Assignment of ISO income in Divorce

[Renee Snow]

Hi There,

My client has over 1m in ISOs and was divorced in 2020. The Marital Settlement Agreement awarded 1/2 of the ISOs to his ex spouse. In the 1st quarter of 2021 she exercised and sold 570K. This amount is reported on my client's paystub and will appear on his W2 for 2021. There is a PLR that says the ex is responsible for reporting the income on her return. I am unclear about the logistics of this. How do you back out W2 income and assign it to another person? Does anyone have experience with this issue?

Thanks!

[IRonMaN]

You can't get it to the ex's return.  The best you can do is hope that the ex is willing to kick some cash back for the tax that is going to end up being paid as part of the transaction.

[Renee Snow]

Thanks, I've relied on your advice in the past. According to PLR-130300-04

E= Employee

X= ex spouse

1. The Court's recognizing X's CP interest in the ISOs and requiring E to exercise X's ISOs only in accordance with X's instructions and requiring E to designate X as the beneficiary of X's share of the options will not violate the requirements of sections 422(b)(5) of the Code relating to nontransferability and lifetime exercise by the employee.

2. AMT income recognized on E's exercise of X's ISOs will be includible in Xs AMT income for falderal tax purposes.

3. Income recognized on E's exercise of X's NSOs that remain in E's name or under E's control will be included in X's income for federal income tax purposes.

4. X will be entitled to any AMT credits as a result of E's exercise of X's ISOs. 

I simply can't think of a way to transfer this W2 income to X other than a negative "other income" adjustment, nominee distribution for X's SS#.

[sjrcpa]

What would happen if Employee told Employer xxx of these ISOs now belong to my Exspouse pursuant to our divorce and property settlement agreement?

I have no idea, just throwing it out there. And if this event already happened, it's too late, isn't it?

Does that PLR exactly fit your fact pattern? Only the person who got that PLR can rely on it.

[BobKamman]

@Renee Snow "I simply can't think of a way to transfer this W2 income to X other than a negative "other income" adjustment, nominee distribution for X's SS#."

Well then, just do it.  But transfer the withholding credits also, as the PLR instructs (although they contemplate the ISO stock being transferred to X before the sale, so this only mentions the NSO's:

"11.   X is entitled to the credit for income tax withheld from the stock or cash proceeds (or paid to Company by X for properly due income tax withholding) at the time of the exercise of the nonstatutory stock options of which X is beneficial owner."

This is essentially what you would do if they were still married and filing separate returns that split the community income and withholding.   What would happen if you filed a Form 8958 with a return marked "Community Income Split" ?  At least it would route processing to the group that knows what you're dealing with. 

The Form 8958 instructions tell us:

This form is intended for individuals who:
1. Are subject to community property laws, and
2. File separate federal income tax returns.

If the shoe fits, wear it. 

[Renee Snow]

Thanks, ISOs are not transferrable so going to the employer won't have an impact. I'm vaguely worried about the reliance on the PLR. Thanks!

[Renee Snow]

Hi Bob,

You're right about transferring the taxes withheld to X and I appreciate the suggestion of attaching Form 8958. I will need to paper file this return and also attach the PLR. Even with these precautions my guess is that the return will be rejected. The ISO sold this year were disqualifying dispositions.

Thanks for your input, it was helpful.

Renee