Apportionment of RSU income under a vesting schedule

[bged]

I previously lived in one state ("A) and, while living there, began employment with an employer that pays me in part through Restricted Stock Units.  These vest according to a schedule -- for simplicity, call it 25% at the end of year 1, 25% at the end of year 2, through year 4.  I later moved to a different state ("B").  For simplicity, let's say I moved at the end of the first year.

My employer proposes to prorate vesting income based on days from grant date to vesting.  For the first year, everyone agrees I lived in state A and the RSU vest is entirely state A income.  What about year 2?  I say I lived entirely in state B, and so I say the second vest is entirely state B income.  In contrast, employer counts the days from grant to vest, and says half those days were state A days, half state B days, so prorates the vest accordingly.  Obviously disadvantageous to me if B has a lower tax rate.  But also seems deeply unfair -- each year's vest covers work done in that year.  (For example, if I took an unpaid leave in a given year, that reduces year vesting in that year but has no effect on any other year.)

I found plenty of discussions about similar questions when employees receive stock options.  But the value of a stock option truly relates to the entire period from grant to vest -- based on the volatility throughout the period.  Somewhat different for me -- these are RSUs, with simpler understanding of valuation.  Also the incremental vesting here doesn't seem to be something many states have thought about in their published guidance. 

Thoughts welcomed and appreciated!

[TomYoung]

The use of "State A" and "State B" confuses the situation here because not all states have the same rules when it comes to how compensation income is taxed when RSUs vest.  Here's an article that explains the situation when moving from California:

https://www.upstartwealth.com/blog/will-you-owe-ca-tax-after-you-leave

and the Franchise Tax Board's guidance is discussed here:

https://www.ftb.ca.gov/forms/misc/1004.html#E-Restricted-Stock-

Perhaps you can find something similar for your states "A" and "B".

[bged]

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.

[shivab]

This is exactly what i was searching an answer for.

As your rightly pointed out, CA says to apply a reasonable appropriation and word "a reasonable way" as something that's obviously beneficial to them. Every CPA i have talked to, takes CA's reasonable way allocation as the default allocation. But i have doubt this can stand a challenge b/c equity options by definition has a time element associated with it by virtue of the incremental vesting. 

A better more appropriate allocation seems to be accounting from the "vesting" date of an option. Meaning if you an option vested while in CA its attributable entirely to CA state, if it vests in another state its attributable to that state. My suspicion is this tracking of options becomes a bit difficult and it also complicates if you happen to jump around a bunch of states in and out during your employment.

I have, however, failed to see a court case against this. My suspicion is CA FTB maybe sends a letter, but maybe settles without trying to take it to the court. All in all, they hope their "reasonable" assumption becomes the default to the common masses

[bged]

Shivab, I'm glad you like the question.  I agree that there isn't much information about this, and also that a taxpayer might be able to prevail on a state tax authority in using another reasonable method based on the facts and circumstances.  Yet not straightforward in light of employer's W2's specifying a particular apportionment.  Uphill battle for the taxpayer to oppose the W2.

I filed a request for General Information Letter with Colorado, a state where I have never lived, but which has  high-functioning GIL process.   Their response was entirely unhelpful to my position, but at least gives a preview of how state tax authorities see this.  https://tax.colorado.gov/sites/tax/files/GIL%2020-004.pdf

I'm no expert on options, and have never received an option in my life, so I won't try to presume how options would be treated.  RSU treatment complicated enough for me!

[shivab]

So this is complete BS argument in my opinion

"In order for the restricted stock unit delivered in year 2 to vest, the employee must remain employed with the employer from the grant date (January 1 of year 1) through December 31 of year 2. During the two-year period the employee was required to work for the employer prior to the vesting of restricted stock units on December 31 of year 2 , the employee worked half of such time (262 work days in year 1 out of 524 total work days) in Colorado. As such, half of the income attributable to the shares delivered in year 2 is sourced to Colorado"

They are basically arguing that RSU, Stock Options with a vesting schedule is effectively a form of deferred compensation. And therefore, stuff that you got in second year is somehow tied to the work you did in first year which is why they keep on accounting from the time of grant. But if that was suppose to be true, then imagine if you got an offer letter that stated your salary would be YYYY total in 4 years with YYYY/48 over the next 48 months, would the same argument apply? 

The problem with all of this is obviously the tax regime is written in a way to carefully craft around the minimal number of ppl to maximize their receipt. So in essence you don't get the impetus to correct the wrong. Also all the intermediaries handling your taxes wants to be on the safer side of this. Safer side of this almost always entails you picking up the tab 🙂