spouse’s pay stubs and W-2’s. Look for an “RSU” or “restricted stock” entry on the pay stubs. If any RSUs have vested in that year, you’ll see the total RSU income listed under the “Year To Date” column.

W-2’s will often list RSU income in box 14 as you can see here.

These alternatives can be a great way to “trust but verify” what your spouse is telling you.

If your spouse claims they don’t have RSUs, but their W-2 or pay stubs reveal otherwise, you need to be particularly diligent in fact-checking going forward. Your best bet in this case is to subpoena the company and get the details.

One thing to keep in mind is that RSU income will only show up on W-2’s or pay stubs once the RSUs vest. So, if your spouse has RSUs which are unvested, checking W-2s and pay stubs won’t help.

What information do you need to obtain for RSUs in a divorce?

Gathering information is key to understanding your spouse’s compensation package, including RSUs.

For each RSU award, here’s what you need to know:

• Grant number
• Vesting commencement date
• Number of shares granted
• Vesting schedule

Here’s a short list of the information you need:

RSU Grant Notice. This is a 1-pager that lays out the specifics of the RSU award listed above. Get the grant notice for each RSU award.

RSU Plan Agreement. Unlike the grant notice, the plan agreement isn’t specific to a particular RSU award. Rather, the plan agreement is a formal governing document that sets out:

• Why the company issues RSU awards,
• Transferability of RSUs
• What happens to unvested RSUs if the employee retires, gets disabled, etc.
• What happens to unvested RSUs if the company is acquired

Account statement for the stock plan account. Ask for all account statements from the date of separation through current. This will give you a snapshot of the owned shares, cash, and any unvested RSUs.

Transaction details. You might also need the RSU Release Confirmation Statements and any sales confirmation statements.

The release confirmation statement shows the details for a particular vesting. It will list the number of shares withheld for taxes, net shares released, taxable income, and the like.

It can be tough to find the Release Confirmation Statements. For some stock plan administrators, you need to go to the grants and click to expand the vest details. Then you can find the Confirmation of Release.

The sales confirmation statements will show the details for the sale of any stock. Together, these documents can help you account for the vested RSUs and any cash proceeds.

Details on reissuing. In some cases, the company will reissue RSU awards. This usually happens if there is a stock split, acquisition, or some other company event.

Why does this matter?

Well, when RSUs are reissued they usually have a different grant date. Remember, the grant date can affect the calculation of what’s marital property. So, you’re going to want to find out the details around the original grant and reissued grant.

(Complicated, I know!)

Jason Crowley is a divorce financial strategist, personal finance expert, and entrepreneur. Jason is the managing partner of Divorce Capital Planning , co-founder of Divorce Mortgage Advisors , and founder of Survive Divorce. A leading authority in divorce finance, Jason has been featured in the Wall Street Journal, Forbes, and other media outlets. He is a Chartered Financial Analyst, Certified Financial Planner practitioner, and Certified Divorce Financial Analyst. You can email him at [email protected] .

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How to Split Stocks in a Divorce: A Denver Expert’s Guide

Laura E. Shapiro - October 6, 2023

Divorce proceedings can be intricate, and the process becomes even more complex when it comes to understanding how to split stocks in a divorce.

The additional complexity of dividing stocks makes it vital that you surround yourself with experts who understand the process, can clearly explain it to you, and can help ensure you get an equitable division.

The Role of a Forensic Accountant in Splitting Stocks

In some cases, your attorney may recommend using the expertise of a forensic accountant. This professional ensures that all assets, especially those in your spouse’s name, are transparently accounted for, and tax consequences are taken into account. 

These experts specialize in valuing stocks and stock options and can explain your best options to get the fair division you deserve.

Options for Equitable Distribution of Stocks in Divorce  

Here are several options that allow you and your spouse to split the stocks or stock options you own together or the shares that one of you owns but are joint marital property:

Selling the Stocks

While selling and splitting the stock proceeds might seem the most straightforward route, many Denver residents prefer to retain their investments to avoid tax consequences. However, the “tax basis” must be taken into account.

You will likely have to pay capital gains taxes if you sell stock for a profit. If you held the stock for less than a year, the gains would be taxed the same as your income bracket.

However, depending on your taxable income and filing status, you may be taxed at 0%, 15%, or 20% for stock owned for longer than a year. Long-term capital gains tax rates are usually lower than short-term capital gains.

It is important to note that the profit amount is taxed, not the total sale price.

Dividing the Investments

You can split your stock holdings as necessary to achieve a fair division. One person can take all the stock in one company while another takes ownership of another company’s stock. Or you can split the number of shares equitably.

For Example

If you have 200 shares, there is no reason why each of you can’t take 100 shares or divide them in another way that ensures you get your fair share according to Colorado’s equitable distribution laws . The division must include consideration of any tax consequences. 

Other Methods of Division

In cases where stock is held only in one party’s name, often received as a work benefit, the stock will be at least partially marital property ; property acquired before the marriage is not marital, but the increase in value is marital. If the party acquires the stock during the marriage, it is considered marital property.

If the holder does not want to sell the stock, they can offer cash or another asset to the other party to ensure a fair division.

Employee Stock Options Add to the Complexities of Splitting Assets

Splitting stocks you already own can be complicated enough, but valuing and dividing stock options during a divorce adds another level of complexity. Stock options, at their most basic, consist of an option to buy the stock at a specific price at a later date. Also, while the owner has the right to buy at a set price, the holder may not be obligated to buy.

These stock options may not have a cash value today, but depending on the company’s success, the options could provide a nice nest egg down the road. This uncertainty makes it hard to put a value on them. 

Sometimes options are non-transferable, so simply dividing them may not work either. 

If either party has stock options, you will want a forensic accountant and an attorney familiar with this topic’s expansive Colorado case law. Colorado does allow parties to take a “wait and see” approach, putting off the division of those assets until the owner purchases the stock. 

Shapiro Family Law: Denver’s Go-To for Dividing Stocks in Divorce 

Shapiro Family Law excels in high-asset and complex divorces in Denver. We’re adept at identifying, valuing, and guiding you on how to split stocks in a divorce. Our collaboration with forensic accountants ensures a meticulous process, from discovery to valuation, providing a strategic plan for asset division.

If you want guidance on splitting stocks in your divorce or another property division matter, call us at 303-695-0200 .  

Connect with a Renowned Denver Divorce Attorney  

With over four decades of expertise in Denver’s intricate divorce landscape, attorney Laura E. Shapiro offers personalized attention, empathetic guidance, and robust representation. Our team is committed to ensuring a fair division of assets during your divorce.

Contact us today to discuss your unique situation with our dedicated team.

Additional Reading

• Protecting Your Fair Share of Investment Accounts
• Protecting Your Retirement Assets in a Divorce
• What Does Equitable Distribution Mean?

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Valuing & dividing stock options in divorce.

By Alynne Zielinski , MBA, CFP, CDFA, Marcum Wealth

Valuing and dividing deferred compensation, specifically stock options, is complicated. Multiple factors determine stock option value. Grant date, grant price, vesting, expiration, and volatility all factor into the value of an option. Other features, including the reward intent (past performance vs future performance), forfeiture, and taxes impact the division of the options in a divorce settlement.

As tough as it is to value and divide stock options, often times it is even more difficult to discover them. Stock options are not listed on tax returns, W2s or other statements unless an exercise occurred. Spouses are inclined to forget they own stock options and will omit the information on the financial affidavit. To understand the full scope of compensation for the employee spouse, either subpoena the company or have the employee spouse provide plan documents with a summary plan description. This should include award letters and information on the grants including: grant dates, number of shares, grant/exercise price, expiration, and vesting schedule.

Two common types of employee stock incentives are non-qualified stock options (NQSOs) and restricted stock.

• NQSOs are a form of equity compensation with vesting schedules of 1-5 years.
• NQSOs provide the employee the opportunity to purchase company stock for a set period of time (usually 10 years) at a specified Grant (exercise) Price ($GP) usually at a favorable rate to the employee.

After non-qualified shares vest, the employee can exercise the vested shares at the current market price ($MP). The exercise results in taxable ordinary income in the amount of ($MP – $GP) x number of shares.

• Restricted stock awards typically depend on the employee spouse meeting a benchmark.
• Restricted stock awards are subject to forfeiture upon termination of employment and typically have vesting schedules of 1-5 years.

After shares vest, the entire amount of the restricted stock award is included as ordinary income and taxed at the employee spouse’s tax rate.

It is important to reiterate that both stock incentives are taxed at the employee spouse’s tax rate . Therefore, these cannot be taken at face value in calculating division, distribution, child support and maintenance.

Four ways to value stock incentives are:

While the intrinsic valuation method is the simplest and the binomial calculation factors in early exercise, the Black-Scholes method is the most widely used valuation method. Many web based calculators are available to assist in calculation, though consulting with a financial professional may also be prudent.

Most states deem options granted and vested during marriage as marital property. Unvested options and options granted before marriage are divided by a time rule known as the coverture fraction. In its basic form, the denominator of the coverture fraction is the total earning period and the numerator is the married years while earning the options.

Table 2 provides a coverture calculation example for an employee spouse with the following assumptions:

• July 1, 2001 – Married
• July 1, 2002 – Hired
• July 1, 2011 – 15,000 options granted for past performance and future incentive with 5 year vesting period
• July 1, 2013 – first batch of 3,000 options vests (a.k.a. 3,000 options “in flight”)
• January 1, 2014 – separated and filed for divorce
• Option grant primarily for future service

Table 2: Coverture calculation for options granted primarily for future service

When stock options are granted primarily for future service , the coverture formula divides the length of time the employee spouse was simultaneously married while contributing to earning the stock options by the length of time between grant and vest. In this example, the grant date for each flight is the same so the coverture numerator is constant at 30. A coverture result of 1.00 indicates all shares vest before the date of separation and may be considered marital property. A coverture result less than 1.00 indicates some shares are not vested before the date of separation and only a portion of the shares in flight may be allocated as marital property. The longer the time between grant and vest, the smaller the portion allocated as marital property.

In this example 10,125 (68%) of the options are marital property. The other 32% may be considered separate property and depending on the laws in your state both vested and unvested stock options could be subject to distribution.

Table 3 below uses the same assumptions as Table 2 but assumes the options are granted mostly for past service . When stock options are granted primarily for past service, the coverture formula divides the length of time the employee spouse was simultaneously married while contributing to earning the stock options by the total length of employment until the options vest.

Table 3: Coverture calculation for options granted primarily for past service

Stock options are non-transferrable unless the plan allows it. Since allowance is rare the employee spouse either has to exercise the options on behalf of the non-employee spouse (in-kind division) or buy out the non-employee spouse. To divide NQSOs in kind, the unvested NQSOs remain in the employee spouse’s account until vested. Once vested, the NQSOs are split and the non-employee spouse receives their allotted shares. This will be taxable to the employee spouse. In a buyout of NQSOs, the employee spouse keeps all of the vested and unvested options. The options are valued based on an agreed upon date and the employee spouse buys out the non-employee spouse based on the current value with tax considerations.

Restricted stock is divided similarly. An in-kind division requires the employee spouse to hold the unvested stock until it is released. Once released, the stock will be split between the spouses and tax will be paid by either the employee or the employee spouse. The buyout strategy is the same as above except restricted stock is subject to forfeiture so that must be factored in.

