Salaries and incentive bonuses may be just the tip of the iceberg – just two of many forms of executive compensation that may be exposed in a complex divorce and child support proceeding. Discovering and dividing executive compensation – such as stock options, restricted stock, stock appreciation rights, non-qualified retirement plans, and perquisites – may be a challenge. Incentive compensation plans may leave footprints on the tax return that can be difficult to decipher. In my book, Frumkes & Vertz on Divorce Taxation, we discuss executive compensation as it relates to high-stakes child support and divorce cases.
- Stock Options:
Years ago, stock options were a common form of equity compensation, particularly for consultants and executives in high-tech companies. Stock options create an incentive for the employee to enhance the value of the company, which makes the stock price go up. Think of the stock option as a coupon to purchase stock at a fixed “strike” price, no matter how much it is worth in the open market. When the market price exceeds the strike price, the option is valuable because the stock can be purchased and simultaneously sold for a profit, in what is called a “cashless exercise.” Stock options usually have a vesting schedule, which restricts the time when the option can be exercised. In a typical vesting schedule, the employee may exercise 1/3 of the options on the first anniversary of the grant date, 1/3 on the second anniversary, and 1/3 on the third anniversary. The taxable income generated by stock options are not reported until the options are exercised and sold.
- Restricted Stock:
Restricted stock has become the most common replacement for stock options, because it is very similar, with one big difference. When restricted stock is granted, and then vests, the employee actually owns the stock, which the employee may choose to hold or sell. The same kinds of vesting schedules are common. Restricted stock is reported as taxable income when it vests, even if it is not sold. If an employee holds restricted stock, and sells it later, there may be an additional gain that may be taxable.
- Stock Appreciation Rights:
SARs are “phantom” stock that is held by the company, in a special account set aside for the benefit of employees. An employee may be entitled to receive gains when the stock’s market price increases, but the stock is not actually transferred to the employee. This type of plan enables the company to maintain control over the stock while sharing the benefits of an increase in market value.