ATTEST & ASSURANCE | TAX COMPLIANCE & RESEARCH | SPECIALTY & CONSULTING PRESENTATION TO: Westchester County Bar Association Domestic Relations and Family Law Section March 24, 2015 Handling Options, Restricted Stock, & Other Compensation in Divorce
ATTEST & ASSURANCE | TAX COMPLIANCE & RESEARCH | SPECIALTY & CONSULTING
PRESENTATION TO:
Westchester County Bar AssociationDomestic Relations and Family Law SectionMarch 24, 2015
Handling Options, Restricted Stock, & Other Compensation in Divorce
Executive Compensation
Presented by:
- Gary Karlitz, CPA/ABV/CFF, CBA, ASA
- Mark DiMichael, CPA/ABV/CFF, CFE
Modern Elements of Incentive Pay
TYPICAL COMPENSATION ELEMENTS FOUND FOR:
CEO of a publicly traded company
President of reinsurance company or bank
Principal of a hedge fund
Portfolio manager of a hedge fund
Principal of private equity fund
CEO of a portfolio company
Financial Advisor
3
Three Fundamental Definitions
Security
Stock
Membership Interest
4
CEO of a Publicly Traded Company (1 of 7)
Base Salary- IRC § Section 162(m) precludes a public
company from deducting for any year compensation paid
in excess of $1 million to a "covered employee" .
5
CEO of a Publicly Traded Company (2 of 7)
Restricted Stock- Can be known as “letter stock” under rule 144 which is not fully transferable but it can be a form of equity compensation under IRC § 83.
- A substantial risk of forfeiture exists where rights in the stock are conditioned
- Vesting may be a “cliff” or a “scheduled over time.” But during the vesting period the stock can’t be transferred.
> Valued as a minority, non-marketable interest
> Taxable as ordinary income when risk of forfeiture lapses
> Alternatively taxed under IRC § 83(b).
6
CEO of a Publicly Traded Company (3 of 7)
Restricted Stock Units (RSU).
- RSUs involve a promise by the employer
- Gained popularity
- The biggest difference between RSUs and employee stock
options
7
CEO of a Publicly Traded Company (4 of 7)
Restricted Stock Units (RSU) - continued.
- Generally RSU’s are considered an incentive to stay with the company. Assuming the employee stays for the entire vesting period, and depending on how the company's stock performs, the employee may actually receive more or less than the value of the RSU’s at date of issuance.
- Example:> At Grant Date - 200 RSUs at $50 Per Share = $10,000
> Vests 3 Years from Grant Date
> At Vesting Date - 200 RSUs at $100 Per Share = $20,000
- Tax Treatment
- Where does the money come from?
- The closing price on the vesting date becomes the cost basis of the vested shares.
8
CEO of a Publicly Traded Company (5 of 7)
Geared RSUs (Performance Grants)- Units that can
convert into a greater (or lesser) than 1:1 ratio
depending on achieving performance targets i.e., share
price, earnings per share, return on equity, peer group
standing.
Stock Options – See discussion later in program.
9
CEO of a Publicly Traded Company (6 of 7)
Parachute Tax Gross Up- Parachute payments arise
when a corporation experiences a change in control.
Severance Rights Agreement - Specifies severance paid
on a termination of employment.
SERP - Non-Qualified Deferred Compensation
Arrangements - "Top Hat" Plan
Perquisites- For example, Jack Welch-General Electric
Company
10
CEO of a Publicly Traded Company (7 of 7)
"In addition, the Company shall provide Mr. Welch, for the
remainder of his life, continued access to Company
facilities and services comparable to those provided to
him prior to his retirement, including access to Company
aircraft, cars, office, apartments, and financial planning
services. The Company shall also reimburse Mr. Welch, upon
the receipt of appropriate documentation, for reasonable
travel and living expenses which he incurs in providing
services at the request of the Chief Executive Officer, or which
he incurs because of his position as a retired Chairman of the
Board and Chief Executive Officer of the Company." (J. Welch
Employment and Post-Retirement Consulting Agreement with
General Electric Company, dated December 20, 1996).
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President of a Reinsurance Company or Bank
(1 of 2)
Base Salary
Cash bonuses
Equity Grant or Equity Participation Plans
Stock Options
Rabbi Trust - Trusts established by Employer to fund
deferred compensation obligations.