The transaction needs to be specifically detailed in the divorce agreement or the court order. Most commonly, options are divided using coverture and valued using Black-Scholes. Each case is different, the calculations are complex and care must be taken when considering any model or formula to divide assets. This piece aims to provide insight into the difficulties discovering stock options and the ways to value and divide them if discovered. It may not be appropriate for all situations.

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Tax-Free Transfers Incident to a Divorce: What Qualifies?

By: Kirstine Fors

Dividing assets in a divorce is rarely a simple matter. It gets even more complicated when there is a transfer of property between spouses after a divorce.

When transferring assets as part of a negotiated settlement or divorce proceeding, it might not be possible to complete the transfer immediately due to financial or logistical reasons.

Timing is everything , as the saying goes.

It’s important to understand the rules regarding the transfer of property between spouses after a divorce, and how the timing impacts how — and whether — transactions are taxed.

Does the Transaction Qualify As a Section 1041 Transfer?

A good starting point is to determine whether the transaction qualifies as an IRC Section 1041 transfer.

Internal Revenue Code Section 1041 lays out the rules for property that is transferred between spouses who are divorcing or are divorced. It provides that a property transfer is incident to the divorce if it occurs within one year of the divorce, or if it is related to the cessation of the marriage.

If the transaction qualifies as a Section 1041 transfer, it is not subject to taxation and the basis of the asset carries over to the receiving spouse.

Special Rules Relating to Timing of Transfer

There are special rules relating to the timing of the transfer. To achieve the most advantageous financial outcome for a divorcing client, family law attorneys should consider how these special rules apply to their clients.

The One-Year and Six-Year Tests

Let’s look at some key property transfer benchmarks on the divorce timeline:

Source: Thomson Reuters Checkpoint, 601 Applicability of IRC Sec. 1041

Transfers Taking Place Within One Year of the Divorce

No support or evidence is required when a transaction takes place within one year of the divorce. The presumption is that property transferred between former spouses is merely a shifting around of jointly owned assets and therefore, is not subject to taxation. This rule applies even if the transferred property was acquired after the divorce was final.

Consider this example:

John and Beth were divorced in July 2017. In January 2018, John purchased stock for $50,000. John then transferred the stock to Beth in June 2018, which increased in value to $60,000, to satisfy an obligation to her as part of the divorce settlement. No gain or loss would be recognized by John or Beth for this transaction.

Transfers Taking Place Between the One-Year and Six-Year Anniversary of the Divorce

A transfer of property that occurs between the one-year and six-year anniversary must be made pursuant to a divorce or separation instrument to be presumed related to the cessation of the marriage and qualify for Section 1041 treatment. A divorce or separation instrument includes a decree of divorce or separate maintenance, a written separation agreement, or other court decree.

It is also worth noting that a divorce instrument includes amendments or modifications to the instrument. A divorce instrument that does not provide for a transfer of property can be later modified to include one and will therefore ensure that no gain or loss will be recognized.

Private Letter Ruling 9306015 provides an example of a transfer of property found to be related to the cessation of the marriage:

Mr. and Ms. Young divorced in 1988. In 1989, they entered into a settlement agreement, which provided that Mr. Young deliver to Ms. Young a promissory note for $1.5 million, which was secured by 71 acres of land. In 1990, Mr. Young defaulted on this obligation and entered into a later settlement agreement to transfer 59 acres of land (42.3 acres of the original 71 acres and 16.7 acres of land adjoining that tract). In accordance with the later settlement agreement, Mr. Young retained an option to repurchase the land for $2.2 million on or before December 1992. Mr. Young assigned the option to a third party, who exercised the option and bought the land from Ms. Young for $2.2 million. No gain or loss was recognized on the transfer of the property from Mr. Young to his former spouse. Ms. Young took the marital basis of the land and recognized a gain on the subsequent sale to a third party.

Transfers Taking Place After the Six-Year Anniversary of the Divorce

In general, property transferred more than six years after the divorce is final does not qualify for Section 1041 treatment.

Any transfer that is not pursuant to a divorce or separation instrument and occurs more than six years after the divorce becomes final is presumed to be unrelated to the cessation of the marriage. While the IRS guidance is unclear, there are special circumstances in which property transfers after the six-year mark would qualify as a tax-free transfer.

The presumption that a transfer was not related to the cessation of the marriage “may be rebutted only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage. For example, the presumption may be rebutted by showing that (a) the transfer was not made within the one- and six-year periods described above because of factors which hampered an earlier transfer of the property, such as legal or business impediments to transfer or disputes concerning the value of the property owned at the time of the cessation of the marriage, and (b) the transfer is effected promptly after the impediment to transfer is removed.” (Source: Section 1.1041-1T(b), Q&A-7 of the Temporary Income Tax Regulations)

There is a documented case where the presumption that the transfer was not related to the cessation of the marriage was clearly rebutted.

In Private Letter Ruling 9235026 (May 29, 1992), the IRS ruled that the transfer of the wife’s interest in business property to her ex-husband was incident to the divorce even though the transfer occurred more than six years after the divorce. It was determined that the transfer was delayed because of a dispute over the purchase price and payments terms. After the disputed factors were resolved, the transfer was promptly completed. Temp. Treas. Reg. §1.1041-1T, A-7 specifically provides that the presumption may be rebutted only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage, and there were factors that hampered an earlier transfer of property. 

To qualify for Section 1041 treatment, a transfer of property should take place before the six-year anniversary of a divorce and be supported by a divorce or separation agreement after the one-year anniversary of the divorce. In circumstances where the property transfer cannot be completed within a six-year time frame, the best support is a written divorce or separation agreement documenting the contemplated transfer, and support for why the transfer could not be completed during the six-year time frame. There are documented exceptions to the six-year rule, but the guidance is not clear and would surely be evaluated by the IRS based on the specific facts and circumstances surrounding the property transfer.

Our litigation support professionals help family law attorneys form solid financial strategies for their divorcing clients. Contact us   online or call 800.899.4623 for help.

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Employers Face Complications if Stock Options are Transferred in a Divorce

Employers may get dragged into an employee’s divorce when stock options are involved. Determining whether stock options may be transferred to a nonemployee spouse and, if so, how to divide them differs in each case. There are important tax ramifications for transferring these benefits that affect how an employer must withhold and report taxes. This article briefly addresses some issues that an employer in this situation should discuss with the divorcing employee and a tax professional.

What are Stock Options?

An employee stock option is a benefit given by an employer that allows the employee to purchase shares of the employer’s stock at a specified price for a specified period of time. The employee is not obligated to pay for the stock until he elects to exercise his option to purchase. The earliest date the employee is eligible to purchase the stock is known as the exercise date or vesting date. It’s common to offer employees a vesting schedule, which details the percentage or number of shares of stock that become vested as of each vesting date and if, or when, the stock option expires.

There are two types of employee stock options—nonqualified stock options (NQSOs) and incentive stock options (ISOs). The employer determines which type of stock option to offer when making the option grant. The difference lies in the income tax treatment when the employee exercises the option.

When an employee exercises an option to purchase an NQSO, he must report the gain as ordinary income. The gain is the difference between the employee’s exercise price and the fair market value of the stock. Ordinary income is subject to income and employment taxes, including Social Security, or FICA, taxes and Medicare taxes. Any subsequent gain or loss on the shares when the employee ultimately sells the stock is taxed as a capital gain or loss.

ISOs are given preferential tax treatment. The employee can select to defer taxation until the date he sells the stock. At that point, the employee is taxed at capital gains tax rates, rather than ordinary income tax rates, on the difference between the stock price when the employer granted the option and the stock price when the employee sold the stock. Certain conditions must be met to qualify for ISO treatment. For example, the employee must hold the stock for at least one year after the exercise date and for two years after the employer granted the option.

Why offer stock options? They can incentivize employees to remain with the company and to improve their performance. Moreover, they may enable smaller companies and companies without substantial cash resources to attract key employees at more modest compensation structures in return for substantial future rewards. Stock options may also be used as a bonus to reward employees for past services.

Divisibility of Stock Options in a Divorce

Stock options, both vested and unvested, are considered assets in a divorce that can be divided between the spouses. The most common way to divide stock options is for the divorcing employee to retain the stock options and award the nonemployee spouse other marital assets of equivalent value as an offset. To do that, the employee and his spouse must agree on the current value of the stock options. Valuing stock options is complex and requires some assumptions about the level of risk and future tax consequences.

Another way to divide stock options in a divorce is to defer distribution in light of the possibility that the stock option may never be exercised. Under this option, the employee may be required to make a one-time cash payment to his former spouse if he ever exercises his stock options in the future. This option prevents the need to calculate the current value of the stock options.

Transferring Stock Options to Nonemployee Spouse

A third, and less common, method of dividing stock options in a divorce is to transfer them directly to the nonemployee spouse. This option is only available for NQSOs; ISOs are not eligible for transfer in a divorce.

The IRS has determined that when stock options are transferred in a divorce, the nonemployee spouse should report the income resulting from the exercise of the stock options and get the credit for the income tax withheld by the employer. As a result, an employer may need to issue a 1099-MISC to a nonemployee spouse and exclude that amount from the employee’s W-2 so the income isn’t taxed twice.

Furthermore, because the amounts received by the nonemployee spouse relate to the employee’s service and remuneration, the unemployment, or FUTA, tax and FICA withholdings would be calculated by reference to the employee’s income. You should consult with a tax professional for specific instructions on how to do that.

Most stock option plans do not permit options to be transferred to a nonemployee under any circumstances. In that case, the divorce decree may indicate that the stock options will remain in the employee’s name but are subject to written exercise instructions given by the nonemployee spouse. In essence, the nonemployee spouse is given a beneficial interest over the stock options and has a power of attorney over the account. The IRS has determined that under this scenario, the nonemployee spouse should bear the income tax consequences, while the employee should receive credit for the taxes withheld by the employer under his name. Again, you should consult with a tax professional for specific instructions.

Bottom Line

Pay close attention to an employee’s divorce when stock options are involved. Inform the employee of any transfer restrictions early in the divorce process. Ask to review the language in the divorce settlement agreement before the employee finalizes his divorce to ensure that his actions are consistent with the stock option plan.

You may need to adjust the tax withholdings and reporting, and cooperate in other respects if stock options are to be transferred to a nonemployee spouse. It would be wise to contact a tax professional for assistance.

This article, slightly modified to note recent updates, was featured in the September 2015 issue of the  Wisconsin Employment Law Letter , which is edited by Axley Brynelson Attorney Saul Glazer and published by BLR®—Business & Legal Resources. Reproduced here with the permission of BLR®—Business & Legal Resources.

Home › Insights › Articles › Post Divorce: What are the Taxation Non-qualified Stock Options?

Post Divorce: What are the Taxation Non-qualified Stock Options?

In many industries non-qualified stock options have been issued to key employees. If these options have been earned by a spouse during the period of marriage they are considered marital property for divorce purposes. If according to the divorce decree the non-qualified stock options are divided between the spouses there are tax ramifications to both spouses when the options are exercised.

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Take for example the situation in which the ex-wife works for a technology company and during the marriage was awarded non-qualified stock options with an exercise price of $100,000. The divorce has been finalized and as a part of the property settlement, in 2012 the husband (non-employee spouse) received a right to 50% of the stock options.

