How Are Stocks Divided in a Divorce?

Everyone knows that one aspect of a divorce is dividing marital property, known in Maryland as the equitable distribution of property. The fundamental rule is that all property acquired by either spouse during the marriage (with narrow exceptions) is considered “marital property.” Accordingly, that property must be divided equitably between the spouses in a divorce. (“Equitable” means that assets are divided in a way that is fair under all the circumstances, and may not be strictly equal; however, an equitable decision usually ends up being close to equal.) One issue our clients often wonder about is how to divide stock in divorce. Let’s discuss some of the common questions we receive on this topic.

I bought some stock before I was married. It’s worth a lot more now. Is the appreciation of the stock marital property?

Stock that you bought before marriage is your separate property. Unless you commingled it with marital assets, it remains separate. The appreciation of the stock should be separate too, because appreciation of stock is “passive” appreciation; that is, you and your spouse didn’t actively do anything to cause the stock to appreciate. “Active” appreciation, like the increase in value of a house due to updates, is more likely to be considered marital property.

My spouse went to work for a startup shortly after our marriage and her company gave her stock options. Am I entitled to any part of them?

Probably. A stock option is a kind of employment benefit in which the employer offers the employee the option of buying company stock at a future date, either at a discount or a stated fixed price. Stock options are easy to overlook as property in a divorce, but they can be very valuable.

With stock options that have not yet been exercised, the first thing to figure out is, “Are they marital property?” Usually, options granted during the marriage are considered marital, but what matters most in this case is when they were earned. This can be complex to determine.

The second question to ask is whether the stock options are vested or not — that is, whether your spouse is able to exercise the options right away, or whether she must wait a certain period of time, known as the “vesting period.” In Maryland, stock options can be subject to equitable distribution whether they are vested or non-vested.

The third thing to think about is how the options will be valued. You could, for instance, subtract the price of the option from the current value of the stock. This is called the “Intrinsic Value Method,” and it is often used in Maryland. However, there are other ways to value stock options, such as the complex Black-Scholes model, coverture fraction, or simply agreeing on a value. Agreeing is the simplest option, but be warned that if you agree to a value that later turns out to be far less than the true value of the stock options, you will not have any recourse.

How do stock options get divided in a divorce?

Once you have decided what the stock options are worth, you need to decide how the non-employee spouse will get their share of the values. The employee spouse typically cannot just assign or transfer half of the stock options to the other spouse. Companies usually offer stock options as a benefit to entice employees to stay with the company and the great majority of businesses prohibit transfer of the options to someone else.

However, the employee spouse doesn’t need to transfer the options — just their value. There are several ways to do that. Let’s say the stock options are valued at $75,000. The simplest thing to do is to allow the employee to keep the stock options, and the non-employee spouse to take some other assets worth the same amount. This can get complicated, though, because of tax consequences.

As an alternative, the non-employee spouse could take deferred distribution. In that situation, the non-employee spouse gets paid once the employee exercises the option. This “wait and see” approach eliminates the need to decide what the options are worth at the time of divorce. There is a caveat: if divorcing spouses choose this method of distribution, the settlement agreement should include provisions to protect the non-employee spouse’s interests, including notifying them if the employment terminates, if any of the options are exercised, if the vesting period accelerates, or if the options are repriced.

What are the tax implications of dividing stock options in divorce?

As soon as the value of a stock option is realized (through exercise of the option), income taxes will be incurred. Tax implications will depend on whether options are “statutory stock options” (also called “qualified stock options”) or “non-statutory (“non-qualified).

Statutory stock options get more favorable tax treatment than non-statutory options. However, when statutory options get transferred, they lose that favorable status and are treated as non-statutory. That said, when the employee with the stock exercises the option and then transfers the stock they acquired by doing so, there is no such negative tax treatment.

Another option is for the divorce settlement to specify that the employee spouse will hold the options for the benefit of the non-employee spouse, and will exercise the option at the non-employee spouse’s direction. In that case, because exercise of the option is a taxable event, the non-employee spouse should receive the proceeds MINUS the amount owed in taxes on the exercise of their share of the options.

Dividing stock options in divorce can be a major source of dispute, especially in high net worth divorces. It is a complex issue that many divorce attorneys rarely deal with. If you or your spouse have stock options, it is important that you work with a divorce attorney who is experienced in these matters. We invite you to contact Strickler, Platnick & Hatfield to schedule a consultation if you want to learn more about how to divide stock options in divorce.