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President of a Reinsurance Company or Bank
(2 of 2)
Secular Trust- An irrevocable trust, not subject to
employer's creditors.
Annuity Contracts- Alternative to Secular Trust the
"inside buildup" will not be currently taxable if the
executive is the owner of the contract.
Life Insurance- see Annuity Contracts.
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Principal of Hedge Fund (1 of 2)
Base Salary - draw against annual compensation
Net profit from management company (if any)
"Points"- Annual Compensation based on a percentage
of Performance Fees or carry
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Principal of Hedge Fund (2 of 2)
Performance Fee Allocation – if a “carry” exists then the
benefit can result in larger share of the fund without
current tax recognition
Voluntary Deferral -a percentage of Annual
Compensation is usually deferred into a master fund, on
or offshore.
Mandatory Deferral - a percentage of Annual
Compensation subject to vesting.
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Portfolio Manager of Hedge Fund
(see Principal of Hedge Fund)
Trading P&L- for a specific investment or investments
during a specific applicable measurement period.
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Principal of a Private Equity Fund (1 of 3)
“Private Equity Fund” – a fund that purchases equity investments, generally in non-public companies.
Base Salary
Net profit from management company (if any)
Convertible Preferred Stock
- Class A, B or C interests –
» A Founder (preferred voting);
» B Investor (preferred voting but less, management control).
» C Employee (non voting Common).
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Principal of a Private Equity Fund (2 of 3)
Options - a security that gives the holder the right to purchase a share of stock at a predetermined price.
Carried Interest - a share of the profits that the general partners of private equity and hedge funds receive as compensation despite not contributing any initial funds (also called Carry, Points, Promote, or Profit Interest).
Catch-up - clause in agreement between the General Partner and the Limited Partners. Once the Limited Partners receive a certain portion of the total return & initial investment, the General Partner participates significantly in the profits until an agreed upon split is reached.
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Principal of a Private Equity Fund (3 of 3)
Claw back - the right of the Limited Partners to reclaim
payments to the General Partner
High water mark
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CEO of a Company in the Portfolio of a
Private Equity Company
Salary
Annual Bonus- Performance Award
Long Term Incentive Grants- RSU's, option, profit
interests
Accelerated Stock Options - Stock options that vest
on an accelerated schedule based on performance
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Financial Advisor
Commissions
Draw against Commissions
Loans
- Forgivable loans
- Bonus paid so financial advisor can repay loan
21
Stock Options 101
Stock Option
- A contract that gives someone the option to buy or sell shares of
a particular stock for a set price, for a set amount of time.
> Call Option
> Put Option
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Stock Options 101
Stock Option- A contract that gives someone the option to buy or sell shares of a
particular stock for a set price, for a set amount of time.
> “For a Set Price”
– Strike Price (Exercise Price) – The pre-specified price at which the holder of a call option can buy a stock.
» $50 - Fair Market Value of Stock» $45 Strike Price - In the Money» $55 Strike Price - Out of the Money
> “For a Set Amount of Time”
– Expiration Date (Exercise Date) » American Style Options» European Style Options
23
Stock Options 101
Example
- Grant Date = January 1st
- Expiration Date = December 31st, 2015
- Market Price as of January 1st, 2015 = $70
- Strike Price = $70
24
Stock Options 101
Types of Value
- Intrinsic Value
- Time Value
25
Option Pricing Model Theory
Two Most Commonly Used Methodologies
- Black Scholes Model
- Binomial (Trinomial, Etc.) Option Pricing Model
- Both methods rely on the concept of “Option Hedging” – the
ability to purchase offsetting options to eliminate risk.
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Black Scholes Model Example
An employee is granted a stock option that vests
immediately.
- The option expires in 5 years.
- The Stock’s Market Value at Grant/Vesting Date is $10.
- The strike price is $10.
- Historical volatility is determined to be 50%.
- The stock pays no dividends.
- What is the option worth?
