The taxation of Restricted Stock Units (RSU), Incentive stock options (ISO), Non-Qualified Stock Option (NSO), and Employee Stock Purchase Plans (ESPP) for employee work in California (CA) can be affected by a relocation to another state. The tax treatment of RSU, ISO, NSO, and ESPP depends on the state in which the recipient was a resident at the time the RSUs were granted, as well as the state in which the recipient is a resident at the time the RSUs vest, exercise or are sold. Please refer to FTB Publication for details.
Restricted Stock Units (RSU)
Let’s say; for example, you were granted 4,000 RSU with a four-year vesting schedule and a one-year cliff. Then, six months after the grant, your company transferred you out of California.
After your first year, 25% of your RSU vest, To know what you owe the state of California for this, you’ve to understand how many days you performed services in the state of California from the grant date to the vesting date.
If the recipient was a resident of California when the RSUs were granted, they might still be liable for California state tax on the RSU income even if they move to another state. The allocation ratio, calculated based on the number of workdays spent in California between the grant date and vesting date, should be used to determine the amount of RSU income allocable to California.
*Allocation Ratio = (total workdays in CA between the grant date and vest date)/ (total workdays between the grant date and vest date)
If the recipient moves to a state with no income tax, such as Texas or Washington, they will only be taxed by the state of residency when the RSUs vest or are sold. However, if the recipient moves to a state with an income tax, such as Massachusetts, they may be double taxed by both states for the same income.
Incentive stock options (ISO), Non-Qualified Stock Options (NSO)
Regarding ISO and NSO, it will be the same allocation, but use the exercise date instead of the vesting date to calculate the ratio.
Employee Stock Purchase Plan (ESPP)
If you exercise an option under an employee stock purchase plan while a California resident or nonresident and later sell the stock in a qualifying or disqualifying disposition while a nonresident, California will tax the resulting ordinary income to the extent you performed services in California from the grant date to the exercise date. Any capital gain had a source in your state of residence when you sold the stock.
Example:
On February 1, 2022, your employer granted you options under an employee stock purchase plan. On February 1, 2022, you exercised these options. From the grant to the exercise, you were a California resident and performed 50 percent of your services in California. On June 1, 2022, you permanently moved to Nevada, and on January 15, 2013, you sold the stock at a gain.
Because you sold the stock before meeting the one-year holding period requirement, the difference between the stock’s fair market value on the date of exercise and the option price is taxable as wages. Since you performed 50 percent of your services in California from the grant date to the exercise date, 50 percent of the wage income would be taxable by California. Any capital gain resulting from the increase in value over the fair market value on the exercise date would have a source in Nevada, your state of residence when you sold the stock.
On top of the taxation discussion above, our clients always have questions about residency determination as CA taxes full-time residency worldwide. Also, you should contact your employer to adjust your home state residency record. There are other ways to allocate the income on the tax returns manually, but it may trigger an IRS audit in the future. Due to the complexity of the paper record and the higher IRS audit possibility, we always recommend our client schedule a consultation with us.
Click to Download: California Equity-Based Compensation Summary Table
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