Navigating the complexities of taxes on equity-based compensation can be a daunting task, especially when considering both federal and state tax issues. For California residents, the state’s tax laws add an extra layer of complexity to the mix, as the California Franchise Tax Board is known for closely monitoring residency status. Moving away from California before receiving a payment may seem like a way to reduce taxes, but one must be careful with timing and proper documentation to avoid residency tax audits.
While leaving California does remove the state’s ability to tax you, the process of establishing non-residency can be complicated. Simply stating that you have moved is not enough to escape California taxes, as the FTB can investigate how and when you left the state. Even after establishing residency elsewhere, California can still tax income generated from equity-based compensation that was earned while residing in the state. However, the allocation of this income between California-source and non-California-source income must be reasonable, typically based on the time spent working in each location.
For nonqualified stock options and other forms of equity-based compensation, the income generated from exercising these options can be allocated based on the number of days worked in California versus outside California. For incentive stock options, which are only taxed as capital gains upon sale, California generally follows federal tax laws and does not tax income from the exercise of these options. However, it is crucial to carefully handle any tax audits or disputes with California, as these can be challenging to navigate.
Overall, understanding the tax implications of equity compensation, especially for California residents, is essential for proper tax planning and compliance. It is important to be aware of the rules regarding when income from equity-based compensation is taxable, whether as ordinary income or capital gain, and how to properly allocate this income between different states. With the potential for audits and disputes from the FTB, it is crucial to carefully document and report any income from equity compensation when filing state taxes.