In Silicon Valley and other tech-driven regions, stock options and restricted stock units (RSUs) are more than just fringe benefits—they’re a cornerstone of executive and employee compensation. When a marriage ends in divorce, these assets can become central to property division. However, dividing stock options and RSUs isn’t straightforward. Unlike traditional assets like homes or bank accounts, equity compensation comes with complex vesting schedules, fluctuating values, and intricate tax implications. For divorcing spouses, understanding how these assets are handled under California’s community property laws is essential—and having the right legal guidance is critical.
In Brief: What Are Stock Options and RSUs?
Before tackling how equity compensation is divided in divorce, it’s important to understand what these benefits entail. A stock option gives an employee the right to purchase a certain number of company shares at a set price (the “exercise” or “strike” price) after a specified period. There are two main types: incentive stock options (ISOs), which offer potential tax advantages but are subject to strict eligibility requirements, and non-qualified stock options (NSOs), which are more flexible but taxed as ordinary income.
Restricted stock units (RSUs), on the other hand, are promises to deliver company shares in the future, typically upon the completion of a vesting schedule. Unlike stock options, RSUs don’t require employees to purchase the shares—they’re awarded outright once vested, though taxes are due upon receipt.
Both forms of compensation are designed to reward performance and incentivize long-term employment. But in divorce, their value—and whether they should be shared—can be hotly contested.
Are Stock Options and RSUs Community Property?
Under California’s community property laws, most assets acquired during a marriage are considered jointly owned by both spouses, regardless of who earned the income or whose name is on the account or contract. This legal framework applies not only to traditional assets like homes and retirement accounts but also to more complex forms of compensation, such as stock options and restricted stock units (RSUs). However, determining whether these assets fall under community or separate property requires a nuanced analysis of both timing and intent.
The first factor courts examine is when the options or RSUs were granted and when they vest. If they were granted and vested entirely before the marriage, they are typically considered separate property. If they were granted and vested during the marriage, they are likely community property. The gray area arises when the assets were granted during the marriage but vest after the couple separates—a common scenario in divorce cases involving equity compensation.
In such situations, the key question becomes: What was the purpose of the grant? If the stock options or RSUs were awarded for past performance—in other words, as a reward for work already performed during the marriage—then they are more likely to be considered community property, even if they vest after separation. If, on the other hand, they were granted to incentivize future services or to encourage the employee to remain with the company post-separation, they may be classified as separate property.
This distinction—past performance versus future incentive—is critical because it determines how much, if any, of the equity compensation should be shared between spouses. Courts rely on this analysis, often informed by employment contracts, stock plan documents, and testimony, to ensure the division of property reflects both the value of the compensation and its underlying purpose.
Key Legal Frameworks for Dividing Equity Compensation
California courts often apply time-based formulas to divide stock options and RSUs fairly. Two of the most widely used are the Hug and Nelson formulas, both named after landmark court cases.
The Hug formula is generally used when the equity compensation is awarded as a reward for past service. It calculates the community interest based on the length of time from the start of employment to the date of separation, divided by the time from the start of employment to the date the options vest.
In contrast, the Nelson formula is used when the award is intended to incentivize future performance. It calculates the community share based on the time from the date of the grant to the date of separation, divided by the time from the date of the grant to the date the options vest.
The court’s choice between these formulas is not automatic—it depends on the specific purpose of the grant, as outlined in the employment agreement or stock plan documentation. This case-by-case analysis underscores the importance of meticulous legal and financial review.
Valuation Challenges and Strategies
Valuing stock options and RSUs during a divorce is far from straightforward. Unvested options may have speculative value, especially in startups or pre-IPO companies. Even vested options and RSUs can fluctuate wildly in value depending on market conditions or company performance.
Valuation approaches vary. In some cases, a Black-Scholes model—a sophisticated method for pricing options—may be used. In others, a discounted cash flow (DCF) analysis may be appropriate. For private companies, the valuation may hinge on recent fundraising rounds or third-party appraisals.
Another layer of complexity is taxation. While RSUs are taxed as ordinary income upon vesting, stock options can trigger capital gains or alternative minimum tax depending on when and how they’re exercised. These tax implications must be considered when valuing and dividing equity compensation in a divorce.
Division Options in Divorce Settlements
Once the value and characterization of RSUs and stock options are determined, divorcing spouses must decide how to divide them. There are typically two main approaches:
- Deferred division: The parties agree to divide the shares as they vest. This approach keeps things equitable but requires ongoing communication and compliance from both parties. It may also raise enforcement issues down the road.
- Immediate offset: One spouse receives the full interest in the equity compensation and “buys out” the other spouse’s share using cash or other marital assets. This method provides a clean break but can be tricky when valuation is uncertain or fluctuating.
Plan restrictions can complicate matters further. Some equity plans prohibit transfer of options or shares, which may require creative settlement terms, such as constructive trusts or delayed transfers.
Private Companies and Startups: Special Considerations
Dividing equity compensation becomes even more challenging when the company isn’t publicly traded. In private companies or startups, there may be no market for the shares, and options may never become liquid. Vesting schedules can be uncertain, and the value may be tied to speculative future events like acquisitions or IPOs.
In these cases, divorcing spouses must carefully review shareholder agreements, vesting provisions, and company policies. They may need to negotiate alternative forms of compensation or agree to future payouts based on liquidation events. An experienced attorney can help craft creative solutions that protect both parties’ interests.
Tax Implications and Planning
Taxation is a key factor in dividing RSUs and stock options. With ISOs, exercising the options may trigger alternative minimum tax (AMT), while NSOs are taxed as ordinary income at exercise. RSUs, meanwhile, are taxed at vesting as regular income.
It’s crucial to structure divorce settlements in ways that account for these liabilities. In some cases, one spouse may bear the tax burden while the other receives a share of the asset, which can lead to inequities. A well-crafted agreement should spell out how taxes will be handled and who is responsible for payment.
Working with a tax professional or forensic accountant can help ensure accurate calculations and prevent surprises.
Protecting Rights and Navigating Discovery
Because stock-based compensation can be difficult to detect, especially in early-stage companies, full financial disclosure is essential. Employees may not always volunteer information about unvested options or future equity grants.
Attorneys may need to use subpoenas, depositions, and forensic accounting to uncover the full scope of equity compensation. Reviewing employment contracts, grant letters, and vesting schedules is crucial. Courts can impose penalties for failure to disclose these assets, so both parties are incentivized to be forthcoming.
Enforcing and Modifying Orders Post-Divorce
Even after the divorce is finalized, disputes over stock options and RSUs can resurface. A spouse may refuse to transfer shares or misrepresent the timing of vesting. In other cases, the value of the asset may change dramatically—especially if a company goes public or is acquired—raising questions about fairness.
Courts can enforce property division orders through contempt proceedings or monetary judgments. In some cases, parties may seek post-judgment modifications, especially if the division was based on incorrect information or unforeseen changes in value.
Legal Advice for Dividing Stock Options During Divorce
Dividing stock options and RSUs in divorce is one of the most complex aspects of family law—especially in California’s high-tech economy. It requires a deep understanding of employment compensation, tax law, and community property principles. Whether you’re an employee with significant equity or the spouse of one, protecting your rights means working with an experienced family law attorney who can navigate the intricacies of these assets. At the Law Offices of Diane J.N. Morin, Inc., we’re here to help you pursue a fair and informed outcome that reflects the true value of your marital estate.
