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INCENTIVE STOCK OPTIONS – NONQUALIFIED STOCK OPTIONS

DIVORCE – INTERNAL REVENUE SERVICE

Consider the following Divorce Settlement.

Listajo and Jane Pacaro divorce in 2014. Central to settlement of this matter was an agreement that Jane was awarded a portion of her highly compensated executive husband's stock options. The form of the Husband's stock options was both Incentive Stock Options (ISO) and Non-Qualified Stock Options (NQSO). Listajo and Jane's options may be exercised in 2019. The anticipated worth of Jane's portion of these options is in excess of $500,000.00. Jane is confident that her award is not subject to loss as her divorce attorney advised that the Stock Option Plan contains a substantial bar to the sale or transfer of the Options.

Query.

Was, Jane's attorney remiss in not making clear to the client the fact that incident to:

  • Internal Revenue Code 26 U.S.C. 6331 (b) Seizure and sale of property
  • Office of Chief Counsel, Internal Revenue Service Memorandum
  • Number: 200926001

Prior to Settlement Did Jane's Attorney Consider:

The Internal Revenue Service is endowed with a superior right of transfer than that possessed by the Optionee. Should it have been made clear to the Former Spouse that

  • The IRS can seize and sell executive stock options held by the Optionee regardless of restrictions on the transferability of the options
  • The IRS can enforce a regular levy served on the Optionee by seizing and selling executive stock options held by the Optionee

Regarding Listajo's Non-Qualified Stock Options attorneys are reminded:

Restrictions on transferability of these NSO's are contractual rather than statutory. Contractual restrictions on transferability are not a bar to the Internal Revenue Service from seizing and selling property under the procedures of section 6335. Moreover, Section 6331(a) gives the Internal Revenue Service broad collection of powers to levy on all property or rights to property belonging to the Optionee. [1]

Regarding Listajo's Incentive Stock Options. IRS treatment of incentive stock options can be analogized to that of ERISA-qualified pension plans. Section 401(a)(13) states that a pension plan will not be considered a qualified trust unless it provides that benefits under the plan may not be assigned or alienated. Under ERISA and federal tax law, anti-alienation provisions enforceable under ERISA against creditors generally are not enforceable against the Service (emphasis mine). Treas. Reg. § 1.403(a)-13(b)(2) (required anti-assignment or alienation clause does not preclude the enforcement of a federal tax levy made pursuant to section 6331). [2]

Subsequent to divorce the high living, free spending Listajo fails to pay his federal income taxes. In 2018 the Internal Revenue Service filed against Listajo, Form 668-A (Notice of Levy) and proceeded to seize all of Listajo's remaining stock options,including those awarded to Jane. All of "Jane's" options were seized by the IRS.

Conclusion # 1.

Stock Options though not inherently evanescent, are tainted by this quality due to their treatment in regulation and statute. This broad reach of the Internal Revenue Service should be recognized by the practitioner. Especially the attorney representing Former Spouse.

Conclusion # 2.

To avoid this unanticipated loss of assets by a Former Spouse it is suggested that the family practitioner, prior to negotiating Stock Options become familiar with relevant federal law and regulations.



[1] This paragraph and the paragraph immediately below were taken virtually verbatim from above referenced Memorandum Number: 200926001.

[2] An incorrect citation in the memorandum to the IRC is corrected in this paragraph.