We recently worked with a client, whom we’ll call James. He faced frustration as court closures during the pandemic caused a delay in his divorce proceedings. James approached his attorney with a plan to sell some stock options to address marital debt, and his attorney supported the idea without asking important questions.

At our financial consulting firm, we made sure to gather vital information from James, delving into key details. We inquired about the specific options he sold, their grant dates, whether they were obtained before or during marriage, the vesting timeline, and the accuracy of his reported gains on tax returns. The Bureau of Economic Analysis highlights that stock options, once perceived as exclusive perks for high-level executives, have now become increasingly prevalent in compensation packages for a wide range of employees. With the rising prominence of these benefits, it is crucial to have a clear understanding of your options.

To James’s surprise, his attorney had not asked any of these questions. This lack of knowledge and poor advice regarding stock options led James to make costly decisions.

To help you understand the essential aspects of stock options in divorce cases, let’s explore some common missteps and what you need to know.

Understanding the Tax Implications When Selling Stock Options in Divorce

Selling stock options to pay off marital debt can be a viable option. However, without an accountant experienced in stock options, you may end up overpaying your taxes. In James’s case, his accountant used the grant price as the cost basis instead of the exercise price, resulting in significantly higher tax payments.

For instance, if the grant price was $10, the exercise price was $40, and the sale price was $80, James was taxed on a gain of $70 (80-10) instead of $40 (80-40). Consequently, he paid almost double the amount in taxes. Luckily, most of the stock options were sold in 2019, enabling us to refer James to a new accountant who can file an amended return to recover a substantial portion of the overpaid amount, approximately $300,000. Unfortunately, any overpayments from previous years cannot be recovered.

Recognizing the Grant Date

When acquiring stock options, it’s essential to note the grant date. If the grant date falls before your marriage or after your separation, the shares are considered pre-marital. If the date is during your marriage, the shares are classified as marital property.

James had acquired stock options both before and during his marriage. He chose to sell the pre-marital shares to reduce his tax liability. However, if he had retained those pre-marital shares as separate property, he would have been in a better financial position after the divorce. Although selling marital shares would have resulted in slightly higher taxes, it would have allowed him to keep significantly more money.

Being Aware of Your Spouse’s Option Grants

Consider the timing of your separation when your spouse’s employer grants stock options. If you separate before the options are granted, any subsequent options received by your spouse will be considered separate property. To protect your interests, it’s crucial to understand the financial implications before agreeing to a separation date.

For example, let’s consider a client – we’ll call her Beth, who decided on a divorce in January. Her husband insisted on separating on February 1. However, her husband’s employer grants stock options in early February each year. Any options granted after the separation date would be his separate property, potentially affecting the division of assets during divorce proceedings. Understanding this beforehand can help you make informed decisions.

Obviously, if you’re at risk, you might need to remove yourself from a dangerous situation as quickly as possible. If you have a choice, time your separation after stock options are granted. Make sure you know the financial impact before agreeing to a separation date.

Factoring Stock Options into Equitable Distribution or Support Calculations

When you receive stock options, they are considered income and should be included on your W-2 form. It’s important to determine whether these options should be considered for equitable distribution or support calculations. Unfortunately, many people overlook this aspect and fail to ask about stock options in divorce.

Consider whether the income from stock options will affect child support calculations or if it should be included in equitable distribution. This consideration can have a significant impact on cash flow and retirement planning.

Final Thoughts

In conclusion, divorce is a complex process, often prompting individuals to rush through it without fully understanding the financial implications. Attorneys may encourage quick settlements without considering the complete financial picture.

However, hasty decisions made without patience and adequate knowledge can lead to overpaid taxes, giving away entitlements, or neglecting important factors like stock options.

A Certified Divorce Financial Analyst (CDFA) understands the intricacies of divorce-related financial matters and knows the right questions to ask. If you’re contemplating divorce and need assistance in understanding the financial impact, we offer consultation services to provide clarity, enabling you to make well-informed decisions with confidence.

Contact us today for personalized guidance.