Dividing Stock Received through an Employee Stock Program. By: Elizabeth L. Juelich and Sherri L. Krueger STEP 1: DISCOVERY

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1 Dividing Stock Received through an Employee Stock Program By: Elizabeth L. Juelich and Sherri L. Krueger There are four main steps that must be undertaken when stock received through an employee stock program are divided in a divorce: discovery, analysis, negotiation, and drafting. While employee stock programs may be pertinent for purposes of determining child support or spousal maintenance, this article will only focus on stock awards from a property division standpoint. STEP 1: DISCOVERY DETERMINE WHETHER ANY STOCK PROGRAMS EXIST. It is important to do this early in the case. It is typically much easier to obtain the information you need to properly assess, value, and divide the stock award as part of the overall property division in the dissolution matter if your client is the recipient of a stock award of some type. Conversely, if your client is the spouse of the employee who is the recipient of a stock award, it may be more difficult to obtain this information. Without this information, however, you do not have a full picture of the marital, and perhaps non-marital, assets involved. If your case is on the fast track for settlement, it is imperative that you begin the task of discovering what assets exists as early as possible. Many attorneys make the mistake of waiting too long to ask for information perhaps because it can be difficult to know where to start or because the attorney improperly assumes there is no value to something that is not vested. Others make the mistake of settling all of the financial issues early, without a full understanding of the stock awards that may exist. This could result in an inequitable division of the marital estate. Sometimes the stock awards are not considered because they are deemed to be under water, meaning the current market value is less than the grant value. Even if the stock is currently under water, the asset still exists. Share prices can and do rise and the stock award should still be considered in the property division. A good place to start gathering information is with your client. Ask for information regarding each spouse s current employment as well as their past employment. Many stock awards do not expire for several years. For example, it is quite possible that an award of stock options will not expire for ten years after they have vested. If your client works for or previously worked for a publicly-traded company, you should ask some specific questions about whether there are any assets derived from a stock program award even if your client says there is nothing. This is especially true if the client or client s spouse held a management position. Many times, a client will believe that an unvested benefit means they don t have an asset and will simply tell you they do not have any stock. Even the unvested benefits must be disclosed and considered as part of the division of marital assets. If, after speaking with your client, you are not clear about what stock award might exist, you may wish to do a cursory review of the parties tax returns and paystubs which may reveal the vesting, exercise, or sale of company stock. Remember, however, that the absence of information about a sale of stock does not mean it does not exist. That is because the various 1

2 types of awards are taxable at different points in time. Restricted Stock Units, for example, are taxed upon vesting, and it is customary for the tax to be withheld by the employer at that time and for the withholding to be reflected on the employee s paystub. Stock options are not taxed until the option is exercised. The tax associated with the exercise will typically be reflected on the paystubs and tax return for the year in which the options were exercised. Some companies also allow employees to defer the vesting of Restricted Stock Units and other executive compensation so special care must be taken to ensure that all assets have been identified. To gather even more information, never underestimate the power of an internet search. Many of the major companies that offer stock awards post online their plan documents for the stock award programs offered as well as frequently asked questions about how a divorce may impact an award. Some companies have even provided detailed descriptions about how to decipher the various codes on a paystub along with an explanation of why certain amounts were withheld for taxes. This type of search might be an efficient and cost-effective way to obtain insightful information in your representation of that client. If your initial efforts to discover information about an employee stock award fail, you will need to pursue additional and more specific information about the actual awards to your client or his or her spouse. The following documents are what you should consider requesting from the employee spouse: Award Letter. Award letters typically contain the date in which the award was made and may summarize other key terms of the award such as the number of units awarded and the grant or strike price (if relevant). It may also refer to other key attachments or enclosures pertinent to the award. Occasionally the award letter will also provide the purpose of the award, e.g., to reward prior performance or to incentivize future performance. This can be helpful when making an equitable argument about why the Salstrom formula (discussed below) should or should not be applied. Grant Agreement/Award Agreement. Most companies require the award recipient to affirmatively accept the terms of the stock award in a grant/award agreement. To the extent not set out elsewhere, this document will set out the essential terms of the agreement such as the option or award number (if applicable), date, the type of stock awarded (e.g., NQSO, ISO, RSU), the number of units awarded, the exercise/strike price (for options), the vesting details, the expiration date, and potentially the value at the time of award. Plan Document. The title of this document may vary from company to company, but this is the governing instrument under which the employee spouse has received his or her award. The plan document often governs many years worth of awards before being modified by the company. This overarching document will not specifically identify the employee spouse or the specific number of units awarded but sets forth the comprehensive terms of the plan such as: manner of exercise, delivery of shares, tax withholding, transferability, termination of employment, change of control with the company, death, and disability. Vesting Schedules. A vesting schedule is a schedule of when the stock award vests. Many times the vesting details will only be provided in narrative form and the schedule must be 2

