Clients often wonder whether they will have to divide their unvested stock options as part of a divorce property settlement. These are the stock options that were awarded during the marriage, but are not allowed to be exercised by the employee until a date in the future, presumably after the divorce is final.
It is crucial that both parties are fully informed about the grant dates and nature of the stock options when determining the value of the marital portion of the asset. A comprehensive company description of the option plan and calendar of granting and vesting dates, as well as the number of shares and price the employee must use to exercise the option, must be made available to the non-employee spouse to review with his or her attorney. In addition, it is important to determine if the options were granted for services to be rendered after the divorce.
Generally, if the options were granted during the marriage, they are considered marital property because the employee has the right to buy the stock at a fixed option price and then sell the shares at the current higher stock price to make a profit. With already vested options, it is easy to determine their value by looking at the fixed grant price and comparing this price to the current stock price. The difference multiplied by the number of shares is the current value of the vested asset.
But what about granted, though unvested stock options? What happens if these options were granted during the marriage, but will vest and be exercisable in the future, after the divorce? And what if the parties are separated but still married at the time the grant occurs?
Other distinctions include whether the option is performance or incentive-based. It is arguable that incentive-based options, which motivate a person to stay employed at the company, are not based on the employee’s contribution but on some future performance after the divorce. Since some options are granted for service that will occur after the divorce, the employee may feel that the ex-spouse did not contribute to the acquisition of the post-divorce portion of the asset. Fortunately there are ways to discount the future options in the interest of fairness.
If the stock options are going to be off-set against other assets, the unvested options granted during the marriage and based on performance during the marriage can be given a lesser present value than the vested ones by use of a formula which takes the future, post-divorce vesting date(s) into consideration.
Often the uncertainty of whether the employee-spouse will stay employed long enough for the unvested options to actually vest makes it risky to off-set any granted though unvested options against other marital assets. In that case, the parties can consider dividing the proceeds in an allocation that is fair to both, “if and when” the options get exercised.
Tax consequences have to be considered as well, since the exercise of a stock option affects the taxable income of the person who owns the option. Sometimes the company Plan prohibits the transfer of the options even as part of a divorce. But if the options can be transferred to the non-employee spouse to exercise in the future, that spouse will owe the taxes, according to the IRS. With any complicated asset such as stock options, it is important to consult with an accountant regarding the tax implications of exercising or transferring the asset.