Restricted Stock Units (RSUs) and Divorce: What You Need to Know

Restricted stock units in divorce

In this guide, I’m going to walk you through how to handle Restricted Stock Units (RSUs) in a divorce.

So if you or your spouse has RSUs, you’ll find the answers to your questions here.

Let’s get started.

How Restricted Stock Units (RSUs) work

(RSUs) work

Before we get too far into the details of how to divide RSUs in a divorce, let’s cover the basics.

Restricted Stock Units (RSUs) are a type of stock-based compensation used to attract and retain employees. Like stock options and phantom stock, RSUs are one of many ways that your employer can provide you with an opportunity to share in the success of the company.

They became more popular as an alternative to stock options after accounting scandals involving companies like Enron and WorldCom.

Until that time, stock options were the vehicle of choice.  But after a Financial Accounting Standards Board ruling in 2004 which changed the corporate accounting rules for stopck options, companies began shifting away from stock options in favor of RSUs.

Like stock options, RSUs provide an incentive to remain with the company (until the shares vest) and help it perform well so that their shares increase in value.

So, what are RSUs exactly?

RSUs are a promise to issue shares of employer stock once certain conditions have been met. 

The shares are “restricted” because they are subject to a vesting schedule based on length of employment or performance goals. The shares may also be subject to further restrictions such as limitations on the ability to sell or transfer shares. These other restrictions are more common with private companies.

RSUs are similar to stock options in that you can receive shares of company stock, but there are some important differences to note as well.  For example, if the stock price declines significantly, a stock option can lose all practical value as the options become “underwater” and the exercise price is higher than the stock price. This effectively eliminates any incentive to remain with the company since your stock options are now worthless.

That is not the case with RSUs.  Even if the share price falls after you are granted shares, the RSUs always have some value (unless the stock price falls to $0).

The catch is that you must remain employed at your company until vesting for the RSUs to have any value to you. If you leave the company, any unvested RSUs are usually forfeited.

Exceptions may take place in certain situations.  For instance, vesting may be allowed to continue or is accelerated due to specific agreements or life changes built into the RSU agreement (e.g., death, disability, or retirement, depending on the plan and grant agreement).

RSUs and Taxes

With RSUs, you are taxed when the shares vest (not when they’re granted). Your taxable income is based on the value of the shares at vesting.

Example: 100 shares vest at $10/share. Your taxable income is $1,000.

This compensation income is subject to federal taxes, state taxes, and payroll taxes (Social Security, Medicare). Like other W-2 income, the company is required to withhold taxes.

RSU taxes

An employer may offer several ways to pay taxes at vesting, or it may use a single mandatory method. The most common practice is withholding some of the vested shares to cover the withholding taxes.

The stock price at vest becomes your cost basis and the vest date is the start of your holding period (if you don’t sell the shares immediately). If you hold the shares for more than one year after vest, any increase in stock price from the value at vest to the sale price is taxable as long-term capital gains. If you hold for less than one year, it’s taxable as short-term capital gains.

An example of how RSUs work

example of how RSUs work

Let’s look at an example of how all this works.

You are granted 10,000 RSUs (shares of company stock) that vest at a rate of 25% a year.  The market price at the time the shares are granted is $20.

  • At Grant: The total pre-tax value of the RSUs is $200,000. However, you have no taxable income to report when the shares are granted.
  • Year 1: 2,500 shares vest
    • The stock price is $25 at the time of vesting. You have $62,500 of taxable income to report. (2,500 shares x $25/share)
  • Year 2: 2,500 shares vest
    • Share prices rise to $30 at the time of vesting. Your taxable income is $75,000 (2,500 shares x $30/share)
  • Year 3: 2,500 shares vest
    • Share prices fall to $10/share. Your taxable income is $25,000 (2,500 shares x $10/share)
  • Year 4: 2,500 shares vest
    • The stock price at vest is $40/share. Your taxable income is $100,000 (2,500 shares x $40/share)

The overall total value of the vested shares at vest is $262,500.

Vesting

The above example is a “graded” vesting schedule because the shares are vested in portions over time.

By contrast, companies can also use “cliff” vesting.  That takes place when 100% of the shares are vested all at once after completing a stated period of service or specific performance goals.

Graded vesting can take place at regular intervals, or there can be varying intervals between vesting dates.

It’s not uncommon to have a combination of cliff and graded vesting. For instance, you might have 25% of the shares vest after 1 year, then have the remaining shares vest monthly for the next 36 months.

Regardless of the vesting schedule, each block of shares is taxable upon vesting.

Understanding the basics of RSUs in a divorce

As part of the divorce process, you and your spouse will be required to complete financial disclosures. The idea is to ensure that you both have an understanding of the entire financial picture.

