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Stock Options and Child Support
By Gregg Herman
Fairshare
November 1999
Stock options are true "win-win" scenarios for businesses and their employees. They only cost the business money if the company appreciates in value. For the employee, contrary to the normal rule of investing that the "greater the return, the greater the risk which must be run," for stock options, there is the possibility of a great return with no risk whatsoever.

In divorce, courts have struggled with various issues regarding stock options. Most of these issues deal with property division, such as whether the option is a reward for past services rendered or payment for future services. A recent Ohio case raises the question of whether stock options are available for child support.
What is a Stock Option?
A stock option is the ability to buy stock at a future date at a specific value, usually the value on the date of granting the option. For example, if the stock is trading at $10 per share, the company may grant an option for, say, 1,000 shares, vesting in one year and good for 5 years. In other words, at any time between one year to 5 years later, the employee may buy 1,000 shares of the company stock for $10 per share. Thus, if the company stock has appreciated to, for example, $20 per share, the employee can instantly realize $10 per share in profit. The option, in theory, entails no risk because if the stock falls below $10 per share, the employee simply does not exercise the option.

Of course there is no such thing as a free lunch. By offering the employee a stock option, the employer may not be affording the employee other compensation, such as salary or a bonus. To the employer, this is a good deal because the stock option will only be exercised if the company stock appreciates. While the employee does not bear the normal risk of an investment if the stock depreciates in value, the employee may have forgone other forms of compensation when the option was granted. In most cases, the employee probably had no choice, as the employer chose the form of compensation.

Child Support Cases

While there is a plethora of published cases on the role of stock options on property division, there have been few cases discussing stock options when setting child support. However, the Ohio Court of Appeals has recently issued a well-publicized decision on this subject. Murray v. Murray held that the appreciation of unexercised stock options should be included in a child support payor’s gross income. The court found that the options were given to the payor every year as an integral part of his compensation. Failure to include the options, the court held, would allow an employee to "shield a significant portion of his income from the courts, and deprive his children of the standard of living they would otherwise enjoy."

The court rejected the payor’s argument that the options are nonrecurring, responding that they were granted to the payor annually. Therefore, the court included the options in the payor's gross income for the purpose of calculating child support.

A similar, although less well publicized, decision was reached by the Colorado Court of Appeals in In re Marriage of Campbell. That court also held that proceeds received from the exercise of stock options were income for child support purposes. The appellate opinion rejected the trial court's consideration of potential income from future options, including in gross income only actual income received (valued as the difference between the "purchase price" and the price at which the stock was sold).

Gross Income?

Are these holdings valid in other states? Under most states' child support guidelines all gross income is considered for child support. Guidelines generally "include as income any source of funds available to the party, taking into consideration all possible financial sources." Stock options fit that definition.

However, it is not that simple. Stock options typically have, following vesting, an exercise period after which the option terminates. No taxes are due until the option is exercised. To take a "snapshot" at any point in time, as would be done for property division purposes, would not be appropriate with respect to child support because it is entirely possible that an option, worth significant money at one point, can be worthless at a different point in time if the value of the stock goes down.

Similarly, to find child support income only when the option is exercised may not be appropriate, since the exercise periods may be lengthy. A payor, knowing that the exercise of a stock option could trigger a significant child support payment could wait, if possible, until his child support terminated before exercising the option.

In many cases, this might be a non-issue. For one, many employees who are awarded options are well enough compensated for the trial court to "cap" child support in any event. And, to the extent the option was valued as part of the marital estate, including it again for child support could constitute impermissible "double-dipping."

Still, practitioners need to be aware of the possibility that the exercise of stock options could have child support ramifications. For the payor, the stipulation should be carefully drafted to identify what sources of income are available for child support. Where child support may be stated as a floating percentage of income (for example 25 percent of all gross income), stock options may be included.

The payor should also be aware of the possible value of stock options. Especially in smaller companies, executives can negotiate compensation packages. Trading off immediate salary for long range benefits, such as stock options, may be one alternative which could defeat the amount of child support which would otherwise be paid.

Compromise

As with most other issues in divorce cases, the true answer lies in compromise. As noted above, if the payor is getting stock options, child support from base salary may be adequate even without their consideration. On the other hand, stock options are clearly a component of compensation. One compromise would be to require the payor to apply a certain percentage of the stock option exercised, after taxes, to the higher education costs of the children. By doing so, there is no "overpayment" of child support, but the children will benefit from any additional compensation, which is an underlying purpose of child support.

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