Divorce is rarely simple, but when executive compensation is involved, the financial landscape becomes far more complex. Particularly in high-net-worth and ultra-high-net-worth divorce cases, a spouse’s compensation can be layered, deferred, and tied to future performance. Understanding how these elements are treated can have a significant impact on both support obligations and the division of assets.
What Is Executive Compensation?
Executive compensation refers to the full range of financial and economic benefits received from employment. In addition to a salary, executives are often paid through a combination of bonuses, equity awards, deferred compensation, and various perks.
In some cases, this compensation can represent a significant portion, if not the majority, of an executive’s overall earnings. Any financial analysis in a divorce must go beyond base pay and examine the entire compensation package.
Common Forms of Executive Compensation
Annual bonuses, restricted stock units (RSUs), stock options, performance shares, deferred compensation plans, carried interest, and executive perks are all elements of compensation, with equity-based compensation often representing the largest and most complex component. It is frequently deferred, conditional, and variable, and subject to vesting schedules, company performance, or continued employment.
Why Executive Compensation Matters in Divorce
When determining a spouse’s ability to pay alimony and child support, it is vital to get a full understanding of any executive compensation structures. For example, an executive may receive RSUs that do not convert into cash for several years, but once they vest, they can significantly increase income.
In New Jersey, both historical earnings and current income are considered. Therefore, it may be appropriate to consider:
- Averaging bonuses over multiple years
- Including vested equity as income
- Structuring support to account for fluctuating compensation
Support can be structured with a base amount plus a percentage of variable compensation.
Uncovering the Full Compensation Picture
A thorough understanding of executive compensation starts with proper financial disclosure. This discovery process is essential in every divorce case but takes on added importance in high-net-worth matters.
Typically, each party will provide a court-required financial statement, known as a Case Information Statement (CIS), identifying income and assets. From there, additional documentation is often requested, including compensation summaries, grant and award letters, and the underlying plan documents that govern how compensation is earned and distributed.
In some cases, it may be necessary to obtain information directly from the employer, either through authorization or a formal legal process. Because compensation plans can be highly technical and unique to each company, having complete and accurate documentation is critical.
Income Versus Assets: A Blurred Line
Income is analyzed to calculate support, while assets are subject to division between spouses. Executive compensation can have aspects that encompass both.
For instance, once RSUs vest, they may be treated as income when received. RSUs that vested in the past may be subject to distribution as assets. Unvested awards present an even more difficult question. Although they have been granted, they may not be considered “earned” in a legal sense.
This creates a timing issue that can significantly affect the outcome of a case. Whether compensation is considered marital property, and therefore subject to division, often depends on when and why it was awarded.
The Complexity of Modern Compensation Structures
RSUs are typically granted with a vesting schedule, meaning the employee earns access to the stock over time. Some plans vest annually, while others vest more frequently, such as monthly or quarterly. In certain cases, a portion of the award may vest all at once after a set period, a structure commonly known as “cliff vesting.”
Each variation affects how and when income is realized. The more frequent the vesting schedule, the more complicated the analysis becomes, particularly when projecting income for support purposes.
Key challenges include:
- Recognizing present value vs. deferred value
- Accounting for vesting schedules and forfeiture risk
- Considering tax impact upon vesting
- Market volatility
Other forms of compensation, such as stock options or deferred compensation plans, add further complexity. Their value may depend on market performance, future employment, or tax considerations.
The Complexity of Modern Compensation Structures
It must be determined whether an unvested award of restricted stock units represents compensation for past efforts during the marriage or an incentive for future performance after the divorce complaint. In New Jersey courts, if the award is tied to efforts during the marriage, it is more likely to be considered marital property. If the award requires future work, it may be considered non-marital.
Many employers describe these awards as serving both purposes, which complicates the analysis. For awards covering both time periods, a common pre-2018 approach was to use a coverture fraction to allocate between marital and separate portions. The coverture allowed the compensation attributable to the marital period to be divided according to a specific formula, while the non-marital portion remained separate property. It’s a perspective that tries to account for a fair balance.
However, a 2018 New Jersey Appellate Division decision, M.G. v. S.M., questioned the mechanical use of the coverture fraction approach in this context and emphasized that courts should instead focus on the underlying purpose of the compensation award. At trial, the central inquiry is whether the compensation reflects payment for past marital efforts (and is therefore subject to equitable distribution), or whether it serves as an incentive for future performance (and is therefore not divisible).
