Divorce and Stock Options: When to Apply the Hug or Nelson Formula
When do the Hug and Nelson formulas apply?
When there are unvested stock options or restricted stock units in a divorce, either the Hug formula or the Nelson formula must be used to value them.
How do you know which formula to use?
Which formula to use depends on what the employer’s intent was when they awarded the shares.
- Use the Hug formula if the shares are an award based on past performance.
- The Hug formula is more favorable to the non-employee spouse because more of the shares will be considered community.
- Use the Nelson formula If the shares were to retain the employee, i.e., for future performance.
- The Nelson formula is more favorable to the employee spouse.
What are the Hug and Nelson formulas?
The Hug Formula:
MONTHS from HIRE DATE to DATE OF SERVICE ÷ MONTHS from HIRE DATE to DATE OF EXERCISABILITY
The resulting percentage is then multiplied against the shares vesting to determine how many of those shares are community.
The Nelson Formula:
MONTHS from GRANT DATE to DATE OF SERVICE ÷ MONTHS from GRANT DATE to DATE OF EXERCISABILITY
As with Hug, the resulting percentage is multiplied against the shares vesting to determine how many of those shares belong to the community.
Therefore, the difference between Hug and Nelson is that Hug uses the date of hire where Nelson uses the date the stocks were granted. They are nearly identical in all other respects.
How do you apply the Hug and Nelson formulas?
First we must outline the stock vesting schedule by year, then we will follow the seven-step process that can be applied to both formulas. This is the simplest way to understand and apply them correctly.
Outline the stock vesting schedule by Year. This not only helps you visualize the granting schedule, but it helps you see what stocks vested before the date of service, and which vested after. The formula is only for those stocks that vest after the date of service. (Because the stocks that were granted after the date of marriage and vested prior to the date of service are community).
Here is the seven-step process that can be applied to both formulas. This is the simplest way to understand and apply them correctly.
- Determine the Number of Shares to Allocate. Using the outline of the full picture of the granting schedule, determine the number of shares to allocate for the time period we are calculating.
- Determine the numerator. For Hug, the number of months from the Date of Hire to the Date of Service. For Nelson, the number of months from the stocks’ grant date to the date of service. (As a reminder, the numerator is the top number in a fraction. For example, in ½, the numerator is 1.)
- Determine the denominator. For the Hug formula, the denominator is the number of months from the hire date to the date of exercisability. For the Nelson formula, the denominator is the number of months from the Grant date to the date of exercisability. (As a reminder, the denominator is the bottom number in the fraction. For example, in ½, the denominator is 2.)
- Divide the numerator by the denominator. The number it yields is called the Community Allocation Share Percentage. For example, if our numerator is 1, and our denominator is 2, we get 50% (i.e., ½ = 50%).
- Multiply the Community Share Percentage by the number of stocks vesting. For example, if there are 1,000 stocks, and the Community Share percentage is 50%, 500 shares are community.
- Determine Each Party’s Community Shares. Finally, divide the community shares and assign one-half of those shares to the non-employee spouse, and the employee spouse takes the remainder (the other half of the community shares plus the remaining share as their sole and separate property). Using our example from above, we had 1,000 shares, 500 of which are community. The non-employee spouse gets one-half of those community shares, or 250 shares (i.e., 500/2 = 250). The remaining shares belong to the employee spouse, i.e., the employee spouse gets 750 shares.
- Total Each Party’s Shares. The non-employee will receive their portion of the community shares. The employee will receive their community shares and their sole and separate shares. Using our example from above, the non-employee spouse gets 250 shares. The employee spouse gets 250 shares plus the remaining shares that belong to the employee spouse (500), i.e., the employee spouse gets 750 shares in total.
Repeat steps 1 to 7 for each set of vesting stocks.
Hypothetical Example
- Husband and Wife are married in 2000.
- Wife is hired by XYZ Corp. on June 1, 2021.
- Each year for her work anniversary, XYZ Corp. grants her 1,500 shares of unvested stock options.
- The stocks vest over a three-year period, with 500 stocks vesting on each of the subsequent three years.
- The date of service of the divorce is December 1, 2024, 3 ½ years after Wife started working at the company
- At the date of service, Wife has received 4500 shares of unvested stock options
- 1500 shares have already vested
- 3000 shares remain unvested
Now let’s work through the steps:
Begin By Outlining the Stock Vesting Schedule
This outline gives an immediate visual of the issue. First, 1,500 shares vested before the divorce started. Those are all community property. Hug and Nelson are only concerned with those grants that are partially community and partially separate.
