Employer Incentives - How to Value and How to Divide

One of the most difficult assets to value and consider in a divorce proceeding are incentives provided by an employer. Not only are these assets, like stock options or restricted stock units, often difficult to value, they may have complicated rules and long timelines around when they can become valuable. These assets also may have substantial potential value and strong emotions associated with them which can contribute to the challenges in divorce.

Employee incentives encompass various forms of compensation that may be contractually provided and/or within the discretion of an employer. There a number of common employee incentives that should be clearly understood if they are part of your divorce.

Bonuses

A bonus is additional compensation awarded to an employee based on various factors, including performance, company profitability, and individual contributions. They can take the form of cash bonuses, stock options, or other incentives (see other descriptions below). When thinking through a bonus in divorce, it is important to consider whether the bonus is an asset to be addressed in property division or part of ongoing income to be addressed in the cash flow analysis. The easiest way to differentiate between these options is to evaluate the timing of the bonus. Here are some common types of bonuses:

• A year-end bonus is a discretionary or performance-based bonus awarded at the end of the fiscal year which may not be paid or transferred to the employee until a later date. If the year-end bonus was awarded for a period of employment during the marriage, regardless of when it is paid, it is likely an asset. If the bonus was awarded for a year in which the parties were married for only part of the year, it may be considered both partially an asset and partially as ongoing income. Once an earned year-end bonus has been paid and addressed in the property division of the divorce, additional bonuses moving forward are likely considered in the cash flow analysis.
• A performance bonus is an incentive payment tied to specific performance or goal. If the performance bonus was awarded for specific performance or meeting a goal during the marriage, regardless of when it is paid, it is likely an asset. If awarded for specific performance or meeting a goal after the divorce, then it may be considered part of income in a cash flow analysis. Once an earned performance bonus has been paid and addressed in the property division of the divorce, additional performance bonuses moving forward are likely considered in the cash flow analysis.
• A signing bonus is a lump-sum payment offered to new hires as an incentive to join the company. If a signing bonus was received during the marriage, it is likely an asset. If received after the divorce, the bonus may be looked at as unusual or irregular income in the cash flow analysis.
• A retention bonus is a payment or ongoing payments designed to retain key employees over a specified period. If a retention bonus was received during the marriage, it is likely an asset. If received after the divorce, the bonus may be looked at as unusual or irregular income in the cash flow analysis.

In summary, regardless of the type of bonus, if it was already earned at the time of divorce, it is likely treated as an asset in property division.

Equity Compensation Units

Another common employee incentive are equity compensation units. Here are the common types of equity comp:

• Stock Options, which are rights to purchase a specified number of shares of company stock at a predetermined price, known as the exercise or strike price, within a certain timeframe. An employee can be awarded stock options at different points in their employment and for various reasons. There are two main types of stock options, including:
  • Incentive stock options (ISOs) that are offered to key employees or upper management as part of their compensation package, providing potential capital gains tax advantages if certain conditions are met.
  • Non-qualified stock options (NSOs or NSQOs) are typically offered to a wide range of employees, with no special tax treatment (taxed as ordinary income) and more flexibility in terms of exercise.
• Restricted Stock Units (RSUs) are grants of company stock that vest over time, subject to certain conditions such as continued employment or performance goals.

Valuing options and RSUs of employee incentives can be complex due to factors such as vesting schedules, market conditions, and tax implications. Many of these incentives vest over a period of time, commonly 3 to 5 years. And% some may have exercise periods that are limited or overlap with other incentive grants making a current valuation difficult. Options that have not yet vested may have limited or no value at the time of divorce. And fluctuations in stock price also makes valuation difficult. Understanding the vesting schedules and exercise periods associated with options is important in a divorce. In order to accurately assess the value of these options, you should obtain documentation showing each grant of options or RSUs. Map out the vesting period for each grant so you can determine the number of shares or units that were granted during the marriage. On the one hand, this analysis can be very complicated.

Here is a proportionate example of a way to share stock options.

The tables above outline the proportion of shares that were granted during the marriage and differentiates between the vested and non-vested shares. The separate shares typically stay with the employee spouse and the marital shares can be shared, often divided equally when/if they vest. This is a way to recognize earnings during the marriage but still provide the employee spouse to benefit from vesting and additional grants after the divorce.

It is important to note that stock options, RSUs and other such incentive assets cannot usually be transferred to the non-employee spouse. Rather, if the agreement is to award the other spouse some of these incentives, it is usually granted in a “constructive” manner. This means that the divorce order dictates the options or units awarded to the other spouse and the employee spouse needs to provide all documentation to the other spouse. When the options or RSUs vest and are exercisable, then the other spouse is given the same opportunities to exercise the options or obtain ownership of the shares once provided. This arrangement requires ongoing communication between the spouses and requires the parties to stay in touch through the end of the vesting period of all shared grants. This often means staying connected 3-5 years post-divorce. While there are challenges and complications with this type of arrangement, it is the most accurate way to share the potential upside of options and RSUs and share the risk of the employee spouse leaving employment and never receiving unvested incentives.

Alternatively, some spouses may choose to estimate the potential benefit and do a buy out with other assets. There are risks to this for both spouses. The employee spouse could end up over-paying if the stock price decreases or they lose unvested shares. The other spouse could end up receiving less in buy out if the stock price soars or any options split. This buy-out option does provide finality and independence moving forward so the spouses do not need to stay in touch on financial matters post-divorce.

Employee Stock Purchase Plan (ESPP)

Another common employee incentive is an Employee Stock Purchase Plan (ESPP) that allows employees to purchase company stock at a discount. In divorce, this type of benefit typically provides an ongoing benefit to the employee spouse that isn’t shared in divorce. Any stock purchased during the marriage is typically included and addressed in property division as marital or joint property. While it may be held in an ESPP account, these shares will typically be addressed like other investment accounts.

There may be other unique employee incentives that will need to be addressed in divorce.

Analysis in Divorce

For all types, you should review documentation showing balances, grants and/or valuation details to ascertain potential value. You may also want to request plan documents that outline policies and rules for all employee incentives. Most employers have documentation outlining rules and regulations for these assets. They may also have template orders or language to include in a divorce decree to make a division post-divorce more efficient. It is often a good idea to seek pre-approval from an employer if you intend to divide these types of assets to make sure you don’t reach agreement in divorce to only find out the employer won’t implement your agreed-upon resolutions.

Keep in mind that stock options and other incentives are subject to various tax treatments, depending on the type of option, timing of exercise, and subsequent sale of shares. Consulting with tax professionals can help mitigate tax liabilities and optimize asset division strategies. The taxes are often incurred by the employee spouse even if the shares are ultimately transferred to the other spouse. If this is the case, it may be best to have a tax professional help ensure that all taxes are paid prior to division or transfer to the other spouse.

When employee incentives are at issue in divorce, emotional considerations can play a significant role for employee spouses. Employee incentives often represent hard work, dedication, and substantial effort for an employer. For many individuals, these assets hold a strong emotional attachment and may symbolize their identity and/or connection to their employer. The employer spouse may feel a sense of entitlement to the incentives they “earned.” It can also be hard for the employee spouse to understand sharing any incentives vesting after the divorce, even if a portion of the vesting period was during the marriage. It is important to keep in mind the sentimental nature of these assets while working out agreements that both of you can live with.