27
Black Scholes Option Pricing Model
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Black-Scholes Call/Put Option Pricing Model
Assumptions
Variables & Values Description
C 4.89$ Call Option Price ($)
P 2.87$ Value of Put Option ($)
S 10.00$ Current Value of the Underlying Stock ($)
K 10.00$ Strike Price of the Option ($)
t 5.00 Time to Expiration of the Option (Yrs.)
r 4.50% Risk-Free Rate (%) (match horizon to Expiration)
v 50.00% Annual Volatility (%) (standard deviation)
d 0.00% Dividend Yield (%)
e 2.71828 2.71828
N(d1) 0.7765 Value of normal distribution at (d1)
N(d2) 0.3603 Value of normal distribution at (d2)
C = S e^-dt N(d1) - K e^-rt N(d2) = 4.89
d1 = (ln(S/K) + (r - d + v^2/2)t)/vt^.5 = 0.7603
d2 = d1 - vt^.5 = -0.3578
Taxation of Employee Stock Options
Two Types of Employee Stock Options – Both Taxed Differently:
1 Non-Qualified Stock Options> When options are exercised, the difference between the market price
and the strike price is taxed as ordinary earned income, subject to payroll taxes.
> After stock purchase, if stock is held for a period of time, any future gains/losses compared to the market value at the exercise date is taxed as capital gains/losses.
2 Incentive Stock Options (ISOs)> Numerous requirements for stock to qualify as an ISO under Internal
Revenue Code Section 422.
> Qualify for favorable tax treatment for the employee’s. Several different taxation issues discussed on next two slides.
29
Taxation of Employee Stock Options
ISOs – Income Taxes on Premature Dispositions
- A Premature Disposition of an ISO is when an individual sells the
stock less than 1 year from the exercise date or less than two
years from the grant date. Taxed as follows:
> Individual pays ordinary income tax on compensation – valued at
the spread between the strike price and the market price at the
grant date.
> Any profit above compensation income is capital gain.
> If employee sell the shares at a loss, the entire amount is a capital
loss, and there is no compensation income to report.
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Taxation of Employee Stock Options
ISOs - Income Taxes on Qualifying Dispositions
- Qualifying Disposition - means that the ISO stock, was disposed
more than two years from the grant date and more than one year
after the exercise date.
> No tax at the time of exercise (potential AMT exception).
> Taxed as a long term capital gain/loss on the difference between the
selling price and the exercise price of the stock.
> The difference between the strike price and the market price at the
grant date (the spread) becomes an Alternative Minimum Tax (AMT)
preference item, which may increase the employee’s tax liability in
the year the grant is exercised.
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DeJesus vs. DeJesus
The parties were married in October of 1979.
In November 1993, Astoria Financial Corporation
granted Wilfred DeJesus two stock option plans:
- Incentive Stock Option Plan (ISO)
- Recognition & Retention Plan (RRP)
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DeJesus Stock Option Plans
Both plans (ISO & RRP) granted in 1993.
Couple filed for divorce in July 1994.
ISO gave Husband an option to purchase company stock at $25 per share, exercisable in three annual installments in January of 1997, 1998, and 1999.
RRP gave Husband a right to receive shares of company stock (with no payment necessary), in three annual installments in January of 1997, 1998, and 1999.
Both stock option plans were contingent on Husband’s continued employment with the company and both were described by the employer as "incentives.“
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DeJesus v. DeJesus
Trial court found that although the rights to the stock
plans did not vest during the marriage and may never
vest, the were “tangible benefits which were bestowed
on [Husband] during the marriage”.
The court referenced a Colorado Decision In re Marriage
of Miller and adopted a methodology for determining the
percentage of a stock option or bonus that is marital
property.
34
Takeaways from DeJesus
Sometimes a spouse is awarded a form of executive compensation for efforts that were expended during the marriage as well as for efforts that are expected to be expended outside of the marriage (before or after).
The first step is to determine the time period during which the compensation is earned.
- Concept of a Bonus vs. an Incentive
This could result in a determination that the efforts were
- Marital
- Separate
- A combination of the two
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The “DeJesus Formula”
If the compensation is determined to be a combination of
marital and separate property, the next step is to determine
the marital portion of the bonus or incentive:
In the case of a stock incentive, the fraction would be:
Time from date of the grant to the date of commencement
Time from date of the grant to the date of exercisability
Bonuses can also be apportioned by the same fraction, but
with different descriptions for the numerator & denominator.
