Family Law
| Jurisdiction | Colorado,United States |
| Citation | Vol. 51 No. 6 Pg. 34 |
| Pages | 34 |
| Publication year | 2022 |
A Primer on Executive Compensation in a Colorado Divorce—Part 2
BY KRISTI ANDERSON WELLS, NICOLA WINTER, AND JOANNE MORANDO
This two-part article discusses executive compensation issues in Colorado dissolution of marriage proceedings. Part 1 set forth a multi-step process for characterizing and dividing stock rights such as options, restricted stock, restricted stock units, performance-based awards, and nonqualified deferred compensation. This part 2 addresses limitations on dividing executive compensation awards, looks at tax issues to he aware of when the awards are divided, and analyzes whether the awards are income for support purposes.
As discussed in part 1 of this article,[1] all marital property in a Colorado dissolution of marriage or legal separation, including executive compensation, must be divided equitably between the parties.[2] Part 1 set forth a three-part process for determining whether an executive compensation award is property, what portion of an award is marital versus separate property, and how to value and allocate the marital portion of the award.
This part 2 addresses limitations on dividing awards, tax considerations to be aware of when allocating awards, and whether and to what extent awards constitute income for support purposes.
A Recap of Executive Compensation
"Executive compensation" as discussed here refers to benefits typically offered to highly compensated employees, executives, officers, and directors. These benefits focus on providing rewards in exchange for results and vary widely from employer to employer. The awards may be in the form of (1) options, restricted stock units, or restricted stock, which link payouts to increases in stock price; or (2) performance or incentive awards, such as cash or stock rights delivered upon the attainment of certain benchmarks. In addition, nonqualified deferred compensation plans may permit or require employees to defer awards or compensation to a later date.
Qualified deferred compensation plans such as IRC § 401(k) plans or IRC § 401(a) defined benefit pension plans are outside the scope of this article.
Limitations on Dividing Executive Compensation
Once an executive compensation award is determined to be marital property, the next step is to allocate the marital portion of the award. As described more fully in part 1, courts have a number of options when determining whether to value an executive compensation award and how best to allocate it between the parties. Several factors must be addressed when deciding how and when to divide executive compensation.
First, all governing documents must be reviewed to determine whether there are restrictions on transfer before vesting. If an executive compensation award is divisible before vesting, it is preferable to divide the award in kind between the parties. If the award is split equally between the parties, each spouse will share equally in the risk of loss or gain. Equal division in kind also allows the parties to avoid the expense and risk associated with having an award valued. If the award is not split equally between the parties, the award should be valued.
Next, practitioners must familiarize themselves with the statutory and plan limitations on transfer of executive compensation awards. For example, IRC § 409A limits when executive compensation may be distributed. Plans and participants who violate this section face dire consequences: the value of the compensation deferred by each participant under the plan will be included in the participants' gross income, plus penalties.[3] Needless to say, no employer or plan administrator will permit a distribution in violation of § 409A because a catastrophic plan failure would result. Thus, court orders and mediated settlements must conform with the timing and distribution rules in statutes and plan documents.
Executive compensation plans subject to § 409A may, but are not required to, permit early distribution of benefits to a spouse pursuant to a domestic relations order (DRO).[4] A DRO conforms generally with the form required for qualified domestic relations orders that family law practitioners use to divide qualified retirement plan benefits.[5] Practitioners should review the plan documents (including the summary plan description) and award agreement, and consider consulting with the plan administrator to determine whether a DRO may be used to effectuate distribution in divorce. If this option is not available under a given plan, a constructive trust (discussed below) should be put in place to protect the non-employee spouse's share of the award until distribution occurs.
In addition, holders of incentive stock options issued under IRC §§ 421 and 422 cannot transfer the options other than by will or the laws of descent.[6] This transfer limitation will be reflected in the plan documents. Similarly, restricted stock awards cannot be transferred until after vesting occurs. As a result, practitioners must familiarize themselves with governing plan documents and understand whether and to what extent a distribution can be made to the non-employee spouse at the time of the divorce.
If the plan or a statute prohibits transferring an award until vesting takes place, a constructive trust may be imposed.[7] Under a constructive trust, the employee spouse continues to own the award until the non-employee spouse's share can be distributed. The employee has a fiduciary duty to manage the non-employee spouse's share of the award with care and in the same manner as the employee spouse manages his or her own share of the award.
Tax Issues Implicated when Allocating Awards
When a constructive trust is imposed on certain executive...
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