Equity Awards in Divorce: A Guide for Plan Administrators

Divorce proceedings that involve equity compensation can quickly become one of the more complex situations a stock plan administrator faces. When stock options, restricted stock units (RSUs), or employee stock purchase plan (ESPP) rights have been earned during a marriage, they may be classified as marital property — and therefore subject to division in a divorce settlement. Understanding the two primary methods for dividing equity awards in divorce, and how to establish a clear company policy, is essential for any organization with an equity compensation program.

Are Equity Awards Considered Marital Property?

Equity awards granted or earned during a marriage can be subject to division in a divorce settlement. That said, companies are automatically required to permit outright transfers to a former spouse. Many equity plans restrict transferability to the award holder's death, and incentive stock options (ISOs) and Section 423 qualified ESPP participation rights are legally required to be nontransferable except upon death.

This creates a fundamental tension: a court may order the division of equity compensation while the company's plan documents prohibit transfer. A clearly documented divorce transfer policy is the most reliable way to manage this conflict before it becomes a legal or administrative dispute.

Two Methods for Dividing Equity Awards in Divorce

When equity grants must be divided pursuant to a divorce decree, companies generally choose between two approaches: assignment of economic interest (structured as a constructive trust) and legal transfer of the awards. Each carries distinct implications for plan administration, tax withholding, and regulatory compliance.

1. Assignment of Economic Interest

In this approach, equity grants remain in the employee's name. A portion of the economic value is assigned to the nonemployee former spouse, but the employee retains legal ownership and holds the former spouse's interest in a constructive trust.

Advantages for plan administrators:

• The company communicates primarily or only with the employee — no need to track split ownership or engage directly with the former spouse.
• Tax withholding remains straightforward, with the employee bearing all obligations.
• ISOs and qualified ESPPs can often retain their tax-qualified status. 

Key considerations:

• Coordination Between Former Spouses: The employee and former spouse must coordinate all transactions, which can be difficult post-divorce.
• Taxation: The employee remains personally liable for the full tax consequences of the award, including the portion benefiting the former spouse — the divorce settlement should explicitly address whether the employee is to be compensated or reimbursed for the tax obligation.
• Insider Trading: The former spouse's ability to transact may be constrained by the employee's insider trading restrictions, including blackout periods and preclearance requirements.

2. Legal Transfer of Equity Awards

In a legal transfer, ownership of a portion of the employee's grants is transferred to the former spouse.  The transferred portions of the grants are moved into an account established by the nonemployee former spouse with the company's third-party stock plan administrator or broker.

Advantages for employees and former spouses:

• Each party controls their own stake independently, without relying on the other for execution.
• The employee generally does not recognize federal income tax on the former spouse's equity transactions (though FICA still applies), and taxes are withheld from the former spouse. See the article "Taxation of Equity Awards Transferred Pursuant to Divorce" for more information.
• The former spouse is typically not subject to the company's insider trading policy.

Key considerations for plan administrators:

• Recordkeeping: Not all stock plan platforms support legal transfers natively. Administrators must confirm whether the system will automatically cancel a former spouse's awards upon the employee's termination, or whether a manual process is required.
• Tax withholding and reporting: Income tax on the former spouse's equity transactions must be processed outside of payroll — deposited via EFTPS and reported on Form 1099-MISC. FICA payments remain attributable to the employee and appear on Form W-2.
• Data collection: I recommend that companies obtain the former spouse's tax identification number, mailing address, and any other information necessary to fulfill their tax withholding are reporting obligations before processing any transfer.
• Global equity plans: Companies with global equity programs must evaluate jurisdiction-specific requirements in each relevant country.

Accounting and Section 16 Considerations

Neither transfer approach should affect the accounting treatment of the underlying equity awards. Transfers of equity compensation pursuant to divorce are not treated as modifications and should not change the award's fair value or expense recognition schedule. Plan administrators should nonetheless verify that recordkeeping updates do not inadvertently trigger material changes in recorded compensation expense.

From a Section 16 perspective, legal transfers pursuant to domestic relations orders are generally exempt from both the short-swing profit rules and reporting requirements. Transfers of economic interest are similarly likely exempt, as the insider no longer holds a pecuniary interest in the transferred securities. Footnote disclosure in the insider's next Form 4 filing is worth considering in either case.

Best Practices: Establishing a Divorce Transfer Policy

Every company with an equity compensation program should maintain a documented divorce transfer policy — regardless of what the plan document says. Courts have been known to interpret broadly worded transfer restrictions narrowly, potentially deeming a divorce-related transfer involuntary and therefore unenforceable.

A comprehensive equity award divorce policy should address:

• How transfer requests will be received, reviewed, and processed
• What documentation is required from both parties
• Who reviews the proposed division of assets to confirm accuracy
• Who communicates with the former spouse, particularly if the employee later terminates employment and triggers forfeiture of unvested awards

Providing employees with a plain-English explanation of the company's equity award transfer policy — one they can share with their attorney or spouse — can help ensure divorce settlements are structured in a manner consistent with plan terms.

Conclusion

Handling equity awards in divorce requires plan administrators to navigate a complex intersection of administrative processes, tax obligations, and legal requirements. Companies that understand both available transfer approaches and maintain a clear, written divorce transfer policy will be better equipped to respond consistently and compliantly when these situations arise.

For a comprehensive analysis — including more detail on the treatment of options, awards, and ESPPs — read the full article: "Treatment of Equity Awards in Divorce."