New work from home (WFH) policies might have you thinking about whether it’s worth it to stay in California or move to a state with a lower cost of living, lower real estate prices, and lower taxes. When thinking about what’s right for you and your family, there’s a lot to consider. Will there be cost-of-living salary adjustments? Will you be closer to or further from family? What do future job opportunities look like elsewhere? Is working from home a good long-term fit for you, or are you happier or more productive at the office?
But there’s one important consideration that may not be on your radar yet. How long will you have to keep paying taxes in California after you leave?
For tech employees with equity compensation, it’s usually not a clean break, even after establishing residency in a different state. In some cases, you might pay taxes in California for years after leaving.
The tax you pay depends on the type and timeline of your equity compensation. Where you live at grant date, vest date, exercise date (if any), and sale date is what matters. We’ll break it all down for you across each type of equity compensation, so you know when you’ll finally be done paying tax to California whether you’re a CA resident or a non-CA resident.
The tax you pay depends on the type and timeline of your equity compensation. Where you live at grant date, vest date, exercise date (if any), and sale date is what matters. We’ll break it all down for you across each type of equity compensation, so you know when you’ll finally be done paying tax to California.
- Restricted Stock Units (RSUs)
- Non-Qualified Stock Options (NSOs)
- Incentive Stock Options (ISOs)
- Employee Stock Purchase Plans (ESPP)
RSU Taxation
Let’s start with how taxes on Restricted Stock Units typically work. RSUs are generally taxable like salary when shares vest. The taxable income incurred on each vest is calculated as follows:
RSU Wage Income = (# of shares vesting) x (share price on date of vest)
This is standard for the IRS, but what about from a state perspective? Because tax laws differ across states, it all depends on where you live on three key dates: when RSUs are granted, when RSUs vest, and when RSUs are sold.
If you are a CA resident when the stock was granted through when it vests, the entire value is taxable income in CA. But what if you leave California after grant but before vesting?
EX: As a CA resident, your new job started on June 1, 2018, and you received a grant of 10,000 RSUs at a public company. Your RSUs have a 4-year vesting schedule with a 12-month cliff, and shares vest annually thereafter. On May 1, 2020 you moved to Austin, TX. How are the 2,500 RSUs that vest on June 1, 2020 taxed now that you are a resident of Texas?
As a CA resident on the grant date but not the vesting date, California applies a “days worked” calculation to determine how much of the taxable income for RSUs vesting on June 1, 2020 is attributable to services performed while living in CA.
The calculation is called the Allocation Ratio, and it’s calculated by taking the total number of workdays you spent in California between grant date (6/1/18) and vest date (6/1/2020), and dividing it by the total number of workdays between 6/1/2018 and 6/1/2020.
Allocation Ratio = (total workdays in CA between grant and vest) ÷ (total workdays between grant and vest)
To find your allocation ratio, this online calculator is a great place to start. Be sure to exclude vacation/holidays and weekends, and include the end date.
Once you know your Allocation Ratio, multiply your total RSU income from the 6/1/2020 vest date by your Allocation Ratio.
CA Taxable Income = (Total RSU income from vest) x (Allocation Ratio)
And keep in mind that when your shares vest in 2021 and 2022, a portion will still be taxable in California.
If you have RSUs at a private company, the logic is the same as explained above, but the allocation ratio is determined by grant date and liquidity date (your ability to sell) rather than vest date.
NSO Taxation
Non-Qualified Stock Options are typically taxed at two key events. The first is when you exercise the right to purchase vested shares. The second time taxes are triggered is when you sell your shares.
So let’s focus on the first tax trigger. The amount that’s taxable when you exercise the right to purchase shares is the spread, which is the difference between the fair market value (FMV) of the stock on the date of exercise and the exercise price. Like salary, the spread is taxed as wage income.
NSO Wage Income = (# of shares exercised) x (FMV - exercise price)
If you were a CA resident when the shares were granted and exercised, all income is attributable to work performed in CA, so the entire spread is taxable in CA.
However, if you were a CA resident at grant but a non-CA resident when you exercised, CA uses the “days worked” calculation to determine how much of the wage income is attributable to services performed while in CA.
EX: As a CA resident, your new job started on June 1, 2018, and you received a grant of 10,000 NSOs at a $1 exercise price. Your NSOs have a 4-year vesting schedule with a 12-month cliff, and shares vest annually thereafter. On June 2, 2019 the FMV is $2 and you exercised the 2,500 NSOs that vest. On May 1, 2020 you move to Austin, TX. On June 1, 2020 another 2,500 NSOs vest and you exercise them on June 3, 2020 when the FMV is $3. Assuming no shares have been sold, what are the tax implications?
Since you were a CA resident from grant date through the first exercise, 100% of the spread is attributable to services performed in CA for 2019 taxes.
2020 CA taxable income from NSO wages is determined by the Allocation Ratio for the number of days worked in California between grant date (6/1/2018) and exercise date (6/3/2020), and dividing the total number of workdays between those dates.
CA Taxable Income = (NSO Wage Income) x (Allocation Ratio)
The allocation ratio for future exercises is determined by the date of exercise.