3 compiled from multiple sources such as the award letter and plan documents. For example, the award letter might tell you that the employee was awarded 120 Restricted Stock Units, and the governing plan documents might specify that all Restricted Stock Unit awards will be subject to a four-year vesting period with one-quarter of the total award vesting on each anniversary of the award. Brokerage Account Statements. After the stock awards have been made, details regarding the outstanding number of units held will typically be found on a brokerage statement generated by the company managing the stock plan. This information usually includes the number of vested and unvested units held, the value as of the statement date, and whether any units have been sold during the statement period. Transaction History and Transaction Confirmations. These documents provide detail such as date, share price, and number of shares sold and are usually generated by the brokerage firm managing the stock plan. Reviewing these documents may help identify potential tax consequences that need to be addressed in the divorce as well as dissipation claims. Much of the information you are requesting is accessible by the employee spouse online. However, it is not unusual if that individual is unaware of where or how to access the information. With client log-in IDs and passwords, the employee spouse will often be able to print the specific information. If your client is the employee spouse, consider bringing him or her into your office and sit down together in front of a computer so you can see the many different reports, summaries, and documents available for your client s awards. You may not know what will be helpful in your case if you don t know what information is actually available to your client in addition to the basics. If your client cannot access the information, or if the other spouse is unable or unwilling to produce the requested documents, you may need to pursue third-party discovery. While written requests for information may give you access to the publicly available information, most of what you are requesting will be private information related to the employee-spouse and may therefore require authorizations for the release of information signed by the employee-spouse or a subpoena. Remember that you must be specific in what you are requesting. Because there is a cost associated with obtaining the documents and information through an authorization or subpoena, try to obtain as much of the basic information online or through informal discovery requests to the other party first. STEP 2: ANALYSIS MAKE SURE YOU UNDERSTAND THE TYPE OF EMPLOYEE STOCK PROGRAM INVOLVED IN YOUR CASE AND FAMILIARIZE YOURSELF WITH THE SPECIFIC AWARD DETAILS. There are four types of employee stock programs that are most frequently encountered in a divorce case: Stock Options, Restricted Stock Units (RSUs), Employee Stock Purchase Plans (ESPPs), and Employee Stock Ownership Plans (ESOPs). Each program requires different considerations by the practitioner to ensure protection of the client s interests. 3

4 Stock Options. Stock options are a contractual right given by a company to an employee to purchase a specific number of shares of the company s stock at a specified price (a.k.a. strike price, grant price, or exercise price) for a specified period of time in the future. This is a right, and the option holder may choose to not exercise the right if there is no value, i.e., the share price at the time of exercise is less than the strike price. In the event the stock price increases between the time the stock option was awarded and when it was exercised, the option holder will realize a gain upon exercise and sale. The stock options must vest before they are exercisable. Once the options have vested, there will be a period of time that the employee may exercise the options before they expire. The employee may 1) exercise the options as they vest, 2) wait until all options vest and then exercise the options, or 3) exercise a portion of the vested options any time after they vest, up until the expiration date. Any options not exercised by the expiration date will expire at no value and with no adverse tax consequences. There may be certain times of the year, called blackout periods when restrictions may limit or prevent the exercise of options. The plan document will control whether an employee will be allowed to exercise any options once he or she leaves the company. The majority of stock options are exercised in a cashless transaction where the option holder exercises the options with his or her company and simultaneously sells the shares through a brokerage account via what is technically a short-term loan from the brokerage firm to the option holder. In a cash exercise, the option holder brings the amount of cash needed to pay for the shares which is calculated by multiplying the strike price by the number of shares. In a cash transaction, the purchased shares can then be held or sold as regular shares. Stock options may be qualified or non-qualified. The distinguishing characteristics are impacted by who may receive the options and how the options are taxed. Non-qualified Stock Options (NQSOs) are offered to non-executive employees as well as to outside directors or consultants. There is no taxation on NQSOs until the shares are exercised, and generally, the proceeds from the exercise of NQSOs will be taxed as ordinary income. Qualified Stock Options, also referred to as Incentive Stock Options (ISOs), are only available to executive employees. Currently, ISOs are subject to a more favorable tax treatment than other types of stock transactions if all requirements are met. Specifically, properly exercised ISOs are not taxed at the time of exercise, which is different than how the Non-qualified Stock Options (NQSOs) are taxed. However, the exercise of ISOs may trigger Alternative Minimum Tax. Restricted Stock Units. Restricted Stock Units are units or shares of company stock that are subject to restrictions. The restrictions are conditions that must occur before the restrictions are released. The release of the restrictions is referenced as a lapse of the restriction. Restricted Stock Units are also typically subject to vesting, at which time they taxed as ordinary income. Under some plans, the stock may continue to be subject to various restrictions regarding selling or transferring the shares, even though the award has vested. It is upon the vesting of the award and the lapse of all restrictions that the recipient of the restricted stock unit award finally holds the company s common stock. The terms vested and released may be 4

