This is the third of a three-part series on executive compensation. In our previous articles How Executive Compensation Impacts Divorce and How Executive Compensation is Divided in Divorce, we identified the prominent forms of executive compensation, discussed why they are important in divorce and what makes them so complicated, and how they are generally divided. The purpose of this article is to discuss some of the nuances of how the more common types of executive compensation are valued and divided in divorce
OPTIONS
Stock Options:
There are two types of options: incentive stock options (ISO’s) and non-qualified stock options (NSO’s). ISO’s are a type of compensation that can be granted only to employees (not to board members or consultants). They offer certain tax advantages under the U.S. tax code. Internal Revenue Code. NSO’s are the right to buy company stock at a predetermined price without tax advantages.
Taxes:
ISO’s and NSO’s are not taxed when granted, but the difference between the exercise price and the fair market value at exercise is taxable. As for ISO’s, the difference in exercise price and fair market value is considered a preference item for the Alternative Minimum Tax (meaning it is not subject to income tax but is included in the calculations for the Alternative Minimum Tax). For NSO’s, the difference is taxed at regular income rates, including Social Security and Medicare taxes. For both ISO’s and NSO’s, capital gains taxes are paid when the stocks are sold. The holding period for determining short-term versus long-term gain starts on the exercise date.
Note that several limitations on ISOs can affect taxes: 1) The value of ISOs that first become exercisable in any one year cannot exceed $100,000 per employee (based on the grant date value). Tax purposes treat any options exceeding this limit as non-qualified stock options (NSOs). 2) Employees who own more than 10% of the company’s stock cannot receive ISOs unless the exercise price is at least 110% of the fair market value on the grant date and the term of the option is no more than five years. 3) ISOs typically must be exercised within 10 years from the grant date, or five years for 10% shareholders. If terminated, employees must exercise ISOs within 3 months after termination. If terminated because of death or disability, they must be exercised within 1 year. ISOs can be transferred to the non-employee spouse upon death.
Valuation and Division in Divorce:
ISO’s are not transferable and most NSO’s are also not transferable from the employee spouse to the non-employee spouse. Those which are transferable can be transferred upon vesting to the non-employee spouse and upon exercise the non-employee spouse pays taxes based on their own tax rates. Those not transferable can be exercised by the employee spouse after vesting and the after-tax value based on the employee’s marginal tax rate can be paid to the non-employee spouse.
When it is possible to transfer NSO’s and they are part of a qualified retirement plan, a QDRO will be required to divide the assets between spouses without triggering immediate tax consequences for the recipient spouse.
For NSO’s and ISO’s, the employee spouse can keep all his/her options by valuing the options and offsetting with other marital assets. However, option valuation is not straightforward.
Easiest to comprehend is the option’s intrinsic value, which is the difference between the value of the stock at separation and its strike price (the value at which the stock can be purchased at exercise). Intrinsic value, while easy to comprehend, does not consider future price volatility or dividend rates.
The Black-Scholes method is the most widely used method for calculating option values. It assumes the employee does not exercise the option until the last day possible and it accounts for future price volatility and dividends.
Last the Binomial Method take the Black-Scholes method and creates a tree of possible option values as well as early exercise. It tends to produce a slightly lower valuation than Black-Scholes. It is not widely used nor understood.
STOCK
Restricted Stock:
Shares granted to executives that are subject to certain restrictions, such as vesting periods or performance conditions. Once the restrictions are lifted, the executive fully owns the stock.
Taxes:
Taxed as ordinary income at vesting (unless an 83(b) election is made), with capital gains tax on any subsequent appreciation.
Division in Divorce
Once vested, restricted stock can be transferred in divorce. If not yet vested, the employee spouse can transfer the stock upon vesting but the taxes will be paid by the employee spouse. Thus, it is important to account for the marginal taxes that will be paid upon vesting in their value at transfer.
Valuation in Divorce:
It is sometimes desirable to value the non-vested restricted stock at the time of divorce rather than wait for division at vesting. In this case, valuation will depend on the projected future stock price of the company. There are two methods for valuing restricted stock.
