Transfer of NQSOs in divorce.

• Author: Laffie, Lesli S.
• Position: From The IRS

In Rev. Rul. 2004-60, the IRS ruled that, when interests in nonqualified stock options (NQSOs) and nonqualified deferred compensation are transferred from an employee spouse to his or her former spouse (the nonemployee spouse) in a divorce, the transfer does not result in a payment of wages for FICA and FUTA purposes. However, there are FICA and FUTA tax consequences when the options are eventually exercised or the nonqualified deferred compensation is paid or made available.

Background: Previously, Rev. Rul. 2002-22 had ruled on the income tax treatment of such transfers. Under that ruling, an employee spouse is not required to include amounts in gross income on the transfer of interests in NQSOs and nonqualified deferred compensation to his of her former (nonemployee) spouse incident to a divorce. After the transfer, the income tax consequences shift to the nonemployee spouse, who essentially steps into the employee spouse's shoes. Amounts are not included in the nonemployee spouse's gross income until the stock options are exercised or the deferred compensation is paid of made available to the nonemployee spouse.

New ruling: Rev. Rul. 2004-60 addresses the FICA and FUTA tax consequences and adopts the rules proposed in Notice 2002-31, with some changes. Generally, compensation realized on the exercise of stock options by a nonemployee spouse and deferred compensation paid or made available to that spouse remain subject to FICA and FUTA taxes as if they had been retained by the employee. Thus, NQSOs are subject to FICA and FUTA taxes when exercised by the nonemployee spouse who received them in the divorce. The options are taxed to the same extent as if they had been retained, then exercised, by the employee spouse. Any nonqualified deferred compensation is subject to FICA and FUTA taxes to the same extent as if the rights to the compensation had been retained by the employee spouse.

Although the nonemployee spouse receives the...