Posted on June 16, 2020

Stock Options And Divorce In Illinois

The term “stock options” has a certain mystique. Stock options seem like sophisticated financial instrument for the rich and about-to-be-rich…and they kind of are.  The problem with sophisticated financial instruments like stock options, is that they are hard to divide in an Illinois divorce.  So, how do you divide stock options in an Illinois divorce?

What Are Stock Options?

There are two classes of options that people refer to when they say “stock option”

One type of stock option is a sophisticated way to buy or sell stocks by betting on the stock’s future value without actually buying the stock. This is usually just called an “option.” This is financial device is not what people usually refer to as a “stock option” in a divorce. I discuss options first, before employee stock options to clarify how the concept of an option works.

An option gives an investor the right, but not the obligation, to buy or sell a stock at an agreed upon price and date.

Whether you have the right to buy or sell a stock through an option is referred to as “calls” or “puts.”

A call is a bet that the stock will go up.  A call might cost as little as $ 2. But it could give you the right to buy a share of Wal-Mart for $ 30.  If Walmart’s stock goes up to $ 50.  You can use your call to buy it for $ 30. That’s an $ 18 profit after the $ 2 call price.

A put is a bet the stock will fail.  So, you can bet the right to sell a stock at a price and assume the price will be less than that.  So, if you have a General Electric put for $ 80 and General Electric is priced at $ 50.  You can buy a share of General Electric at $ 50 and then sell it via your put at $ 80 and keep the $ 30 difference.

These types of stock options usually only last for a short period of time. They never last more than 2 years. Because of the short time frame, these types of independently exercised stock options are never divided in a divorce because the expiration date usually passes before the divorce is finalized.

Employment Based Stock Options

The stock options that are usually subject to division of assets in an Illinois divorce are stock options associated with one party to the divorce’s employment.

Typically, a company will offer employees the option of buying calls for the stock in the company after a period of time…so long as they still work there.

This builds up a lot of loyalty in the employee as they are committed to both 1) staying at the company and 2) making sure the company is successful. 

The period the employee waits until they can exercise the call is called “the vesting period.”  Until the day the call can be exercised, the options are considered non-vested.  If the employee leaves the company with non-vested stock options, those stock-options can never be exercised so they just disappear.

If the waiting period expires and the stock options can be exercised, those stock options are considered “vested.”  The employee can exercise those vested stock options any time, even if they leave the company. 

As you can see, non-vested stock options are worthless at any given time before the options finally vest.  So how could you possibly divide something that is theoretically worthless in an Illinois divorce?

How Do You Divide Stock Options In An Illinois Divorce?

It just isn’t fair to say that non-vested stock options have no value.  If the employee just keeps working at the company, those options will eventually have value.  It’s like saying a lottery ticket that will win in two years has no value because you can’t cash it in yet. 

Illinois used to have a bunch of convoluted court rules for how to best distribute both vested and non-vested stock options.  So, be careful when you read articles about stock options and divorce in Illinois written before 2016.

Now, Illinois has a statute that says that it doesn’t matter if a stock option is worthless today…it’s still a marital asset like anything else that was earned during the marriage. 

“For purposes of distribution of property under this Section, all stock options and restricted stock or similar form of benefit granted to either spouse after the marriage and before a judgment of dissolution of marriage or legal separation or declaration of invalidity of marriage, whether vested or non-vested or whether their value is ascertainable, are presumed to be marital property.” 750 ILCS  5/503(b)(3)

An Illinois divorce court “shall divide the marital property without regard to marital misconduct in just proportions considering all relevant factors” 750 ILCS 5/503(d)

If a stock option is somehow premaritally earned, a gift, or an inheritance, then the stock option is NOT divisible in an Illinois

“This presumption of marital property is overcome by a showing that the stock options or restricted stock or similar form of benefit were acquired by a method listed in subsection (a) of this Section.” 750 ILCS 5/503(b)(3)

The statute openly acknowledges that no one knows what stock options are worth and the two parties will have to wait to determine the value and distribution of a stock option.