The financial disclosures include providing details on all assets and compensation. That includes any RSU grants.

RSUs and other forms of stock-based compensation can be valuable assets that need to be addressed in a divorce.

Seeking stock options and RSUs as compensation during a divorce can be challenging, mainly because the value will change over time.

Stock prices change all the time.  As a result, the value of the stocks will not become fixed until a spouse decides to exercise his or her options and cash out or until the RSUs vest.

There are two main ways to divide RSUs.

  • Option 1: The employee spouse can keep the RSUs and buy out the other spouse’s interest based on the current value.
  • Option 2: Deferred division. Witht this approach, the employee spouse continues to hold the unvested RSUs in his/her name until the RSUs are released. At that time, the non-employee spouse would receive their share of the vested RSUs.

Both methods carry their advantages and disadvantages.

If your spouse cuts you a check for the value of the RSUs now, you could miss out on future gains, especially if the company is still in the start-up phase.

But by getting the value of the options upfront, you are also eliminating the risk of future drops in value.

If a spouse received RSUs while you were married, they will likely be considered as marital property (at least in part).  This means you are entitled to a portion as part of your divorce settlement, depending on the divorce laws of your state.

Before a proper division can take place, there will need to be a determination of what part of the RSUs is marital property vs. separate property.

How to determine the marital (community) portion of RSUs in divorce

marital (community) portion of RSUs in divorce

Laws will vary from state to state, but no matter where you live, determining the marital portion of RSUs can be complicated.

Part of this depends on the property division laws in your state.  Some states, such as California, are community property states, and all marital assets are divided equally.  In equitable distribution states, which encompass the vast majority of states, assets are divided fairly but not always equally.

Determining what part of RSUs are community property is influenced by several factors:

  • When was the RSU award granted?
  • What is the vesting schedule?
  • What is the vesting criteria? In other words, do the RSUs vest over time or is vesting contingent on meeting certain performance metrics?
  • Why was the RSU awarded? Employees can be granted RSUs as rewards for past performance or as an incentive for future performance. If the RSU was granted for past performance, it means a spouse may receive RSUs after separation as a bonus for work that took place during the marriage.
  • Most RSUs do not allow an employee to transfer ownership of restricted shares to their spouse.

If RSUs are granted and vest during a marriage, then determining the characterization (marital vs. separate) is relatively simple.  If the employee wants to keep the RSUs, then they can negotiate an equitable trade-off based on the current value of the RSUs.  The other option is the split the present value of the stock, and sell half, which is given to the non-employee spouse.

Time Rule Formulas

Dividing RSUs after a divorce is especially relevant in California. Many Silicon Valley tech companies, particularly start-ups, offer employees RSUs as a form of deferred compensation.

When RSUs are granted during a marriage but not yet vested, a division becomes more complicated.  Often in California divorces, The Hug Formula or the Nelson Formula are used to sort things out.

Hug and Nelson refer to California Appellate cases that further defined the division of stock options and RSUs in a divorce. Both of these are variations of the time rule. 

The time rule essentially looks at the total earning period and what portion of the total earning period occurred during marriage. That ratio is the marital percentage.

Keep in mind, vesting is contingent on the employee spouse staying with the company for several years.  If the employee leaves or terminates, those RSU grants have no value.

The Hug Formula for Calculating the Marital Portion of RSUs

Using the Hug Formula, the shares owed to the non-employee spouse are calculated by thinking of an RSU as deferred compensation for past performance. The formula calculates the percentage of community interest as follows:

(Period of Time Between Start Date at Company and End of Marriage) /

(Period of Time Between Start Date at Company and Vesting)

The community interest is multiplied by the total shares harvested.  That number is divided in half. That total is the non-employee’s portion of the vested shares.

The Nelson Formula for Calculating the Community Portion of RSUs

The Nelson Formula considers the stock as primarily future incentives for performance. The community interest under the Nelson Formula is:

(Time worked between the date of the grant and the date of separation) /

(The date of the grant and the date the option is first exercisable)

Community interest is multiplied by the number of shares that have vested and divided in half. That amount is the non-employee’s portion of the vested shares.

Both formulas are applicable but do have some differences to note. After weighing these differences, the choice of which one to use is typically determined by both spouses.

In some cases, RSUs are considered marital property on the date the RSU was granted.  If the RSU is not vested by is deemed marital property, the parties will need to negotiate a value of the RSUs and compensate the non-employee with a payment.

Another option is for both parties to agree to wait until the RSUs vest in the future when they can be sold, creating a more accurate valuation.  Most divorcing couples do not go this route, instead preferring a clean financial break from their partners.

Looking at a few different scenarios for RSUs and divorce

Depending on your situation, dividing RSUs in a divorce can be relatively easy to determine, or it can be just the opposite.

