Tax Brake with Robert G. Nath, Esq.
"Psst - Want My Stock Option in Our Divorce?"
- Week of 8/12/02 -
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| Who wants stock options these days? Very few, but a few years ago, of course, they were all the rage. And they may be again. The IRS has recently issued a favorable ruling on how these are treated for tax purposes.
The basic problem is that state laws see stock options and deferred compensation as property to be divided in a divorce. Therefore, Spouse 1 may be forced (or may want) to transfer them to Spouse 2 in a divorce. Is that transfer taxed? Normally it would be, but the IRS has concluded it is not. This ruling (formal title: Revenue Ruling 2002-22) applies to “nonstatutory” stock options. The IRS concluded that even though the transfer to Spouse 2 is an “arm's length disposition,” which normally is taxed, here it is not because the intent of another statute, Section 1041 of the Internal Revenue Code, was NOT to tax such transfers between spouses. How about when the option is exercised? Here again, the IRS is kinder and gentler. Normally income is taxed to the person who earned it, in this case Spouse 1. But the IRS ruled that Spouse 2 would be taxed when the option is exercised. Deferred compensation programs would yield the same result. Another part of the issue concerns Social Security (FICA) and unemployment taxes. Here the IRS said the transfer of these types of stock options to Spouse 2 is not the payment of “wages” to Spouse 2. No surprise there, given the main part of the ruling. But there will be FICA tax when the non-employee spouse exercises the options. Finally, the IRS has given everyone a chance to plan ahead. The ruling is effective only on and after November 9, 2002. So divorcing spouses can take this time to negotiate and plan for who reports the income on these stock options and deferred compensation arrangements. |
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