How your stock options and RSUs are taxed if you leave California
This article is being shown solely for informational purposes. Please consult a tax professional for advice for your particular situation.
A question I, and our advisors at Secfi Wealth, get frequently asked is about the tax implications of equity when moving out of the state of California. While the tech industry is still mainly focused in the sunshine state, the increase in remote work has allowed many to move to other parts of the country.
While leaving California can have benefits — income tax can be as high as 13.3%, the highest tax rate in the country — moving across state lines can also introduce complications and complexities. To help you with your financial, tax, and equity planning, here are some guidelines on the tax implications of leaving the state of California and what it means for your equity.
If you want to learn more about how equity compensation is taxed, this guide is also a good starting point.
Defining when you are no longer a California resident
Simply leaving the state doesn’t necessarily mean you are no longer a resident. And which state taxes you may owe will be determined by when your residency is established in a new state.
In 1985, the Corbett v. Franchise Tax Board determined that there are 29 different factors that the California Franchise Tax Board (FTB) will use when determining whether or not you are a California resident. Some of the factors include:
- Mailing address
- Number of days present in the state
- Voter registration
- Car registration
- Driver’s license
- Where you own real estate and/or rent property
- Where your spouse and/or children reside
Basically, just because you cross state lines doesn’t mean you’re no longer a resident of that state. If, for example, you leave California and stay with family while you look for a house to buy, or an apartment to rent, you could still be considered a California resident during that time if you don’t yet update some of the information listed above. Also, if you leave California but only plan to be away for part of the year, that may not change your residency status. California also has a “six-month presumption” rule, meaning that if you reside in California for more than 183 days, you may be considered a resident. This could be an important factor for those moving out of the state but who still plan to travel there. You can learn more about residency status in the FTB’s 2022 Guidelines for Determining Residency Status.
How moving across state lines affects equity compensation
You are, typically, taxed twice with stock options and equity:
- When you exercise stock options (or vest shares)
- When you sell exercised shares.
There are also two types of income that are taxable: ordinary income and capital gain income. Depending on the type of equity you have — ISOs, NSOs, and RSUs — and the trigger event — like, exercising, vesting, or selling — you may be subject to either ordinary income tax or capital gains tax.
Capital gains tax is typically straightforward. You’ll only be taxed by the state where you have residency at the time of the sale. Ordinary income isn’t always so straightforward. Instead, you may owe taxes in more than one state, the one where you currently have residence and in California. Knowing if you do depends on the “Allocation Ratio.”
To determine the Allocation Ratio, you take the number of days you worked in California and divide it by the total number of workdays during that period. Basically, you’ll owe California ordinary income state tax based on the percentage of time you were a resident of the state.
It’s important to note that for taxes owed when exercising options or vesting shares, the Allocation Ratio is dependent on when and where the equity was granted to you, rather than when and where they vested. Meaning, you may continue to vest equity in your new state that could still be subject to tax in California.
To illustrate this all a bit better, let’s break it down by equity type and how those are taxed by California if you leave the state.
1. Incentive stock options (ISOs)
ISOs trigger tax both when exercised (purchased) and when you sell them. However, you may be able to avoid taxes when exercising your ISOs, unlike NSOs.
When exercising:
Exercising ISOs triggers Alternative Minimum Tax (AMT). The amount you owe depends on the spread, or the difference between, the 409A valuation, or Fair Market Value (FMV), at the time you exercise and the strike price. AMT is an alternate tax system and the benefits are that you can reclaim that tax in the future, especially after you sell any of the shares.
Not all states have AMT, but California does. If you exercise stock options granted to you in California after you leave the state, any AMT you owe would be based on the “Allocation Ratio” explained above.
The only other states that currently have AMT are Colorado, Connecticut, Iowa, and Minnesota. If you moved to one of those states, you may also owe AMT there.
When selling:
Depending on how long you hold onto your exercised ISOs before selling, the shares will be considered either a “qualified disposition” or a “disqualified disposition.” If you hold your shares for at least 2 years after they were granted and 1 year after exercising them, they are considered a qualifying disposition and are subject to the preferable long-term capital gain tax, which is usually at a lower rate. The taxable amount is the difference between the strike price and the amount you sell them for.
