Equity Compensation and Business Interests

For a household whose wealth is in options, restricted stock, carried interest, or an operating company, the retirement accounts are the easy part. Two rulings govern the equity, and they do not point the same direction.

Nonstatutory stock options and nonqualified deferred compensation transferred to a former spouse incident to divorce are governed by Rev. Rul. 2002-22: the transfer itself is not a taxable event, and when the former spouse later exercises the options or receives the deferred compensation, the income is theirs, taxed to them at their rates and with the same character it would have had in the employee’s hands. That is the good outcome, and it is available only if the options are actually transferable under the plan — most equity plans forbid assignment, in which case the employee spouse holds them in constructive trust, exercises on instruction, and remits the proceeds, keeping the tax on their own return. Sort out which world you are in before you value anything. Note also Rev. Rul. 2004-60: the employment taxes stay with the employee spouse’s wage base regardless, so the FICA and withholding run through the employee’s payroll even when the cash goes to the ex.

Incentive stock options cannot be transferred at all without destroying their statutory status, and unvested equity raises the separate question of what portion is marital in the first place — courts apply time-rule coverture fractions that turn on whether a grant rewarded past service or future retention, and the grant documentation is the evidence. Closely held business interests bring the third problem: valuation. Get a qualified appraisal, expect the discounts discussed at section “LLCs for Estate Planning” to be argued in both directions, and remember that a buyout note from an ex-spouse is an unsecured claim against a person who has every incentive to underperform. Where the business is the marriage’s main asset, trading it against liquid assets and a low-rate mortgage is usually cleaner than co-owning it.

Goodwill: The Part of the Business That May Not Be Divisible For a professional practice — medicine, law, consultancy, an agency — most of the appraised value is goodwill, and the divorce turns on splitting it in two. Enterprise goodwill belongs to the entity and survives the owner’s departure: the name, the location, the client contracts, the referral systems, the trained staff, the recurring revenue that would continue under a new owner. Personal goodwill is the owner’s own reputation, relationships, and skill — it walks out of the building with them and cannot be sold to a buyer. Most states treat enterprise goodwill as a divisible marital asset and personal goodwill as not divisible, on the reasoning that dividing personal goodwill would be dividing future earnings that support has already accounted for. The practical fight is entirely about the ratio, and it is decided by evidence: a covenant not to compete, a transferable client list, and a management team that runs the business without the owner all push value toward enterprise; a practice where every client came for one person pushes it the other way. Where the same earnings stream also drives the support calculation, insist that the appraiser and counsel address double-dipping explicitly — capitalizing the owner’s income into a divisible business value and then again into a support obligation charges for the same dollar twice.