5 used interchangeably, when the vesting and the release of all restrictions occurs at the same time. Because some plans establish different dates for vesting and release of the restrictions, it is important to use these terms carefully. At the time of the vesting, shares are typically withheld to cover the estimated tax due. Because an employee may invoke an exception to this rule of taxation, although rarely used, if you determine from review of the employee s paystub that no taxes were withheld, you should consult with a competent CPA or tax professional to understand how the taxes have been or will be paid. Employee Stock Purchase Plan (ESPP). An Employee Stock Purchase Plan allows employees to purchase shares of the company s common stock, usually at a discount of 10-15% off the market price. An employee participates in the ESPP by identifying the dollar amount or percentage to be deducted from his or her paychecks throughout the offering period. The offering period is the timeframe during which the company collects the cash from the employee via payroll deductions. The length of the offering period varies by company but is commonly three to six months. The accumulated cash is used to purchase the discounted stock at the end of the offering period. Employee Stock Ownership Plans (ESOPs). Employee Stock Ownership Plans are plans which allow employees to acquire company stock and operate much like a 401(k). The contribution or purchase of the company s stock is made with pre-tax dollars and the employee is not required to pay income tax at the time of the contribution. Only the distribution is taxable to the employee. Early distribution is penalized with a 10% penalty if the distribution is taken from the ESOP before normal retirement age. In addition, an employee or the employee s former spouse, may roll over his or her interest in the ESOP into an IRA or other retirement plan to avoid the penalty when he or she leaves the company or receives his or her interest in the divorce. An ESOP is unique in that it is required by law to invest primarily in the stock of the company of the sponsoring employer. A Qualified Domestic Relations Order (QDRO) may be used to award an interest to the non-employee spouse. If the participant s interest is not fully vested, in certain circumstances, the QDRO may be drafted to allow a distribution of the ESOP to the alternate payee with a deferred distribution as the participant becomes fully vested. Companies, especially closely-held businesses, may impose restrictions on the sale and transferability of the shares. The impact of such restrictions must be understood and addressed in the divorce. STEP 3: NEGOTIATION PREPARE FOR AND NEGOTIATE A SETTLEMENT. One of the first considerations in preparing for a settlement negotiation involving stock awards is to determine what portion of the asset is marital and what portion is nonmarital. Unvested awards are not automatically non-martial assets. This is a frequent mistake made by inexperienced attorneys in negotiations. 5

6 Be familiar with the formula arising from Salstrom v. Salstrom 1, where the Minnesota Court of Appeals addressed the division of stock options that were granted during the marriage but were unvested at the time of the marriage. This formula is applicable to those stock options that remain unvested as of the valuation date. Under the formula, the numerator is the number of months during the marriage between the date of the grant and the valuation date. The denominator is defined as the total number of months from the grant date to the vesting date. The commonly expressed equation for the Salstrom Formula is as follows: Marital Value % = (Valuation Date - Grant Date) (Fully Vest Date - Grant Date). Although the Salstrom formula used months to calculate the marital percentage, online date calculators make it easy to perform a more precise calculation by using the exact number of days between the valuation date and the grant date and the fully vest date and the grant date. Once you have a firm understanding of the amount at stake in the negotiations, do a costbenefit analysis to determine what amount of resources your client is willing to expend to pursue the claim. If the stakes are high, consider using a financial expert and tax advisor to analyze and prepare the precise calculations under various scenarios. This will help you put your client in the best possible position when making an offer of settlement and will help you see the best and worst potential outcomes if settlement cannot be reached. Consider your client s overall wishes and needs, including the level of risk he or she is willing to take and your client s willingness to have an ongoing connection with his or her former spouse. Understanding your client s needs will help determine whether to negotiate a division of the stock award or whether to pursue an allocation of the entire stock award to the employee spouse with the non-employee spouse receiving other assets if there are sufficient assets in exchange. Keep in mind that there may be circumstances outside of the employee s control that impact the realized value of a stock award, including whether the award actually vests, whether the stock holds or increases its value, and whether the plan is sustained. Other circumstances, such as termination of employment, may not be in the spouse s control, yet may have a significant impact if the termination results in the forfeiture of an award or an accelerated expiration date, specifically with respect to an award of stock options or restricted stock units. The plan documents explain what happens upon termination. Because of this risk of forfeiture or acceleration of the expiration date upon termination of employment, it is important to advise that your client consider the security of the employee spouse s position. This consideration is important for both the employee and non-employee spouse and will likely be a factor in the negotiation. It is likely that the employee spouse will not want to take the stock award and give other assets to his or her spouse in exchange if his or her position is not secure and the stock award would be forfeited upon termination. On the other hand, other approaches to the negotiation might be considered. For example, an employee spouse may be willing to do a buyout of the non-employee spouse s interest in the stock award at a discount, and the nonemployee spouse may be willing to accept a lower amount for the buyout in exchange for the ability to walk away from both the risk and the ties to the former spouse. In the negotiation phase you must understand that there will be a tax impact, and the tax impact cannot be ignored. If the award is divided but continues to be held by the employee 6