“The court shall allocate stock options and restricted stock or similar form of benefit between the parties at the time of the judgment of dissolution of marriage or declaration of invalidity of marriage recognizing that the value of the stock options and restricted stock or similar form of benefit may not be then determinable and that the actual division of the options may not occur until a future date.“ 750 ILCS 5/503(b)(3)

How Can I Get My Share Of The Stock Options When They’re Exercised Years After My Illinois Divorce?

Now that the parties are divorced, the non-stock option holding party must rely on the stock-option holding party to exercise those stocks options and then distribute the proceeds per the parties’ Marital Settlement Agreement

The instructions contained in the Marital Settlement Agreement as to how the future value of the stock options shall be handled is referred to as a “Constructive Trust

“[A] constructive trust requires any other party who receives the…proceeds, but who has an inferior equitable right to them, to hold the proceeds solely for the vested beneficiary.” Perkins v. Stuemke, 585 NE 2d 1125 – Ill: Appellate Court, 4th Dist. 1992

So, the party with the non-vested stock options becomes the trustee for their ex-spouse’s interest in those options until such a day when the stock options can be exercised and distributed.

What Do I Need To Include In My Illinois Marital Settlement Agreement In Regards To My Stock Options?

Dividing stock options and creating a constructive trust that provides the trustee with instructions and the beneficiary (the ex-spouse) with appropriate expectations is really complicated.

So, here’s an example below of what I put in my Marital Settlement Agreements regarding stock options. (This is seriously the shortest example I could fine)

“Ronald has an interest in certain non-qualified McDonald’s stock options (“NSOs”) that were granted during the marriage in connection with her employment and specifically described and divided on Exhibit A hereto.

The stock options are in Ronald’s name and are not transferable or assignable by their terms.  Accordingly, the Parties agree to the following procedures as to the options awarded to Wendy (also hereinafter “assignee”):

Wendy shall give written notice of intent to exercise any options awarded herein. Such notice shall specify precisely the grant and number of shares to be exercised.

Notice shall be delivered by certified mail, facsimile or email.  Notice by facsimile or email shall not be valid without acknowledgement of receipt by Law Office of Russell D. Knight, Ronald’s Attorney.

Notice shall specify the Grant ID, number of shares to be exercised, date of exercise, and whether or not the stock is to be sold (cashless exercise) or certificates issued.

Within two (2) business days of receipt of Wendy’s written authorization, Ronald shall exercise the options as requested, unless doing so would violate any SEC “black out” provisions. 

Unless there are special circumstances, Wendy shall not request an exercise of stock options more than once every three (3) months. 

In the event that Ronald is unavailable because he is not at his home or workplace due to vacation or illness, she shall exercise the options upon her return and shall not be liable for any change in stock price.

Ronald  shall deliver all net proceeds and documentation from exercise of Wendy’s options to Ronald within twenty-four (24) hours of receipt of proceeds.  In the event Wendy elects to receive stock certificates instead of sale proceeds, Wendy shall direct that upon exercise the shares be registered in Wendy’s name and delivered to Wendy, if possible.

Payment of Exercise Price, Taxes, Fees and Liabilities.  Wendy shall be solely responsible for the exercise price, commissions, taxes, fees, or any other expenses, except for expenses associated with paragraph _____for Law Office of Russell D. Knight which Ronald will assume such fees, related to the exercise of his options and the subsequent sale or other disposition of the stock received.  As a result, Ronald will direct his employer to withhold the employee portion of Illinois personal income tax (5%) and the Head of Household Federal Income Tax Rate for wages (33%) when Wendy exercises her options.

