STOCK OPTIONS AS INCOME FOR PURPOSES OF SPOUSAL SUPPORT

© 2000 National Legal Research Group, Inc.

Only a few reported cases consider the extent to which stock options constitute income for purposes of spousal support. We will begin by discussing the limited body of law available and then consider how the law might develop in the future.

Cases Holding That Stock Options Do Constitute Income

The leading case holding that stock options are income for purposes of spousal support is In re Kerr, 77 Cal. App. 4th 87, 91 Cal. Rptr. 2d 374 (1999). In Kerr, the husband regularly received stock options as a fringe benefit of employment. The trial court held that the option plan was part of [the husband’s] overall compensation package from employment and must be considered in setting both spousal support and child support. 91 Cal. Rptr. 2d at 377. Consideration of the package was difficult, however, as the value of the husband’s options depended upon the value of the employer’s stock, a number which tended to vary greatly over time. The court resolved the dilemma by basing its monetary support award upon the husband’s income and bonuses alone. Then, in addition to its support order. the court ordered [the husband] to transfer to [the wife] 40 percent of the beneficial ownership in any future Qualcomm stock options he exercised until April 1, 2003, when the 40 percent award would be reduced to 25 percent, and would continue until further court order. Id. Thus, as an incident of spousal support, the trial court awarded the wife a set percentage of the profit from any stock options which the husband actually exercised in the future.

The husband appealed, arguing that the court could not award a specific percentage of the options as an incident of spousal support. In particular, he argued that the trial court’s award was tantamount to a division of separate property. The court summarily rejected that argument:

Contrary to [the husband’s] argument, [the wife] will not be receiving a portion of his separate property if he exercises a stock option. Rather, income [the husband] receives upon exercising an option is properly considered for purposes of setting support.

Id. at 379. The second of these two sentences makes more sense that the first. Stock options earned by the husband after the end of the marriage were obviously not community property, and the court’s support order therefore did divide a separate asset. But the husband did not explain why such division was improper. Spousal support is always based upon postdivorce separate income; in fact, the very purpose of a spousal award is to award the recipient a share of the payor’s future income. There is no logical reason why awarding the wife part of the husband’s postdivorce stock options should be any more offensive than awarding her a portion of the husband’s postdivorce salary. The husband was trying to use a property division argument to win a spousal support issue, and the court quite properly rejected his position.

After holding that the trial court did not improperly divide separate property, the appellate court then approved the trial court’s decision to state its award in the form of a percentage:

The record before us reflects that the court carefully weighed and considered the parties’ unique circumstances before exercising its broad discretion to make its support order based on a percentage of income once the stock options were exercised, and after financial gain was realized. In setting a percentage of uncertain earnings, the court was attempting to avoid an indefinite number of future hearings at which the details of income, expenses, investment success or failure, tax consequences and fairness must be reevaluated. Generally, the use of percentages to determine support will beneficially remove the need for further litigation with its attendant costs, and oftentimes, emotional upheaval.

Id. The court’s approval of a percentage award must be understood in the context of California spousal support law, which generally permits awards of varying or escalating spousal support. While some states agree with California on this point, other courts hold that spousal support must take the form of a fixed amount which cannot vary in the future unless a court finds changed circumstances. See generally Brett R. Turner, Redefining Alimony in a Time of Transition: Recent Cases on the Law of Spousal Support, 4 Divorce Litigation 221, 225-27 (1992) (discussing the split in authority); cf. Brett R. Turner, Rehabilitative Alimony Reconsidered: The Second Wave of Spousal Support Reform, 10 Divorce Litigation 185, 195-200 (1998) (by combining time-limited and permanent awards, the court can build in some degree of automatic variance in support, even in states where a percentage award or escalator provision is generally not permitted). In states that do not permit varying support awards, the form of support awarded in Kerr is obviously improper. Nevertheless, the substance of the Kerr holding is that the exercise of stock options creates income for purposes of spousal support, and that holding does not depend in any way upon the form that the award takes.

