What should I do to protect my finances now that we have filed for divorce?

If you are the person who asked for a divorce, you may be surprised by the emotional chasm between yourself and your spouse and how long the process is taking. You spouse may be shocked, hurt and feel confused by your decision and it can take time for your spouse to engage in the divorce process or “catch up”. Many of my clients are frustrated by this delay, but there are still steps you can take to prepare yourself for what happens next. Here are five financial steps that you should do after you file:

1.    Set up a divorce notebook.  Use a binder or file folder that have sides to them so that when you lift up the file, things don’t fall out the sides. There can be a lot of paper generated during your divorce and having those papers organized allows you to be more prepared and less disoriented.

2.    Open individual bank account(s) in your name. New accounts often have more restrictions such as deposit holds. The sooner you can start a history with a bank, credit union or other financial institution, the sooner you will establish credibility with that institution. These are accounts in your name individually, and minimally you need a checking account and a savings account.

3.    Apply for a credit card in your name. If you have kept your credit cards separate, then you already have individual accounts. If you’ve been operating your credit cards as joint accounts, however, you want to have an account in your name. If you’re not sure if you’ll qualify, then get your FICO credit score first.  Remember that whenever you apply for a credit card, you get an inquiry on your credit report.  

4.  Scan financial statements and documents. You’ll want to get into the habit saving and downloading any financial statements that you receive so that you have them at hand, or file them in your divorce file for easy access. These documents include investment and bank statements, tax returns (most recent two years), debt statements, social security reports (usually received before your birthday), and any other statements that have to do with assets and liabilities (debts).

5.    Get your credit report and credit score.  Your credit score will give you information about what your credit options are, and the credit report will let you know which of your existing credit cards are joint vs. individual, as well as letting you see if there are any financial items you don’t recognize.

You can contact me at Amanda@gordonfamilylaw.com for more information.

Stock Benefits – How are they divided at divorce and who pays the Taxes?

Experienced Bay Area family law attorneys can help answer questions regarding stock options, RSUs, and ESOPs. This is one of the most common assets in family law cases in the Bay Area. We encourage you to reach out to Gordon Family Law to have a full analysis of your situation, as each company plan is unique. We often find that clients and even professionals face confusion and difficulty when explaining these plans to the court and the other spouse. We encourage you to speak to a professional about your options early in the process as the financial and tax consequences can shift based on timing.  

What is a stock option benefit? Stock options to purchase a share of a company are sometimes granted to employees to provide financial incentive in the future growth of the company.

A stock option gives you or your spouse the right to purchase a specified number of shares of Common Stock at a fixed price per share (the “exercise price”) payable at the time the option is exercised.

How do I find out what options my spouse has?

The general terms governing all option grants are set forth in a document called the Company Plan.  The exact terms of the options, including (i) the type of option, (ii) the number of shares of Common Stock you may purchase, (iii) the exercise price per share and (iv) vesting schedule, can be found in either the Company Plan or the Grant Letter/Award Agreement.

How do I find out what my spouse’s stock options are worth?

The exercise price per share is generally a number by the Company Board and is typically equal to the fair market value per share of Common Stock on the date of the option grant. The exercise price will be fixed for the life of the option even if the value of the Common Stock increases or decreases in the future.  

If the company is not public, the “Fair Market Value” of the Stock on any given date is the fair market value of the Stock determined in good faith by the Company Board based on the reasonable application of a reasonable valuation method not inconsistent with Section 409A.  You should ask for your companies most recent 409A valuation.

When an option is “exercised,” the employee purchase shares of Common Stock by paying the exercise price for those shares to the Company.

Often, the shares of Common Stock purchasable under the option are subject to vesting provisions.  A stock options “vest” over time, meaning the employee must continue to work for the Company in order to “earn” the right to exercise stock options and keep the shares acquired upon the exercise of stock options. 

The employee may not exercise any portion of stock options until that portion has vested, unless the Award Agreement provides otherwise with an early exercise program.  The shares subject to the option will typically vest in installments over a period of years.  We commonly see vesting over a four-year period, with 25 percent of the shares vesting upon completion of one year of service measured from the grant date, and the remaining shares vesting in equal monthly installments over the next 36 months.

Stock options permit an employee to pay a price equal to the fair market value of the stock on the date they were granted. Generally, the stock will be purchased at a future date when, presumably, the price of the stock will have increased.   

