Understanding Equity-Based Compensation

January 23, 2023

Kriste J. Rodriguez, CPA/ABV 

Typical forms of compensation are salaries and bonuses; however, there are instances when employees are given non-cash compensation in the form of equity.  Equity-based compensation can include stock options, restricted stock or restricted stock units (“RSU”).  When going through a divorce, there are several issues concerning equity-based compensation, such as the value of the stock options or RSU’s, tax implications of the awards, and whether the awards are marital, separate property or subject to equitable distribution in part.   

Typically, equity-based compensation is granted on a specified date and is subject to a vesting schedule and/or performance benchmarks.  Stock options give an employee the option to buy shares (once they are vested) in the company at a predetermined price, known as the strike price.  Vested stock options become valuable if the market value of the stock is higher than the strike price.  Unlike stock options, once RSU’s have vested, they do not have to be purchased.  As soon as they vest, they are no longer restricted, and are treated exactly the same way as if one had bought them on the open market. 

Determining whether stock options/RSU’s are separate or marital property will depend on when they were granted, when they vest and if the vesting is contingent upon future services/performance.  The most common issue concerning equity-based compensation arises when the stock option or RSU was granted during the marriage but vests after the date of complaint.  The question often becomes: was the compensation awarded for past services or for future services or future performance?  If the award was compensation for services already rendered, most likely the award would be considered marital and subject to equitable distribution.  On the other hand, if the award was an incentive for future services or performance, it may be considered exempt and not subject to equitable distribution.   

Sometimes it is not clear whether the award was for past or future service or performance.  When the intent of the award is unclear, it is common to use a formula known as a coverture fraction to determine what portion of the shares are subject to equitable distribution.  A coverture fraction is the period of time between when the award was granted and the date of complaint, divided by the period of time between when the award was granted and the date the awards vest.  If for example, RSU’s were granted one year prior to the date of complaint and vest two years after the date of complaint, 12/(12+24) = 1/3 of them would be marital and subject to equitable distribution. 

In addition to the typical requests as it relates to income and compensation, i.e. personal tax returns, W-2‘s, year-end paystubs; in order to determine if the stock options or RSU’s are marital, separate property or subject to a coverture fraction, it is also important to obtain and understand the following documents:

  • Award/compensation statements for each award granted;
  • Detailed schedules showing the respective award, grant date, exercise price (if applicable), and vesting schedules; and
  • Any plan documents that outline why the award was granted.  

If it is determined that the stock options/RSU’s are subject to equitable distribution, there are options for dividing this part of the marital estate as outlined below: 

  • The working spouse can give the non-working spouse other marital assets equal in value to their share of the stock options/RSU’s, however tax implications on the shares must be considered;
  • The vested shares could be sold to generate cash and be divided.  Again, the tax implications for capital gains must be considered;
  • An agreement can be reached where the parties wait until any unvested shares (if determined to be marital) vest and the shares could be sold.  Taxes again will have to be taken into consideration;
  • The employee spouse can hold the options/RSU’s in a constructive trust that outlines the process once the shares vest; and
  • There may be an option where the employer allows for the options/RSU’s to be transferred to the non-employee spouse, although this tends to be rare. 

 

About Kriste Rodriguez

Kriste Rodriguez is a Director in the Forensic, Litigation and Valuation Services Group with over 10 years of experience in business valuations and matrimonial disputes.