The IRS has ruled that when a taxpayer transfers non-qualified stock options incident to a divorce there is no taxable income upon the transfer to the former spouse. The ruling also states that the former spouse upon exercise of the options has to report in gross income the difference between the exercise price and the fair market value of the stock. The question now is how the exercise of the options should be reported by the non-employee spouse.

If in 2016 the non-employee spouse exercises his 50% of the options with an exercise price of $50,000 and a fair market of $1,250,000.

Revenue Ruling 2002-22 holds that the property transferred to the non-employee spouse has the same character and is includible in the income of the non-employee spouse under section 83(a) to the same extent as the property would have been includible in the income of the employee spouse. For FICA tax purposes the income is reportable by the employee spouse as FICA and Medicare wages on Form W-2 and requires the employer to withhold and remit the FICA and Medicare taxes due.

The income recognized by the non-employee spouse upon exercise is subject to withholding taxes even though the non-employee spouse is not considered an employee. The employer is required to withhold income tax at a rate of 25% on the first million dollars of income and anything over one million dollars of income at the federal highest income tax rate. In this example the withholding would be $250,000 on the first million of income and $79,200 on the remaining income of $200,000. The withholding taxes are withheld from the non-employee spouse’s income at the time of the exercise of the stock options.

The employer of the ex-wife is required to report the income of $1,200,000 of the non-employee spouse on Form 1099-MISC in box 3 and the income tax withheld of $329,200 in box 4 and issue the Form 1099 at year end. The employer is also required to make timely deposits of the withheld taxes. Penalties could be substantial if not timely.

Tax guidance in this area is available from Withum. There are too many pitfalls for all parties involved not to have proper advice.

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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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Tax aspects of dividing stock options in divorce.

Mr. Kochansky Meets Revenue Ruling 2002-22

Richard W. Kochansky was a medical malpractice attorney who divorced his wife, Carol, in 1985. As part of their property settlement Richard agreed that he would share the contingent fee in a medical malpractice suit he was pursuing.

Little did he know that his agreement to share his prospective earnings with his soon to be former spouse would, more than a decade later, become part of a landmark revenue ruling that would determine how Silicon Valley royalty would be taxed on millions (perhaps billions) of dollars in stock options.

The general rule of dividing property between spouses in a divorce is governed by IRC Section 1041, which states that such transfers are as tax free gifts between the spouses with mandatory non-recognition of gain or loss. There is a carryover of basis and holding period to the transferee spouse. If and when the transferee spouse disposes of the property, he or she will recognize gain or loss as if he or she had owned the property from inception, and there is no tax effect on the transferor spouse.

However, these matters are not always so easy to determine, particularly at the intersection for tax purposes of income and property, especially in light of the fact that the term “property” is not defined in Section 1041.

The enactment of Section 1041 provided legislative relief from the effect of the Supreme Court’s decision in United States v. Davis, 370 U.S. 65 (1962), which held that the transfer of appreciated property to a spouse or former spouse in return for a release of marital claims, (for example Alimony), was a taxable event resulting in the recognition of gain or loss to the transferor. It was also the intent of Congress that Section 1041 would equalize the federal tax treatment of property transfers between divorcing taxpayers who reside in Community Property states, and those who reside in Common Law states.

It happened that Richard and Carol Kochansky lived in the Community Property state of Idaho at the time of their divorce. The fact that the forthcoming tax drama took place in a Community Property state turned out to be much less significant than one might suppose, but this is largely due to a technical oversight in Tax Court made by Mr. Kochansky acting as his own attorney. Evidently, he was a much better personal injury attorney than tax attorney.

While Richard and Carol were still married, Richard entered into an agreement with Mr. & Mrs. McNary which provided that Richard would represent them in a medical malpractice suit on a contingent fee basis.

After the suit commenced, but prior to its settlement, Richard and Carol divorced. As part of there divorce agreement, it was decided that if and when the contingent fee from the McNary’s lawsuit was paid, it would be split evenly between them.

The lawsuit settled, and the success fee was split as agreed. Richard paid the tax on his portion, and Carol paid the tax on hers.

Upon audit the IRS determined that Richard was responsible for all of the tax on all of the contingent fee. The IRS took the position that the portion of the fee that was allocated to Carol constituted an anticipatory assignment of income that should be included in Richard’s gross income from his law practice in the year received. Furthermore, IRS determined that Richard was liable for a negligence penalty. The case went to Tax Court (Kochansky v. Commissioner, 92F.3d 957(1996)) where the IRS prevailed on both the tax assessment to Richard (who represented himself) as well as the negligence penalty.

As would any self-respecting attorney he filed an appeal.

The Appeals Court (Ninth Circuit) ruled that the Tax Court did not error in holding that the entire contingent fee resulting from the malpractice suit was taxable to Richard Kochansky, despite the fact that half of it was paid to his former spouse.

The Court opined that Kochansky’s case was controlled by the definitive Supreme Court decision of Lucas v. Earl 1930, in which it was held that income is taxable to the person who earns it. Thus, laying the cornerstone for the Assignment of Income Doctrine. This ancient case is eerily similar to Kochansky, in that Earl was an attorney who had executed a contract whereby half of the salary and attorney’s fees earned by him were to become the property of his wife. The Court came down solidly on the side of the Government.

The essence of the Court’s reasoning boils down to one often quoted sentence from the decision: “The fruits of a person’s labor cannot be attributed to a different tree from that on which they grew”. In a gallant but futile attempt to differentiate his case from Lucas v. Earl, Kochansky argued that because his prospective fee in the malpractice case was “uncertain, doubtful, and contingent”, it was not subject to the Assignment of Income Doctrine. To put it another way, he could not assign income that he had not yet earned. He also cited two cases which appeared to support his argument (Jones v. C.I.R. 306 F.2nd 1962; and Cold Metal Process Co. v. C.I.R. 247 F.2nd 1957). However, the Court pointed out that both these cases were distinguishable from Lucas v. Earl, as well as Kochansky’s case, because they involved the transfer of underlying income producing assets, as opposed to merely a contractual right to receive future earned income. Jones was a case of a construction contractor who had earlier transferred all of his assets to a successor corporation, and then assigned it a disputed claim for past overages on a government contract.

The Circuit Court held that the claims award, when paid, was taxable not to Jones, but rather the transferee. One reason offered by the Court in Jones, was the “uncertain, doubtful, and contingent” nature of the assigned claim. However, the Court also pointed out that the assignment contract was conducted at arm’s length for a business purpose. This is a key distinction. Mr. Jones transferred his entire business to a corporation which then undertook to maintain and finance the litigation of a claim for past construction services disputed by a customer. Kochansky is distinct, because he transferred only his right to the income, which was by no means disputed.

The Appeals Court further opined that the Cold Metal case is even more easily distinguished from Kochansky. Here the Sixth Circuit held that Cold Metal did not have to pay tax on royalties from patents it had assigned, in part because the collection of the royalties was contingent on the outcome of a lawsuit. As in the Jones case, Cold Metal involved a transfer of income producing property where the donor relinquished to the recipient not merely the future income, but also complete ownership and control of the income producing property.

Kochansky did not own, and therefore could not transfer, his client’s malpractice claim that produced the contingent income which he assigned to his former spouse. He only transferred to Carol the right to receive future income that might never have materialized. This is not the same thing as a transfer of property. Further, the Court noted even though the fee was contingent upon the successful outcome of the malpractice litigation, this did not change the fact that when it was paid, it was without question compensation for Kochansky’s personal legal services. In short, the Kochansky case fell well within the parameters of Lucas v. Earl, and the contingent legal fee was 100 percent taxable to Richard Kochansky.

Richard and Carol Kochansky resided in the Community Property state of Idaho at the time Richard filed the medical malpractice claim on behalf of his clients. One might ask why Richard simply did not argue that under Community Property law, Carol had a 50% Community Property interest in the contingent fee at the time of the divorce, and that upon divorce, that interest became her sole and separate property, and she therefore was solely responsible for the tax on her portion of it.

In the author’s opinion, Mr. Kochansky’s argument that Community Property rules trumped Lucas v. Earl was not bad. However, the Appeals Court dismissed it out of hand because he did not raise it in Tax Court, and because the necessary facts to support the existence of a Community Property interest had not been developed. Thus, Mr. Kochansky learned the hard way that putting forth arguments in tax cases, like voting in Chicago, should be done “early and often”.

Time marched on for Richard Kochansky. From what can be gleaned from the record, he had identical Assignment of Income issues during subsequent years with the outcomes similar to his original case. After his divorce he remarried, and for at least one year his new spouse was granted Innocent Spouse Relief. One presumes that by the time that happened, the new spouse had become former spouse number two, or greater.

While Kochansky was doing battle with his former spouses and IRS, the granting of stock options and other forms of deferred compensation was becoming increasingly popular in large part due to the proliferation of start up companies that were the fruit of the dot.com and technology boom.

Broadly speaking stock options come in two varieties, Incentive Stock Options (ISOs) and Non-Statutory Stock Options.

If a Non-Statutory Stock Option has a readily ascertainable Fair Market Value (FMV) at the time it is granted, the taxpayer will recognize ordinary income equal to the stock’s FMV at the grant date, minus any amount paid for the option (IRC Section 83 Et al.). If a non-statutory stock option does not have a readily ascertainable FMV at the grant date, the taxpayer will recognize ordinary income at the time the option is exercised. The ordinary income recognized will be equal to the stocks FMV at the date the option is exercised, minus any amount the taxpayer pays for the option.

Example: Buffy works for a privately held start up tech company called WESEEU. On July 1, 2019 she is granted options to purchase 1,000 shares of WESEEU at $2 per share anytime prior to December 31, 2020. The options have no readily ascertainable FMV. On September 30, 2020 when the stock has an FMV of $12 per share, Buffy exercises her options and purchases 1,000 shares of WESEEU stock. Buffy will recognize $10,000 of ordinary income (1000 shares x the $10 spread per share).

In the case of an Incentive Stock Option, the taxpayer does not recognize income upon the granting or exercise of the option. Instead, gain or loss is recognized at the time of the sale of the underlying stock (IRC Section 421(a)). Gain or loss from the sale of stock resulting from an Incentive Stock Option is capital gain or loss assuming a certain holding period and other requirements are met. Obviously, most taxpayers will find Incentive Stock Options preferable over Non-Statutory Stock Options due to the probable delay in recognition of income, and favorable capital gain tax rates if and when the stock is sold at a gain.

As Mr. Kochansky discovered, love that is found can also be lost, and when such lost love involves marriage, there are often complex tax issues to resolve. In order to provide some measure of relief to divorcing taxpayers, Congress enacted Section 1041 so as to “make the tax laws as unintrusive as possible with regard to relations between spouses” (H.R. Ref No. 432, 98th Cong. 2nd Session. 1491 1984). Section 1041 was also intended to make the tax consequences of property transfers between divorcing taxpayers as uniform as possible, “notwithstanding that property may be subject to differing state property laws” (Id. At 1492).