A court must also examine the intent behind the grant, in which case plan documents, grant letters, and testimony become critical. Testimony from the spouse in question may be required, and in some instances, from a representative of the company as well. This can complicate matters, as employers generally prefer not to be involved in divorce proceedings.
Of course, if the court determines that the grant is marital, the court will still need to decide what percentage share the non-owning spouse should receive, taking into account all of the equitable distribution factors.
Tax Considerations
Tax implications play a significant role in evaluating executive compensation. Different types of compensation are taxed differently, and those differences can materially affect their value.
For example:
- RSUs are taxed at vesting
- Stock sales will trigger capital gains tax
- Deferred compensation is taxed upon distribution
Failure to account for tax consequences can significantly distort the true value of an asset in settlement negotiations. Clients will need the input of a tax professional in considering the consequences of compensation and assets.
When Assets Cannot Be Easily Divided
In some situations, executive compensation cannot be directly transferred between spouses due to employer restrictions. When that happens, courts and practitioners may rely on a legal mechanism known as a constructive trust or a Callahan trust.
Under this approach, the employee retains the asset in their name but holds a portion in a trust for the benefit of the other spouse. When the asset becomes payable or is sold, the proceeds are distributed according to the agreement. This arrangement requires careful coordination with respect to taxes and timing, but it provides a practical solution when direct division is not possible.
The Role of Experts
Given the complexity of executive compensation, financial specialists are often brought into the process, but their involvement is determined on a case-by-case basis and costs must be considered. Forensic accountants and valuation professionals may be necessary, though, to interpret compensation plans, quantify economic benefits, and assess tax implications.
An expert is typically needed to measure the economic benefits of perks or determine the economic equivalent of compensation for presentation to a court. These professionals’ input can be invaluable in high-net-worth and ultra-high-net-worth divorces, where the stakes are higher and the financial structures more complicated.
Confidentiality
Information provided during the case should be subject to a confidentiality agreement and used only for the case, particularly if the company has already imposed confidentiality obligations on the employee. If a subpoena is issued for confidential information, a judge may order production but mandate that the information be kept confidential. This is especially important where compensation plans contain proprietary or sensitive corporate information.
Flexibility Through Settlement
Because the outcome can be uncertain, many parties prefer to resolve these issues through settlement rather than risk leaving the decision to a judge. Courts are bound by certain parameters in how they structure support awards, whereas settlements allow for more flexible solutions and can result in a more tailored and predictable outcome.
For example, parties may agree to a base level of support tied to salary, with additional payments based on bonuses, equity vesting, or other forms of compensation. This type of arrangement can better reflect the realities of executive income, which is often variable and performance-based.
What Clients Should Do
Clients receiving executive compensation should gather all relevant information and documentation for their lawyer, including annual compensation sheets, the grant/award letters, and the technical plan documents. For the non-receiving spouse, they should share any knowledge they have, such as the timing of bonuses or the cashing out of vested stock, which can be corroborated with documents like tax returns, W2s, and pay stubs.
Some key questions to ask legal counsel include:
- How will compensation be classified (income vs. asset)?
- Will a coverture formula be considered by way of settlement in dividing these awards?
- How will taxes impact the division?
- Should a forensic accountant or valuation expert be involved?
- How can support be structured to reflect variable income?
- What protections exist for confidentiality?
The Importance of Early Legal Guidance
Executive compensation in a divorce requires careful analysis, strategic planning, and a thorough understanding of both legal and financial considerations. For that reason, it is essential to seek experienced legal counsel as early as possible in the process.
For both spouses, having the right legal counsel in place can help ensure that all aspects of compensation are properly identified, evaluated, and addressed. Early and informed guidance is not just helpful, it is critical to protecting your financial future.
Skoloff & Wolfe, P.C. represents clients in all matters of family law, including Divorce, High Net Worth Divorce, Child Custody, Child Support, Separation, and Mediation. Leaders and the spouses of leaders of finance, law, entertainment, sports, real estate, and members of America’s prominent families, rely upon the attorneys of our family law group. From start to finish, we work side-by-side with our clients to identify reasonable objectives and achieve the best possible result.
