Years ago, only highly compensated executives were the benefactors of lucrative benefits such as stock options, but now many rank and file have significant wealth through employer incentive compensation plans. Over 15 million employees have stock options and restricted stock plans, and this number is expected to balloon in the coming years.
Corporations are desperate to motivate, boost morale, spur productivity and retain their best talent, but are short on cash due to COVID-19. Compensation committees are turning to incentive compensation plans to help bridge the gap and make up for the smaller cash bonus that will be paid in 2020 and 2021.
One challenge with this type of compensation is that in a divorce, the employee can easily “forget” to include the details of the incentive compensation package, leaving their spouse oblivious to their existence. Determining if your spouse has an incentive payment scheme in addition to a base salary is not always easy. Stock options and restricted stock do not appear on tax returns, W-2s, or other financial statements unless the employee spouse exercises the options, or the restricted stock is vested in that tax year. It can be like finding a needle in a haystack.
Davon Barrett with Francis Financial is a retained expert for divorce financial analysis. He often works with women who do not have a full understanding of the family finances and are concerned about outliving their income and assets after a divorce. “Often I will work with the spouse who may not have been involved in the financial details during the marriage,” Barrett says. “Being able to help them to identify and understand what assets exist puts them in a much better position to negotiate an equitable divorce settlement.”
What Are Stock Options?
Stock options give the employee the right to buy a share of company stock at a particular price at a future date. By locking in a purchase price for the stock now, the employee can make a nice profit in the future, assuming the company performs well and the share price increases.
Many companies offer employees stock options that will vest after the employee has worked for the company for a certain number of years. Typically, when the company grants the stock options, they come attached to a vesting schedule that dictates when the employee can exercise the stock options and buy the underlying stock. This “golden handcuffs” agreement rewards the employee for helping drive up the stock value and can make leaving for another job financially irresponsible.
What Is Restricted Stock?
Restricted stock is a form of executive compensation that has become even more prevalent than using stock options to incentivize employees. With restricted stock, shares of the company are issued to employees as additional compensation. Like stock options, the role of restricted stock may be to retain the employee and encourage them to produce results that will drive up the stock price. The shares may also be subject to a vesting schedule, handcuffing the employee to the company. If the employee is terminated for cause or leaves their job willingly, the entire portion of the shares not vested may be forfeited.
For example, an employee might receive 10,000 restricted stock units as part of their annual bonus. The employer is using their shares to buy the employee’s loyalty, and the goal is to motivate the worker to stay with the company for the next five years.
The vesting schedule may look like this:
- Year 2: 2,500 shares vest
- Year 3: 2,500 shares vest
- Year 4: 2,500 shares vest
- Year 5: 2,500 shares vest
If the employee leaves the company after Year 4, only 7,500 units awarded as part of their annual bonus would be vested, and the other 2,500 would be forfeited.
Following Breadcrumbs to Find the Bread
As part of the discovery process in a divorce, your legal counsel should be sure to ask about employer stock plans and insist that they are included in the Statement of Net Worth and/or Financial Disclosure Statement provided to the court. Discovery demands and depositions (questions asked of your spouse under oath) are also mechanisms to find employee stock plans. If you are concerned that your spouse is not willingly sharing these valuable assets and income, you should ask your lawyer how to locate this information.
It may make sense to have the employee-spouse sign an authorization for the employer to release all documents related to your spouse’s compensation to your lawyer, including the stock plans and grants. If the employee will not sign such an authorization, then your attorney may need to subpoena the employer after other discovery mechanisms have been utilized.
Lisa Zeiderman, a matrimonial attorney, Certified Divorce Financial Analyst and Certified Financial Litigator, works with many high-net-worth clients with significant wealth tied up in employer stock plans. Zeiderman advises: “Be sure to retrieve all compensation documents. It is imperative to work with a matrimonial attorney who understands this complex compensation structure, the taxation issues, and has the ability to analyze what portion of the compensation is incentive-based versus compensation for past services. Be sure to retain an attorney who will have your back and who will strongly and strategically advocate for your fair share. The cost of smart litigation can pay off significantly if handled by the right attorney.”
There is much you can do to determine if your partner is hiding an employer stock plan and ensuring that you receive a fair distribution of those assets. Employers must give a Plan Document and Summary Plan Description to all employees who participate. This document details the program benefits and how the plan works. Employees also receive an award letter when the stock options or restricted stock are granted along with a schedule of the grants. The time when your spouse would have received this is right around when they meet with their manager for their annual review and get their compensation details for the next year.
Many employers also produce an annual statement of employee benefits, and this equity compensation is usually included. The employee manual can also provide clues as to whether a plan exists. Some companies post details about their incentive compensation plans online, making Google your new best friend.
As part of the discovery process, be sure to have your attorney request the following documents from your spouse:
- Plan document and summary plan description, including the stock option or restricted stock plan document and all amendments.
- Award letter or email, telling when stock options or restricted stock was granted to the employee.
- Schedule of grants, including grant date, the number granted and vesting period. You will also want to ask for the strike price and expiration date for stock options.
- Annual statement of employee benefits.
- Transaction history of past exercises.
- Employment offer letter and employment contract.
- Employee manual.
Division Can Get Messy
Typically, an employer plan does not allow stock options or restricted stock to be transferred to another person, even if they are divorcing the employee. In some cases, it is best to have the employee spouse keep the stock and buy out the other spouse’s interest based on the shares’ current value. This strategy seems quite straightforward, but the devil is in the details. “Uncle Sam will be knocking on the employee spouse’s door when they eventually exercise their shares or options,” Barrett cautions. “The proceeds will be taxed at sky-high ordinary income levels and, depending on the tax bracket, the employee could pay upwards to 40% or more of the value in taxes.”
Some couples will instead elect to hold the shares until they vest. Once they are exercised, the after-tax proceeds are distributed as per the agreement provisions. Again, tax considerations are key with this strategy. Zeiderman weighs in: “Too many divorcing spouses leave money on the negotiation table because their team of experts did not advise them properly about the adverse tax consequences of dividing incentive compensation. Be sure to get a clear picture of your choices and the pros and cons of each before you sign on the dotted line. Additionally, if you are the spouse holding the shares, be cautious of any buyout; it may be best to have an agreement that provides your spouse only receives the shares if and when, with a tax true-up to be sure that you are reimbursed for any taxable consequences.”
President & CEO, Francis Financial Inc.
Stacy is a nationally recognized financial expert and the President and CEO of Francis Financial Inc., which she founded 15 years ago. She is a Certified Financial Planner® (CFP®) and Certified Divorce Financial Analyst® (CDFA®) who provides advice to women going through transitions, such as divorce, widowhood and sudden wealth. She is also the founder of Savvy Ladies™, a nonprofit that has provided free personal finance education and resources to over 15,000 women.