Every year, without fail, a few of our clients relocate to a new state.
It’s usually for work, but even with this, it can (unfortunately) create some unforeseen tax consequences, especially with equity compensation. (People start getting confused when they receive W2s for states they don’t even live in, and rightfully so.)
Needless to say, with Covid’s expansion of remote work policies, we’re expecting to see more & more of our clients move out of state.
Before Covid, so many people “had to” be located in San Francisco or California, but after nearly 3/4 of a year of working from home with no end in sight, lots of people are considering moves to cheaper locations.
This post will go over everything you need to know about state taxation of stock options and RSU when you move, based on the state of California. (But even if you’re not dealing with California, there will be a lot of similar principles with most other states, you’ll just need to look up what those exact rules are.)
Key Terms to Know About State Taxation of Stock Options After a Move
When you’re figuring out what your state income taxes will be, there are six key terms to keep in mind.
A few of these are common to regular stock options and RSU vocabulary, and a few others are terms I just use with my clients to help them better understand their situation.
Here’s what they are, before we get into explaining how to figure out what your taxes *should* be, regardless of what a W2 says:
1) Time: You’ll need to know the time (in number of days) that you spent working in your previous state. This way, we can figure out exactly what percentages to calculate in relation to the last tax year (typically 365 total days).
2) Compensation: Compensation is the income you receive for performing your job.
Put simply, it’s your pay. As a tech employee, your pay includes a combination of salary, bonus, stock options, and RSU. Things like salary and bonuses are pretty straight forward in relation to work performed = compensation given. But with equity compensation, it’s usually not as clear-cut. Most of the time, there are gaps between work performed, compensation awarded, and compensation received. This “gap” with stock options and RSU is what makes things confusing… but we’ll clear up how to figure it out.
3) Property: Stock options and RSU are unique, because for some period of time they can be compensation, but they may also be considered property later on.
For example, when stock options are exercised, they become property after the exercise. When RSU vest and are released, the shares become property upon release.
After these shares become your property, it’s no longer related to your performance as an employee. You don’t have to stay employed to keep your shares; you get to take them with you if you leave the company or move to another state. (This is different from stock options prior to exercise or RSUs that haven’t vested yet. If you leave the company, you may have to forfeit those options or RSU.)
4) Vest: When stock options and RSU are granted, they’re usually given as a total number that vest over time. A common vesting schedule is a four-year vest with a one-year cliff. (This means after one year of employment, 25% of your options vest. From there on out, your options vest in quarterly or monthly installments for the remainder of the four years.)
5) Exercise: Exercise only applies to stock options, because even after they vest, they may still be subject to expiration or loss if you quit your job or your employment ends. They only become “yours” when you exercise, which is when you use the stock options to purchase shares that become your property.
Exercise is important as it relates to state income tax for two reasons:
One, the exercise is the event that triggers the recognition of compensation income on stock options. When you exercise and hold ISO (incentive stock options), you recognize a deferral item for the AMT. If you’re working with NSO (non-qualified stock options) or ISO DSD (ISO in a disqualifying disposition), you recognize ordinary income.
Two, exercise marks the transition from compensation to property. In an exercise and hold, the shares you hold after exercise are property (and no longer looked at as compensation.)
6) Release: This applies to RSUs, which have two key events.
The first event is when the RSUs vest and become yours. When this happens, they’re no longer subject to expiration if your employment ends. The second is the release, which is when the RSUs convert to shares and you receive the shares.
Vest and release usually happen at the same time, but with double-trigger RSUs that have a time-based vesting schedule and an event-based release, your vest and release may not happen at the same time.
For state tax purposes, you don’t recognize compensation income on RSU until they’re released and the shares become your property.
California State Taxation of Stock Options & RSU for Tech Employees Who Move Out of California
Here is where the math gets fun (read: not fun), and why knowing the number of days you spent in your previous state is so, so important.
Let’s say, for example, you were granted 4,000 NSO with a four-year vest 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 NSO vest, so you decide to exercise and sell all 1,000 of your stock options. If you have NSO, you get taxed on the day you exercise. To know what you owe the state of California for this, you’ve to know how many days you performed services in the state of California from the grant date to the exercise date.
You’ll have to calculate the percentage of time from the grant date to the exercise that you spent working in California, and then the percentage of that income will be taxed in California.
There were 365 days from grant to exercise, and you worked 50% of those days (182) in the state of California. Because of this, 50% of the wage income from that exercise would be taxable in California.