The graph also shows where the shares need to be divided. In all, there are six different blocks of 500 shares that will vest in the next three years. Each of these blocks will need to be calculated under Hug or Nelson.
HUG FORMULA
Steps One through Seven for Stocks Vesting in 2025
These formula steps require us to run multiple versions of the same calculation using slightly different numbers. But this redundancy and the outline of the steps above show how simple the calculation can be once you understand the basic principles of the formula. At first, these calculations can seem complex and may be intimidating, but when broken down, with each step detailed, the math is elementary.
We will start with the Hug Formula, and we will apply it first to those stocks vesting in 2025.
MONTHS from HIRE DATE to DATE OF SERVICE ÷ MONTHS from HIRE DATE to DATE OF EXERCISABILITY
The hire date, service date, and exercisability date are all the same numbers for all the stocks vesting in 2025. Therefore, as the grant date does not matter here, we can calculate all three blocks vesting in June 2025 together:
Stocks Vesting in 2025
- Number of Shares to Allocate = 1500 (shares vesting in 2025)
- Numerator = 42 (months)
*3.5 years between the Hire Date (6/1/2021) and the Date of Service (12/1/24)
- Denominator = 48 (months)
*4 years between the Hire Date (6/1/2021) and the Date of Exercisability (6/1/2025)
- Community Property Percentage of Stocks = 87.5% (are community property)
*Divide the Numerator by the Denominator
[42 ÷ 48 = 87.5%]
- Shares of Community Property Stocks = 1,312.5 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[87.5% X 1500 = 1,312.5]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse = 656.25 shares to Husband and 656.25 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[1,312.50 ÷ 2 = 656.25]
Assign Remaining Stocks to Wife (Employee Spouse) = 187.5 shares to wife
*Number of Shares to Allocate Subtracted by Community Property Stocks
[1,500 – 1,312.50 = 187.50]
- Total
Husband (non-employee) = 656.25 shares
Wife (employee) = 843.75 shares
Repeat for stocks vesting in 2026
- Number of Shares to Allocate = 1000 (shares vesting in 2026)
- Numerator = 42 (months)
*3.5 years between the Hire Date is 6/1/21 and the Date of Service (12/1/24)
- Denominator = 60 (months)
*5 years between the hire date (6/1/2021) and the exercisability date (6/1/2026)
- Community Property Percentage of Stocks = 70.0% (are community property)
*Divide the Numerator by the Denominator
[42 ÷ 60 = 70.0%]
- Shares of Community Property Stocks = 700 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[70.0% X 1,000 = 700]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse =
350 shares to Husband and 350 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[700 ÷ 2 = 350]
Assign Remaining Stocks to Wife (Employee Spouse) = 300 shares to wife * Number of Shares to Allocate Subtracted by Community Property Stocks
[1,000 – 700 = 300]
- Total
Husband (non-employee) = 350 shares
Wife (employee) = 650 shares
Repeat for Stocks Vesting in 2027
- Number of Shares to Allocate = 500 (shares vesting in 2027)
- Numerator = 42 (months)
*3.5 years between the Hire Date (6/1/2021) and the Date of Service (12/1/24)
- Denominator = 72 (months)
*6 years between the Hire Date (6/1/2021) and the Date of Exercisability (6/1/2027)
- Community Property Percentage of Stocks = 58.33% (are community property)
*Divide the Numerator by the Denominator
[42 ÷ 72 = 58.33%]
- Shares of Community Property Stocks = 291.67 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[58.33% X 500 = 291.67]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse =
145.83 shares to Husband and 145.83 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[291.67 ÷ 2 = 145.83]
Assign Remaining Stocks to Wife (Employee Spouse) = 208.33 shares to wife * Number of Shares to Allocate Subtracted by Community Property Stocks
[500 – 291.67 = 208.33]
- Total
Husband (non-employee) = 145.83 shares
Wife (employee) = 354.17 shares
Totaling Up HUG Formula Breakdown
The total shares, including the 1,500 shares that vested during the marriage, under the Hug formula: Husband receives 1,902.08 shares, and Wife receives 2,597.92 shares.
NELSON FORMULA
Steps 2 through 6 of the Nelson Formula are the same as in Hug, but the big things that change are numerator and denominator. The hire date in Hug is replaced by the grant date in Nelson.
MONTHS from GRANT DATE to DATE OF SERVICE
MONTHS from GRANT DATE to DATE OF EXERCISABILITY
It also means where the numerator remained constant in Hug under this scenario, it is going to change quite a bit here. This means Nelson takes a little more work, as we can no longer group together the blocks of stocks vesting in the same year.
