California tax implications for ISOs exercised by one who becomes a nonresident

[yuyunfan]

Consider this example:

A person joined a company on July 1, 2019 while he was a California resident and has been working for that company since then. He received a grant of 10,000 shares of incentive stock options at $1/share with grant date of July 1, 2019, a 4-year vesting schedule, and a 12-month cliff. He moved to Texas on August 1, 2019. The options started to vest on July 1, 2020.

On December 1, 2022, he exercised and held 1,000 shares of the ISOs with the FMV of $5/share. Was any portion of the spread (5 - 1) * 1000 subject to AMT considerations of California?

On December 1, 2023, he exercised and sold (thus a disqualifying disposition) 1,000 shares of the ISOs with the FMV of $10/share. Was any portion of the proceeds (10 - 1) * 1000 subject to income tax of California?

So the question is essentially whether exercise of the ISOs is counted towards CA income if grant is before but vesting and exercise occur after one becomes a CA nonresident. If yes, is the grant date determining when work starts to be performed for the income such that allocation ratio is calculated as (move-out date - grant date) / (exercise date - grant date)?

[DavidD66 · Accepted solution]

Ordinary income, California will tax the income on the exercise and sale of your ISOs based on the percentage of time you were a resident.  The Allocation Ratio is determined by taking the # of days worked in California divided by the total # of workdays for the period, where the period is the length of time between the grant date and the disqualifying sale date.  In your example the period would be July 1, 2019 to December 1, 2023.  So, approximately 31/1613 = 1.92%.   The “spread” when exercising  Incentive Stock Options is not considered ordinary income and is only considered income for AMT purposes.

Alternative Minimum Tax -  Unlike most states, California does have it's own AMT.  The spread would be an AMT adjustment for California tax.  The period subject to allocation would be July, 2019 to December 1, 2022.  It is highly unlikely you would be subject to California AMT given the small amount that would be allocated to California.

Form more information, see Section E of the California Franchise Tax Board's  Taxation of Nonresidents and Individuals Who Change Residency