New ruling for stock options in divorce.

• Author: Dawson, Leslie
• Position: Stock Options - Brief Article

If you practice family law, stock options are not the hot topic they were two years ago. Yet, the issue of dividing compensatory stock options between divorcing spouses still causes major headaches.

The IRS recently issued Revenue Ruling 2002-22, purportedly to provide assistance in this area. It also issued Notice 2002-31, which details the proposed rules and guidance for employers in situations involving stock options and divorce. Unfortunately, these rulings may cause confusion rather than provide clarification.

NEW PROVISIONS

While Rev. Rul. 2002-22 and Notice 2002-3 1 apply to some deferred compensation arrangements as well, this discussion will be limited to their application to stock options.

Rev. Rul. 2002-22 and Notice 2002-31 provide that:

* The transfer of non-statutory stock options from the employee spouse to the non-employee spouse is not a taxable event.

* The non-employee spouse will recognize the ordinary income upon the subsequent exercise of their share of the options.

* The employer must issue a Form 1099 to the non-employee spouse reporting their income on the exercise. The non-employee spouse will report this income on their individual income tax return.

* The employee's W-2 must reflect, as additional FICA wages, the income from the exercise of the non-employee's non-statutory stock options. The employee spouse will not report the income on their individual tax return, but will be responsible for the Social Security and Medicare taxes resulting from the exercise.

LIMITED APPLICATION

On the surface, Rev. Rul. 2002-22 provides insight regarding the IRS position on stock options in divorce. It appears that compensation income is to be treated as community property; each party reports one-half [see Poe v. Seaborn (1930) 9 AFTR 576].

It also appears that the IRS is following previous rulings by requiring that the employee spouse be responsible for the Social Security and Medicare taxes on all earned income attributable to their efforts (Rev. Rul. 71-116, 1971-1 CB 277).

However, this ruling is quick to limit its application:

* The ruling does not apply to unvested options at transfer.

* The ruling does not apply to transfers not connected to a divorce.

* The ruling applies only to non-statutory options.

* The ruling will apply to statutory options only if they become disqualified as a result of transfer to the non-employee spouse (statutory options cannot be transferred under IRC Sec. 422 and 423).

STILL NO GUIDANCE

As a...