It was in this spirit that IRS issued Revenue Ruling 2002-22. Like the Kochansky case, Revenue Ruling 2002-22 faces down the issue of when does income become property, and when does property become income. For purposes of the Assignment of Income Doctrine the ruling begins by acknowledging that the doctrine does not apply to every transfer of future income rights. In particular, it cites Hempt Bros., Inc. v. United States, in which the Court concluded that the doctrine should not apply to the transfer of accounts receivable by a cash basis partnership to a controlled corporation where there was a valid business purpose for the transfer of the accounts receivable, together with the other assets and liabilities of the partnership to effect a Section 351(a) incorporation of an ongoing business. It should be noted that here we have a case of codified legislation colliding with the Assignment of Income Doctrine, and the legislation came out the winner.

As with Kochansky, there have and will continue to be similar clashes between the Assignment of Income Doctrine and Section 1041 relating to property settlements in divorce. Even so, IRS acknowledges in Revenue Ruling 2002-22 that simply applying the Assignment of Income Doctrine to divorce cases to tax the transferor spouse when the transferee spouse ultimately receives income from the property that has been transferred would frustrate the purpose of Section 1041. The ruling unambiguously states, “… the transfer of Non-Statutory Stock Options between divorcing spouses is entitled to non-recognition treatment under [Section] 1041”.

However, the ghost of Kochansky will shortly arise to prove that the above is not always true, but in general, when a transferee exercises stock options, it is the transferee who must recognize gross income to the extent required by IRC Section 83(a). Revenue Ruling 2002-22 states that this applies in both community and non-community property states. The ruling further states that the same would hold true when an employee transfers a Statutory Stock Option (Incentive Stock Option) to a spouse or former spouse in connection with a divorce. This is because under Section 422(b)(5) and 423(b)(9), the transfer of the Incentive Stock Option would cause the option to be “disqualified”. Thereby transmogrifying it into a garden variety Non-Qualifying Stock Option. Hence, Revenue Ruling 2002-22 clearly leads one to believe that the treatment of all varieties of stock options transferred in divorce is identical.

This would seem simple enough, except for the fact that in 2007 the IRS issued (private) Letter Ruling 200737009. In this instance, the IRS ruled that the transfer of an Incentive Stock Option in a divorce will not disqualify the Incentive Stock Option (thereby automatically triggering Non-qualified Stock Option treatment) in instances when the Incentive Stock Option is community property. This ruling may put the tax practitioner in a bit of a quandary, as Private Letter Rulings (PLRs) only apply to the parties to whom they are addressed and not the public at large. However, PLRs do give us some insight as to how the IRS views a matter. Further, this position makes considerable sense, because if Incentive Stock Options were earned during the marriage, as community property, one-half of them are the property of the non-earning spouse by operation of state law. Why then should they violate the lifetime exercise requirement of IRC Section 422(b)5 automatically triggering non-qualified treatment with it’s associated harsh tax consequences? Section 422(b)5 provides that ISOs cannot be transferred by the person who was granted the option other than at death.

The position taken by the IRS in Letter Ruling 200737009 begs the question, would the outcome have been different for Mr. Kochansky had he argued early on that his wife’s share of the medical malpractice settlement represented her community property interest in joint income that was earned during the marriage, or at least her due portion of a community asset (the fee agreement)? Perhaps so, but likely not, for near the end of the Ruling we are given two exceptions. One is when Non-Qualified Stock Options that are unvested or subject to substantial contingencies are transferred between spouses in connection with divorce. In this case it is the position of the IRS that when the non-employee spouse exercises the options, it is the employee spouse who will be responsible for the tax burden. The other exception pertains to certain divorce agreements entered into prior to November 9, 2002, although in general Revenue Ruling 2002-22 is meant to be retroactive.

To provide some legal brace work for its stance, the IRS references (you guessed it) Kochansky v. Commissioner. The reader may note the irony here that the very arguments that Mr. Kochansky put forth in 1996 (substantial doubt, contingencies, etc.) are the same ones used by the IRS to turn the tax liability back on the spouse who “earned” the options in the first place.

Thus, like the hapless Mr. Kochansky, the transferor of unvested Non-Qualified Stock Options, will be stuck with the worst of both worlds – the payment of tax on money that went to somebody else. Practitioners should take careful note of this, as to do otherwise is a malpractice suit waiting to happen. Imagine a client’s reaction upon finding that he or she is responsible for the tax on a huge gain realized on stock options that were exercised by a former spouse, who in turn will be keeping all the cash. Such a situation would make the tax plight of poor Mr. Kochansky appear paltry, as at least he only had to deal with the Assignment of Income issue on the original earned income, and not millions of dollars (or more) in appreciation on some technology stock offering.

And so it appears that the ghost of the Kochansky case, not to mention Lucas v. Earl will be with us for sometime to come, forever reminding taxpayers that the line between income and property is not always well defined, particularly when it comes to dividing up the wreckage of love that was once found, but has since been lost, or in other words – divorce.

Have a question? Contact David Ellis , Ellis & Ellis CPAs, California.

“This article is  for  informational purposes  only  and  does not  constitute tax advice. No  advisor/client  relationship is  created  between  the  author  and  the reader  in the context  of  the viewing  this material.”

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David Ellis is the managing partner of Ellis & Ellis, CPAs, Inc. located in Pasadena, California. He has over 25 years of experience in the practice of Divorce, Trust/Estate, and other family tax matters. He is an advisor in matters pertaining to Trust, Estate, and Corporate Taxation to the Los Angeles County Office of the Public Guardian. The firm also provides other general tax services and IRS representation. He earned his Bachelor’s Degree from the University of Southern California in Communication Arts and Sciences. He is a frequent writer and speaker on various tax subjects, and has provided continuing education services to other CPAs and tax professional in the area of Divorce, Trust, and Estate Taxation. An article that he recently co-authored entitled The Tax Consequences of Dividing Marital Property can be found in the December 2014 issue of Practical Tax Strategies, a national professional tax publication.

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1 comment on “Tax Aspects Of Dividing Stock Options In Divorce”

When he sold his stock options, and if he had reported all of this gains/losses at that time, then if he would have written a check to his ex-wife, he could have 1099’d her as a nominee, and he would have only paid tax on his gains.

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How Are Stocks Divided Upon Divorce?

When you decide to get a divorce in California, you will need to divide your assets equally with your spouse. Some of these assets can be easy to designate, such as pieces of property and cash. However, one of the more difficult items to divide is your stock options. You often receive these stock options from your employer, but if you acquired them during the marriage, you have to consider how to divide them.

What Are Stock Options?

You and/or your spouse may each receive stock options from your employers. Stock options give an employee the right to purchase stock at a later time and for the price specified in the option. While these options provide you and your former spouse a great way to collect funds in the future, stocks may present a challenge during divorce proceedings.

One of the most important considerations that you make when determining how to divide a stock option is if the stock is vested or unvested. Vesting refers to the transfer of full ownership of a stock – for example, your company gives you full control of the stock with no stipulations. If the stock is unvested, your company sets aside a certain amount of stock for your use, but you have to meet certain conditions before you can receive full ownership of the stock.

Marital Versus Separate Stock Options in California

Under California law, the state considers all property that you acquire over the course of your marriage to be community property and therefore subject to division during negotiations. If you receive stock from your employer and that stock vests while you are married, it is community property. You and your spouse are each entitled to a one-half distribution of this stock option in negotiations.

Challenges arise if you receive the stock while you are married, but your employer does not vest the stock to you until after your date of separation from your spouse. Since you did acquire the stock option during the marriage, it is still community property and you may still have to award a portion to your spouse. This process can involve two calculations, either the Marriage of Hug formula or the Marriage of Nelson formula.

The Marriage of Hug Formula and Stock Options

First, the court will determine what your employer’s primary intent was in awarding you the stock options. The court may determine that the stock option rewarded you for past services. In this case the court will use the Marriage of Hug formula to determine the portion you may have to give to your spouse. Your stock options will be considered deferred compensation – and therefore community property earnings.

To determine the community portion of your stock, the court will multiply the value of your stock by a fraction. This fraction will be the total number of years you worked at the company until you received the stock option compared to the total number of years you were married. The community portion will be evenly divided between you and your spouse.

The Marriage of Nelson Formula and Stock Options

If the court determines the stock option was intended as an incentive for you to work or to continue working for the company, the court will calculate the community portion using the Marriage of Nelson formula by determining the community portion by a different fraction.

This fraction is the number of years between receiving the award and the date when you exercised the stock option, and the number of years you were married. You and your spouse will each receive one-half of the community portion.

To protect your interests and stock options during your divorce, hire a San Diego divorce attorney to assist you with these negotiations.

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• PERSONAL FINANCIAL PLANNING

Tax planning issues to consider when assisting clients in a divorce

• Personal Financial Planning
• Tax Planning
• Individual Income Taxation
• Tax Planning; Tax Minimization

Editor: Carolyn Quill, CPA, J.D., LL.M.

Co-editors: Richard Mather, E.A., MSA, CAA; Jonathan McGuire, CPA; and Kathleen Moran, CPA, MBA, MT

Navigating a divorce can be an emotional experience for clients, and assisting them can likewise be poignant for their tax advisers, particularly when the adviser has a long-established relationship with both spouses. Once a client notifies you they are contemplating a divorce and any potential conflict-of-interest matters are resolved, it is important to swiftly meet and address tax planning issues. It is imperative to collaborate with the divorce attorneys and investment advisers so that the time frame to plan and structure optimal tax outcomes for the parties is addressed and deadlines are met.

Parties should discuss the timing of the divorce. They can file an income tax return jointly if married on the last day of the tax year, resulting in significant tax savings, if they agree the return is accurate. Signing a joint return makes each party jointly and severally liable for the tax.

Evaluate income tax impact of asset transfers

Communicating with legal counsel early will avoid surprise tax liabilities and allow for thoughtful tax planning, including maximization of tax savings for both parties.

Sec. 1041(a) provides that no gain or loss is recognized on a transfer of property from an individual to, or in trust for the benefit of, a spouse or a former spouse, but only if the transfer is incident to a divorce. Sec. 1041(c) defines a transfer of property as incident to a divorce if it occurs within one year after the date the marriage ends or is related to the cessation of the marriage.

Temp. Regs. Sec. 1.1041-1T(b), Q&A-7, defines a property transfer as related to the cessation of a marriage if the transfer is pursuant to a divorce or separation instrument and the transfer occurs not more than six years after the date the marriage ends. Transfers not pursuant to a divorce or separation instrument and transfers occurring more than six years after the end of the marriage are presumed not to be related to the cessation of the marriage. Taxpayers can rebut this presumption by showing that the transfer was made to effect the division of property owned by the former spouses at the cessation of the marriage.

It is not always possible or practical to transfer assets when the divorce is finalized. Sec. 1041 provides taxpayers additional time to plan for assets that are difficult to transfer, including closely held business interests, real estate, and notes receivable assignments.

High-net-worth couples and those owning family businesses often have extended and complicated divorce proceedings. Additional disputes can arise after the original divorce instrument is executed, resulting in transfers of property that would otherwise be taxable if they did not qualify under Sec. 1041. Courts do not focus solely on the original divorce instrument or timing of the transfer but carefully consider whether the transfer was made to divide property between the former spouses when the marriage ended.

In  Belot,  T.C. Memo. 2016-113, the husband was entitled to nonrecognition of gain from the sale of his business interests held jointly with his former wife based on a second settlement agreement. The taxpayers agreed in the initial divorce decree to equal ownership interests in family businesses. Within a year, the taxpayers realized they could not act as equal business partners. Pursuant to a second settlement agreement, the husband sold his business interests to his former wife.