1) Intrinsic Value Method: This method involves calculating the current value of the restricted based on the current stock price, discounted for any remaining time until vesting. The formula might look like this: Intrinsic Value = Number of Restricted Stock Shares x Current Stock Price x Probability of Vesting x Discount Factor. The discount factor accounts for the time value of money.
2) Projected Value Method: This approach first uses a coverture fraction to determine the portion earned during the marriage relative to the total vesting period (unless the restricted stock was granted based on past performance). It then estimates the future value of the restricted stock when they are expected to vest. Projected Value = (Time from grant date to separation date / Total vesting period) x Number of shares x Projected Stock Price at Vesting x Probability of Vesting x Discount Factor and then delete the third point altogether. Note: future stock price projections are often speculative and need careful consideration.
Restricted Stock Units (RSU’s):
RSUs are a promise to deliver shares of stock (or the cash equivalent) at a future date, once certain conditions (like vesting) are met. They do not represent actual shares upon grant. Once vested, the RSU’s convert into actual shares. Dividends may be paid on unvested units and some plans accrue dividends and pay at vesting.
Taxes:
Employees are taxed when the RSUs vest and convert into actual shares. The fair market value of the shares at vesting is considered taxable income. Unlike restricted stock, there is no 83(b) election available for RSUs.
Division in Divorce:
RSU’s are generally not transferrable. The employee spouse will have taxes withheld at the time of vesting. There is precedent that allows the employee spouse to issue a 1099 to the non-employee spouse. This is so that the non-employee spouse can later pay taxes at his/her rate. It is based on a number of cases where taxpayers obtained a private letter ruling from the IRS that approves this practice. However, exercise caution, as the practice may not hold up in an audit. Also, if an employee spouse issues a 1099 for the amount of stock transferred, the employee spouse must still pay the social security and Medicare taxes. They should be compensated for that by the non-employee spouse.
Valuation in Divorce:
Same as for restricted stock.
Performance Stock:
Shares granted based on the achievement of specific performance targets. These targets can be financial metrics, such as earnings per share (EPS), or non-financial metrics, such as customer satisfaction scores.
Taxes:
Same as with restricted stock units.
Division and Valuation in Divorce:
Same as with restricted stock units.
Performance Stock Units:
Similar to restricted stock units but vesting is based on meeting performance standards, not the passage of time.
Taxes:
Same as with restricted stock units.
Division and Valuation in Divorce:
Same as with restricted stock units.
Deferred Compensation:
Earnings that are set aside to be paid out at a later date.
Taxes:
Taxed as ordinary income in the year of payment.
Valuation and Division in Divorce:
You must calculate the present value of future payments, and then either offset the value or defer the distribution to the non-employee spouse until the payments go to the employee spouse. In an offset, and in cases where you consider after-tax asset values, you should adjust the present value based on the non-employee spouse’s expected marginal tax rate at the time of distribution.
Summary and Conclusion
Executive compensation can represent a substantial asset in divorce. Future executive compensation can also be a sizeable amount of income on which to base support. Thus, it is crucial to understand whether various compensation types exist. When they can be transferred, how they will be taxed at transfer. And how they might be valued if they are not transferable or if waiting for a transfer is undesirable. Adding a Certified Divorce Financial Analyst® that is trained and experienced in identifying and valuing executive compensation to the divorce team is critical. Whether they work directly with a client as a mediator or consultant or in conjunction with the client’s attorney.
Take Control of Your Future
When you consider divorce, one of the biggest realities for those in the divorce process is the financial settlement and financial analysis post-divorce. Get the assistance of Berni Stevens, a Mediator and Certified Divorce Financial Analyst® (CDFA®.)
Berni provides step-by-step guidance on matters related to divorce. With a wide range of experience and expertise related to divorce issues. Berni will simplify the process and provide much-needed clarity in areas such as long-term tax consequences, asset, and debt analysis, dividing pension plans, continued health care coverage, stock option elections, protecting support with life insurance, and much more.
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
When you consider divorce, one of the biggest realities for those in the divorce process is the financial settlement and financial analysis post-divorce. Get the assistance of Berni Stevens, a Mediator and Certified Divorce Financial Analyst® (CDFA®.)
