Stock Options and RSUs in California Divorce: Dividing Deferred Compensation

In high-asset California divorces, stock options and restricted stock units (RSUs) often represent a significant portion of a spouse’s compensation. These forms of deferred compensation are common in the tech, finance, and biotech industries, and they can substantially affect the division of property, especially when the assets were granted during the marriage but do not fully vest until after separation or divorce.

Dividing stock options and RSUs during divorce is one of the most complex and contested financial issues in family law. These assets may appear on pay stubs or in employment agreements, but their value, character, and timing raise questions that require detailed legal and financial analysis.

This blog explains how California courts handle stock options and RSUs in divorce, how to determine whether they’re community or separate property, and what you can do to ensure a fair division.

What Are Stock Options and RSUs?

Before diving into the legal framework, it’s important to understand what these assets are and how they function:

• Stock Options: These give an employee the right to buy company shares at a fixed price (called the “strike price”) after a certain vesting period. If the market value exceeds the strike price, the employee can exercise the option and profit from the difference.

• Restricted Stock Units (RSUs): RSUs are promises to grant actual company shares once certain conditions are met, typically after a set number of years or continued employment. Unlike stock options, RSUs do not require the employee to purchase the stock.

Both are designed to incentivize employee loyalty and long-term performance, often with vesting schedules that stretch across several years.

Are Stock Options and RSUs Community or Separate Property?

California is a community property state, meaning that all earnings and assets acquired during the marriage are presumed to be jointly owned. But stock options and RSUs challenge this presumption because:

• They are earned over time, not at a single point

• They often vest after separation, even if granted during marriage

• Their purpose (past services vs. future incentive) can change their characterization

This creates a need to apportion the asset between community and separate property interests based on when it was earned and why it was granted.

The Key Question: Why Was the Stock Granted?

California courts focus on intent and purpose when determining whether stock-based compensation is community or separate. The key question is:

Was the stock or RSU granted as compensation for past services performed during the marriage, or to incentivize future performance after separation?

• If it was compensation for past services, it’s likely community property

• If it was an incentive for future work, it’s likely separate property

In many cases, it’s both. The court must then allocate a portion to the community and a portion to the individual spouse.

How Courts Divide Stock Options and RSUs: Apportionment Formulas

California courts use formulas developed in key cases to divide deferred compensation. Two of the most common are:

1. The Hug Formula

Established in In re Marriage of Hug (1984), this formula is used when the options or RSUs were granted as compensation for past services.

Hug Formula:

Community property portion =
(Date of hire to date of separation) ÷ (Date of hire to date of vesting)
× Number of shares

This method allocates the community’s interest based on how long the employee was with the company before the separation, relative to the entire vesting period.

Example:

• Employee hired: 2015
• Separation: 2022
• Vesting: 2025
• 7 years married / 10 years total = 70% community interest

2. The Nelson Formula

Developed in In re Marriage of Nelson (1986), this formula is more favorable to the separate property spouse and is used when the options or RSUs are granted as incentives for future services.

Nelson Formula:

Community property portion =
(Date of grant to date of separation) ÷ (Date of grant to date of vesting)
× Number of shares

This approach shortens the community interest to only the period after the stock was granted, rather than the full employment duration.

Courts use the formula that best matches the intent of the employer. In some cases, multiple formulas are used for different grants.

Understanding Grant Dates, Vesting Schedules, and Cliff Periods

Many stock options and RSUs have “cliff vesting,” meaning no shares vest for the first year or two, and then a large chunk vests all at once. After that, the remainder may vest gradually.

Example Vesting Schedule:

• 25% after year one (cliff vest)

• 1/48 of total every month thereafter over four years

It’s critical to identify:

• The grant date: When the employee received the right

• The vesting schedule: When the stock becomes exercisable or owned

• The separation date: The cutoff for community property accrual

Even if the shares vest after separation, a portion of the value may still belong to the community.

Valuing Unvested Stock Options and RSUs

Stock options and RSUs are often unvested or illiquid at the time of divorce. Courts typically do not divide unvested shares directly, but instead:

1. Award a percentage of the shares to the non-employee spouse once they vest

2. Assign a value to the shares and offset with other assets

3. Defer division until vesting occurs, using a “time rule” or formula

4. Use a QDRO or other mechanism to divide upon sale

Valuation often requires input from financial experts who consider:

• Current stock price
• Strike price (for options)
• Volatility and likelihood of vesting
• Market conditions and potential tax consequences

It’s essential to protect your interests by having a lawyer and, when appropriate, a forensic accountant review the terms and value of equity compensation.

Tax Implications

Equity compensation often triggers complex tax consequences:

• Stock options may result in ordinary income or capital gains depending on the type (NSO vs. ISO)

• RSUs are taxed as ordinary income upon vesting

• The spouse receiving the shares may incur tax liability when they vest or are sold

Divorce settlements should clearly specify who is responsible for tax consequences, and whether the employee spouse will sell shares on behalf of the other spouse or transfer vested shares directly.

These provisions must be carefully negotiated and clearly documented in the Marital Settlement Agreement.

Common Mistakes in Dividing Equity Compensation

Some of the most frequent—and costly—mistakes include:

• Failing to identify all stock grants (review offer letters, employment agreements, pay stubs)

• Assuming that only vested shares have value

• Using the wrong formula or applying it inconsistently

• Ignoring future vesting and its potential worth

• Not accounting for tax treatment or deferral

• Failing to provide for ongoing cooperation to divide shares after divorce

Given the stakes involved, stock compensation should never be treated casually in divorce. A misstep could mean leaving tens or hundreds of thousands of dollars on the table.

Negotiating a Fair Division

In many cases, dividing stock options and RSUs becomes part of a larger settlement negotiation. Spouses may agree to:

• Offset equity compensation with other assets (e.g., home equity, retirement accounts)

• Defer division until shares vest, with clear formulas in place
• Sell shares upon vesting and divide proceeds
• Use a neutral third-party or financial professional to handle division post-divorce

In long-term marriages or when options are a key part of total compensation, this issue may dominate negotiations. Skilled legal strategy is essential to ensure you’re not undervaluing what could be your most significant marital asset.

Final Thoughts

Stock options and RSUs are valuable assets that deserve careful treatment in California divorce proceedings. Whether you’re the spouse who earned them or the one entitled to share in their value, understanding how these assets are characterized, valued, and divided can significantly impact your financial future.

California family law has clear—but complex—rules about how to divide deferred compensation. With proper legal representation and financial analysis, you can protect your rights, avoid unnecessary disputes, and reach a resolution that reflects the true value of what was earned during the marriage.

At Minella Law Group, we specialize in high-net-worth divorce and have extensive experience dividing stock options and RSUs. We work with financial experts, forensic accountants, and QDRO professionals to ensure our clients receive the full value they are entitled to.

 

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