2022 Grant Vesting in 2025
- Number of Shares to Allocate = 500 (shares granted in 2022 vesting in 2025)
- Numerator = 30 (months)
*2.5 years between the Grant Date (6/1/2022) and the Date of Service (12/1/2024)
- Denominator = 36 (months)
*3 years between the Grant Date (6/1/2022) and the Date of Exercisability (6/1/2025)
- Community Property Percentage of Stocks = 83.3% (are community property)
*Divide the Numerator by the Denominator
[30 ÷ 36 = 83.3%]
- Shares of Community Property Stocks = 291.67 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[83.3% X 500 = 416.5]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse =
208.25 shares to Husband and 208.25 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[416.5 ÷ 2 = 208.25]
Assign Remaining Stocks to Wife (Employee Spouse) = 83.5 shares to wife
*Number of Shares to Allocate Subtracted by Community Property Stocks
[500 – 416.5 = 83.5]
- Total
Husband (non-employee) = 208.25 shares
Wife (employee) = 291.75 shares
2023 Grant Vesting in 2025
- Number of Shares to Allocate = 500 (shares granted in 2023 vesting in 2025)
- Numerator = 18 (months)
*1.5 years between the Grant Date (6/1/2023) and the Date of Service (12/1/2024)
- Denominator = 24 (months)
*2 years between the Grant Date (6/1/2023) and the Date of Exercisability (6/1/2025)
- Community Property Percentage of Stocks = 75% (are community property)
*Divide the Numerator by the Denominator
[18 ÷ 24 = 75%]
- Shares of Community Property Stocks = 375 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[75% X 500 = 375]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse = 187.5 shares to Husband and 187.5 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[375 ÷ 2 = 187.5]
Assign Remaining Stocks to Wife (Employee Spouse) = 125 shares to wife
*Number of Shares to Allocate Subtracted by Community Property Stocks
[500 – 375 = 125]
- Total
Husband (non-employee) = 187.5 shares
Wife (employee) = 312.5 shares
2024 Grant Vesting in 2025
- Number of Shares to Allocate = 500 (shares granted in 2024 vesting in 2025)
- Numerator =6 (months)
*.5 year between the Grant Date (6/1/2024) and the Date of Service (12/1/2024)
- Denominator = 12 (months)
*1 year between the Grant Date (6/1/2024) and the Date of Exercisability (6/1/2025)
- Community Property Percentage of Stocks = 50% (are community property)
*Divide the Numerator by the Denominator
[6 ÷ 12 = 50%]
- Shares of Community Property Stocks = 250 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[50% X 500 = 250]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse = 125 shares to Husband and 125 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[250 ÷ 2 = 125]
Assign Remaining Stocks to Wife (Employee Spouse) = 250 shares to wife
*Number of Shares to Allocate Subtracted by Community Property Stocks
[500 – 250 = 250]
- Total
Husband (non-employee) = 125 shares
Wife (employee) = 375 shares
2023 Grant Vesting in 2026
- Number of Shares to Allocate = 500 (shares granted in 2024 vesting in 2025)
- Numerator = 18 (months)
*1.5 years between the Grant Date (6/1/2023) and the Date of Service (12/1/2024)
- Denominator = 36 (months)
*3 years between the Grant Date (6/1/2023) and the Date of Exercisability (6/1/2026)
- Community Property Percentage of Stocks = 50% (are community property)
*Divide the Numerator by the Denominator
[18 ÷ 36 = 50%]
- Shares of Community Property Stocks = 250 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[50% X 500 = 250]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse =
125 shares to Husband and 125 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[250 ÷ 2 = 125]
Assign Remaining Stocks to Wife (Employee Spouse) = 250 shares to wife
*Number of Shares to Allocate Subtracted by Community Property Stocks
[500 – 250 = 250]
- Total
Husband (non-employee) = 125 shares
Wife (employee) = 375 shares
2024 Grant Vesting in 2026
- Number of Shares to Allocate = 500 (shares granted in 2024 vesting in 2026)
- Numerator = 6 (months)
*.5 year between the Grant Date (6/1/2024) and the Date of Service (12/1/2024)
- Denominator = 24 (months)
*2 years between the Grant Date (6/1/2024) and the Date of Exercisability (6/1/2026)
- Community Property Percentage of Stocks = 25% (are community property)
*Divide the Numerator by the Denominator
[6 ÷ 24 = 25%]
- Shares of Community Property Stocks = 125 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[25% X 500 = 125]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse = 62.5 shares to Husband and 62.5 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[125 ÷ 2 = 125]
Assign Remaining Stocks to Wife (Employee Spouse) = 375 shares to wife
*Number of Shares to Allocate Subtracted by Community Property Stocks
[500 – 125 = 375]
- Total
Husband (non-employee) = 62.5 shares
Wife (employee) = 437.5 shares
