Employee stock options (ESOs) have long been a staple of executive compensation in America, and for good reason: They offer distinct advantages to both the issuing company and the receiving employee. To the company, they offer a preferred and inexpensive means of compensation as well as a method of aligning the interests of the employee with those of the employer. To the employee, they are tax-advantaged and can offer immense upside value. However, with tax rates ranging from 10% to almost 50% on the gains realized from the exercise of ESOs, planning for the tax impact requires either a thorough understanding of the governing tax legislation or working with a specialist who does. Not understanding these rules can be a costly mistake.
With the soaring popularity of ESOs over the last few decades, the federal government has issued extensive legislation to govern the taxation of these securities. The result is that while federal regulations are complex and intricate, in most cases there is precedent to support the tax treatment of the gains created. However, many state governments have legislation that is far less developed. As a result, state taxation of ESOs can be much more complex. For instance, Georgia enacted new regulations on Jan. 1, 2011, allowing the state to tax the exercise of ESOs by certain non-residents. Under this new law, individuals who are granted stock options while working within the boarders of the state may not be able to escape Georgia taxation by changing their residence prior to exercising their options. Consequently, if an individual owning ESOs based in Georgia subsequently moves to another state, any gains recognized from the exercise (exceeding a de-minimis amount) could be taxable as Georgia income and would thus incur additional taxes. Further complicating this matter is the fact that the individual’s new state of residence may not follow similar rules when allocating income from the same ESO exercise. In most cases, you might receive an offsetting resident state tax credit for the taxes you paid to another state, but that may not always be the case. For reasons such as this, having a seasoned tax professional who comprehends both the intricacies of ESOs as well as how to navigate the turbulent waters of multi-state nexus is invaluable to anyone seeking to minimize the tax cost of exercising their options.
If you have stock options and especially if you are thinking about moving to another state with them, plan now for the tax impact and adjust your plan for when, how much and ultimately what you’ll net.