Stock options are still common but since 2007 they no longer provide a tax benefit for the issuing company. RSUs (Restricted Stock Units) have become increasingly widespread as a method of compensation. This is my third RSU article. The first one is here. The second one is here.
RSUs are usually an incentive for the employee to stay with the company. They sometimes take the place of an annual bonus.
RSUs come in the form of grants of shares of stock with a vesting schedule. The shares of an individual grant may be separate property, community property or a mixture of the two.
Unvested RSUs pay dividends if the underlying stock pays dividends.
The shares of an RSU grant are taxed as ordinary income when the shares vest. Therefore, the company withholds state and federal income tax at this time. It does this by selling enough shares of the stock to cover the tax liability. However, FICA is not withheld. The employee will have to pay the 12 and a half percent FICA tax when they file their individual tax returns. This is unless they have already paid the annual maximum of FICA.
If vested shares are sold in the first year of ownership, any gain from the vesting price will be taxed as a short-term capital gain. If they are sold after the first year, any gain will be taxed as a long-term taxable gain.
RSU and Division of Assets
In a divorce, if one or both spouses has RSUs, they are considered assets. They therefore must be taken into consideration as part of the division of assets and debts. Sometimes the employee spouse will be awarded all of the RSUs in a divorce. But other times, the RSUs are divided somehow between the spouses.
Regardless, it’s essential in a divorce to characterize the RSUs. This means to determine whether they are the separate property of the employee or community property or a mixture of the two.
If the employee spouse quits or is fired, the unvested RSU grants will probably be forfeited. This risk should be taken into consideration when valuing RSUs in a divorce.
Almost all company RSU plans do not allow RSUs to be transferred from an employee spouse to a non-employee spouse in a divorce. So if the non-employee spouse is to receive the value of some RSUs, they must first be converted to cash. Then the cash can be transferred to the non-employee spouse. Alternatively, the non-employee spouse could receive other assets in the divorce settlement agreement.
If the divorce settlement says that the employee spouse will continue to hold RSUs to which the non-employee spouse has an entitlement, the divorce settlement agreement should indicate that these RSUs will be held in “constructive trust.”
Language for this in the settlement agreement may be something like the following: “On each vesting date the non-employee spouse will tell the employee spouse if they want anything done regarding the vested RSUs. In the absence of any such instructions, the employee spouse will continue to hold the RSUs in constructive trust.”
Nelson and Hug formulas
The Nelson and Hug formulas were developed in California case law to determine how much of a given RSU grant (if any) is community property,
Because RSUs are usually an incentive for future performance, the Nelson formula is used much more frequently than the Hug formula. Nelson is used for awards that are based on the expectation of future service.
The Hug formula is usually used for RSUs granted at hiring. They recognize the recipient’s past performance at previous jobs.
RSU and Support
Grants of RSUs an employee can expect to receive in the future are treated as income for (child and spousal) support purposes. This is true even if the RSUs will be the separate property of the employee spouse.
