How do you divide RSUs in a Divorce in Massachusetts?
When going through a divorce, the division of RSUs (Restricted Stock Units) can often arise. RSU is a type of deferred compensation. Deferred compensation is any income that is earned at a future date in addition to an employee’s regular compensation, and, although this blog is going to be focused on RSUs, there are a number of different types of deferred compensation to be aware of when going through a divorce:
- Nonstatutory (or Nonqualified) Stock Options (NSO, NQOs, NSSOs – all mean the same thing)
- Incentive Stock Options (ISOs)
- Restricted Stock Awards (RSAs)
- Restricted Stock Options (RSUs)
- Stock Appreciation Rights (SARs)
- Performance Shares
- Performance Units (PSUs)
Is an RSU the same as a stock option?
Many people confuse RSUs and stock options, so it’s important to know the difference between a stock option and an RSU since they have some similarities but other important differences.
A stock option is the ability to buy a stock at a certain set price, but that does not mean the holder of the option has to buy or will buy the stock.
RSUs are a promise from an employer to issue shares of employer stock once certain conditions have been met that usually vest over a period of time. They are usually provided as an incentive to keep an employee through at least the vesting period, which also gives the employee an objective to perform well as their performance can help increase the stock value.
The restrictions usually are related to the length of the employee’s employment with the company or with the company’s or the employee’s performance goals (or a combination of both), and there may also be limitations on the employee’s ability to sell or transfer their shares.
RSUs are similar to stock options, but have some differences also. If the stock price declines significantly, a stock option can lose all its value as the options are viewed as “underwater” and the exercise price is higher than the stock price. However, with RSUs, even if the share price falls after they are granted, the RSU always has some value (unless the stock price itself falls to $0). With a stock option, you do not lose the value of the stock (even if it is a negative value). With an RSU though, if you leave the company or do not meet any other requirements associated to the RSU, any unvested RSU that you’ve received is almost always forfeited. There may be exceptions to this depending upon the RSU agreement, so if you have a case where RSUs are potentially at issue, make sure you ask for the RSU agreement within discovery.
Tax Issues Relating to RSUs
RSUs are not taxed when they are granted, but, instead, are taxed at the time that they vest. (For example, if 100 shares vest at $20 per share, the value of $2,000 is taxable to the employer and the associated taxes are usually withheld by the employer. Typically, any income earned or taxed relating to RSUs will be seen in the employee’s paycheck and W2. However, another common way a company can cover the withholding taxes is to withhold some of the vested shares. If RSUs are at issue in your case, it’s important to understand this as it effects how the language associated with the division should be drafted.
Another important thing to note is how long the shares are held after they vest before they are sold. If the shares are held for more than one year after they vest, any increase in the stock price between the value of the stock at the vesting date to the actual sale price is taxable as long-term capital gains. If the shares are held for less than a year, then any increase in value is taxed only as a short-term capital gains.
NOTE: On a Financial Statement, RSUs that have not vested still need to be disclosed but, as there is no value until those shares vest, it would be appropriate to list a value of $0 with an explanation in the footnotes of how many shares are held and what the vesting schedule is. If RSUs have already vested, then an actual value can be calculated, which should be recorded within the deferred compensation section of the financial statement.
What is a typical vesting period for RSUs?
Every company has the right to create a vesting period that they see fit. To be able to provide an example, however, Company ABC has provided its new employee with an RSU Agreement that grants the employee 10,000 RSUs (the shares of the employer’s stock) that vests over 4 years at a rate of 25% per year. At the time of the grant, the share value is $10 per share.
- At Grant: The total pre-tax value of the RSUs is $100,000. (However, none of this is taxable income because they have not yet been earned – i.e. the conditions to actualizing the RSUs have not been met yet.) That means that this entire amount is nothing more than hypothetical income – that does not mean it should be ignored however, because, so long as the conditions are met, the RSUs turn into realized income.
- Year One: 2,500 shares vest (25% of the original 10,000). If the stock price increased to $15 per stock at the time this first group of shares vest, the employee currently has taxable income in the amount of $37,500 (2,500 shares x $15/share) related to the shares or stocks that have just vested – the remainder of the shares (7,500 are there, but have not yet vested, so they have absolutely no actual value currently).
- Year Two: The next 2,500 shares vest. The share price has now increased to $30 per share, so the taxable income relating to these vested shares is $75,000. (If the employee had not sold the prior shares and did so now, the increase in value would be treated as long-term gains once that year holding mark hits, which usually can save a significant amount in taxes (always check any tax issue with your specific tax advisor though).
- Year Three: The next 2,500 shares vest. However, now the stock price fell to $10/share. So, the taxable income is only $25,000. (If the employee was still holding the stock from previously, and sells at a lower rate, there may be a loss that is able to be reported based on the amount taxes were previously paid on – again, check with your individual tax advisor).
- Year 4: The final 2,500 shares vest, and the stock price at vesting is now $40 per share. The taxable income for that final vesting is $100,000 (2,500 x $40)
From this example, the original “value” of the 10,000 shares at the time they were granted was thought to be $100,0000, however, assuming the shares were realized at the time they vested for this example, the realized value over the four years was actually $237,500.
