Family Chiropractic Sports Injury & Rehab Clinic, v. Comm’r, T.C. Memo. 2016-10, 2016 WL 234515 (2016)
Facts: Husband and wife operated a chiropractic The practice had an Employee Stock Ownership Plan (“ESOP”). Husband and wife were the only participants.
The parties were divorced in Iowa. The decree was silent on the ESOP, but the wife agreed to transfer her interest in the ESOP to the husband. She later did so.
The IRS decertified the ESOP, resulting in the loss of valuable tax benefits, on the ground that the transfer to the wife violated the antiassignment provision of the plan and the antiassignment provision of ERISA. The practice filed a declaratory judgment action questioning the decertification.
Issue: Did the IRS err in decertifying the ESOP?
Answer to Issue: No.
Summary of Rationale: The plan provided that vested benefits could not be transferred. There was no divorce exception. The wife’s vested benefits were transferred to the husband. Therefore, the provision was violated and the ESOP was correctly decertified.
The most important fact in Family Chiropractic, clearly stated in the opinion but not stressed in the court’s reasoning, is that the wife benefits were transferred with her full consent. The holding is therefore that even a fully consensual transfer of ESOP benefits violates the antiassignment provision.
The solution is probably not to get a QDRO. ERISA applies only to welfare and retirement plans, and a stock option plan is neither. “Employee stock option plans are generally not covered under the Employee Retirement Income Security Act (ERISA), as they are not considered welfare or retirement plans.” Matthew T. Bodie, Aligning Incentives with Equity: Employee Stock Options and Rule 10b-5, 88 Iowa L. Rev. 539, 547 (2003); see also Oatway v. Am. Int’l Group, Inc., 325 F.3d 184, 187 (3d Cir. 2003) (“[M]ost courts have uniformly held that an incentive stock option plan is not an ERISA plan.”; citing cases); Brett R. Turner, Equitable Distribution of Property 6:50 n.19 (3d ed. 2005 & Supp. 2015).
This issue is a perfect example of how federal law is sometimes a heavy obstacle to fair and reasonable divorce settlements. There is a compelling need to amend federal law to recognize a QDRO-like device for allowing divorce-related transfers of benefits out of stock option plans.
Until and unless federal law changes, it is very difficult to divide stock options through payments directly from the plan. It is best to use other methods, such as direct payments of cash between the divorcing parties.