The calculation, responsibility and any preparation fees for the allocation of taxes from Wendy to Ronald shall be the responsibility of Jane to determine as follows:

Ronald’s actual income tax liability for the year shall be based on the total tax liability reflected on her personal income tax return filed.  The tax liability shall not include any withholding or other tax payments/income such as a new spouse’s income and shall always be determined at the head of household rate, unless Jane is no longer entitled under applicable tax laws and regulations to file her returns under the head of household rate, in which case the tax liability shall be determined at the single filing rate, if Ronald is not married on December 31 of the tax year in question, or the married rate, if Ronald is married on December 31, of the tax year in question;

Less:  a pro-forma income tax liability calculated in exactly the same manner as the above return noted in _____return but without the gains/taxable income from the exercise of the restricted and non-restricted stock and stock options on behalf of assignee and the exercise of the restricted and non-restricted stock and stock options and ordinary/capital gains on behalf of Ronald.

The difference in the above two calculations between the two paragraphs above equals the income tax due to the exercise of stock options and other capital assets on behalf of both Wendy and Ronald

The income tax due to the exercise of stock options determined in the above paragraph shall be multiplied by the ratio of Wendy’s total gains/taxable income on his restricted and non-restricted exercised options divided by the sum of Wendy and Ronald’s total gains/taxable income on their restricted and non-restricted exercised options and capital assets, which equals the income tax due on Wendy’s exercise of options allocated to him.  The withholdings set forth in the introduction of this paragraph associated solely with the exercise of options allocated to Wendy shall be deducted from the income tax due on the exercise of stock options allocated to Wendy.  Such amount or credit shall be promptly paid or reimbursed by Wendy or Ronald respectively.

The assignee shall have the right to appoint a Certified Public Accountant at Wendy’s cost to review the Ronald’s calculations set forth above.  Ronald shall provide the relevant portions of his tax returns, supporting calculations and any necessary data to the qualified CPA appointed by Wendy by April 15th of the following year (or the date on which Ronald files his tax returns for the year in question if later than April 15, but not past October 15 of the following year) in which the options were exercised.

In the event Ronald’s employment with McDonald’s is terminated for any reason, thereby requiring the exercise of the outstanding stock options within a specified time period, Ronald or his representative shall promptly notify Wendy in writing of such time period. 

Nothing in this Agreement shall be construed to require Ronald to violate any securities laws, other applicable laws or the rules and regulations of the underlying employer plan documents in the exercise of such stock options.

In the absence of a written authorization from assignee, Ronald shall also on assignee’s behalf exercise any and all stock options awarded to assignee hereunder that would otherwise terminate, expire, or be forfeited if there were not exercised; provided, however, that the exercise of said stock options without written authorization shall not result in a net loss.  Exercise of stock options on assignee’s behalf without his written authorization pursuant to this paragraph shall occur no more than three (3) business days before the termination, expiration, or other forfeiture of the stock options unless Ronald is otherwise instructed in writing by assignee.

In the event there is a limitation as to the number of shares which may be exercised during a particular period, Ronald shall advise the assignee of such limitation, and if both desire to exercise some or all of their respective options during such period, then each shall be entitled to exercise options equal to 50% of the available limitation.

In the event the assignee of the stock options awarded herein states his intent to receive the actual shares under option versus the “cash proceeds” (i.e., forgo the cashless exercise option), then she shall tender to Ronald a cashier’s check in the estimated amount necessary to pay all costs of such transaction including income tax at 39.6% and Medicare tax.  If the estimated amount paid to Ronald is insufficient to cover all such costs, then the shortfall shall be paid by cashless exercise.

If assignee wishes to exercise certain stock options and immediately sell such shares, Ronald may elect in lieu of actual exercise of the shares to pay in cash directly to assignee an equivalent amount to the net value assignee would have received from the exercise and sale transaction.

Vested Options:  Some of the options transferred to Wendy by this Agreement are vested as of the date of the entry of the Judgment for Dissolution of Marriage (hereinafter “vested options”).  Only in the event that McDonald’s allows the use of Internal Revenue Service Ruling 2002-22, then this provision shall apply.  Accordingly, only the exercise price and applicable commissions, fees, Medicare tax, and withholding of income tax at the minimal rate allowed by law or such greater rate as specified by Wendy shall be withheld at the time of exercise.  Pursuant to Internal Revenue Service Ruling 2002-22, Wendy shall report and pay tax on all income resulting from his exercise of vested options.  She shall receive credit for all income tax withholding at the time of exercise.  Should either Party desire clarification of this paragraph absent agreement the matter shall be submitted to arbitration.

