Many working spouses collect stock options during marriage (especially in Silicon Valley) as a form of compensation for employment. These options are Incentive Stock Options.  They are not transferable and their exercise is contingent upon continued employment.  

These options are considered community property if earned, vested, and exercised during marriage. Community property will normally be acquired from the date of marriage to the date of physical separation of the parties.  
Problems occur with regard to the allocation of stock options in divorce court, however, when the options are earned during marriage but their benefits are realized only after the couple separates. In this case, the community portion of the options must be allocated by the court.  Three approaches have been utilized by the courts.

1. Stock Options During Marriage And Exercisable After Separation

In  In re Marriage of Hug (1984) 154 Cal.App.3d 780, the court created a formula (the "Time Rule") to determine shares of stock characterized as community property as follows:

Number of Months between SOE and DOS

______________________________________________________________X     Number shares 
Number of Months between SOE and DOE

(SOE=Start of Employment
DOS=Date of Separation
DOE=Date option is exercisable)

The Hug case involved stock options which were granted prior to the date of separation of the parties but became exercisable after the date of separation. In fashioning its formula, the court held that the trial court had broad discretion “to select an equitable method of allocating community and separate property interests in stock options.” The court in Hug did, however, noted that no one formula would dictate the conclusion of the court.

2. Incentive Stock Options

In another case, another approach, the Harrison approach (In re Marriage of Harrison (1986) 179 Cal.App.3d 1216) was used in order to determine the community property rights in stocks:


Number of days between DOG and DOS
______________________________________________________________   X     Number shares
Number of days between DOG and DOV


(DOG=Date of Grant
DOS=Date of Separation
DOV=Date option became vested)

The Harrison case involved incentive stock options.  These options were used as an incentive for a party to stay with the employer. Under one of the options, the husband had the right to buy his employer's stock in increments of 25 percent on specified dates extending over a period of four years. 

Under several other options, the husband could purchase all the stock covered by the option on the day the option was granted but restrictions applied. Stock issued once the options were exercised was to be forfeited to the employer if the employee was terminated for cause or left voluntarily without the employer’s consent. 

3. Alternative Calculation: Options Granted Before Separation of the Parties

In a third case, In re Marriage of Nelson (1986) 177 Cal. App. 3rd 150, the court applied a third formula in order to apportion options between community and separate shares as follows:

 Number of months from DOG to DOS       ___________________________________________      X   Number shares                 Number of months from DOG to DOE

(DOG=Date of Grant
DOS=Date of Separation
DOE=Date option is exercisable)

In the Nelson case, the above formula was applied to options
 granted before the parties separated but were not exercisable until after they separated. 

Distribution of Incentive Stock Options in Divorce

The value of the Incentive Stock Options using one of the above formulas must be distributed to each party equally as community property.   This is done with a court order authorizing exercise of the options on the non-employee's behalf and distribution to the non-employee. 

Because the options are non-transferable, the court order should provide that the employee spouse must exercise the options for distribution to the non-employee spouse.

Transaction costs and income taxes, should be deducted from the proceeds that the non-employee spouse receives. The court should not award the actual options themselves to the non-employee spouse.

Thus, Incentive Stock Options are often the subject of family law litigation with the court attempting to fashion an equitable solution for their distribution. Differences in the community share are traced to the approach used above.

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