For executives at Houston’s publicly traded energy companies, financial institutions, and technology firms, a golden parachute clause can represent millions of dollars that will pay out if the company changes hands. When those executives are also going through a divorce, the interaction between a potential change-in-control payout and the property division process creates one of the most complicated situations in Texas family law.
What Is a Golden Parachute?
A golden parachute is compensation an employer promises to pay a key executive if the company undergoes a change in control, typically through a merger or acquisition. These benefits commonly include enhanced severance, accelerated vesting of equity awards, and bonus payments. They are designed to keep executives from resisting acquisitions that would benefit shareholders.
From a tax perspective, these payments are governed by Internal Revenue Code section 280G. If the total parachute payments to a “disqualified individual” (generally a top officer or highly compensated employee) equal or exceed three times that individual’s average annual compensation over the prior five years, the excess portion is called an “excess parachute payment.” The company loses its tax deduction on that excess, and the recipient pays a 20 percent excise tax under IRC section 4999 on top of ordinary income taxes. For a highly compensated executive, the combined federal tax rate on excess parachute payments can approach 60 percent or more.
How Golden Parachutes Enter a Texas Divorce
The key question in a Texas divorce is whether the potential parachute payment is community property. Under Texas Family Code section 3.002, compensation for services performed during the marriage is community property. A golden parachute payment is contingent compensation tied to employment during the marriage period, so the portion attributable to the marriage period is generally community property.
The timing complexity is significant. The parachute may not have been triggered at the time the divorce is filed or even at the time the decree is signed. If the company is acquired after the divorce is finalized, and the executive receives a large parachute payout attributable to work performed during the marriage, the former spouse may have a claim to a portion of it. A well-drafted decree needs to anticipate this possibility.
Valuing a Potential Parachute Payment During Divorce
Valuing an untriggered golden parachute for purposes of property division is genuinely difficult. The payment may never occur if the company is never sold. Financial experts can apply probability-weighted valuation techniques to assign a present value to the contingent benefit, but those valuations are inherently speculative. Both spouses typically have incentives to disagree about whether and when a transaction might occur.
In practice, Houston divorce lawyers often structure settlements around a deferred distribution mechanism. The divorce decree awards the non-executive spouse a specified percentage of any golden parachute payment actually received within a defined period after the divorce. This approach avoids the need to value the contingent benefit at the time of divorce but keeps the parties financially connected longer than either might prefer.
The 280G Excise Tax and Settlement Negotiations
The 280G excise tax creates an important negotiation issue. If the executive expects a parachute payment to be subject to the excise tax, the after-tax value of the community share is lower than the gross amount suggests. Any agreement that divides the gross payout without accounting for the excise tax will produce an inequitable result. The non-executive spouse’s share should be calculated based on the net after-tax proceeds, or the parties need to agree in advance on how the tax burden will be allocated.
Some executive employment agreements include “gross-up” provisions that require the company to pay the executive enough additional compensation to cover the excise tax. If a gross-up exists, the analysis changes because the net value is effectively the full gross amount. An experienced Houston divorce attorney will know to request the full employment agreement, change-in-control plan, and any related amendments to understand exactly what protection the executive has.
For related reading on how employment contracts affect divorce settlements, see our discussion of that topic later in this series. For background on equity awards in high-net-worth divorce, our comprehensive guide to executive compensation and stock options provides additional context.
Blog 110: Phantom Stock and Stock Appreciation Rights in a Texas Divorce
Many executives at privately held companies in Houston, Spring, Stafford, and Richmond receive phantom stock or stock appreciation rights (SARs) rather than actual equity. These instruments are designed to give employees an economic interest in company value without giving them actual ownership. In a Texas divorce, they are treated as deferred compensation and carry their own set of characterization, valuation, and tax challenges.
What Are Phantom Stock and SARs?
Phantom stock is a contractual promise to pay the holder an amount of cash equal to the value of a certain number of company shares at a future triggering event, typically a sale of the company, a specified date, or the employee’s departure. A full-value phantom stock plan pays the entire share value. An appreciation-only plan pays only the increase in value since the grant date, similar to a SAR.
A stock appreciation right gives the employee the right to receive cash (or sometimes stock) equal to the appreciation in the company’s share price between the grant date and the exercise date. SARs are functionally similar to stock options, but they are always settled in cash and never require the employee to pay an exercise price.
Both instruments are classified as nonqualified deferred compensation plans. They must comply with Internal Revenue Code section 409A, which governs when payments can be made and imposes severe penalties (a 20 percent excise tax plus interest) if the plan fails to comply. When they pay out, the proceeds are taxed as ordinary income to the recipient.
Community Property Characterization
Because phantom stock and SARs are deferred compensation, they follow the same characterization framework as other employment-based compensation in Texas. If the phantom stock or SAR was granted during the marriage and vests during the marriage, it is community property. If it was granted during the marriage but vests or pays out after the divorce, Texas courts will apply a time-based allocation similar to the approach used for stock options under Texas Family Code section 3.007, comparing the period of employment during the marriage to the total vesting or accrual period.
The challenge in many privately held company situations is that there is no market price to refer to. Phantom stock tied to a closely held Houston-area business requires an independent business valuation to determine the current value of the underlying shares. That valuation must account for applicable discounts for lack of marketability and minority interest, unless the specific plan documents provide a different formula. The value assigned will directly determine what portion of the award falls into the community estate.
Division Strategies
Because phantom stock and SARs are contractual rights, not transferable securities, they almost never can be split into two separate awards for two people. Most plan documents prohibit assignment to anyone other than the employee, and many plans would forfeit the award entirely on any attempted transfer.
As a result, the most common approach is for the employee spouse to retain the award and agree to pay the former spouse their community share when the payout actually occurs. The divorce decree should include specific provisions requiring notification when a triggering event occurs, a timeline for payment, and security for the obligation, such as a lien on other assets or a letter of credit. Without those protections, the non-employee spouse may find themselves unable to collect years after the divorce.
Tax allocation matters here as well. Because the payout will be ordinary income to the employee spouse, any division agreement needs to be clear about whether the amounts owed to the former spouse are calculated before or after taxes.
For more on how restricted equity instruments are handled in divorce settlements, see our article on restricted securities in divorce and our guide to RSUs, PSUs, and divorce.