Let’s take a closer look a few scenarios:

  • RSUs granted during marriage that vest during marriage: These are generally considered as marital or community property and would be divided according to the division of asset laws for your state.
  • RSUs granted after a separation or a divorce are generally considered separate property.
  • RSUs granted during a marriage that vest after separation: There is usually a marital portion and a separate portion. This is calculated using one of the time rule formulas discussed above.
  • RSUs granted before marriage that vest during marriage: This falls in the same category as RSUs granted during marriage that vest after separation. There’s a marital portion and a separate portion.

How to Value or Divide RSUs in Divorce

Value or Divide RSUs in Divorce

Ok, so now you’ve figured out the marital portion of the RSUs.

What’s next?

Decision time…

Do you want to divide the RSUs or do a buyout?

Let’s look at how both of these options work.

Dividing RSUs in Divorce

With this option, you and your spouse will split the marital (or community) property RSUs.

Unvested RSUs can’t be transferred on the books. Luckily, there’s a workaround.

The employee spouse can hold the other spouse’s RSUs in constructive trust. Don’t worry, you don’t actually have to create a trust. All this means is that the employee spouse essentially becomes the broker for the other spouse’s RSUs. The employee spouse will transfer the other spouse’s shares to them once the RSUs vest.

The shares can be transferred (not the unvested RSUs).

Dealing with the taxes is where things can get a little complicated.

In a nutshell, the income and withholdings are all reported in the employee’s name. You can allocate the spouse’s portion of the income and withholdings to the spouse on your tax returns. If you’re going this route, be sure to work with a CPA.

The alternative to allocating income and withholdings is to simply have the employee pay the taxes and only deal with the net shares released.

The drawback here is that the shares withheld are often not enough to cover the taxes owed. Sometimes, the employee spouse gets the short end of the stick with this approach.

How to Value RSUs for Offset in a Divorce

The other option for dealing with RSUs is to value them for offset. This means you’re going to place a value on the RSUs that you’re keeping and your spouse will get other assets or cash in exchange.

If the company is publicly traded, this approach is actually pretty simple.

Step 1: Calculate the marital (community) property portion.

Step 2: Multiply the number of unvested community property RSUs by the current stock price. This gives you the pre-tax community value.

Step 3: Apply a tax discount. This can be a little tricky, but the idea is to estimate the taxes that you would pay on the RSUs.

Step 4: Divide by 2 to calculate each spouse’s portion.

Let’s look at how this works with an example.

Let’s say there are 200 total unvested RSUs and 100 of them are community property. The stock price is $10 per share.

100 community shares x $10/sh = $1,000 pre-tax community value

Let’s assume the tax rate is 25%.

Tax discount = $1,000 x 25% = $250

After-tax marital (community) value = $1,000 – $250 – $750

After-tax value for each spouse = $750 / 2 = $375

In this example, you would owe $375 to buy out your spouse’s interest in the community RSUs.

Keep in mind there’s a risk that the unvested RSUs are forfeited if the employee leaves the company prior to vesting.

That’s why it’s unusual for the non-employee spouse to consider doing a buyout.

It’s not all or nothing

So far, we’ve talked about either doing a buyout or splitting the RSUs.

It’s not all or nothing. You could consider doing a partial buyout, where one spouse buys out a portion of the other’s RSUs and you split the rest of the RSUs.

This can be a good solution in situations where you have a lot of RSUs and one spouse wants to trade for other assets like the marital home or a pension.

How do RSUs impact alimony and child support

In most states, a big part of calculating child support and alimony payments is based on the income of both parties.  Generally speaking, guidelines are in place to consider all sources of income.

Compensation, in general, has gotten more complex than ever before.  RSUs are one form of this more complicated compensation issue. Bonuses, commissions, deferred compensation, stock options, and other sources of income can all impact the amount of income parents make and must report for child support purposes.

The tricky part is that these forms of compensation are not always paid out regularly.  That is true for RSUs awarded on a cliff schedule (all at once), and sometimes on a graded schedule if the intervals are not spaced consistently.

The IRS does not treat the initial grant of the restricted stock as income for income tax purposes.

However, for purposes of calculating child or spousal support, a court might treat the vesting of the right to exercise the option as income. The current value minus the purchase price will determine the amount of income.

The IRS allows an 83(b) election if the employee wants to be taxed as ordinary income before vesting, or before the lapse of restrictions. Any increase in value is taxed at capital gains rates, which are almost always less than ordinary income rates. Note that an 83(b) election is only allowed for restricted stock – not for RSUs.

Ultimately, when the stock is sold, any profit will be income available for purposes of calculating alimony or child support, regardless of whether it is ordinary income or capital gains income.

