Tom, thanks for these thoughts. I agree that states' rules vary. My employer is large and has many employees affected, probably as to every state, so I'm trying to get to the bottom of whether the employer's approach is correct. In any event California is a great state to start with.
The California FTB guidance is pretty good, in the sense of being easily understood. You will note their overarching principle "you must allocate to California that portion of total compensation reasonably attributed to services performed in this state". That also makes sense. They then go on to describe "one reasonable method" based on time worked -- an Allocation Ratio based on "California workdays from purchase date to vesting date ÷ Total workdays from purchase date to vesting date". Finally, they offer Example 3 to show how to apply this ratio.
The problem with the FTB guidance is that, like all the state documents I've looked at to date, it doesn't consider the possibility of a vesting schedule and incremental vesting. In my example, the first year's vest is best understood as compensation for the first year of employment, and the second year's vest is best understood as compensation for the second year of employment. The FTB Allocation Ratio method would incorrectly allocate the second year vest based on the workdays of years one and two collectively, which is contrary to economic substance.
I'm still trying to find guidance -- from any state tax authority or any secondary source such as a tax professional's memo or explanation -- of how to handle a vesting schedule with incremental vesting. I'm expecting someone to have the intuition that I have -- for my example, that the second year vest is compensation for the second year of employment activity, and should be allocated based on residence within the second year. To my surprise I haven't yet found anyone saying anything like that -- it's as if all the authorities have overlooked incremental vesting and its implications.
