## Facts

- An employee held nonstatutory (nonqualified) stock options granted as compensation by the employer.
- The employee also held rights to future payments under the employer’s nonqualified deferred-compensation plans.
- The employee and spouse lived in a state treating stock options and deferred-compensation rights as marital property.
- A divorce judgment required the employee to transfer to the former spouse a specified portion of the nonstatutory stock options and specified deferred-compensation rights.
- The transfer was incident to divorce and made solely as part of the property settlement.
- After the divorce, the former spouse exercised the transferred options and acquired employer stock.
- After the employee’s employment ended, the employer paid deferred compensation directly to the former spouse with respect to the transferred rights.

## Issues

1. Whether the transfer of nonstatutory stock options to a former spouse incident to divorce is a nonrecognition transfer under I.R.C. § 1041, and who includes the resulting compensation income when the former spouse later exercises the options.
2. Whether the transfer of nonqualified deferred-compensation rights to a former spouse incident to divorce is a nonrecognition transfer under I.R.C. § 1041, and who includes the income when the employer later makes payments to the former spouse.
3. Whether the assignment-of-income doctrine requires taxation of the employee-transferor rather than the former spouse-transferee on income realized after such a divorce-related transfer.

## Decision

- The transfer of nonstatutory stock options to a former spouse incident to divorce is a nontaxable transfer of property under § 1041.
- When the former spouse exercises the transferred nonstatutory options, the former spouse includes the resulting compensation income in gross income under the usual rules for nonstatutory options.
- The transfer of nonqualified deferred-compensation rights to a former spouse incident to divorce is a nontaxable transfer of property under § 1041.
- When the employer later pays deferred compensation attributable to the transferred rights, the former spouse includes the payments in gross income.
- In this setting, § 1041 governs the tax consequences of the transfer and prevents applying the assignment-of-income doctrine to tax the employee-transferor on the transferee’s later realization events.

## Legal Principles

- I.R.C. § 1041 provides nonrecognition for transfers of property between spouses or to a former spouse incident to divorce.
- Nonstatutory stock options and nonqualified deferred-compensation rights may constitute “property” for § 1041 purposes when transferred pursuant to a divorce property division.
- After a § 1041 transfer, the transferee spouse is the taxpayer with respect to income realized upon later exercise of transferred nonstatutory options.
- After a § 1041 transfer, the transferee spouse is the taxpayer with respect to payments later received on transferred nonqualified deferred-compensation rights.
- The assignment-of-income doctrine does not shift taxation back to the employee-transferor when realization occurs after a divorce-related § 1041 property transfer.

## Conclusion

A divorce-related transfer of nonstatutory stock options and nonqualified deferred-compensation rights is treated as a nonrecognition property transfer under § 1041, and the former spouse who later exercises the options or receives the deferred-compensation payments bears the resulting federal income tax.


Rev. Rul. 2002-22, 2002-1 C.B. 849 (2002)