A recent opinion by the Massachusetts Appeals Court in the case of Ludwig v. Lamee-Ludwig (2017) has clarified an area of MA law that has beleaguered judges, attorneys, and divorce litigants for some time: In Massachusetts divorce cases, are unvested stock options and RSUs considered income, assets or both? The short answer is that unvested shares can be both assets and a source of income for future support, depending on the timing of the stock grant, the vesting date, and the final date of divorce.
Stock Options, RSUs, and the Alphabet Soup of Equity Compensation
Before focusing on the divorce implications, it is worth noting that stock options and RSUs are not the same. The timing, value and purpose of stock options and RSUs differ in important ways. The same is true of RSAs, NSOs and the veritable alphabet soup of similar forms of equity compensation paid to corporate managers and executives. What most of these forms of compensation have in common, however, is this: the employee is paid by a “grant” of stock shares by his or her employer company, the employee must continue to work for the company for a period time for the shares to “vest”, when the vest date arrives, the employee receives a payment that is typically taxable to the employee as ordinary W2 income.
While the details of the various forms of profit sharing and/or equity compensation differ, the generally similar purpose, timing, conditions, and tax treatment of such payouts means they are treated similarly for divorce purposes. Indeed, an unpublished 2014 decision by the Appeals Court, Brookes v. Brookes (2014), characterizing stock options and RSUs as being part of the same family, and in most cases, Massachusetts courts are likely to treat the various forms of equity compensation that combine stock shares and a vesting period in a similar fashion.
(For the purposes of this blog, my references to vested and unvested “shares” will be equally applicable to stock options, RSUs, RSAs, PSUs, etc.)
Unvested Shares as Assets vs. Income: Why Does it Matter?
If an unvested share is treated as an asset in a divorce, the other spouse can argue that he or she should receive 50% of its value in the division of assets. However, if the unvested shares are treated as a source of future income, the other spouse will likely receive a substantially smaller amount in the form of future alimony or child support payments (typically between 15%-35%). In some divorces, this asset vs. income distinction can amount to hundreds of thousands of dollars. While many attorneys have long understood that a choice must be made between treating unvested shares as assets vs. income, a precise method for resolving the asset vs. income question was elusive.
Before the Ludwig decision, which I discuss more fully below, a clearly-defined guidepost for resolving whether unvested stock shares were assets or income was unavailable. However, two cases, Baccanti v. Morton and Wooters v. Wooters, shed light on the question. To understand Ludwig, it is helpful to review the prior decisions.
Unvested Stock Option and RSUs as Assets in Divorce Cases: Baccanti v. Morton (2001)
In Baccanti v. Morton (2001), the Court held that unvested stock options can be divided as assets in a divorce, but acknowledged that unvested stock options that were granted to an employee just before a divorce can be treated differently than stock options that are close to vesting at the time of the divorce. In short, if an employee received a grant of stock options with a 5-year vesting period one month before the divorce, the Baccanti court held that only a small portion of these brand new stock options should be divided equally, as assets in a divorce. Conversely, if the stock options were granted 5 years earlier, and would vest one month after the divorce is finalized, then most of these almost-vested shares should be divided as assets in a divorce.
This common-sense approach, in which unvested shares are divided as assets based on how close they are to vesting at the time of the divorce, has been dubbed the “Baccanti Formula”. The “Baccanti Formula” remains the most common method to for dividing stock options and RSUs pursuant to the division of assets in a MA divorce.
Under Baccanti, a certain portion of unvested shares will be treated as assets and divided in a Massachusetts divorce. What Baccanti did not specify, however, was how shares that were excluded from the division of assets should be treated with respect to the future payment of child support or alimony.
Unvested Stock Options and RSUs as a Source of Income for Child Support and Alimony Payments: Wooters v. Wooters (2009)
In the case of Wooters v. Wooters (2009), the Massachusetts Appeals Court held that a former husband’s stock options (and presumably RSUs) were part of his gross annual employment income and subject to calculations for alimony, stating that income derived from the exercise of stock options “is commonly defined as part of one’s compensation package, and it is listed on W-2 forms and is taxable along with the other income.” The Wooters Court also noted that if exercised stock options were not “deemed income for alimony purposes, a person could potentially avoid his or her obligations merely by choosing to be compensated in stock options instead of by a salary.”
In Wooters, the parties had entered a separation agreement eight years prior in which the husband agreed to pay a percentage of his annual bonus income to the wife as alimony. The Appeals Court held that under the specific language in the parties’ agreement, the husband’s stock options should be treated as bonus income for the purposes of the alimony provision. Further, the Court clarified that proceeds from stock option payments should be treated as gross income for the purposes of calculating child support and alimony moving forward.
Like Baccanti before it, Wooters advance the understanding of judges and lawyers with respect to how to treat unvested stock shares following a divorce. However, where Wooters focused on stock shares that the husband had acquired several years after the parties’ divorce, it did not address the question of how to treat unvested shares held by a spouse at the time of the divorce that are not divided as assets.
Tying it All Together: Stock Options as Both Income and Assets in Ludwig v. Lamee-Ludwig (2017)
The recent decision in Ludwig v. Lamee-Ludwig (2017) saw the Appeals Court clarify and apply the “Baccanti Formula” for dividing unvested stock options pursuant to the division of assets in a divorce, while simultaneously ruling that unvested stock options that are not divided as assets under the Baccanti Formula should be used as a source of income for calculating alimony or child support. The decision provides a clear framework for dealing with all unvested shares held at the time of the divorce:
- The date of the divorce should be used to calculate each party’s share of unvested stock options under Baccanti. Fixing the valuation date to the date of the divorce was an important aspect of the decision, as moving the valuation date backwards to the date of separation or service of the Complaint of Divorce would undermine the reliability of the Baccanti Formula by turning every case into a debate over which dates should be used to determine whether unvested shares should be treated as assets vs. income.
- Stock options excluded from division under Baccanti are treated as income for the payment of future alimony or child support. In Ludwig, the husband argued that treating these unvested shares as income for support constituted “double dipping,” but his argument was rejected by the Court. The Ludwig Court held that any unvested shares that are excluded from division under Baccanti should be treated as income for support purposes at the time of the divorce. Indeed, where the Baccanti Formula articulates exactly how many shares should be divided as assets, Ludwig provides equal precision for how many unvested shares should be treated as income for child support or alimony purposes.
The well-written and unambiguous opinion in Ludwig effectively combines the reasoning of Wooters and Baccanti into a unified decision, thus providing a clear path forward for divorce cases in MA involving stock options and RSUs.
About the Author: Jason V. Owens is a Massachusetts divorce lawyer and Massachusetts family law attorney for Lynch & Owens, located in Hingham, Massachusetts.