In our previous article, “How Executive Compensation Impacts Divorce,” we presented the types of executive compensation that should be considered for purposes of marital property division, as well as future income that should be included for support calculations. This article will examine the basics of dividing executive compensation. We begin by identifying several key aspects of executive compensation in divorce.
Identifying the Marital Portion
In most cases involving divorce, we must first determine to what extent the compensation is marital and subject to division. In all cases, if the compensation was awarded and vested during the marriage, they are 100% marital. If awarded but not vested, we must first determine the extent the award is based on past service vs. future performance. To the degree based on future performance, that portion would be considered separate property. To the extent that there are no plan-specific rules regarding the division of benefits, coverture fractions are used to determine the percent marital.
Applying Coverture Fractions
Coverture fractions based on past performance are based on the Hug formula. The numerator (marital service credit) represents the total number of years or months during which the retirement benefits were earned or accrued while the spouses were married. This includes the period from the date of marriage to the date of separation or divorce filing, whichever is applicable. The denominator (total service credit) represents the total number of years or months that the spouse worked or accumulated service credit that counts towards the retirement benefit. Up to the present date or retirement date. Calculate the marital coverture fraction by dividing the numerator (years of marital service credit) by the denominator (total years of service credit).
Coverture fractions based on future performance are based on the Nelson formula. The numerator (period of marital service) represents the period during which the spouse earned or accrued retirement benefits while the marriage was intact. This typically starts from the date of marriage to the date of separation or divorce filing, depending on state laws. The denominator (total period of service) represents the total period during which the spouse worked or accumulated service credit that counts towards the retirement benefit up to the present date or anticipated retirement date. Calculate the marital coverture fraction by dividing the numerator (period of marital service) by the denominator (total period of service).
Divide or Offset?
Most executive compensation cannot transfer directly to the non-employee spouse. Even if it can be, it may not be advantageous to transfer it at the time of vesting or payment. In these cases, we need to be able to provide a value for the portion earned during the marriage so that the employee-spouse can keep the compensation while the non-employee spouse receives other assets to compensate. Valuation, however, is not always a straightforward exercise.
Tax Considerations
When transferring to a non-employee spouse, we need to adjust for the taxes paid at the time of vesting or exercise. Depending on the plan, the recipient’s marginal tax rate applies to some transfers when exercised. Only the employee spouse can exercise others, using the employee spouse’s marginal tax rate at vesting or exercise.
Attorneys may subpoena the employee spouse’s company or the employee spouse can provide documents that are necessary to determine if the executive compensation is based on past or future performance, granting conditions and vesting schedules. Request the following documents:
- Compensation plans and all amendments
- Grant agreements and all amendments
- All correspondence (letters, memorandum, emails) relating to grants
- Summary plan descriptions
- Annual statements of employee benefits
- Employee manuals the describe employee’s right to benefits
- Employment contract or offer letter
- Beneficiary designation forms
- Employee’s employment file
- Valuations conducted for IRC Section 409(A) purposes or other purposes
- Employee’s W2’s
In our next article, we will look at some of the nuances of handling executive compensation across the more common types of executive compensation.
Take Control of Your Future
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