In contrast to this example, a company may instead use “cliff” vesting. This is when 100% of the shares vest all at once after completing a specific period of service or specific performance goals. It’s not uncommon to have some sort of combination of vesting schedule. Again, always ask for the RSU Agreement to know what is at play in the specific case you’re dealing with.
Dividing RSUs within a Divorce in Massachusetts
Dividing RSUs within a divorce can be tricky because stock values change constantly and the price does not become fixed until the employee spouse decides to exercise his/her options and cash out the stock or until the RSU actually vests. Both of these issues must be considered within a divorce.
There are two primary ways to divide RSUs within a divorce:
- Buy-out: The employee spouse keeps the RSUs and buys the other spouse’s interest out based on whatever the current value is.
- Deferred Division: 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. This could be by transferring the stock to them directly, requiring the sale, or the holding spouse buying out the other spouse at each interval as the RSUs actually vest.
Questions to ask if the case involves RSUs in a Massachusetts Divorce:
- When was the RSU award granted?
- What is the vesting schedule?
- What is the vesting criteria? (Do they vest over time and/or are they contingent on meeting certain performance metrics?)
- Why was the RSU awarded? (Past performance or future performance)
- Can the RSU be transferred? (Most cannot)
Massachusetts Case Law involving Stock Options and RSUs
Baccanti v. Morton (2001) – Held that unvested stock options can be divided as assets in a divorce, but that it might be unfair to treat unvested stock options received just before a divorce became final as an asset, where the employee spouse may be required to work a number of additional years before the value of the stock could be recognized. In order to make it fairer, the Court established the “Baccanti Formula.”
Wooters v. Wooters (2009) – Held that the ex-Husband’s stock options were considered income for purposes of calculating alimony following the parties’ divorce. (Holding that if they were not considered as income for alimony purposes, a person could potentially avoid his/her obligation simply by choosing to be compensated in stock options instead of by salary). Note: This case dealt with stock options that were exercised by the Husband years after his divorce and were not divided as a marital asset within the divorce.
Ludwig v. Lamee-Ludwig (2017) – Combined the reasoning of Baccanti and Wooters while dividing stock options and RSUs in divorce cases by holding (1) that the calculation date under Baccanti is the date of the divorce (not the date of the parties’ separation or the filing date of the complaint for divorce) and (2) Stock Options excluded from division under the Baccanti Formula can be considered future income for payment of alimony or child support.
Example of the Baccanti Formula at work:
The Baccanti Formula divides shares that vest during the marriage differently than shares that vest after the marriage, taking into consideration that the employee spouse still needs to perform and meet future requirements that were not met during the marriage period and, therefore, should receive a higher percentage of the shares.
If the stock has vested prior to the date of the divorce, then 100% of the vested shares value is considered a marital asset and should be divided (usually in a 50/50 manner).
Utilizing the same RSU example from above (10,000 RSUs over a four-year period with 25% vesting per year), let’s say that the divorce takes place after the first-year vesting schedule.
At the time of the divorce, the first 2,500 shares have vested for $37,500. This amount is a marital asset divided a 50% to each spouse (assuming a 50/50 division is equitable for this example). The remaining 7,500 RSUs have no current value as the employee still needs to fulfill their requirements to meet the terms of the vesting schedule.
The Year Two award would have spent one year during the marriage and one year after the marriage prior to vesting, meaning that 50% of the total value would be divided as a marital asset. Pursuant to the Baccanti Formula, only 50% of the value, however, would be considered a marital asset and divided. The employee spouse would receive a total of 75% of the value while the non-employee spouse would only receive 25%.
The Year Three award spent 1/3 of the vesting period during the time of the marriage, meaning only 1/3 of the total value would be divided as a marital asset. This year, the non-employee spouse would receive 1/6th (or 16.7%) of the total amount while the employee spouse retained the remainder.
The final and fourth year award spent 25% of it’s vesting time within the marital period, so only 25% of the shares granted would be divided as marital property. The non-employee spouse would receive 12.5% while the employee spouse would receive 87.5%.
It’s important to note in this example, that the tax issue was not addressed. As the taxes often are withheld from the employee spouse’s pay regardless of whether they actually sell the stock or not, this is an extremely important issue to address or the employee spouse could be left penalized with the entirety of the tax liability.
The amount that was not divided as a marital asset could potentially be viewed as income, however, and subject to being considered in a support modification action. Again, the language surrounding this division within a Massachusetts Divorce Separation Agreement becomes incredibly important for how it can be treated in the future.
Dividing stock options and RSUs within a divorce can be extremely confusing since it is not a simply black and white issue. If you require assistance in dividing RSUs, stock options, or any other type of deferred compensation, an experienced Massachusetts divorce attorney at O’Connor Family Law can definitely help you make sure your interests are protected within this type of division.
When going through a complicated divorce in Massachusetts, you need an experienced high asset divorce attorney to fight for your rights throughout the separation process. The team at O'Connor Family Law is here for you. We'll give you the representation that you deserve because here, you're family. Call (774) 315-4220 to get started now!