Berni provides step-by-step guidance on matters related to divorce. With a wide range of experience and expertise related to divorce issues. Berni will simplify the process and provide much-needed clarity in areas such as long-term tax consequences, asset, and debt analysis, dividing pension plans, continued health care coverage, stock option elections, protecting support with life insurance, and much more.
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
When you consider divorce, one of the biggest realities for those in the divorce process is the financial settlement and financial analysis post-divorce. Get the assistance of Berni Stevens, a Mediator and Certified Divorce Financial Analyst® (CDFA®.)
Berni provides step-by-step guidance on matters related to divorce. With a wide range of experience and expertise related to divorce issues. Berni will simplify the process and provide much-needed clarity in areas such as long-term tax consequences, asset, and debt analysis, dividing pension plans, continued health care coverage, stock option elections, protecting support with life insurance, and much more.
Whether you’ve decided to do it on your own or are preparing to work with TruNorth Divorce, there are several things to consider before filing. While there are extensive and pragmatic ways to financially prepare for divorce, much of the emotional preparation is up to you and the daily choices you make during the duration of the proceedings. This guide offers 5 ways to best approach the emotional side of divorce and prepare you for what can be a traumatic event.
The trauma associated with separation, however, is somewhat unique in that it can be planned and prepared for with some healthy amounts of patience and consistency. If you can respond from a more emotionally stable place, you’re going to be able to make healthier decisions in regards to the divorce.
1. Taking Care of Yourself During a Divorce
First and foremost, slow down, pump the breaks, and center yourself by taking care of you. While the phrase has been distorted by Instagram influencers, self-care applies to divorce too. Self-care encompasses the daily rituals or routines we practice in order to nourish ourselves. This includes the messages we send ourselves when we make choices about what goes into our bodies and minds.
Prepare for your divorce by by empowering yourself to make practical daily choices when it comes to your health and wellbeing. This reinforces your sense of self-worth. More reliable than high self-esteem, a strong sense of self-worth allows you to navigate the obstacles and stressors that often arise with divorce more easily.
Things to Do Before Filing For Divorce
So, stock up on fresh foods, arm yourself with supplements that will assist your immune system and combat stress and tell yourself you’re worthy of being taken care of. Find a physical outlet that allows you to let loose, the sillier and more recreational the better.
Setting even 5 minutes aside every morning to meditate can literally be the difference between feeling capable of handling the day or not. Last, do this on a cadence that works for you. The idea is to be compassionate with yourself; you are, after all, going through a divorce.
2. Accepting the Divorce Process
Our strongest cause of suffering is the attachment to our ideas of what should be happening, what we shouldn’t be doing, or most often than not, what someone else should be doing. These elements are entirely out of our control, especially during separation and divorce mediation, and when we cling tightly to a specific outcome, we suffer when our reality doesn’t match up to our expectations.
In the case of court proceedings with divorce lawyers, there isn’t an emotional “winning” or a “losing.” There is only finding the solution that will benefit both parties, children included, for the future. This requires letting go of the narrative of what happened or what your spouse did wrong.
Self Compassion & Divorce
Easier said than done, acceptance is a daily choice. With an attitude of acceptance, however, you can be aware of your triggers and prepare for the subjects that are touchy before the courtroom. Knowing what your triggers are ahead of time and communicating them with your divorce lawyers can save you a lot of self-loathing and feeling emotionally out of control.
The point is that you are human, and this is a process, one where you will move between stages of denial, isolation, bargaining, rage, and depression before you can fully accept the reality of the divorce. Accept you will have bad days and accept you may need to cry in order for your body to have a release. After accepting it, you can focus all of your attention on beginning your new life.
3. Focus Your Attention on the Divorce In Spurts
There can be a trap of fully immersing yourself into the doom and gloom of divorce papers and landing in a click bait circle of misery. While it is important to research what to expect in a divorce separation in order to fully understand the process, healthy boundaries still apply. An example of a healthy attention goal could be no divorce talk after 6pm. Strive to not allow the divorce to become a defining stick of furniture in the living room of your life; this is not the end, your life is not ruined, and it will ultimately be okay.
There are a myriad of tips on how to prepare financially for divorce, but from an emotional perspective, the object is to not create a story where you are a victim, powerless to choose how you feel. Choosing what you focus your attention on, and away from, can help you feel more empowered throughout the divorce.
