For spouses that invest considerably in the stock market, divorce can cause all kinds of complications. One of the most important questions you need to ask yourself is whether your stocks will be considered property or income. Although you might think that the answer to this question is fairly straightforward, the truth can be a little more complex. As always, the answer also depends heavily on your unique situation. That being said, there are a few things you should know when determining the true classification of stocks.
The Law is Very Unclear
Courts cannot seem to decide whether stocks should be classified as income or property. The truth is that each state seems to approach this subject in its own unique way. Even within individual states, there may be numerous contradicting rulings that leave spouses (and lawyers) scratching their heads. For example, Massachusetts was quite clear that stock options should be considered marital assets – until it came to a different conclusion a few years later. Baccanti v. Morton in 2001 established that stock options were marital assets – even though the actual value of these options was uncertain.
The husband’s “right to buy” was considered an asset in and of itself. The husband could exercise his options and split half the net gain with his wife or allow her to exercise her share of the options independently. In 2009, courts in Massachusetts came to a very different decision with Wooters v. Wooters. This case involved a husband that accepted a new job after the divorce and was provided with stock options. 12 years after the divorce, he exercised his stock options and boosted his gross pay to over $1 million in the process. The ex-wife was entitled to one-third of her ex’s future gross income through an alimony agreement, which meant she had a vested interest in having her husband’s stock options classified as income. This time, the court ruled in the wife’s favor.
So which is it? Are stock options income or property? In both these cases, it seems that the outcome favored the “receiving spouse,” suggesting that stock options will be classified in whatever way serves their best interests. But it is not really that simple, since you also have to consider factors like timing, how stock options are exercised, and how much profit is gained by the transaction. Reporting capital gains from exercising stock options on a W-2 may also increase the chances of income classification, and another method could help avoid this.
In addition, there is a well-known distinction between day trading and long-term investments that have been held over many years. While profits from both are considered income, they are taxed differently. In terms of child support or alimony, a day trader might have their monthly gains treated like income. But a spouse who holds their stocks for years without any intention of selling in the near future might have these investments classified as property instead.