After approving the concept of a percentage award, the Kerr court then considered whether the specific percentage awarded was excessive on the facts. On this point the husband fared better, for the price of the stock in question had increased greatly. As a result, the wife’s 40% interest in the profits from the options, added to the trial court’s traditional support award and the wife’s earning capacity, exceeded her reasonable needs. Thus, the amount of the percentage award was excessive:

[T]he court was not presented with the typical range of stock activity that would generate some additional income [from exercise of the options.] Rather, due to the enormous increase in value of Qualcomm stock and consequently [the husband’s] stock options, the court’s percentage support order will far exceed the parties’ standard of living, even considering their investment and reinvestment history, during or at the end of their marriage.

91 Cal. Rptr. 2d at 379. The case was remanded with the following instructions:

We remand the matter to the trial court to determine an amount of additional support that is just and equitable ([Cal. Fam. Code] 4320, subd. (l)), using the parties’ marital standard of living as a point of reference against which the other statutory factors must be weighed. Once the court does so, a percentage support award based on [the husband’s] exercised option income would be permissible so long as the court sets a maximum amount proportionate to its findings of the marital standard of living. Id.

The issues upon which the husband prevailed in Kerr are every bit as important as the issues upon which the wife prevailed. The wife’s theory was apparently that her past contributions to the husband’s earning capacity and to the marriage in general entitled her to a share of the husband’s future earnings. The court strongly rejected this theory, instead reaffirming the basic principle that spousal support is intended to permit the recipient to live at the marital standard of living. If the payor is able to rise above the marital standard of living after the divorce, the recipient is not entitled to share in the payor’s bounty, even if that bounty resulted to some extent from the recipient’s contributions to the marriage. This rule has traditionally been applied when the recipient seeks an increase in support, based solely upon an increase in the payor’s income, without any corresponding increase in the recipient’s financial need. The purpose of alimony is to care for the wife’s needs after divorce, not to provide her with a lifetime profit-sharing plan. Homer H. Clark Jr. The Law of Domestic Relations in the United States 17.6 at 282 (2d ed. 1987). See generally Brett R. Turner, Redefining Alimony in a Time of Transition: Recent Case Law Applying the Changed Circumstances Standard, 6 Divorce Litigation 241, 247-48 (1994).

The second portion of the Kerr opinion holds that future earnings which take the form of stock options are not materially different from future earnings which take the form of salary. In other words, to use Professor Clark’s term, a lifetime profit-sharing plan does not become acceptable merely because the profits shared are something other than traditional salary. It could be argued that the traditional rule is outdated and that spousal support should be a form of profit-sharing plan; many states, in fact, accept something close to this point when they award reimbursement alimony to a spouse who contributes to the other spouse’s professional education. See generally Brett R. Turner, Equitable Distribution of Property 6.21 (2d ed. 1994 & Supp. 1999). It is hard to see, however, why fundamental rules on the basic nature of spousal support should differ, depending only upon the form which future earnings take. If Clark is wrong, and spousal support is profit-sharing, then the recipient should be able to reach both future salary and future stock options. But no state has to date adopted such a fundamental restructuring of the nature of spousal support. As long as spousal support continues to be a device for addressing financial need and not something akin to a profit-sharing plan, any award of future stock options must be limited by the extent of the recipient’s financial need, measured at the general marital standard of living.

www.versuslaw.com). There, the wife argued in the trial court that the options were income; she did not argue that they were marital property. The husband failed to present any evidence challenging the wife’s accountant’s testimony that the options should be considered only in establishing alimony. Given this state of the record, the husband was obviously not in a good position to complain upon appeal that the trial court erred by treating the options as income. The court held:

In this case, the trial court refused to treat the options as an asset and instead considered them as income available to [the husband] for both alimony and child support. We believe it would be inappropriate, especially on this record, to limit the trial court’s discretion by stating that options can never constitute income.

1999.FL.0049762 18. The court then qualified this statement by adding the following footnote:

We note that if a trial court decided to treat certain stock options as an asset, it apparently could not then treat these same options as income for the purpose of calculating alimony.