Marital time period during which the bonus was earned
Entire time period during which the bonus was earned
36
S.H. v. E.S. – Application of DeJesusCitation: S.H. v. E.S., xxxxxxx, NYLJ 1202676582939 at *1 (Sup., WE, Decided October 24, 2014)
Plaintiff / S.H. - Husband
Defendant / E.S. – Wife
Husband hired by Bank Capital on Sept 22, 2008
Date of Commencement – November 4, 2009
Husband was awarded several separate stock option
and bonus plans that were contested.
37
S.H. v. E.S. – Special Cash Award
Hire Date - Sept 22, 2008
Date of Commencement – November 4, 2009
$1,750,000 awarded on hire date, payable in 2 annual installments:- 1st anniversary (9/22/09) – Parties agreed this was marital
- 2nd anniversary (9/22/10) – Disputed by parties
Court decided that the award was entirely marital- Bank offer letter refers to it as a bonus
- Not based on Husband’s performance
- Husband merely needed to maintain employment.
It appears that tenure alone does not render the award as partially separate property.
38
S.H. v. E.S. – 2008 Equity Participation Plan
(EPP) Award
Hire Date - Sept 22, 2008
Date of Commencement – November 4, 2009
Equity Participation Plan- Basic Award - 423,923 shares
- 20% Bonus Award - 84,786 shares
- 10% Bonus Award - 42,393 shares
- Shares are “Provisionally Granted” and to be paid out over a period of 3 to 5 years at the discretion of the plan trustee
Court decided that the award was an incentive plan, not a bonus.- Plan document stated that the purpose of the plan was “to align key
employees interest with those of the bank group shareholders”.
- The DeJesus formula was applied.
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S.H. v. E.S. – Incentive Share Plan
Hire Date - Sept 22, 2008
Date of Commencement – November 4, 2009
Plan was granted to plaintiff on April 3, 2009.- Plan would provide 54,799 shares and also accrued 633 accrued
dividend shares to plaintiff.
- The award letter stated that the shares were earmarked for the plaintiff, but that the plaintiff had no right to them or any interest to them until his third anniversary of the award date at the discretion of the trustee.
Court decided that the award was an incentive plan- The plan name is “Incentive Share Plan”.
- The DeJesus formula was applied.
40
S.H. v. E.S. – Cash Value Incentive Plan
Hire Date - Sept 22, 2008
Date of Commencement – November 4, 2009
Plan was granted to Husband in August 2010- This plan was a hybrid award to husband of cash and stock.
- Though granted to Husband in August 2010, the plan was “recommended” in 2009 (the precise date was unknown) for the 2009 through 2011 plan cycle.
- “Participants in the Plan are the most highly valued executives in the firm and membership is a reflection of my assessment of your past and potential future contribution to exceptional business performance”
Court decided that the award was an incentive plan that was earned at least partially for work occurring during 2009.
The DeJesus formula was applied to determine the percentage of the husband’s award that is marital, to be distributed as if and when it is paid to the Husband.
41
S.H. v. E.S. – The “One Off Payment”
Hire Date - Sept 22, 2008
Date of Commencement – November 4, 2009
Letter dated December 17, 2009 stating that Husband
would receive a one time payment of $45,955 net of
taxes in January 2010 in exchange for the Husband’s
agreement to give 3 months notice of termination.
The court determined that this was separate property of
the husband.
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Questions???
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CONNECTICUT | NEW JERSEY | NEW YORK | PENNSYLVANIA CITRINCOOPERMAN.COM
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CITRIN COOPERMAN & COMPANY, LLP
Gary Karlitz CPA/ABV, CBA, ASAPartner in Charge, Valuation & Forensics Department
E-mail: [email protected]
Phone: 212.697.1000
NEW YORK OFFICE
CONNECTICUT | NEW JERSEY | NEW YORK | PENNSYLVANIA CITRINCOOPERMAN.COM
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CITRIN COOPERMAN & COMPANY, LLP
Mark DiMichael, CPA/ABV/CFF, CFEManager, Valuation & Forensics Department
E-mail: [email protected]
Phone: 212.697.1000
NEW YORK OFFICE
CAYMAN | CONNECTICUT | NEW JERSEY | NEW YORK | PENNSYLVANIA
CITRINCOOPERMAN.COM