What are the types of stock options that my spouse may have?

There are two types of stock options:

1.     Qualified Option - Incentive Stock Option (ISO). These are the “best” types of options because if certain requirements are met, ISOs are given special tax treatment unless they are ‘disqualified’ ISOs.

2.     Non-Qualified Stock Options (NQ). Most options are NQs and there is no special tax treatment, but they also have no special requirements or restrictions.

Exercise of stock options creates a taxable event. This is because the fair market value of property transferred from an employer to an employee in connection with the employment relationship is treated as compensation to that employee in the year received and all restrictions removed. NQs are taxed in this manner.

In general, the employee will have to pay ordinary income tax for the value of the stock over the price paid once the stock has been transferred to the employee and all risk of forfeiture has lapsed. The taxable event for NQs and disqualified ISOs is the date the options are exercised and the stock purchased by the employee. For example, if the exercise price of stock is $10 but the fair market value at the time the option vests is $20 dollars, the employee must pay ordinary income taxes on the difference in value (20-10). If the stock is held for more than a year and sold at $35 a share, the employee will pay capital gains on the $15 of increase between the FMV on the date of exercise and the FMV on the date of sale.  This is also true for tax losses.  The employee spouse will also have additional FICA taxes on the amount of the difference.

Sometimes employees can elect to an early exercise of NQs. The taxable event for early exercise is the vesting of the stock and there are generally no U.S. federal income tax consequences to you with respect to the unvested shares you acquire.  As the shares vest, the employee will realize taxable ordinary income in an amount equal to the fair market value of such number of shares of Common Stock that have vested on the vesting date, less the exercise price of the shares. 

One special option for early exercise is that an employee may make a Section 83(b) Election within 30 days of exercise and recognize taxable ordinary income in the year of exercise in an amount equal to the fair market value of the shares at the time of exercise, less the exercise price.  If an employee expects that a private company is going to increase in value due to an upcoming fundraising round, they may want to early exercise all of their stock and take a Section 83(b) Election so that their ordinary income taxes are based on an exercise price that is close to the FMV at the time of exercise.

Here is an example:

Harry joins EmojiUniversity an up and coming Chat platform in June 2017 as a product manager. Harry receives a stock option grant from his company EmojiUniversity of 100 Non qualified options with a strike price of .50 cents.  EmojiUniversity tells Harry that the most recent 409A valuation says that the FMV is .60 cents a share. These NQ options will vest over a period of 4 years with a 1 year cliff and monthly thereafter. Harry is allowed to purchase these options early through the companies early exercise program. Harry knows that EmojiUniversity is looking to raise Series B funds in January 2018 and VentureBeat says that EmjoiUniversity is going to be the next WhatsApp.  Harry is uncertain about the hype but nonetheless knows it’s a good idea to exercise all of his options because of the tax consequences.

Harry purchases all 100 of his options for $50 in February 2017 and elects a Section 83(b) election.  Section 83(b) requires the employee to pay taxes in an amount equal to the fair market value of the shares at the time of exercise, less the exercise price. This means that for Federal Income Taxes in 2017, Harry pays ordinary income taxes on .10 x 100 or (.6-.5)(100) or $10.

In January 2018, sure enough as predicted by VentureBeat, EmjoiUnversity receives a valuation equal to .85 cents per share. If Harry had purchase his NQ without taking the 83(b) Election he may have had to pay more taxes.  This is because under the early exercise rules, as the shares vest, Harry will realize taxable ordinary income in an amount equal to the fair market value of such number of shares that have vested on the vesting date, less the exercise price of the shares. Harry would have to pay ordinary income taxes on the difference in FMV at vesting and exercise price on the 25 shares that vest in July 2018. 

If EmojiUnversity is a success, Harry is better off having elected Section 83(b) and paying the smaller amount of ordinary income tax during the first year.  However, there are some risks with Section 83(b).  If he makes a Section 83(b) Election and subsequently forfeit the shares, he will not be entitled to a deduction or tax credit as a consequence of that forfeiture.

What are the tax rules for Incentive Stock Options?

For ISOs, the exercise of the options will result in alternative minimum taxable (AMT) income. This means that if the employee holds the stock for a required period of time, he/she will recognize capital gain income when sold for the difference between the sales price and the exercise price paid. Generally, any difference between the exercise price and the value of the shares at the time of exercise may be subject to AMT taxation.