7 spouse, there must be a mechanism by which the non-employee spouse assumes the tax responsibility for his or her portion of the award, which would otherwise be left to the employee spouse. If a buyout is negotiated, you should obtain the assistance of a qualified CPA to calculate the estimated taxes that will be owed at the time of exercise or vest so the buyout amount paid to the non-employee spouse can be adjusted to the after-tax value of the stock assets awarded to the employee spouse. As a negotiator, remember that equitable considerations should be raised when appropriate. For example, consider the purpose of the award in terms of whether it was to reward past performance occurring during the marriage, or whether it was an incentive to continue with the company. Under such equitable considerations, it might be agreed that the unvested portion of a stock award will be considered a marital asset, or that a portion of an award vesting after the valuation date will be considered marital. STEP 4: DRAFTING DRAFT THE JUDGMENT AND DECREE. When drafting language to award stock awards, it is important that you use the correct terminology. The terms have technical meaning and it is important you use the proper terminology to avoid ambiguity and enforcement issues later. For example, do not interchange the terms exercised and sold. Stock options are exercised. Stock is sold. Do not inadvertently call restricted stock unites restricted stock because the two are different. Restricted stock is something offered under different circumstances and different regulations. Mirror the language that is used in the plan documents. For example, restricted stock units vest or are released and different companies may have specific meaning applied to each term. A small error in drafting might change the entire meaning of the provision or prevent the parties from carrying out their intended division of the asset. Specificity and detail is essential when drafting a Judgment and Decree. Include the date of the grant or award, the number of shares, the date of vesting, and the number of shares vested and unvested for each separate grant. These details are essential for application of the tax consequences at a later date, which may not be for several years. Further, detailed drafting protects the less financially savvy spouse from being taken advantage of by the other spouse, who may then be positioned to select more favorable stock. Finally, more detail will prevent the potential for future litigation over ambiguous terms at the time of implementing the transfer or delivery of the asset. Include the specific terms regarding the transfer of the non-employee s interest in the award. If the asset is not transferable, include the specific duties and responsibilities of the employee spouse in continuing to hold the non-employee spouse s award. The Judgment and Decree must include clear language regarding how the tax liability associated with the allocation of the stock award will be shared. Consider defining the process for calculating each parties tax liability at a later point in time in the Judgment and Decree. It might be good to include a dispute resolution provision to address disagreements that might arise in the future. 7

8 CONCLUSION While determining how to approach the task of dividing stock awards in a property settlement may seem daunting, following these four steps will help you to focus your approach and better advise your client. With a clear and defined approach, you will increase your understanding and negation power, and you will be situated to craft a Judgment and Decree that meets your client s needs N.W.2d 848 (Minn. Ct. App. 1987). Elizabeth Juelich is a Partner at Krueger & Juelich, PLLC in Minnetonka, Minnesota. She focuses her practice on family law and estate planning, advocating on behalf of clients to protect and preserve their assets and to represent their children s best interests. Ms. Juelich s family law practice includes spousal maintenance, property division, child support, custody, and parenting time. She is admitted to practice law in Minnesota and is a member of the Hennepin County and Minnesota State Bar associations and their respective Family Law and Estates and Trusts sections, the Family Law League, and the Association of Family and Conciliation Courts. She also is actively involved in the Wills for Heroes program which provides free estate planning services to First Responders, and the Volunteer Income Tax Assistance (VITA) Program. Ms. Juelich was named to the Minnesota Rising Stars list by Super Lawyers in 2012, 2013, and Sherri Krueger is a Partner at Krueger & Juelich, PLLC in Minnetonka, Minnesota. She focuses her practice on family law and family law mediation. Ms. Krueger is a member of the Minnesota Bar Association, the Hennepin County and 8 th District Bar Associations, the Family Law League, and the Association of Family and Conciliation Courts where she currently services on the Board of Directors. Sherri practices in all areas of family law and is passionate in looking for resolutions that meet each client s need. Ms. Krueger was named to the Minnesota Super Lawyer s list in 2014 and was named to the Minnesota Rising Stars list from 2011 to