The court rejected the IRS’s argument that the transfer did not qualify for nonrecognition of gain because it was not included as part of the original divorce decree. The taxpayers had agreed that their first agreement contained shortcomings related to division of the family businesses and executed a second agreement with terms agreeable to both parties. The court found the transfer was made to effect a division of property at the time of, and was related to, the cessation of the marriage.

The court in  Belot  held that Sec. 1041 applies to multiple divisions of marital property. The court also found that Sec. 1041 can apply to marital property that is sold between former spouses and that jointly held business interests qualify as marital property.

Temp. Regs. Sec. 1.1041-1T(d), Q&A-11, provides that the transferee will have a carryover basis in the transferred property. Carryover basis will apply even if there is a bona fide sale of the property. The carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than the fair market value at the time of transfer and applies for calculating gain or loss when the transferee later disposes of the property. It is important to note that the rules in Sec. 1041 differ from those in Sec. 1015(a) for determining the basis of property acquired by gift.

Sec. 414(p) defines a qualified domestic relations order (QDRO) as an order that assigns the payee’s rights to receive benefits payable under a retirement plan to an alternate payee. Sec. 414(p)(1)(B)(i) provides for the tax-free transfer of retirement assets, including stock options and deferred compensation plan assets, pursuant to a divorce.

Often, the downside of a QDRO is that this is not a shift of currently income-generating assets that the transferee spouse needs to support his or her lifestyle. If the transferee spouse is under age 59½, a 10% penalty on early withdrawal of retirement assets is assessed.

Another strategy for transferring income-generating assets is to shift low-cost-basis securities to the spouse under Sec. 1041. If the securities were held more than one year, they can be sold and taxed at long-term capital gains tax rates to generate cash. The transferee spouse is typically in a lower tax bracket and will benefit from a long-term capital gains tax rate that is lower than the transferor spouse would have paid had he or she retained and sold the securities.

When determining an equitable split of assets between parties, advisers should calculate the future income tax liability associated with assets such as retirement funds and highly appreciated stock and consider it in the overall plan of equitable asset transfers between spouses.

The parties should decide whether the primary residence will be retained or sold prior to finalizing the divorce. Sec. 121(b)(2)(A) provides for a $500,000 capital gain exclusion from the sale of a primary residence if the taxpayers resided in the home for two of the past five years. Sec. 121(b)(1) provides for a $250,000 capital gain exclusion on the sale of a primary residence on a tax return with single or head-of-household status. However, careful drafting of the divorce decree will allow each taxpayer to exclude up to $250,000 of capital gain from the home sale in a post-divorce year. Sec. 121(d)(3)(B) provides that an individual moving out of the marital home is treated as using the property as his or her principal residence during any period of ownership that such individual’s former spouse is granted use of the property under a divorce or separation agreement and will qualify for a $250,000 exclusion of gain upon the sale of the residence.

If the spouse who continued living in the marital home remarries, sells the home, and files a joint return, the couple can exclude up to $500,000 of capital gain on the sale of the property because Sec. 121(b)(2)(B) requires only one taxpayer to meet the ownership test. In this scenario, the taxpayers can collectively exclude up to $750,000 of gain on the sale of the home because the former spouse also qualifies for a $250,000 exclusion of gain on the home sale, assuming the divorce decree was properly drafted.

Gift tax issues related to property transfers

There can also be gift tax issues related to property transfers in a divorce. Proper planning eliminates the need to use the taxpayer’s lifetime exclusion to transfer assets upon a divorce.

Sec. 2516 provides that if a married couple enter into an agreement regarding their marital and property rights and a divorce occurs within the three-year period beginning on the date one year before the agreement is entered into, any transfers of property or interests in property in settlement of marital or property rights or to provide reasonable support for minor children are considered to be transfers made for full and adequate consideration and are not considered taxable gifts. If the requirements are not met, the transfers are subject to gift tax, and the spouse making the transfers must file a gift tax return.

Income tax attribute carryforwards

Tax advisers should analyze the final joint tax return and determine how taxpayers will report carryforwards in years subsequent to the divorce. Income tax carryforwards used in future years have current value and should be considered in calculating an equitable allocation of assets.

Capital loss carryforwards

Regs. Sec. 1.1212-1(c)(1)(iii) provides that if a capital loss is reported on a joint return, the carryforward is allocated between spouses on separate returns, based on which spouse incurred the capital loss.

Assume the taxpayers had the capital gains and losses as shown in the table, “2020 Joint Tax Return,” below.

Assume that in 2021 the taxpayers finalized their divorce. Spouse 1 is entitled to the entire capital loss carryforward of $4,000 on his or her 2021 tax return because the capital loss carryforward was a result of Spouse 1’s $15,000 short-term capital loss.

NOL carryforward or carryback

When taxpayers change their filing status pursuant to a divorce, Regs. Sec. 1.172-7(d)(1) provides that carryforward and carryback net operating losses (NOLs) generated by both spouses are allocated by the joint NOL that is attributable to the income and deductions of the spouses as if each had separately computed their income and deductions. If the NOL was generated by one spouse, the carryover is only available to the spouse who generated the loss. Rev. Rul. 80-7 provides guidance on allocation of estimated tax payments and overpayments on a joint return that are used when an NOL from separate returns is carried back to a prior joint return.

Suspended passive activity losses

If investments reported as passive activities are transferred to a spouse pursuant to a divorce settlement, Sec. 1041(b) provides that the taxpayers will treat the passive activities as acquired by gift, and the transferee’s basis in the property will be the carryover basis of the transferor. Sec. 469(j)(6) provides that the basis of the passive activity will be increased by any suspended passive losses, and losses will not be realized until the activity is sold. If representing the transferee, the tax adviser should request all relevant data related to the passive investments transferred, including the date of the original purchase and the adjusted basis at the time of the transfer.

Charitable contribution carryforward

Regs. Sec. 1.170A-10(d)(4)(i)(b) provides that a charitable contribution carryforward is allocated between spouses based on how the contribution would have been allocated if the taxpayers had originally filed as married filing separately. Rev. Rul. 76-267 provides that the taxpayers must follow rules set out in Regs. Sec. 1.170A-10 to determine the allocation of the charitable contributions and are not permitted to make their own allocation agreement.

S corporation losses

Transfers of S corporation stock incident to a divorce are tax-free under Sec. 1041(a). S corporation suspended basis losses are carried over to the transferee. Sec. 1366(d)(2)(B) provides that the transferee will treat disallowed S corporation losses as incurred by the S corporation in the succeeding tax year.

Ensuring an equitable division of assets

Tax advisers play an important role assisting clients in determining the tax consequences of asset transfers prior to the finalization of a divorce settlement and in making tax filing decisions for post-divorce tax years. Tax advisers have historical knowledge that is crucial to identifying tax issues that need to be addressed to provide for an equitable division of the couple’s assets. Coordinating early and frequent communication with the client and trusted advisers will ensure a fair and equitable asset division for both parties.

For more on this topic, see “ Dividing Up Assets When a Marriage Ends: Tax Implications ,” also in this issue.

Editor Notes

Carolyn Quill , CPA, J.D., LL.M., is the lead tax principal at Thompson Greenspon in Fairfax, Va.  Richard Mather , E.A., MSA, CAA, is a director at EFPR Group in Rochester, N.Y.;  Jonathan McGuire , CPA, is senior tax manager at Aldrich Group in Salem, Ore.; and  Kathleen Moran , CPA, MBA, MT, is a director at Pease Bell CPAs in Cleveland. Unless otherwise noted, contributors are members of or associated with CPAmerica Inc. For additional information about these items, contact Carolyn Quill at  [email protected] .

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What You Need to Know About Dividing Stock Options in Divorce

One of the more difficult items to divide in divorce is a stock option. An option is a specific type of employment benefit in which the employer company gives the employee an option to buy company stock in the future at a discounted or stated fixed price. So rather than simply offering the employee stock as a benefit, they are given the ability to purchase stock at an attractive price at some point in the future. Understandably, valuing and dividing stock options incident to divorce can prove quite challenging.

As an initial matter, it is important not to ignore the fact that a spouse has stock options. Just because this an option isn’t exercisable until the future, it is still often a source of tremendous wealth. If your spouse has stock options you certainly want to take the time to explore if any portion of the options are marital property and subject to division. If you do not know whether or not your spouse has options, be sure to obtain complete discovery showing all of his or her employment benefits.

Options have been a source of astronomical wealth for many people – consider for a Silicon Valley employee who was granted options in a software startup twenty years ago. Although they weren’t handsomely compensated at the time, many of these software engineers were granted options, and as the employer company’s wealth skyrocketed the options rewarded them with a serious payout.

Although the vast majority of North Carolina divorces will not involve Silicon Valley stock options, there are many local startups that may have offered stock options as an employment benefit. Getting full disclosure from your former spouse about each employment benefit is immensely important.

Marital v. Separate Property

If a spouse has unexercised stock options, the first step will be to determine which options, if any, are considered marital. One might assume that any options granted during the marriage are considered marital. However this assumption is not entirely correct. Options are often granted as a reward for past work and as incentive for future work. Granting options is a way for a company to ensure that an employee will stay, even if the company doesn’t have the funds to properly compensate the employee right away.

The concept that the option might have been granted in some capacity as a reward for past work can complicate the analysis of labeling options as marital or separate. Contemplate a situation where a spouse was granted an option after separation. If the option was in some part compensation for work completed during the marriage, at least a portion of the option would be considered marital. Similarly, if an option was granted shortly after marriage, for work done before the marriage, a portion of that option would be considered separate, and not subject to distribution.

In classifying stock options as marital or separate, first it must be determined what the option was granted for. If it was granted for services rendered during the marriage, it is marital. This can often be hard to determine, so be sure that you gain access to the employee handbook, employment contract, and all other documents that give insight into whether the option was granted for past work or for future work.

Vested v. Unvested Options  

In addition to determining whether the options are separate property or marital property, you will need to consider whether the options are vested or not. The vesting period refers to the amount of time an employee has to wait before he is able to exercise an option. For instance, an option may have been granted to an employee in 2005, but may not be exercised until 2015. That option will be considered “unvested” until 2015.

As you can imagine, a vesting schedule will complicate the division of stock options incident to divorce even further. Consider the above example where the option was issued in 2005 but not vested until 2015. Add the fact that the spouses were married in 2003 and separate in 2012? Can the unvested stock options be classified as marital property?

Yes. In North Carolina both vested and non-vested stock options are subject to distribution. So, if a spouse has unvested options those options must still be classified as marital or separate, valued, and divided. In the above example, a portion of the unvested stock options would be subject to distribution.

Valuing the Option

Once it has been determined that the options are marital, a value will have to be attached to them. This too, is a complicated process, and there are several methods that can be used.

The most common method used in North Carolina is known as the “Intrinsic Value Method.” The calculation used under this method subtracts the option strike price from the value of the current stock price, and then multiplies this by the number of options the spouse owns. This option is ideal when dealing with publicly traded stock. There are some detriments to this method, however. Because of the simplicity of the formula, there is no consideration given to the marketability of the shares, the fact that the value could drop before they could be exercised, and the risk that the options would never vest to name a few.