There are often holding periods associated with ISOs. If the employee sells the shares acquired upon exercise of ISOs after (i) the two-year period following the date on which you were granted your option and (ii) the one-year period following the date after the shares are transferred to you upon your exercise of the Incentive Option, the employee will realize a capital gain to the extent that the price at which the shares were sold exceeds the exercise price you paid for your shares.  In the event the employee does not satisfy the holding period, the tax consequences associated with the sale of such shares will change and the employee must pay ordinary income taxes with respect to some or all of the gain. 

This has the advantage over NQs by converting ordinary income to all capital gain and paying the lower rates.  As the shares vest, an amount equal to the fair market value of such number of shares of Common Stock that have vested, less the option price of the shares, could be subject to AMT taxation. 

ISOs are also entitled to special Section 83(b) treatment. With respect to any unvested shares you acquire upon the early exercise of your Incentive Option, an employee may make an election with the Internal Revenue Service (the “IRS”) under Section 83(b) of the Internal Revenue Code (a “Section 83(b) Election”) within 30 days of exercise to recognize, in the year of exercise, any AMT tax liability for all such shares. If the employee makes a Section 83(b) Election and subsequently forfeit the shares, they will not be entitled to a deduction or a tax credit as a consequence of that forfeiture.

What is restricted stock?

Restricted Stock Units (RSU) are units payable in shares or cash. These are granted to the employee subject to a vesting schedule. In Silicon Valley, RSUs are the most common form of stock compensation.

Restricted Stock (RS) are shares granted to the employee subject to restrictions on sale until vested.

Performance Stock Units (PSU) – the employee is granted units versus actual shares. These units or range of units are generally subject to a vesting schedule and often further subject to the company meeting certain goals.

Employee Stock Purchase Plan (ESPP).  Allows an employee to use funds withheld from paychecks to purchase stock for less than the current fair market value. There are generally holding periods required to not recognize income from this discount.

RSUs are taxable as compensation based on their fair market value when vested and all restrictions on the shares are released. No action on the part of the employee is required.  Typically, the company automatically sells enough shares to pay the required withholdings and payroll taxes. The remaining shares released to the employee who can choose to sell immediately or anytime in the future.

Should I purchase my spouse’ interest in stock options?

The variability in the dollar value of stock benefits makes it difficult to recommend the employee spouse purchase the other spouse’s interest in the community options.  Additionally, due to the fact that there are always tax consequences associated with stock options and stock plans, we recommend that clients carefully consider their options.

Experienced Bay Area family law attorneys will emphasize that the goal is the divide the “property” with each party reporting his or her share of the income. Because of the tax complications, you will need communication between the parties (or at least their tax preparers) to share the employee’s W-2 each year and work out the allocations between you and your spouse.

This results in the parties diving the options and the tax consequences. You can divide the tax consequences between the divorced spouses “property” becomes taxable in the future:

The good news is that there is IRS guidance on how the tax consequences of some of these divisions shake out. 

A non-employee spouse who wants to exercise their ½ of the community options in their employee-spouse’s plan should contact the employer to determine whether the stock is transferable.

Revenue Ruling 2002-22 talks about the exercise of vested NQ options by the non-employee spouse incident to divorce. Upon (1) the exercise of vested non- qualified stock options (NQ) by the non-employee spouse of his or her shares (under community property laws), the difference in ordinary income will be taxable to that non-employee spouse and (2) payments from a non-qualified deferred compensation plan to the non-employee spouse (as his or her share of the community interest in the plan) will be taxable to that non-employee spouse. The employee spouse will still be responsible for the social security and Medicare taxes on the transaction.

If the NQs may not be divided according to the terms of the employer, the employee spouse should insist that the tax consequences should still be divided.

Additionally, if the employer allows for transfer, the transfer of non-qualified options or non-qualified deferred compensation plans from the employee spouse to the non-employee spouse should not be a taxable transaction at the time of the transfer.  

You should request that the employer provide the non-employee spouse with a 1099 to report the tax consequences on his or her shares. Some employers will transfer the non-employee spouse’s share of the options into his or her name and social security number. The non-employee spouse can then exercise his or her shares directly with the employer.  