Id. 18 n.4 (emphasis added). The most important phrase in the above footnote is emphasized: these same options. The footnote suggests that if a given set of options is treated as property it could not then also be treated as income. In most cases, however, the spouse who holds the options will receive some options before the divorce and other options after the divorce. Nothing in the above footnote would prevent the court from treating options acquired after the marriage as income while treating options acquired during the marriage as property. Indeed, given that stock options can permissibly be treated as income under the first-quoted portion of the holding, this pattern of treatment seems highly consistent with Florida law.

It is worth stressing that options can be treated as income to the nonowning spouse as well as to the owning spouse. In Bybee v. Bybee, 879 S.W.2d 793 (Mo. Ct. App. 1994), the husband owned at the time of divorce an interest in a stock option plan. Shortly before the divorce, the plan sold all of its stock to another company and apparently existed only as funds held by a fiduciary, awaiting the formality of distribution. The trial court awarded the wife alimony, and the husband appealed, arguing that the wife’s share of the plan balance, if prudently invested, would suffice to meet her financial needs. The appellate court agreed and reversed the award. The wife’s share, even if invested conservatively as 4%, would produce income of $28,000, which would allow the wife to meet her claimed needs and also to add to her total assets without immediate tax consequences. Id. at 795.

Cases Holding That Stock Options Do Not Constitute Income

Cases holding that stock options do not constitute income tend to involve limited and specific facts. In Denley v. Denley, 38 Conn. App. 349, 661 A.2d 628 (1995), the original divorce decree provided that the husband would retain certain stock options acquired from his employer. The opinion does not state this point expressly, but it is fair to assume that the wife received offsetting property to compensate her for her rights in those options. The court also awarded spousal support. One year later, the husband filed a motion to reduce support, alleging that his income dropped when he lost an important client. The wife argued in response that the husband had additional income from exercising the stock options awarded to him in the divorce decree. The trial court considered the proceeds as income and rejected the husband’s motion. The appellate court found error:

The mere exchange of an asset awarded as property in a dissolution decree, for cash, the liquid form of the asset, does not transform the property into income. Simms v. Simms, 25 Conn. App. 231, 234, 593 A.2d 161, cert. denied, 220 Conn. 911, 597 A.2d 335 (1991). The fact that the asset, when converted into cash, provided a profit is irrelevant because [o]nly in cases of fraud can a modification be based on an increase in the value of assets. Id. The trial court should not have included the profit that the plaintiff generated by exercising the stock options in its determination of whether there had been a substantial change in the circumstances of the parties.

661 A.2d at 631. The court nevertheless affirmed the trial court’s judgment, holding that the husband had failed to prove that additional accounts gained by the husband would not offset the income earned from the lost account. In other words, the court’s error in considering stock options as income was held to be harmless.

www.versuslaw.com). To the extent that the court held that capital gains can be treated as income only where fraud is present, it should be noted that this strict rule is not followed in many other states. See generally Brett R. Turner, Redefining Alimony in a Time of Transition: Recent Cases on the Law of Spousal Support, 4 Divorce Litigation 221, 230-31 (1992) (cases holding that support may be based upon assets as well as income). Also, the basis for the rule seems to be that only unforeseen changes justify modification and that fluctation in the value of assets is always foreseeable. E.g. Simms v. Simms, 25 Conn. App. 231, 593 A.2d 161, cert. denied, 220 Conn. 911, 597 A.2d 335 (1991). However true this point may be regarding the great majority of assets, it is particularly untrue regarding stock options, which tend to fluctuate greatly in value for reasons which are difficult or impossible to foresee in advance. If Connecticut were to apply Denley on facts similar to those of Kerr, where the stock increased in value dramatically and unforeseeably, a real injustice could result. Of course, the increase would still permit modification only up to the level of the recipient’s actual need; that was the block upon which the wife and the trial court in Kerr ultimately stumbled.

Analogy to Retirement Benefits

Since most states have not yet directly considered whether stock options constitute income for purposes of spousal support, counsel facing this question will be forced to search for analogous authority. Fortunately, the question of whether the same benefit can constitute both property for property division purposes and income for spousal support purposes has arisen in several other contexts. The most common such context involves retirement cases.