The Black-Scholes model is another approach to placing a value on a stock option. Unlike the Intrinsic Value Method, this model is complicated and typically requires a professional, such as a forensic accountant. This model produces a theoretical estimate of the value based on derivative investment instruments. It considers numerous additional factors, such as the historical price of the stock, the strike price, and the vesting schedule.

Although not a common method to value a stock option, a North Carolina court has held the “coverture fraction,” typically used to value qualifying retirement plans, may be used to value stock options. This formula divides the length of time a spouse was simultaneously married and contributing to the earning of the stock options by the total length of employment during which the options were earned.

A final approach to valuing stock options is to simply reach an agreement. The spouses can simply agree that the value of the marital portion of the options is a certain amount. This method obviously does not require the hiring of a forensic accountant, but it can be risky. If you agree that the marital portion of the assets is worth $50,000, but then later find out that this value is actually way less than the options are truly worth, there is nothing you can do to get your hands on the true value you were owed.

Dividing the Option  

After you have determined that the options are marital, whether or not they have vested, and you have come up with a value to assign to the marital portion, the work is still not over. At this point the way in which the value of the option will actually be distributed to the non-employee spouse will have to be addressed.

The easiest and most common method to divide stock options is to have the employee spouse who owns the option offset the agreed upon value of the option with another asset. For instance, if the option is valued at $100,000, the non-employee spouse is entitled to $50,000. Rather than actually attempting to split the option and potentially trigger adverse tax consequences, the non-employee spouse can agree to take the $50,000 she is owed by accepting another asset. She may prefer to get an the additional $50,000 in a lump sum cash transfer, or take title to a vehicle, jewelry, retirement account or other asset worth a comparable amount.

Sometimes the offset method above doesn’t work, however. Consider a situation where the employee spouse simply does not have an additional $50,000 in cash (or asset of comparable value) to transfer to his former spouse.

The deferred distribution model is a way to work around the aforementioned scenario. This model allows either the court, or the spouses, to decide on a formula that will prescribe how the non-employee spouse will be paid once the employee spouse has exercised the option. This distribution model eliminates the need to agree to a current value and allows for the valuation to be determined once the option is exercised – it is a “wait and see” approach. Essentially, the employee spouse will pay a prorated portion of the benefit to his former spouse once he receives the benefit.

If the deferred distribution model is the chosen method of distributing the value of the options, the non-employee spouse will want to make sure that the agreement prescribing this method of distribution contains language that protects the non-employee spouse. The following provisions are just a few of the many that should be included:

• Notice must be given to the non-employee spouse if his employment terminates.
• Notice must be given to the non-employee spouse if the employee-spouse exercises any options.
• Notice should be given to the non-employment spouse if the employer re-prices the options or grants replacement options.
• Notice should be to the non-employment spouse if the employer accelerates the maturity date (vesting schedule) of the options.

Finally, the employee spouse should hold the options in a constructive trust that specifies the process that should be followed when there are newly vested options.

As you may have noticed, actually dividing the ownership, or transferring the option itself to a former spouse is not mentioned as a potential distribution method. This is because the vast majority of employee stock option plans explicitly prohibit the assignment or transfer of rights in the options. Companies usually offer stock options as a benefit to incentive the employee to stay with the company longer, if the employee were able to transfer his right to the options to someone else, this benefit would be lost.

Tax Implications

Stock options that have value will result in the incurring of income taxes as soon as the value is realized. The tax implications will vary depending on what type of option is at issue, how the option is exercised and how much the option is worth. To further complicate the tax issues associated with the division of stock options, tax law is a moving target and may change in the future and the tax burden cannot be transferred to the non-employee spouse, so the employee spouse must be sure to anticipate any potential tax issues in advance.

The tax penalty that will occur when transferring stock options is a function of whether the options are “statutory stock options” (otherwise known as qualified stock options) or “non-statutory stock options” (otherwise known as non-qualified stock options).

The transfer of the latter type of option will result in the income being taxed at the usual rate upon the option being exercised. The employee spouse would be taxed when he or she exercised the option, and the non-employee spouse would be taxed once the shares were sold. These options can be transferred tax-free incident to divorce, and taxes will not be assessed until the option is exercised. Once these options are exercised they will be subject to withholding at the supplemental withholding rate and FICA taxes will be deducted.

Statutory stock options are treated differently, however. When statutory stock options are sold, the resulting consequence is capital gain treatment from the profits acquired when sold. When statutory stock options are transferred, however, they lose their status as statutory stock options and become non-statutory options. Statutory stock options have more favorable tax treatment, so it is advised that the receiving spouse consider ways to obtain the options without executing jeopardizing the favorable tax treatment of qualifying options. It is worth noting, however, that a different result occurs when instead of transferring qualifying stock options, the employee transfers the stock that is acquired once the qualifying option is exercised.

One option is to agree to a monetary value that the options will be worth once exercisable, and simply receive that amount as a lump sum from the other spouse. Another option is to include a provision in the separation agreement or court order expressing that the employee-spouse who owns the options will hold them on behalf of the other spouse. The spouse who is owed the options will have the authority to ask the other spouse to exercise the option at any time per his or her wishes. Because there will be a tax consequence when the options are exercised, the spouses should agree that the receiving spouse only takes the amount left after the tax penalty has been assessed. This transaction would not jeopardize the favorable tax status of qualifying stock.

Obviously, transferring stock options can create quite a headache from a tax standpoint. It is advisable to consult with an attorney or CPA before transferring any stock options so both spouses are fully aware of any tax consequences in advance.

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Yahoo Finance

‘Is he trying to bamboozle me?’ My husband wants a divorce after 20 years. He offered his $275,000 401(k) in exchange for our $250,000 house.

Dear Quentin,

My husband no longer wants to be married to me.

I am 61 and he is 51. In 2006, I left a job and used my 401(k) to pay off all of our debts. A couple of years later, he applied for and got a credit card in his name to buy an anniversary gift of a three-stone diamond ring for me. And we started building debt again.

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In 2012, I quit work because I became disabled. He was in favor of me quitting for my health. I used my 401(k) for life expenses because doctors found a parasite behind my husband’s eye. He was off work for a month. I sold my Jeep to pay our expenses.

Six months after quitting work I qualified for Social Security Disability Insurance. With SSDI I got only $500 less than when I was working. Last year, I sold another Jeep so we could pay off all our debt. As of next month, we only have our mortgage and his car payment.

And now? We are getting divorced. In March, we were married for 20 years. Am I entitled to half of his 401(k), which is currently valued at $275,000? How would that withdrawal work? He wants to give me his 401(k) in exchange for our house, which is worth $250,000.

What do you think? He thinks I could use the money from his 401(k) to either buy a house or use some as a down payment. Is he trying to bamboozle me?

Soon-to-be-Divorced in Wisconsin

Related: ‘I’m torn’: Is it creepy to give my 13-year-old daughter her late grandfather’s iPhone number?

I have a question for you. Why doesn’t your husband use the money from his 401(k) to either buy a house or use it as a downpayment? As a general rule of thumb, people don’t make grand gestures in a divorce unless it benefits them — and I’m just going to go out on a limb here — more than it benefits you.

Wisconsin, as you probably know, is a community-property state so all assets contributed during the marriage are community property and, as such, would be divided 50/50 in a divorce. So any contributions made to his 401(k) over the last 20 years would be deemed community property and, I assume, were his peak earning years.

You should already receive 50% of those contributions because that’s the law in your state, and you deserve them because you liquidated your own 401(k) to pay for debts that were due, at least in part, to your husband’s illness. You did a good thing. Now, it’s time for him to return the favor, even if he does so unwillingly.

Don’t take my word for it — talk to your attorney and CPA. But since you asked: If you took your husband’s entire $275,000 401(k), you would have to pay income taxes on your withdrawals, so the divorce settlement should take that into account. If you gave him the house, he would walk away with a $250,000 asset that will, presumably, continue to increase in value.

Tax obligations of 401(k)s

“When dividing retirement assets, the court is obligated to consider the tax implications to both parties,” according to Karp Iancu , a law firm with offices across Wisconsin. “It is the ‘industry standard’ in Wisconsin family courts, to discount the present value of retirement accounts (with the exception of ROTH IRAs) by 20%.”

“Dividing a 401(k) in a divorce is also a bit like dividing a pension and a bit like dividing an IRA,” the firm adds. “Like pensions, the account can only be divided with a special court order called a qualified domestic relations order. But like IRAs, they can be easily valued by simply looking at the balance on a current account statement.”

From your letter, you both contributed to a lifestyle where you were living above your means. And, yes, people often get into debt because, try as they might, they cannot make ends meet without putting some expenses on a credit card. Now that you are planning to live apart, you will get to see who is most able to live within their means.

About that credit card: Should your husband have taken out a credit card for a three-stone diamond engagement ring after you cashed out your 401(k) before you were 59 ½ and incurred a 10% early-distribution penalty? No. You both need to take accountability for that. Was that the real/only reason he took out a credit card? Probably not.

If he continues to make risky financial decisions based on “want” rather than “need,” your divorce will not spell the end to his financial near-misses.

Previous columns by Quentin Fottrell:

My father ‘deliberately and hurtfully’ cut my late sister’s two kids out of his will. How can I ensure they get their fair share?

‘They left nothing except junk’: My brother emptied our father’s house. It stands empty years after his passing. What can be done?

‘My brother and sister are villains’: My siblings took control of my late mother’s estate and won’t reveal the contents of her trust. What do I do?

Bond king Jeffrey Gundlach still sees a U.S. recession coming. Here’s when.

‘I got seriously burned’: My financial adviser took me for lunch, bought my kids gifts — and had me invest $500,000 in annuities. What should I do?

30-year mortgage rate drops to a seven-week low 

STOCK TRANSFER IN DIVORCE NOT TAXABLE.

Ltr 200221021.

• Institutional Authors Internal Revenue Service
• Code Sections Section 1041 Section 2516
• Subject Area/Tax Topics Accounting periods and methods Estate, gift and inheritance taxes
• Jurisdictions United States
• Language English
• Tax Analysts Document Number Doc 2002-12591 (5 original pages)
• Tax Analysts Electronic Citation 2002 TNT 102-42

Index Nos: 1041.01-00, 2516.00-00

[1] This letter responds to your request for a letter ruling, on behalf of A and B, regarding the change in title of B's stock certificates. You request rulings that (1) no gain or loss will be recognized to A or B as a result of the change in title, and (2) the change in title does not constitute a gift for gift tax purposes.

[3] At the time of the divorce proceeding, A's and B's marital assets included y shares of Company, a closely held business. The shares were titled in A's name. Under state law, however, the shares of Company, regardless of how title is held, constitute marital property subject to division between the parties.

[4] In order to equalize the marital property, the order allocated v percent of the shares to A and w percent of the shares to B. B's w percent interest in Company, combined with other assets she received, gave her one-half of the marital estate. Although the stock certificates for B's w percent interest in Company were never titled in her name, the order stated that the "true ownership" of that interest is "apportioned" to her. A and B represent that the record ownership of the w percent interest was left in A's name to protect the value of the stock, encourage investment in Company, and enhance the future marketability of the stock. Further, it is represented that A and B did not enter into a written agreement relative to their marital property rights prior to Year 1, the year of the divorce.

[5] In Year 2, B filed a lawsuit asking the Court to direct that the w percent interest in Company be titled in her name. As a result of mediation of the issues raised in the lawsuit, the parties submitted this request for a private letter ruling.