For ISOs, the IRS has provided a letter ruling that allows for a mechanism to allocate the income from the exercise of ISOs between the spouses. Though the income received will continue to be reported on the employee’s W-2, both the income and the income tax withholdings should be partially allocated to and reported by the non- employee spouse for his/her exercises. The AMT income should be allocated as well.  

The IRS has also indicated that the designation of the non-employee spouse as the beneficiary of a share of the community options in a trust arrangement will not disqualify the ISOs, but they cannot actually be transferred to him/her.

One option that is utilized if transfer of stock is not permissible is that spouses coordinate the sale of stock. The employee spouse provides the non-employee spouse with ½ of the community stock after taxes are withheld. For example, if 45 RSUs vest and the company sells 15 RSUs to pay for withholdings, the non employee spouse will receive 15 RSUs or (45-15) ÷ 2. 

This is often accepted by the IRS despite the incorrect tax treatment of the RSUs. However, the IRS may audit the returns and prompt responses to the notices with sufficient calculations and documentation generally resolve these notices. It is advised for preparers to warn the clients of this possibility so as to not look as though an “error” was made.

It’s important to provide the non-employee spouse with the actual benefits of the stock transactions, not just the tax consequences. The spouse should immediately receive his or her share of the cash or shares so the taxes can be paid. It may be prudent to require that the non-employee spouse’s share of the stock benefits be liquidated immediately to remove the risk of future stock decline and ensure that he or she can pay the taxes as they come due.

The information set forth in this Question and Answer was not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of avoiding United States federal tax penalties that may be imposed on the taxpayer.  The information was written to support the promotion or marketing of the matters addressed in this Question and Answer.  All taxpayers should seek advice based upon the taxpayer’s particular circumstances from an independent tax advisor.  The foregoing language is intended to satisfy the requirements under the regulations in Section 10.35 of Circular 230.

If you want to learn more about stock benefits and divorce,  you can contact me at Amanda@gordonfamilylaw.com for more information.

My spouse won’t complete their financial disclosures, what should I do?

Experienced Bay Area family law attorneys will tell clients that if a party fails to serve declarations of disclosure, the first step for the complying party is to informally request the noncomplying party prepare the declaration of disclosure. FC §2107(a). If the informal request is unsuccessful, then the complying party may file one or more of the following motions:

1. Motion to compel further responses. FC §2107(b)(1)

2. Motion for an order preventing the noncomplying party from presenting evidence onissues that should have been disclosed. FC §2107(b)(2).

If you are interested in learning more, you can contact me at Amanda@gordonfamilylaw.com for more information.

How much time do I have to fill out my financial disclosures?

Have you filed and served your petition?  Turned in your proof of service? Great, the next step after you have filed for divorce will be to start working on your financial disclosures. This means you need to disclose everything you own and owe to the other party. 

How soon should you start working on this? Right away! The deadlines for preliminary disclosures are quick as a preliminary disclosure declaration may be served with the summons and petition or thereafter. See Fam C §2104(a). The declaration must be served within 60 days of filing the petition. Fam C §2104(a), (f).

The respondent may serve his or her preliminary declaration, along with his or her response, no later than 60 days after filing the response. Fam C §2104(a), (f). These deadlines may be extended by court order or by written agreement of the parties. Fam C §2104(f) (operative Jan. 1, 2013). See also Fam C §2450; Cal Rules of Ct 5.83(c)(4)(C). 

You will need to complete the following documents:

FL 142: Schedule of Assets and Debts

FL 150: Income and Expense Declaration

FL 140: Declaration of Disclosure 

FL 141: Proof of Service of Declaration of Disclosure. 

You can contact me at Amanda@gordonfamilylaw.com for more information.

Check out our post about how to fill out FL 150 here for details on how to fill out your FL 150 properly.   

I don’t know what types of equity compensation my wife has at her start-up, what documents should I ask for in a divorce?

The document that you are looking for in order to determine what type of stock award your spouse has been given is called an Equity Compensation Plan Document. At the company level this is a document that applies to all employees. You will also want something called a Grant Notice, which describes the specific provisions of each grant given to the employee.

Last, you will want to ask for an Account Statement, which is a snap shot of where the employees accounts are today.

You can contact me at Amanda@gordonfamilylaw.com for more information..