Ronald shall request that Wendy receive statements on a quarterly basis of the account relating to Wendy’s restricted and non-restricted options with the broker of record”

This is about as sophisticated as it gets in Illinois divorce law.  So, if you or your spouse have stock options, it should be clear that you’re going to need an experienced Illinois divorce lawyer.

Restricted Stock Units And Divorce In Illinois

Another common employee benefit/incentive is to award employees restricted stock units.

A restricted stock unit is a form of compensation issued by an employer to an employee in the form of company shares.  These restricted stock units are issued through a vesting plan and distribution schedule just like stock options. 

So, an employee may accrue restricted stock units over time but the restricted stock units will not turn into actual stock shares until they’ve vested.

The exact same principles are applied regarding restricted stock units and stock options when it comes to dividing these non-vested assets in a divorce.  A constructive trust has to be created in the Marital Settlement Agreement. 

The difference between restricted stock units and stock options are that restricted stock units always turn into the stock of the company after completely vesting. That stock in the company is going to have some value unless the company goes bankrupt.

Stock options, however, may not have any value because if the price of the stock option is higher than the value of the stock, the stock option is worthless. 

Stock Options, Maintenance And Child Support In Illinois

Stock options and restricted stock units are not only quasi-assets to be divided in an Illinois divorce…they are also income.

Often, an asset cannot be both a distribution of marital assets and income under Illinois divorce law. When a party exercises stock options or restricted stock units, that is a taxable event because it is income at that moment regardless of when it was earned. This implies that stock options and restricted stock units, when exercised are income.

Because the unvested stock options transformed into a realized distribution, it would seem that the distribution is not marital property being counted as income, but instead the fruits of the marital property…even if the stock distribution is marital property…the pertinent case law persuades us that marital property can also be income for child support purposes.” In re Marriage of Colangelo, 355 Ill. App. 3d 383, 390 (Ill. App. Ct. 2005)

This sudden burst of income may affect the initial calculation of child support and maintenance. A future options exercise or award date may warrant a future modification of the maintenance award from one spouse to another.

Are Stock Options Really Worth Fighting Over In A Divorce?

Stock Options have a price. The stock of the company has a price. If the stock option (the right to buy the stock) costs more than the actual stock, the stock option has no value…and therefore you shouldn’t fight over it. 

Moreover, stock options are clearly a real hassle to effectively divide and distribute.  Ex-spouses will have to deal with each other for years as they slowly exercise and divide stock options.  Do you really want to be in the business of holding a sophisticated financial instrument with your ex-spouse?

In lieu of dividing stock options in an Illinois divorce, parties should consider awarding something or relatively similar value in lieu of the stock options. 

For example, an MSA could say “Wendy is awarded the marital home in its entirety in lieu of receiving any marital interest in Ronald’s stock options or restricted stock units.” 

Stock options, by their nature have an uncertain value so the determination of what marital assets to allocated in lieu of stock options will be inherently uncertain as well. 

“The uncertainty of the values of the unvested stock options and RSUs [is] not an impediment to an equitable distribution when they become vested.” In re Marriage of Micheli, 2017 IL App (2d) 150984-U

Counting on some future stock option paying off and dividing the way you hope is a gamble and like the old song says “sometimes, you gotta know when to hold ‘em and know when to fold ‘em.”

If you’d like to learn more about stock options, restricted stock units and Illinois divorce laws, contact my Chicago, Illinois family law office to discuss your matter in a free consultation.

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Russell Knight

Russell D. Knight has been practicing family law as a Chicago divorce lawyer since 2006. Russell D. Knight amicably resolves tough cases while remaining a strong advocate for his client’s interests.

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