The law on consideration of retirement benefits is the subject of a split in authority. One line of cases holds that retirement benefits can constitute both property for property division purposes and income for spousal support purposes. Riley v. Riley, 82 Md. App. 400, 571 A.2d 1261 (1990); Braderman v. Braderman, 339 Pa. Super. 185, 488 A.2d 613 (1985); In re Albrich, 162 Or. App. 30, 987 P.2d 542 (1999); In re Halpert, 157 Or. App. 276, 970 P.2d 253 (1998); Moreno v. Moreno, 24 Va. App. 190, 480 S.E.2d 792 (1997); Sachs v. Sachs, 163 Vt. 498, 659 A.2d 678 (1995). Some of the cases reason that the relevant statutes list retirement benefits as both a marital asset and a source for spousal support and hold that any inconsistency is a question for the legislature. E.g. Moreno. Other cases rely upon the longstanding rule that property as well as income can be a source for spousal support. E.g. Braderman.

A second line of cases holds that retirement benefits which are treated as marital property cannot then be treated as a source for spousal support. These cases reason that a benefit must constitute either property or income, but not both. See Ellis v. Ellis, 699 So. 2d 280 (Fla. Dist. Ct. App. 1997); Rogers v. Rogers, 622 So. 2d 96 (Fla. Dist. Ct. App. 1993); Innes v. Innes, 117 N.J. 496, 569 A.2d 770 (1990); D’Oro v. D’Oro, 187 N.J. Super. 377, 454 A.2d 915 (Ch. Div. 1982), aff’d, 193 N.J. Super. 385, 474 A.2d 1070 (App. Div. 1984); Kruschel v. Kruschel, 419 N.W.2d 119 (Minn. Ct. App. 1988); In re Colling, 139 Or. App. 16, 910 P.2d 1165 (1996); Stemper v. Stemper, 403 N.W.2d 405 (S.D.), modified on other grounds, 415 N.W.2d 159 (S.D. 1987); Pelot v. Pelot, 116 Wis. 2d 339, 342 N.W.2d 64 (Ct. App. 1983).

The retirement benefits cases have occasionally been applied by analogy to other types of benefits. See Balven v. Balven, 734 S.W.2d 909 (Mo. Ct. App. 1987) (early retirement benefits); In re Fisher, 148 Or. App. 208, 939 P.2d 149 (1997) (future insurance renewal commissions); Hubert v. Hubert, 159 Wis. 2d 803, 465 N.W.2d 252 (Ct. App. 1990) (accounts receivable of a business).

The second line of cases applies only to retirement benefits which are earned during the marriage and treated as marital property. Retirement benefits earned after the marriage can properly be treated as a source for support. See Staver v. Staver, 217 N.J. Super. 541, 526 A.2d 290 (Ch. Div. 1987); Olski v. Olski, 197 Wis. 2d 237, 540 N.W.2d 412 (1995)

Conclusion

While only a few cases address the treatment of stock options as income for purposes of spousal support, the cases are mostly consistent, and the outlines of a general rule are beginning to become visible. Stock options awarded after the end of the marriage, like all other fringe benefits of employment, do constitute income for purposes of spousal support. Spousal support based upon stock options is no different from spousal support based upon salary, and the amount of support is therefore limited to the amount necessary to enable the recipient to maintain the marital standard of living. In other words, support based upon stock options is not a profit-sharing plan. Kerr.

It is not yet clear whether stock options earned during the marriage and treated as marital property can also be treated as income for spousal support. Seither, in dicta, says no, but Florida is among those states holding that retirement benefits cannot constitute both property and income. If Bybee applies to unliquidated options at all recall that the option plan in that case had sold its stock and existed only as money in a trust account it holds only that the income earned upon marital property after the divorce is a source for support, a proposition with which all courts agree. Denley clearly holds that no income is realized unless exercise of the option yields a profit, that is, unless the option price at the time of exercise is less than the fair market value of the stock. To the extent that Denley holds that a capital gain cannot be considered, it is based upon the unique Connecticut rule that capital gain is not income for support purposes.

In the absence of authority more directly considering the status of options earned during the marriage, it seems likely that the retirement benefit cases apply by analogy. Since the law in those cases is divided, it seems likely that a similar division will probably apply to stock options earned during the marriage. This point has not yet been expressly recognized, however, in any of the reported cases.

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