Capital gains tax is only paid to the state where you are currently a resident, meaning you would likely not owe California but only the state where you reside at the time of the sale.
If you sell any shares before those two requirements are met, they will be considered a disqualifying disposition and be subject to short-term capital gains tax, which is the same as ordinary income tax. So you would apply the “Allocation Ratio” to the sale to determine what you owe California.
2. Non-qualified stock options (NSOs)
NSOs are similar to ISOs, in that you owe tax both at the time of exercise and when selling exercised shares.
When exercising:
Like ISOs, NSOs are taxed on the spread between the 409A, or FMV, at the time of exercise and the strike price. Unlike ISOs, this “bargain element” as it’s called (or sometimes referred to as “phantom income”) is subject to ordinary income tax on your W2, rather than AMT.
Any income tax you owe California would be subject to the Allocation Ratio.
When selling:
The tax you owe is determined by the difference between the 409A, or FMV, at the time you exercised and the sale price.
If you exercised shares as a California resident, but later sell them as a resident in a new state, the sale would be subject to capital gains tax only in your current state. Meaning, the sale would not be subject to California tax.
3. Restricted stock units (RSUs)
RSUs are different from ISOs and NSOs because they are not stock options that need to be exercised. Instead, once they vest they are now shares that you own. But you will owe tax when they vest and again when you later sell.
However, you may have single-trigger or double-trigger RSUs. Single-trigger RSUs will be taxed immediately upon vesting. These are common for those at public companies.
Double-trigger RSUs aren’t taxed at vesting until there is a second trigger, oftentimes an IPO or an acquisition. These are more common at later-stage, private startups so that employees don’t owe taxes at vesting on shares they can’t yet sell.
But both types of RSUs are taxed similarly upon vesting and selling.
When vested:
At vesting, RSUs are subject to ordinary income tax. This is true for both single-trigger and double-trigger RSUs. For single-trigger RSUs, the tax is determined by the share price at the time of vesting. For double-trigger RSUs, the tax is determined by the share price when the second trigger happens — again, this is often an IPO, but could also be an acquisition or another type of exit.
In both cases, the Allocation Ratio will apply to all RSUs you vested while still a California resident.
When selling:
RSUs are subject to capital gains tax when selling, based on the difference between the share price when you vest and the sale price. If you sell them while the resident of a different state, you will not owe tax in California.
4. Employee Stock Purchase Plans (ESPP)
An ESPP is a program that allows employees to purchase company stock at a discounted rate, often as high as 15%. You only pay tax when you sell any stock you’ve purchased.
When selling:
The tax you owe is based on the spread of the FMV when you bought the stock and the sale price.
Like ISOs, the shares will be considered either a qualifying or disqualifying disposition upon the time of the sale, depending on how long you hold them. To be considered a qualifying disposition, you must hold them for at least one year from when you purchased them, and two years from the ESPP original offer date (similar to a grant date).
If you lived in California during the period you were eligible to purchase shares but sell after you move away, you will pay California tax based on the number of days you worked in the state.
However, this Allocation Ratio is slightly different than other equity types, which are based on what you vested when a California resident. For ESPPs, the Allocation Ratio considers your “working days” as those during the buying period, meaning when the shares are transferred to you and then when you are eligible to sell them.
What happens if you move back to California?
Even if you move away but return to California and then sell any type of equity, you’ll most likely be subject to taxes on 100% of any income you get. That’s true even if you exercised ISOs or NSOs, vested RSUs, or purchased ESPPs while in a different state. This also means that the Allocation Ratio would not apply in the case of returning.
However, California may offer you a tax credit if any sale is also subject to taxes from the state you just left.
This stuff is complicated but you can work with professionals
While I hope this article is a helpful overview on this topic, it by no means covers every edge case or possible scenario. The reality is that equity compensation and taxes can be very confusing. But you also don’t need to figure it all out on your own.
Our recommendation is that you always consult a professional, both a certified public accountant (CPA) and a financial advisor. It’s important to work with someone that specializes in equity compensation so they can provide you the best help and recommendations. If you’re looking for help,, you can request to speak to one of our financial advisors.
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