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NJ Family Legal Blog Pertinent Information As It Relates To New Jersey Family Laws

DEFERRED COMPENSATION – INCOME, ASSET OR BOTH?

Posted in Alimony, Child Support, Equitable Distribution, Practice Issues

 Very often, we deal with cases where our client or his/her has compensation from employment that is more than just salary plus bonus. Rather, with all of the financial services companies, pharmaceutical companies and other corporations in this area, we see all sorts of different compensation structures, including stock options, restricted stock, RSUs, REUs, etc.  Moreover, when the employee is in management or higher up in the company, the types of deferred compensation and/or equity plans can get even more complex.  Further, by its very nature, deferred compensation is not realized as income immediately, but usually over several years, typically 3 to 5 years.  Often it vests in two ways.  On way is serial vesting – 100 options are granted which vest over 5 years – 20 per year.  Sometime there is cliff vesting which means that the options all vest in year 5.  When an employee has been with a company for several years, then often start to have deferred compensation vesting each year and possibly available for income.

The question often arises as to whether these deferred compensation vehicles are income, assets or both,  While the answer is not simple, it is not as complex as many make it out to be..

Typically, deferred compensation that was granted prior to the date of the Complaint for Divorce is treated as an asset and is subject to equitable distribution.  If the deferred compensation is vested, meaning it can be immediately cashed in, then quite often it is equally divided (though again, New Jersey is an equitable distribution state not an equal division stated so it is not an automatic that these assets will be equally divided – sometimes it just seems that way.)

If the deferred compensation is not vested and requires continued, post-divorce Complaint service in order for vesting to occur, that is where things get more difficult.  I have seen some simplistically argued that anything granted before the Complaint gets equally divided no matter when it vests.  More recently, I have seen a greater use of some type of calculation (coverture fraction) used to recognize the post-complaint service of that spouse.  Many believe this to be the fairer way of equitably dividing deferred compensation.

Now, most types of deferred compensation cannot be transferred directly to the non-employee spouse.  As a result, the employee holds the deferred compensation for the other spouse by way of a constructive trust (in NJ called a "Callahan Trust" after the Callahan case).  For options, the non-employee would tell the other party to exercise the options and then give them the money.  The money comes net of taxes because the employee has to pay taxes on the compensation since it is in their name.  How Callahan trusts work and the tax issues will be the subject of a future blog.

So during the marriage, year after year, the parties the employee recognizes the income from the deferred compensation and it shows up on his W-2.  Say for example, his average income over the last 5 years is $500,000 with roughly $400,000 being salary and bonus and $100,000 being deferred compensation.  When we calculate alimony and child support, we are going to use $500,000 right?  Not so fast.

Why you may ask since you are intelligent and know that under the Child Support Guidelines and case law, that the definition is basically all inclusive for child support and alimony purposes?  Well, you just divided all of the deferred compensation granted pre-complaint as part of equitable distribution right? In our example, shouldn’t the number for support purposes be $400,000 since the other $100,000 was divided for the next few years.

Does that mean that future deferred compensation should never be considered?  No.  Seemingly it was part of the marital lifestyle, if for nothing else, the savings and investment component though many people use this money to further their lifestyle.  So when does the post-complaint deferred compensation get counted.  It gets counted when the income is realized.  So depending on how long the new deferred compensation vests, at that time, consideration could probably be given of that income for alimony and child support. Sometimes this is done by way of a pre-determined formula and sometimes the amounts could be capped.

To be clear, in the case of options, there is case law that says it is not when the options that vest but when they are exercised that they be included in income.  Whether that is fair or not is another story because someone could choose to sit on options for years, which has the effect of delaying the other party receiving their share in future support.

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Eric Solotoff is the editor of the New Jersey Family Legal Blog and the Co-Chair of the Family Law Practice Group of Fox Rothschild LLP. Certified by the Supreme Court of New Jersey as a Matrimonial Lawyer and a Fellow of the American Academy of Matrimonial Attorneys, Eric practices in Fox Rothschild’s Roseland, New Jersey office though he practices throughout New Jersey. You can reach Eric at (973)994-7501, or esolotoff@foxrothschild.com.