[7] Section 1041(b) provides that in the case of any § 1041(a) transfer of property, (1) for purposes of subtitle A, the property shall be treated as acquired by the transferee by gift, and (2) the basis of the transferee in the property shall be the adjusted basis of the transferor.

[8] Section 1041(c) provides that, for purposes of § 1041(a)(2), a transfer of property is incident to the divorce if such transfer (1) occurs within one year after the date on which the marriage ceases, or (2) is related to the cessation of marriage.

[9] Section 1.1041-1T(b), Q&A-7, of the temporary Income Tax Regulations provides that a transfer of property is treated as related to the cessation of the marriage if the transfer is pursuant to a divorce or separation instrument, as defined in § 71(b)(2), and the transfer occurs not more than 6 years after the date on which the marriage ceases. A divorce or separation instrument includes a modification or amendment to such decree or instrument. Any transfer not pursuant to a divorce or separation instrument and any transfer occurring more than 6 years after the cessation of the marriage is presumed to be not related to the cessation of the marriage. This presumption may be rebuffed only by showing that the transfer was made to effect the division of property owned by the former spouses at the time of the cessation of the marriage. For example, the presumption may be rebutted by showing that (a) the transfer was not made within the one-and six-year periods described above because of factors which hampered an earlier transfer of the property, such as legal or business impediments to transfer or disputes concerning the value of the property owned at the time of the cessation of the marriage, and (b) the transfer is effected promptly after the impediment to transfer is removed.

[10] Section 71(b)(2) provides that the term "divorce or separation instrument" means (A) a decree of divorce or separate maintenance or a written instrument incident to such a decree, (B) a written separation agreement, or (C) a decree (not described in subparagraph (A)) requiring a spouse to make payments for the support or maintenance of the other spouse.

[11] In the present case, B has sought an order from the Court directing that B's w percent interest in Company be titled in her name. If granted, the change in title will represent a transfer pursuant to a "divorce or separation instrument" within the meaning of § 71(b)(2).

[12] The transfer, however, will not be made before the expiration of 6 years from the date the marriage ended. Thus, under § 1.1041-1T(b), Q&A-7 of the temporary regulations, there is a rebuttable presumption that the transfer is not related to the cessation of the marriage. Notwithstanding the presumption, it is our position that the transfer in title of the shares of Company is related to the cessation of the marriage of A and B.

[13] First, it is clear that the transfer of Company stock from A to B is being made to effect the division of property owned by A and B at the time of the divorce. The Company stock was marital property owned by A and B at divorce, and the order issued by the Court at the time of the divorce allocated w percent of the shares to B. A and B have simply chosen to delay the transfer of title of such shares for more than six years after the cessation of the marriage. Second, A and B have represented that there are compelling business reasons concerning why the transfer will occur more than 6 years from the date the marriage ended. These reasons include maintaining investor confidence in Company, enhancing the marketability of the stock, and facilitating future growth. Thus, valid business reasons exist to explain the delay in the transfer. Accordingly, the transfer is related to the cessation of the marriage under § 1041(c)(2) even if it occurs more than six years after the cessation of A's and B's marriage.

[14] With respect to the issue relating to the applicability of the gift tax provisions, § 2501(a) imposes a tax for each calendar year on the transfer of property by gift during the calendar year by an individual.

[15] Section 2511(a) provides that the gift tax applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.

[16] Section 2512(b) provides that where property is transferred for less than an adequate and full consideration in money or money's worth, then the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift.

[17] Under § 25.2511-2(b) of the Gift Tax Regulations, as to any property, or part thereof or interest therein, of which the donor has so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or the benefit of another, the gift is complete. But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete, or may be partially complete and partially incomplete, depending upon all the facts in the particular case. Accordingly, if a transfer of property is subject to a reserved power, the terms of the power must be examined and its scope determined.

[18] Section 25.2511-2(c) provides that a gift is incomplete in every instance in which the donor reserves the power to revest the beneficial title to the property to himself.

[19] Section 2516 provides that where a husband and wife enter into a written agreement relative to their marital property rights and divorce occurs within the 3-year period beginning on the date 1 year before such agreement is entered into (whether or not such agreement is approved by the divorce decree), any transfers of property or interests in property made pursuant to such agreement -- (1) to either spouse in settlement of his or her marital rights, or (2) to provide a reasonable allowance for the support of issue of the marriage during minority, shall be deemed to be transfers made for a full and adequate consideration in money or money's worth.

[20] In the present case, it is represented that A and B did not enter into a written agreement relative to their marital property rights prior to Year 1, the year A and B were divorced. The determination of A's and B's respective marital property rights were delineated in the Court's order. Under the order, the Court directed that the parties divide the y shares of Company so that the stock remains titled in the name of A, but the true ownership is apportioned between the parties v% to A and w% to B. B is to be treated as and considered a shareholder and is to receive her proportionate share of any dividends, stock splits, or other matters affecting the structure and/or value of the stock. The parties are to share in the proceeds/benefits/consideration resulting from the sale of the stock in the same percentages as they hold ownership. A is not permitted to sell, pledge, or otherwise transfer, directly or indirectly, any stock that he owns in Company without prior written consent of B.

[21] The order irrevocably assigned w% of Company stock to B in Year 2. A cannot revoke the order and revest B's interest in the w% to himself. In addition, he is required to take all necessary steps to protect B's interest. Although legal title of the stock has remained on the books of Company in the name of A since the time of the order, B has received all the benefits of any sales of the stock as well as other economic benefits such as appreciation in the stock's value (no dividends have been paid on the stock).

[22] Under § 2516, where a husband and wife enter into a written agreement relative to their marital property rights and divorce occurs within the 3-year period beginning on the date which is one year before the agreement is entered into, any transfers of property interests made pursuant to such agreement to either spouse, in settlement of his or her marital rights, is deemed to be a transfer made for a full and adequate consideration in money or money's worth. Based upon the requirements of § 2516, we conclude that the transfer of w% of the y shares to B is a transfer made for adequate consideration in money or money's worth within the meaning of § 2516. Accordingly, the proposed change in title of Company stock from A's name to B's name will not result in the application of the federal gift tax under § 2501 of the Internal Revenue Code.

(2) The proposed change in title of B's w% of Company stock from A's name to B's name will not result in the application of the federal gift tax under § 2501.

[24] This ruling is directed only to the taxpayer(s) requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

[25] In accordance with the power of attorney on file, we are sending a copy of this letter to both of the taxpayers.

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Dividing Your Property and Debt in a Divorce

Learn more about how Texas law allocates property and debt in divorces.

What property and debt is divided in a divorce?

Community property and debt are divided in a divorce. Separate property and debt are not divided.

At the end of your divorce case, a judge will divide your property and debt by signing a Final Decree of Divorce (also referred to as Final Decree). The Final Decree of Divorce will:

• list the community property each spouse will keep or, in some circumstances, order community property (such as a house) sold and say how the proceeds should be split;
• list the separate property (if any) of each spouse;
• list the debts each spouse is ordered to pay; and
• awarded (given) 100% to the spouse who earned the benefits or
• divided between the spouses.

Note: The Final Decree of Divorce divides your property and debt; however you may need to take additional steps after the divorce to transfer vehicle titles or real estate deeds.

What is community property and debt?

Community property includes all property you and your spouse have at the time of divorce except property that you or your spouse can prove (or the both of you agree) is the separate property of one spouse.

Your community property may include real estate (a house or land), a business, cars, money, retirement accounts, furniture, and other things earned or purchased by either spouse during your marriage. It doesn’t matter which spouse’s earnings were used to purchase the property or which spouse’s name is on the title.

Community debt is debt you or your spouse acquired during the marriage.

The law says that community property and debt should be divided "just and right" when you get divorced. This does not necessarily mean a 50/50 split.

Note: There are exceptions to these general rules. If you have questions, it’s important to talk with a lawyer.

Read Texas Family Code chapter 7  for more information.

What is separate property and debt?

Separate property includes:

• property owned or claimed by one spouse before the marriage,
• property received as a gift or inheritance to one spouse during the marriage,
• money received by one spouse for personal injuries that occurred during the marriage (not including money received for lost wages or medical expenses), and
• stock dividends and capital gains on the separate property investments of one spouse.

Unless both spouses agree, a spouse must prove that something is separate property by “clear and convincing evidence.” If a spouse cannot prove something is separate property, it is considered to be community property. Read Gathering and Presenting Evidence to help you understand what is allowed in court.

Separate debt is debt one spouse acquired before the marriage.

The law says that separate property cannot be divided. Once something is proved to be separate property, the judge must confirm it as the separate property of that spouse.

Can one spouse be reimbursed for improvements to the other spouse’s separate property?

If money earned during the marriage is spent to improve the separate property of one spouse, the other spouse might be able to argue that they should get credit for a portion of the money spent. Talk to a lawyer if this is an issue in your divorce.

What if we agree on how to divide our property and debt?

If you and your spouse agree on how to split your property and debt, the judge will usually approve your agreement. You will fill out the Final Decree of Divorce form so that it reflects your agreement. Talk to a lawyer if you need help or have questions. You will find the correct Final Decree of Divorce form for your case in the appropriate guide:

I need a divorce. We do not have minor children.

I need a divorce. we have children under 18., i need a divorce. we have minor children. a final custody and support order is already in place..

Note: The TexasLawHelp.org Final Decree of Divorce form is written for people who do not have a lot of property or debt. If you or your spouse have property of significant value (such as a house, business, retirement account, or other financial accounts) or a lot of debt, it is important to have a lawyer review your Final Decree of Divorce before going to court to finish your case. When you have a lot of property, making a mistake can be costly. Hiring a lawyer now can save you time and money in the long run.

My spouse and I have been separated for a while. Do we need to include personal belongings, like furniture and clothing, in the Final Decree of Divorce?

If you and your spouse have already separated your personal belongings, like furniture and clothing, you probably don’t need to include those items in the Final Decree of Divorce. The Final Decree awards each spouse the personal property in that spouse’s care, custody, or control unless specifically ordered otherwise.

You do need to include property of significant value like vehicles, real estate, businesses, jewelry, and financial accounts.

What if my spouse and I don’t agree on how to divide our property and debt?

If you and your spouse cannot agree on how to split your property and debt, a judge will divide your community property and debt in a way that the judge decides is “just and right" in a final hearing. This usually means 50/50, but not always.

How does divorce affect debt?

A creditor’s right to collect a debt is not affected by your Final Decree of Divorce.

This means if the judge orders your spouse to pay a debt that is in both your names (such as a car loan or mortgage) but your spouse does not pay it, the creditor can still seek payment from you. Ask a lawyer how to protect yourself in this situation.

What if we own (or are purchasing) a house or land together?

It is important to talk with a lawyer if you and your spouse have a house or land. A lawyer can help you understand and correctly address the issues that come up in a divorce when you own a house or land.

