Brandon R. Amaral, CFP®, EA
Founder & Financial Planner, Amaral Financial Planning
If you’re a tech worker in the Bay Area, the thought has probably crossed your mind (or come up in a Slack channel), “I’ll just move to Washington or Texas to sell my stock options or RSUs and I won’t owe any state taxes”. While you might be thinking that you just single-handedly outsmarted the California Franchise Tax Board, think again.
As Ben Franklin kinda said (not really), “In this world, nothing is certain except death and California taxes on equity compensation“. There are many nuances surrounding taxes when it comes to RSUs (Restricted Stock Units), Stock Options, and ESPP (Employer Stock Purchase Plans). Unless you enjoy reading the California Revenue and Tax Code in your spare time, this article will help you understand the basics of Federal and California tax on your equity compensation, and if you will still owe taxes after moving out of state.
Here is a summary of how your equity compensation will be taxed after moving out of California:
RSUs (Restricted Stock Units)
If you aren’t already familiar with RSUs, here is how they work:
Rather than receiving a cash bonus from your company, you can be awarded company stock in the form of Restricted Stock Units. When your RSUs vest (typically on an annual or quarterly basis), the Fair Market Value (# of shares) X (the stock price) becomes taxable income. This will appear as income on your paystub and W-2. From there, you have the choice of selling your RSUs right away or holding them and selling them later.
When it comes to California taxes, it is important to make note of three important dates:
- Grant date – when you were awarded the RSUs
- Vest date – when you actually received the RSUs
- Sale date – when you sold the RSUs
Depending on where you were living at the time of these dates will determine whether you will owe California taxes or not. If you lived in California the entire time between the grant and vest dates, then the FMV on the vest is fully taxable in California. However, if you moved out of California before the vest date, then you will need to use the Allocation Ratio.
To calculate the Allocation Ratio, you divide the total days worked in CA between the grant and vest dates by the total days worked between the grant and vest dates. You then multiply the FMV on the vest date by the Allocation Ratio to determine what amount is taxable in California.
As an example, let’s assume that you were granted 1,000 RSUs (vesting over 4 years) on January 1st, 2021. You lived in California through June 30th and moved to Washington on July 1st. On January 1st, 2022, 250 shares (1/4 of your RSUs) will vest at a stock price of $10.
Allocation Ratio = 180 days ÷ 365, which is 49%
Income taxable in CA = (250 shares X $10) X 49%, which is $1,225.
When you later sell the shares, the gains or losses recognized beyond the vest date will be taxable income to whichever state you moved to (unless that state does not have an income tax).
Stock Options
Stock options are a great benefit that is commonly provided to employees at private companies. They give the employee the right to buy company shares at a discounted price. ISOs (Incentive Stock Options) have preferential tax treatment, while NQSOs (Non-Qualified Stock Options) are taxed as ordinary income.
ISOs (Incentive Stock Options)
When it comes to ISOs, you may or may not owe taxes when you exercise the options. This is determined by your:
- Current AGI (Adjusted Gross Income)
- Exercise (strike) price
- Number of shares exercised
- FMV of the share on the day of exercise
This tax is also known as AMT (Alternative Minimum Tax). AMT is a complex tax calculation that is completed for your Federal income taxes. To make matters even more confusing, California has its own AMT calculation as well. To create an ISO exercise plan to avoid AMT, you should work with a financial planner or tax advisor.
When it comes to selling your ISOs, you will fall into two buckets: disqualifying disposition or qualifying disposition.
Disqualifying dispositions are the most common situation you will run into. This happens when you sell your ISOs within 2 years of your grant date and 1 year of your exercise date. When shares are sold as a disqualifying disposition, you will need to apply the Allocation Ratio to determine what amount is taxable in California.
Qualifying dispositions are the preferential portion of ISOs. This happens when you sell your ISOs beyond 2 years of your grant date and 1 year of your exercise gate. When shares are sold as a qualifying disposition, you will be subject to capital gains tax rates. The gains or losses recognized will be taxable income to whichever state you moved to (unless that state does not have an income tax).
NQSOs (Non-Qualified Stock Options)
For NQSOs, you are taxed twice: when you exercise and when you sell.
When you exercise your options, you will recognize ordinary income (NQSO income), which will appear on your paystub and W-2. To calculate this, multiply the number of shares exercised by the bargain element. The bargain element = FMV – your exercise (strike) price.
Depending on where you were living at the time of your grant date and exercise date will determine whether you will owe California taxes or not. If you lived in California the entire time between the grant and exercise dates, then the NQSO income on the exercise is fully taxable in California. However, if you moved out of California before the exercise date, then you will need to use the Allocation Ratio.
When you later sell the shares, the gains or losses beyond the exercise (strike) price will be taxable income to whichever state you moved to (unless that state does not have an income tax).
ESPP (Employer Stock Purchase Plan)
ESPP (Employer Stock Purchase Plan) shares are offered to employees once your company is public. You are able to deduct a portion of your pay each pay period and purchase shares of the company at a discount (up to 15%).
For ESPP, you only owe tax when you sell the shares, not when you purchase them. When shares are purchased, the difference between the FMV and your discounted purchase price is called the Bargain Element. Once you sell your shares, you will recognize ordinary income (the Bargain Element), which will appear on your paystub and W-2. This can happen years later if you don’t sell them right away.
Depending on where you were living at the time the purchase period began and the date the shares were purchased will determine whether you will owe California taxes or not. If you lived in California the entire buying period, then the Bargain Element on the sale is fully taxable in California. However, if you moved out of California before the Vest date, then you will need to use the Allocation Ratio.
To calculate the Allocation Ratio, you divide the total days worked in CA during the buying period by the total days worked during the buying period. You then multiply the Bargain Element by the Allocation Ratio to determine what amount is taxable in California.
When the shares are sold, any gains or losses beyond the discount you received are taxable income to whichever state you moved to (unless that state does not have an income tax). If the shares are sold within 2 years from the start of the purchase period and 1 year of your purchase date, this will be a disqualifying disposition and taxed as ordinary income. If the shares are sold beyond 2 years from the start of the purchase period and 1 year of your purchase date, this will be a qualifying disposition and taxed as capital gains.
Navigating the many nuances of equity compensation and California taxes can be very confusing. If you would like to work with a financial planner to walk you through your options, I would love to help you!
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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.