4. Preparing for Separation If You Have Children
When it comes to emotionally preparing for divorce, often the greatest anxiety among parents is how this decision will affect their children. This anxiety may not go away for several years, but rest assured to know there are no perfect parents and no one knows exactly the right thing to say all the time. However, as long as you are willing to talk about the divorce and are emotionally available for their fears and concerns, you’re on the right track.
Some key guidelines are not disparaging your spouse in front of them, or using them as a source of sympathy to your stressors; they aren’t the therapist you need to vent to. Another good rule to follow is to not lie to your children about what’s going on. This only further complicates the situation, and will ultimately lead to your child resenting you or feeling as if they’ve been betrayed.
It’s best to keep things as honest as possible while also bearing in mind that your child’s age will have a lot to do with how they handle such a large change. If you feel challenged by talking with your children about divorce, there are a ton of great resources and self-help books that can provide valuable scripts on how to best communicate the changes that come with divorce.
5. Find Divorce Support
Your separation and unlimate divorce can be a tumultuous and incredibly grading stressor on your sense of well-being, not to mention the necessary grief that comes with mourning your previous life. Intentionally seek out support before, during, and after your divorce, even if it means fighting through the uncomfortable feelings of being vulnerable or feeling like you’ve messed up.
There’s nothing shameful about joining a Meetup or support group and talking to others who are also going through a divorce. In fact, having conversations with fellow divorcees can help you feel less alone and far less alienated throughout the divorce process.
Another essential way to prepare emotionally for divorce is to ask your friends and family if they have any referrals for a therapist or contact your insurance company to find out if your policy covers mental health; even if it’s only an online therapist, it’s wise to have a professional guide you through what can ultimately be a traumatic event.
TruNorth Divorce Can Help
These are just some ideas to consider when emotionally preparing for divorce. Taking care of your body and mind first and foremost, like putting on your oxygen mask on a plane before anyone else, allows you to approach the divorce with a greater sense of self-worth and stability.
Use these five best practices to make sure you are emotionally prepared for your separation, before it traumatizes you. If you need some extra assistance, we’d love to hear from you in the comments section. We’re also on Facebook, and if you want to learn more about divorce or want to explore your options, which includes my free ebook, reach out to me. TruNorth Divorce Solutions can help you.
“Divorce is Not for Wimps” is about the realities of divorce and how it too often leads to painful and long-term emotional, financial, social, and parenting consequences. Unless you’re made of steel, pain in divorce is unavoidable. Long-term trauma can be mitigated if you assume the position of a winner or champion in your divorce. There is, of course, no true winning in divorce but there is surviving, mitigating damage, and putting you and your family on track for a better future.
Whichever end you’re on—initiator or responder—you need to decide that divorce will not define you. At the same time, it’s going to be a dominant force in your life for a bit. That bit of time may be short or quite long depending on your circumstances and how you manage the process.
So, what are the essential steps?
Acknowledge that you can’t do it alone. Build your support team. Initially, it might be your best friend and sister or mother. But don’t stop there! Your best friend can’t fix this for you—they don’t have the skills or knowledge.
Build your divorce team. You need emotional, psychological, financial, and “legal” help. A divorce coach, therapist, divorce financial planner, parenting coach, mediator, real estate and mortgage professional who specializes in divorce and maybe a lawyer
Stop burdening your family, friends, and children. Especially your kids, whether young or adult, don’t want to shoulder your divorce! If they are young or teens, you can create long-term damage for them. Your family and friends will be there for you, ask questions, call to check in, but they can not fix this for you and trashing your soon-to-be-ex is going to grow very old very fast.
Get organized. Gather your financial statements, tax returns, trust documents, will, insurance policies, business documents and financial reports. Put them in a safe place (electronically or physically).
Develop a plan. Do NOT pick up the phone and call a lawyer! You are setting yourself up for an unnecessarily miserable and expensive divorce. Call a divorce coach, a divorce financial analyst, a mediator. Make a plan to champion your divorce. It does not start with an attorney, even if eventually you need the services of a lawyer to deal with a contentious divorce.
You got this. It’s going to be hard but you can do it and you’ll be glad you took charge.