If you’ve got ISO, their compensation “counts” on the day you exercise. The state’s AMT deferral item is included to the extent that you performed services in California from the grant date to the exercise date. (Just like with NSO, except instead of wage income, it’s an AMT deferral item that you’re counting here.)
On the date you sell the stock from your ISO at a gain, the capital gain is not taxable by California, but there is a possible CA AMT tax credit that is applied. (Unless you sell your ISO in a disqualifying disposition, then it’s treated like NSO.)
With RSU, you’re taxed on the date the shares are released to you and they become your property.
Again, the income from RSU is taxable in the state of California to the extent that you worked there from the grant date to the vest date… BUT the taxes aren’t owned until the shares are released, so you could be paying taxes to California for years after you leave. (Annoying, right? Absolutely, but it’s important to keep in mind.)
Needless to say, it’s a good idea to have a pro who’s used to handling these things help you out. Click here to schedule a call with one of our financial advisors.
Other California State Tax Credits to be Aware Of (That Will Save You Headaches & Money)
Almost all income tax rules have the avoidance of double-taxation built in. (So, for example, even though you have to pay tax to California AND your new state, the same income can’t be taxed by both states at the same time… that’s just unfair. They’ll each have to tax portions of it.)
In the state of California, this is known as the Other State Tax Credit. Read over the provisions, and be aware of the rules as you sort out multiple states’ tax on your equity income.
An Example: How State Taxation of Stock Options is Easily Messed Up
One of our clients, Amanda, worked for a tech company for five years, starting in the state of California. During her time there, her company gave her five grants of double-trigger RSU.
After 2.5 years, her company transferred her to Texas.
The company went through an IPO in her fifth year, when she was living and working in Texas.
When the time came around and Amanda got her W2, it showed $775,000 of wage income from her RSU, but only $38,000 of income to be taxed by California from the RSU. (Such a tiny percentage!)
As a first step, we calculated how much of her RSU income should be taxable in California based on the time she worked there. (Which is measured from grant to vest… NOT from grant to release.) We made a table to track this for us:
| Grant Date | Vest Date | Shares | Share Price | Total Income | Total Days | Total CA Days | CA Income |
| Grant 1 | Vest 1 | 512 | $30 | $15,360 | 494 | 494 | $15,360 |
| Vest 2 | 512 | $30 | $15,360 | 584 | 584 | $15,360 | |
| Vest 3 | 512 | $30 | $15,360 | 674 | 674 | $15,360 |
(Please note that this is only three rows of a 30+-row table… but it gives you an idea of how thorough our tracking and calculations were. Being this thorough is crucial in a situation like this, which is why it’s so great to have an experienced financial advisor on your side.)
Our calculation revealed that instead of the $38,000 listed, $415,00 of the RSU income should be taxable in California. ???? A huge difference from what her W2 told her.
Once we had the calculations done, Amanda took them to her company for correction, where they stood by their $38,000 calculation and refused to correct her W2. (Frustrating, to say the least… and why it’s so important to work with a professional financial planner in a situation like this.)
Because the company refused to budge, we adjusted the reported income on Amanda’s tax return to correctly report her RSU income for California and Texas… so she wouldn’t have problems or penalties later on. Plus, we’ve got detailed documentation of our calculations according to state laws just in case any notice does come through to back us up.
Figuring Out the Taxation Rules for Your State
Like I said at the beginning of this article, there’s no doubt that more & more people are going to be dealing with income tax in more than one state. With all the remote work & moving that’s happening during the Covid outbreak, it’s pretty inevitable.
States are usually really good about making this type of information available, so a good starting point is to Google “[YOUR STATE] + tax department” + “stock options” or “restricted stock units.”
If you’re looking it up for California, their tax department is called the Franchise Tax Board, which you can abbreviate as FTB.
So, for example, when I Googled “CA FTB restricted stock units,” I was able to find CA FTB Publication 1004 Equity-Based Compensation Guidelines. This document details everything we’ve talked about here for both residents and non-residents with equity compensation.
Prepare for Multiple-State Taxation of Stock Options to Avoid a Penalty
If you’re in this situation, the first major step to take is to just be aware of the fact that you’ll be dealing with different state income tax laws like this.
When you’re aware, you can do your research and start preparing your calculations now with your financial advisor instead of waiting until tax time to figure it all out and potentially missing out on something important due to time constraints.
Just like Amanda and I did the math ahead of time so we knew immediately when there was an issue with her W2: we were ready to correct the errors and save her MAJOR headaches and tax penalties in the future.
