If you live in Silicon Valley, you are probably familiar with the acronym RSU. RSUs or Restricted Stock Units have become an increasingly popular form of equity compensation.
An RSU is a promise by a company to an employee regarding the right to own company stock in the future. No stock is issued to the employee with a RSU grant - instead, the stock is released to the employee after certain conditions have been met. However, unlike a stock option, once vested, an RSU has a monetary value without the employee exercising the option.
These days, a typical tech employee receives a large RSU grant when they join a company and may be given refresher grants periodically based on performance and company growth. RSUs usually have a 4-year vesting schedule with a one-year cliff and after the first year of employment, RSUs vest quarterly.
RSUs are taxed under federal income tax rules based on the market value of the RSU when the shares are delivered to the employee – almost always at vesting. To ensure that employees pay the required income tax, some companies take the taxes out for the employees by taking back a portion of the RSU grant. If an employee chooses to hold on to the shares and later sell those shares on the market for a higher price, then they pay capital gains tax on any appreciation over the market price of the shares on the vesting date.
The division of RSUs as community and separate property in California is a complex topic for both family law attorneys and divorcing couples. Part of the confusion is that as of September 2015, no California court has defined a specific formula for division of RSUs at divorce.
RSUs are tricky to divide as community property since (1) the grant date, vesting date, and potential sale date of RSUs are always different, (2) non-cash equity compensation is associated with the variable stock value of the company and thus the fair market ‘value’ of the stock at a future date is hard to predict, (3) most RSU grants do not allow an employee to transfer ownership of restricted shares to their spouse, (4) an employee’s RSU grants do not vest unless specific conditions have been met – such as continuing to remain employed at the company, (5) employees can be given grants as rewards for past performance – meaning that after separation an employee can be awarded RSUs as a performance bonus for work during marriage.
RSUs granted and vested during marriage
If RSUs are granted during marriage and vest during marriage, then division is straightforward. There are really two options: (1) If the employee spouse wants to keep the vested stock, parties can agree on an equalization based on the current fair market value of the stock or (2) If the parties want to split the then current value of the stock – half of the stock can be sold on the market and given to the non-employee spouse. A complicating factor can be the capital gains taxes that are incurred as a result of the sale.
RSUs granted but vested after marriage
If RSUs are granted during the marriage and vest after the marriage ends, the division becomes more complicated. First, vesting is contingent on the employee spouse staying with the company for several years. If the employee leaves or is terminated, those RSU grants have no value.
Parties can consider RSUs fully earned marital property based on the date the RSU was granted. If the non-vested RSU is community property, the parties can agree to value the RSUs and compensate the non-employee with an equalization payment or the parties can agree to wait until RSUs vest in the future, after divorce, and split 50% of the current market value.
The downside of this approach is that RSUs are hard to value until vested and the RSU owner cannot sell the RSU until it vests. Also, my experience is that the parties who divorce are not super keen on staying in touch and relying on each other for many of future transactions.
Another alternative is that the parties can consider an RSU that is granted during marriage and not yet vested as partially earned marital property and divide the RSUs in accordance with the Hug/Nelson“time rules.”
Hug and Nelson are California Appellate Cases that explored the division of stock options in divorce.
Under Hug, you calculate the shares owed to the non-employee spouse by thinking of an RSU as deferred compensation. The formula used to calculate the % of community interest is [Period of Time Between Start Date At Company and End of Marriage]/[Period of Time Between Start Date At Company and Vesting]. You then multiply the community interest by the total number of shares that harvested and divide that number in two. That number is the non-employee’s portion of the vested shares.
The Nelson Rule looks at stock as primarily future incentives for performance. The community interest under Nelson 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]. You then multiply the community interest by the total number of shares that have vested and divide that number in two. That number is the non-employee’s portion of the vested shares.
Either formula can work to divide RSUs- the choice of the formula is typically the parties.
RSUs granted after separation for past performance of employee during marriage
The final tricky issue is how to value and divide RSUs granted after the date of separation in the form of bonus payments or compensation for the employee’s performance during marriage.
If the spouse who is awarded the RSUs wants to keep these RSUs to herself, she will argue that the grant is merely a refresher grant meant to continue compensation at the current level and is compensation for future work.
A non-employee spouse who wants the RSU grant because they believe the grant was only awarded due to the employees performance during the marriage will need to argue that the company has a policy of providing bonuses in the form of RSUs and that the grant was specifically awarded for past work. Next, they will need to calculate what percentage of the grant is community.
RSUs are here to stay in Silicon Valley - tech companies love them because they offer favorable tax treatment to the company (not necessarily the employee). However, popularity does not make the government any faster in providing clear guidance. If you’re going through a divorce and have questions about RSUs, please reach out with questions.