Not talking to a lawyer can be  very  costly. For example:

• You could lose ownership of the property and still be responsible for the mortgage . A mortgage company’s right to payment is not changed by a divorce decree. If you and your spouse are on the mortgage and the divorce decree gives the house or land to your spouse and your spouse does not pay the mortgage, the mortgage company can still seek payment from you . This is true even if the judge ordered your spouse to pay the mortgage. A lawyer can help you figure out how to protect yourself in this situation.
• You could be unable to enforce an agreement or order that your spouse pays you part of the value of your house or land. An order for one spouse to pay the other spouse part of the value (equity) in a house or land should usually be secured by a lien on the property. If it’s not, you may not be able to get the money awarded to you. A lawyer can help you with this.
• You could be unable to sell the property later. If you are keeping the property, a Special Warranty Deed should be signed by your spouse and filed with the property records office. If that does not happen, you could have trouble selling the property later. You must hire a lawyer to write the Special Warranty Deed form.

TIP: You can hire a lawyer just to give you advice or draft any deed or lien forms needed in your case. You can then handle the rest of your case yourself. Hiring a lawyer for a limited purpose is called limited scope representation .

Read  Divorce & Real Estate  to learn more.

Is it important to include the “legal description” of our house or land in the Final Decree of Divorce?

Yes.   It is very important to include the complete legal description of your house or land in your Final Decree of Divorce. The legal description is the language used to legally identify real property.

You can find the legal description on the most recent deed for the property. You can get a copy of the deed at the county clerk’s office in the county where the property is located.

It is very important that the legal description be written in your Final Decree of Divorce exactly as it is written on the most recent deed for the property.

The address of the property is not the legal description.

The shortened legal description on your property tax records is not  the complete legal description and may be incorrect.

If you’re not absolutely sure about the legal description, talk to a lawyer.

Does it matter whose name is on the deed for our house?

No. A house or land purchased during the marriage is community property – no matter whose name is on the deed–unless the house was purchased with the separate property money of one spouse.

Is it important to include the vehicle identification number (VIN) in the Final Decree of Divorce?

Yes.  It is important to include the vehicle identification number (VIN) for each vehicle. The VIN can often be found on the lower-left corner of the vehicle dashboard, in front of the steering wheel. Look through the windshield from the outside to read the number. You can also find the VIN on the vehicle title, insurance documents, or owner's manual.

How do I transfer title to a vehicle?

If you are awarded a vehicle that is in both your and your spouse’s names, take a certified copy of the Final Decree of Divorce to your local county tax office and apply for title. Be sure to bring proof of current insurance and the application fee. Call ahead to learn the fee, or look it up on the county clerk's website.

If your Final Decree does not include the vehicle, you must have a properly assigned title to transfer the title. Your ex-spouse can assign the title to you by signing the back of the actual title or by signing a power of attorney.

TIP: You should not have to pay taxes on a title transfer because of divorce. Check the tax-exempt box on the title application form.

My spouse is keeping the car. Can I get my name off the debt?

Your spouse must refinance the car loan to get your name off the debt. If your spouse is unable or unwilling to refinance the loan, you will continue to be responsible for the debt. Talk to a lawyer about your options.

Can retirement benefits be divided?

Yes. Retirement benefits earned by either spouse during the marriage are usually considered to be community property that can be divided by the court. This is true even if you or your spouse has not yet retired.

Retirement benefits are often a couple’s most valuable asset. Retirement benefits include pensions, military retirement, 401(k) accounts, 403(b) accounts, employee stock ownership plans, profit-sharing plans, thrift plans, Keogh plans, stock option plans, individual retirement accounts (IRAs), annuities, and variable annuity life insurance.

If you want the judge to divide retirement benefits as part of your divorce, you must include specific information about the retirement benefits in your Final Decree. You must also ask the judge to sign an additional form, usually called a Qualified Domestic Relations Order (QDRO) (unless you are dividing an IRA). You should have the QDRO prepared before you go to court, so the judge can sign it when you finish your divorce.

After the judge signs the QDRO, send a certified copy to the retirement plan administrator. The retirement benefits will NOT be divided until the plan administrator gets a certified copy of the QDRO that was signed by the judge.

To learn more about this, read Dividing Retirement Benefits Upon Divorce .

Important:  TexasLawHelp does not provide QDRO forms. You may contact the employer or retirement plan administrator to see if they have a sample QDRO form. If not, you should hire a lawyer to draft the QDRO form. If you use the employer or plan administrator’s form, you should still have a lawyer review it to make sure you are not giving up important benefits.

Can we each keep our own retirement?

Yes. Check the boxes in the Final Decree of Divorce that give each spouse 100% of any retirement benefits in that spouse's name. You do not need a QDRO if you are keeping your own retirement benefits.

Related Guides

My spouse filed for divorce., related articles, community property, divorce and real estate, dividing retirement benefits upon divorce, pets in family law cases, enforcing the property division in a divorce, gathering and presenting evidence.

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Golfer Rory McIlroy just filed for divorce in Florida. Does he have a new squeeze?

• Oops! Something went wrong. Please try again later. More content below

Pro golfer Rory McIlroy , who filed for divorce last week, is apparently a big topic of conversation.

Internet investigators are convinced the Irishman, who announced he was splitting with his wife of seven years, Erica Stoll, on May 13, is dating someone new.

She’s CBS’s “19th Hole” reporter Amanda Balionis.

Rumors began the day before the filing, on Mother’s Day, when Balionis was interviewing McIlroy at the Wells Fargo Championship in Quail Hollow, North Carolina.

View this post on Instagram A post shared by Amanda Balionis (@balionis)

After he failed to mention Stoll, the mother of his 3-year-old daughter Poppy, tongues began to wag.

A source dished to the Daily Mail that the chemistry sensed between the two went beyond the greens, and that McIlroy had been spotted around the journalist’s neighborhood in San Diego.

Adding fuel to the fire is that Balionis, coincidentally, is also going through a divorce, from former NFL quarterback Bryn Renner.

If the trolls are correct, McIlroy, 35, and Balionis, 38, are logging a lot of air miles to see one another. The Puttery Miami co-owner currently lives in Jupiter, Florida. It is unclear who will get the home after the divorce is finalized; as per Palm Beach County court records, there has been no updated or recent activity on the docket.

Facts: McIlroy and Balionis had already collabbed outside of the golf arena.

Last month, McIlroy shot an adorable promo for Balionis’ nonprofit , Puppies & Golf, helping rescues find forever homes.

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18 Reasons Why Over 50s Divorce Their Partners

Posted: May 22, 2024 | Last updated: May 22, 2024

Gray divorce, once rare, is now increasingly common, with over a third of American divorcees being older than 50. This trend reflects evolving expectations and social constraints, as individuals seek personal happiness and fulfillment even after decades of marriage.

Increased Financial Independence

More individuals over 50, especially women, now have financial independence due to careers and pensions. This financial security enables them to leave unhappy marriages where economic dependence once kept them trapped. The ability to support themselves post-divorce empowers many to prioritize personal happiness. Financial freedom provides the confidence to make life-altering decisions without fear of financial instability.

Changing Priorities

As people age, their priorities evolve. This often impacts marriages. Couples may grow apart as they desire different things and fail to prioritize their relationship. This shift can lead to incompatibility, making separation a path to greater happiness. The pursuit of individual goals often reveals deep-seated differences that were previously overlooked.

Increased Social Circles

Older adults are increasingly engaging in broader social circles and community activities. These networks provide new perspectives and support. They encourage individuals to pursue happiness, even if it means divorcing. Support from friends and communities plays a crucial role in this decision. Social interactions can inspire a sense of belonging and validation outside the marriage.

Change in Societal Norms

Societal attitudes toward divorce have become more accepting over recent decades. The reduced stigma makes it easier for older couples to consider divorce. This cultural shift encourages open discussions about the sustainability of long-term marriages. Modern views on personal fulfillment and self-worth have made divorce a more viable option.

Personal Growth and Self-Discovery

Midlife often brings a phase of self-reflection and personal growth. People may realize they may have outgrown their partner and seek relationships that better match their current self. This quest for authenticity can lead to the decision to part ways. Embracing new identities and aspirations often highlights misalignments in long-term partnerships.

Empty Nest Syndrome

Adjusting to an empty nest after years of raising children can be challenging. Many couples find they struggle to reconnect once their children have moved out. This shift can lead to the realization that they are happier apart than trying to revert to their pre-family dynamic. The absence of a shared parenting focus often exposes underlying marital issues.

Focusing on Happiness

There’s a growing emphasis on the importance of happiness at the everyday life stage. Many individuals over 50 are choosing to prioritize their fulfillment, even if it means facing difficult decisions like divorce. This shift values personal contentment over traditional marriage longevity. The recognition that life is finite drives many to seek joy and satisfaction.

Looking for More Adventure

The desire for new experiences can prompt some to reassess their marriages. Divergent aspirations, like one partner wanting to travel or pursue new hobbies, can lead to separation. The pursuit of adventure and personal growth often becomes a solo journey or one with a new partner. The longing for a more dynamic and fulfilling lifestyle can outweigh the comfort of the familiar.

Realities of Retirement Life

Retirement brings significant lifestyle changes, sometimes revealing strains in a marriage. Couples who spend all their time together may find it overwhelming. This can lead them to reassess their relationship. This new phase can make them see their marriage in a different light. This shift from structured work lives to open-ended days can highlight compatibility issues.

Second Chances at Love

The belief in second chances inspires many older individuals to leave unfulfilling marriages. The hope of finding a more compatible partner motivates them to seek new relationships. This optimism for future love drives the pursuit of happiness through change. The desire to experience a deeper connection and renewed passion encourages these life-altering decisions.

Legacy Considerations

Aging brings a focus on the legacy one wishes to leave behind. This can include personal happiness and fulfillment. This introspection can lead to the revaluation of marital situations. It can lead some to pursue change for a more authentic life. Striving to leave a legacy of joy and contentment becomes a compelling motivation for some to end their marriages.

Longer Life Expectancies

With people living longer and healthier lives of over 78 years , many reassess their relationships as they age. The thought of spending decades more in an unfulfilling marriage prompts some to seek happiness elsewhere. Society’s growing acceptance of personal fulfillment at any age supports this trend, making divorce a viable option.

Poor Communication

Effective communication is crucial for a successful marriage, but longevity doesn’t guarantee it. Issues like regular arguments, not listening to your partner, silent treatment, and misunderstandings can erode a relationship. After decades of communication problems, many couples reach a breaking point and opt for a divorce.

Lack of Intimacy

Long-term relationships often fall into comfortable routines, sometimes at the cost of intimacy. As partners become preoccupied with their own lives, the connection can fade. Regardless of how they have been together, few want to spend the rest of their lives without intimacy. This leads to separation.

Financial Mismanagement

Disagreements over finances, especially concerning retirement savings, can cause significant strain. Differing financial priorities or mismanagement can lead to stress and insecurity. These financial disputes can often become more pronounced with age. It drives older couples to divorce.

Technological Advancements

Technology has simplified meeting new people, even for those over 50. Online dating platforms and social media offer new romantic opportunities that were previously unavailable. This ease of connection encourages individuals in satisfying marriages to explore new relationships.

Health Issues

Health changes can alter marriage dynamics, particularly if one partner assumes a caregiving role. The physical, emotional, and financial strain can become overwhelming and sometimes lead to divorce. This reevaluation under the pressure of health issues can highlight the need for change.

Falling Out of Love

Falling out of love is a painful yet common experience, especially in long-term relationships. Over time, couples may grow individually and change priorities. It leads to a loss of affection. This natural drift can result in a decision to divorce, seeking new paths for happiness.

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