In some cases, these non-salaried forms of compensation may be much higher than an employee’s regular paycheck.  Predicting their amounts for child support can be difficult as a result.

Offsetting this is that in some states, the amount of income used to determine child support is capped.  The thinking is that at some point, child support will cross a line of being too high because the parent’s income is so high, resulting in an amount that is far and above what a child needs.

(I’ve had cases where child support was set at almost $100,000 per month!)

But that may not be the case in some states which don’t have a cap.

It can make for interesting negotiations between parents and their attorneys.  When a disagreement can’t be resolved, parents may need to resort to mediation, or the court will step in and resolve the matter instead.

More Frequently Asked Questions about RSUs

Frequently Asked Questions about RSUs

What is the withholding rate on RSUs?

RSUs are considered as supplemental wages (like bonuses) and are subject to statutory withholding requirements. Here’s a breakdown:

  • Federal: 22% on supplemental wages up to $1M, 37% on supplemental wages in excess of $1M
  • Social Security: 6.2% (on annual wages up to $132,900)
  • Medicare: 1.45% regular plus 0.9% on wages in excess of $200,000
  • State: varies based on your state

One of the common misconceptions is that bonuses are taxed at higher rates the regular pay. That’s simply not the case. Keep in mind that these are the withholding rates, which is just an approximation of your actual taxes. The withholding might be different, but your total taxes are the same at the end of the day.

Do you receive dividends on RSUs?

You will have voting and dividend rights only after you are vested (because technically you don’t own the shares until they’re vested).

Companies sometimes pay dividend equivalent payouts for unvested RSUs which may be reported on a W-2 as wages in some circumstances. These dividend equivalents that can be moved into an escrow account to help offset withholding taxes.  They can also be reinvested through the purchase of additional shares.

RSU Dividend Equivalent Units

How can I tell if my spouse has RSUs?

There are a couple ways to tell if your spouse has RSUs.

First, you could have your attorney subpoena the company that your spouse works for. This is the most surefire way to get the details on your spouse’s compensation package.

The drawback to this apprach is that it can be challenging to keep things amicable if you’re issuing subpoenas.

Fortunately, there are a couple of other alternatives.

Ask for your spouse’s pay stubs and W-2’s. Look for an “RSU” or “restricted stock” entry on the pay stubs. If any RSUs have vested in that year, you’ll see the total RSU income listed under the “Year To Date” column.

W-2’s will often list RSU income in box 14 as you can see here.

W-2 showing RSU income and 401k contributions

These alternatives can be a great way to “trust but verify” what your spouse is telling you.

If your spouse claims they don’t have RSUs, but their W-2 or pay stubs reveal otherwise, then you know you need to be super diligent about fact checking. You’re best bet in this case is to subpoena the company and get the details.

One thing to keep in mind is that RSU income will only show up on W-2’s or pay stubs once the RSUs vest. So, if your spouse has RSUs which are unvested, checking W-2s and pay stubs won’t help.

What information do you need to obtain for RSUs in a divorce?

Gathering information is key to understanding your spouse’s compensation package, including RSUs.

For each RSU award, here’s what you need to know:

  • Grant number
  • Grant date
  • Vesting commencement date
  • Number of shares granted
  • Vesting schedule

Here’s a short list of the information you need:

RSU Grant Notice. This is a 1-pager that lays out the specifics of the RSU award listed above. Get the grant notice for each RSU award.

RSU Award Agreement

RSU Plan Agreement. Unlike the grant notice, the plan agreement isn’t specific to a particular RSU award. Rather, the plan agreement is a formal governing document that sets out:

  • Why the company issues RSU awards,
  • Transferability of RSUs
  • What happens to unvested RSUs if the employee retires, gets disabled, etc.
  • What happens to unvested RSUs if the company is acquired

Account statement for the stock plan account. Ask for all account statements from the date of separation through current. This will give you a snapshot of the owned shares, cash, and any unvested RSUs.

Transaction details. You might also need the RSU Release Confirmation Statements and any sales confirmation statements.

The release confirmation statement shows the details for a particular vesting. It will list the number of shares withheld for taxes, net shares released, taxable income, and the like.

It can be tough to find release confirmation statement. For some stock plan administrators, you need to go to the grants and click to expand the vest details. Then you can find the Confirmation of Release.

RSU Release Confirmation

The sales confirmation statements will show the details for the sale of any stock. Together, these documents can help you account for the vested RSUs and any cash proceeds.

Details on reissuing. In some cases, the company will reissue RSU awards. This usually happens if there is a stock split, acquisition, or some other company event.

Why does this matter?

Well, when RSUs are reissued they usually have a different grant date. Remember, the grant date can affect the calculation of what’s marital property. So, you’re going to want to find out the details around the original grant and reiussued grant.

(Complicated, I know!)

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