2024 Grant Vesting in 2027
- Number of Shares to Allocate = 500 (shares granted in 2024 vesting in 2027)
- Numerator = 6 (months)
*.5 year between the Grant Date (6/1/2024) and the Date of Service (12/1/2024)
- Denominator = 36 (months)
*3 years between the Grant Date (6/1/2024) and the Date of Exercisability (6/1/2027)
- Community Property Percentage of Stocks = 16.67% (are community property)
*Divide the Numerator by the Denominator
[6 ÷ 36 = 16.67%]
- Shares of Community Property Stocks = 83.3 community shares
*Multiply Community Property Percentage of Stocks by the Number of Shares to Allocate
[16.67% X 500 = 83.35]
- Assign Shares to Each Spouse
Assign Community Property Stocks to Each Spouse = 41.65 shares to Husband and 41.65 shares to Wife
*Divide Community Property Stocks by 2 (Husband and Wife)
[83.3 ÷ 2 = 41.65]
Assign Remaining Stocks to Wife (Employee Spouse) = 416.7 shares to wife
*Number of Shares to Allocate Subtracted by Community Property Stocks
[500 – 83.3 =416.7]
- Total
Husband (non-employee) = 41.65 shares
Wife (employee) = 458.35 shares
Totaling Up Nelson Formula Breakdown
Here, when we total it up, including the 1,500 shares that vested during the marriage, Wife receives 3,000.1 shares under Nelson, and Husband receives 1,499.9 shares.
In all, Wife receives just over 400 more shares under Nelson than she does under Hug.
Other Issues
But what if Wife’s hire date was 2001 instead of 2021. Would that make a difference?
Under Hug, yes, it makes a significant difference. Under Nelson, it makes no difference because Nelson does not factor in hiring date. Therefore, from a practical perspective, the longer someone has been at a company, the greater the disparity is going to be between the Hug and Nelson figures.
Look at how the numbers change under Hug if the start date in June 1, 2001:
- Stocks vesting in 2025: For the 1,500 stocks vesting in 2025, the numerator is now 246 months, and denominator 252 months. 246/252 = 97%. That means 1,464.3 shares are community. Husband’s half of the community shares is 732.15. Wife gets the remainder: 767.85 shares.
- Stocks vesting in 2026: For the 1,000 shares vesting in 2026, the numerator is 246, and the denominator is 264 months. 246/264 = 93.18%. This means 931.8 shares are community. Husband’s half is 465.9. Wife takes 534.1.
- Stocks vesting in 2027: For the remaining 500 shares, the numerator remains 246 months, and the denominator is 276 months. 246/276 = 89.8%. This means 448.9 shares are community property.
Here is how it totals up.
In all, 2,845 shares of the 3,000 shares that vested after the date of service are community property. The 1,500 shares that vested during the marriage are also community property. That means, under Hug, Husband receives 2,172.5 shares and Wife receives 2,227.5 shares. That means Husband’s shares increased by 270.42 shares when 2001 is the hire date as opposed to 2021.
He is also getting 672.50 more shares than he does under Nelson (he takes 48.3% of the stocks under Hug and 33.3% of the stocks under Nelson).
But what if Wife gets fired in 2025 and none of the remaining shares vest?
Arizona has not addressed this exact question yet, so the answer is not definitive. But some cases might provide some guidance here, and those cases suggest that whether Wife would still owe Husband the value of the shares may depend on why she was terminated. Husband may have a waste claim if he can prove she acted unreasonably.
In Goodell v. Goodell, the Husband owned restricted stock units that were set to vest over the course of the next few years. But then suddenly, his division in the company shrank from 80 employees to 1.5 employees. Sensing that his time at the company might not be long, Husband left to seek employment elsewhere, forfeiting his shares. Wife filed a waste claim. The Arizona Court of Appeals found that it was not waste. In doing so, it held that a spouse’s post-petition conduct must only be reasonable under the circumstances. The Husband in Goodell obviously had good reason to move on from his job, and after the date of service, spouses are not required to make unreasonable financial decisions to serve a community that no longer exists. Goodell would suggest then that whether Husband may have a waste claim may depend on whether Wife was fired as a result of unreasonable conduct.
In Meister v. Meister, the community business lost its major client, causing the value of the business to tank. The Court of Appeals found the trial court should have valued the business in light of this development, even though it occurred after the date of service, and even though it was the result of some questionable business practices. Meister then would suggest that a Court could consider the loss of the stock even though it happened after the date of service.