Now let’s address that second key time that taxes are triggered for NSOs. If you leave CA after exercise but before you sell your shares, any capital gain or loss on the sold stock as a non-CA resident is not considered CA income. However, if you re-establish residency in California prior to sale, CA will tax 100% of the capital gains proceeds.
ISO Taxation
Incentive Stock Options are taxable at exercise and at sale, like NSOs. Unlike NSOs, exercising ISOs may or may not trigger a tax. The ISO spread is included in the Alternative Minimum Tax (AMT) calculation rather than the traditional tax calculation like NSO wage income.
State and federal AMT calculations are complex and beyond the scope of this essay. As you’ll see on the table at the end of this section, California applies the Allocation Ratio to determine the tax implications of exercising ISOs because CA has its own AMT calculation. If you want to dive down the AMT rabbit hole you can learn more in the AMT section of our equity comp guide.
For now, let’s focus on the decision we know will impact your taxes - selling ISOs.
EX: As a CA resident, your new job started on June 1, 2018, and you received a grant of 10,000 ISOs at a $1 exercise price. Your ISOs have a 4-year vesting schedule with a 12-month cliff, and shares vest annually thereafter. On June 2, 2019 the FMV is $2 and you exercised the 2,500 ISOs that vest. On May 1, 2020 you move to Austin, TX. On June 1, 2020 another 2,500 ISOs vest and you exercise them on June 3, 2020 when the FMV is $3. What are the tax implications if on July 15, 2020 you sell all 5,000 of your exercised ISOs?
When an ISO is sold it is either a qualifying disposition or a disqualifying disposition.
Qualifying dispositions apply to ISOs sold at least 24 months after the grant date and 12 months from exercise. Qualifying dispositions are taxed at long-term capital gains rates on the difference between the sale price and the exercise price. The 2,500 ISOs exercised in June 2019 meet the 24-month and 12-month thresholds, and would be a qualifying disposition. Since you were a non-CA resident at sale, none of the gain is taxable in California.
Disqualifying dispositions apply to ISOs sold within 24 months of grant date or 12 months of exercise. The July 2020 sale was within 12 months of the June 2020 exercise, so the gain on these 2,500 shares is taxed like NSOs because they do not qualify for the special tax treatment. This means the Allocation Ratio comes into play to determine the spread attributable to days worked in CA, which is included as wage income.
Although there are too many possible scenarios to model all the CA tax implications for ISOs, the table below can help you prepare for questions to ask your tax preparer in advance of your decision to exercise or sell.
ESPP Taxation
ESPP shares are generally included in taxable income when you sell the shares. The spread between the FMV at purchase and the purchase price is included as wages at sale. Similar to ISOs, ESPP sales are either qualifying or disqualifying dispositions. The difference between sale price and FMV at purchase is taxed at capital gains rates based on how long the shares were held.
If you are a CA resident at the beginning of the buying period (think grant date), but a non-CA resident when you sell, CA will tax you on a portion of the proceeds based on the number of days you worked in CA during the buying period (think exercise or vest date). But that tax is still only triggered at sale, even if that’s several years after moving out of CA.
The “days worked” formula is different for ESPP shares than for RSUs. Here, CA only counts the days between the beginning and the end of the buying period (when the shares transfer to you and are eligible for sale).
The Allocation Ratio based on days worked is multiplied by the wage income from the spread. Any gain or loss beyond that discount would only be taxable in CA if you were a CA resident upon sale.
Closing Thoughts
If you’re thinking about leaving CA due to new WFH policies, make sure to consider the tax implications of an out-of-state move on your equity compensation. Depending on how much equity compensation you have, it may be worth it to partner with a professional who can help you avoid costly tax mistakes, and help you balance the professional, financial, and personal components of a relocation. The more equity compensation you have, the higher the cost of tax missteps.
If you’d like to learn more about equity compensation and how to optimize it, check out our comprehensive equity compensation guide. And to get our content straight to your inbox, sign up here to stay in touch.
Final note on California residency… Section G on p5 of CA’s Residency Guidelines provides factors for how to determine your state of residence. This is more straightforward for a traditional move than for the modern nomad who has the flexibility to bounce around and is taking things year by year. However, guidance is still not explicit for how to handle location independence in the new WFH era.
The examples (p6) for leaving CA involve contract employment outside of CA, a new and permanent job internationally, or living out of a Nevada vacation home part time - all of which have fairly obvious answers. The ambiguity around the WFH flexibility weighs in CA’s favor for claiming tax on income earned by non-CA residents. Especially if your move to another state is by choice, isn’t tied to an employment contract, and/or your employer is still CA-based and doesn’t have a formal office location in your new state of residence.
It appears that California is leaving this open ended so auditors can make the case that people leaving CA still have their “closest connections” in CA (section G), which would result in more future tax revenue for California. They may also claim there is no evidence you do not intend to return to CA, arguing the move is “temporary or for transitory purposes” (section H). We strongly recommend collaborating with your tax preparer if you are unsure of how your decisions will influence your tax situation.
We will update this post as more information becomes available, however you can also call the Franchise Tax Board for clarification… but good luck getting someone to pick up the phone :)
