Ruling expands Sec. 1041 exemptions from assignment-of-income doctrine.

• Author: Bakale, Anthony
• Position: Divorce settlements - Internal Revenue Code

In May 2002, the IRS issued Rev. Rul. 2002-22, which provides guidance on the tax consequences when nonstatutory stock options and nonqualified deferred compensation are transferred between spouses pursuant to a divorce or separation agreement. Although such compensatory benefits may constitute a significant portion of the marital estate of divorcing taxpayers who are participants in such plans, properly anticipating the tax consequences of the division and later payment of these benefits has been difficult.

In the revenue ruling, A and B were married individuals. Prior to their divorce in 2002, A had received nonstatutory stock options from his employer. In addition, A is a participant in the employer's nonqualified deferred compensation plans. Under one of the deferred compensation plans, participants are entitled to payments based on the balance of their individual accounts. By the time of A's divorce from B, A had an account balance of $100. Under the second deferred compensation plan, participants are entitled to receive single-sum or periodic payments following separation from service, based on a formula reflecting their years of service and compensation history. By the time of the divorce, A had accrued the right to receive a single-sum payment of $50 under that plan, following A's termination of employment. A's contractual rights to the deferred compensation benefit under these plans were not contingent on A's performance of future services.

Under the law of their resident state, stock options and unfunded deferred compensation rights earned by a spouse during marriage are marital property subject to equitable division between the spouses in the event of divorce. Pursuant to the property settlement incorporated into their divorce judgment, A transferred to B (1) one third of the nonstatutory stock options; (2) the right to receive deferred compensation payments under the account balance plan based on 75% of A's account balance under the plan; and (3) the right to receive a single-sum payment of $25 under the other deferred compensation plan on A's termination of employment.

In 2006, B exercises all of the stock options and receives employer stock with a fair market value (FMV) in excess of the options' exercise price. In 2011, A terminates employment, and B receives a single-sum payment of $150 from the account-balance plan and a single-sum payment of $25 from the other deferred compensation plan.

The ruling concludes that B (the...