Hi all, I'm seeking some pointers from ISO stock options / AMT / foreign tax credit (1116) experts for how to report a tricky tax situation on the US tax return in order to avoid double taxation of ISOs between the US and Switzerland. Here are the details about me and my case:
- US citizen, currently resident in Switzerland since 2020
- have an ISO grant from US-based company I was an employee of in 2020 in the US
- relocated to Switzerland later in 2020, less than a month after the grant
- exercised ISOs in 2023, did not sell stock
- about 95% of the option vesting is attributable to Switzerland based on the time method, and is therefore taxed as regular income in Switzerland (which treats all options the same and doesn't distinguish between ISO / NSO, doesn't have preferential tax treatment like the US)
- the US does not consider the bargain element from ISO exercise as income for regular taxes (see next point for AMT) and instead taxes the full spread at the time of sale (between grant price and sale price)
- the ISO exercise does count for AMT income purposes and does trigger AMT in my case for tax year 2023 (if the full bargain element is considered, as I assume it should be, rather than only the portion vested in the US)
- the company did not provide me Form 3921 for the exercise, and I believe they did not file it with the IRS either, but I believe this is a mistake of the company, since I fit all the criteria necessary for such a form to be filed/provided; they did not attempt to fix this after I pointed it out to them; regardless, I have all the necessary info needed to properly calculate and report the exercise event in my tax return
- since relocating, my income tax rate in Switzerland is higher than the US federal income tax rate and regularly results in excess FTC (may or may not be relevant to the issue here but including it just in case and since it's unusual for most other lower-tax places in Switzerland)
While I'm experienced in using Form 1116 to claim FTC for taxes paid on regular wages and even for interest and dividends resourced by tax treaty, I don't know how to handle this new situation with different treatment of this event under US and Swiss tax rules. In an ideal situation, the income taxes paid to Switzerland on the bargain element would result in some tax credit / cost basis such that in the future, when the resulting stock is sold, I would not have to pay capital gains tax on the bargain element for which income tax was already paid (in Switzerland).
That said, is this possible, and if so, how to report it properly?
I've searched online extensively but found no answers. Here is one resources which describes the issue well but also does not provide answers for how to properly handle it: https://www.vistra.com/insights/gran[product key removed]ns-expats-what-employers-cant-afford-overlo...
Some options I've considered so far (but am not sure about):
1. Do not include the bargain element from the exercise in foreign earned income & therefore total income for regular tax. Report the full bargain element as AMT income for AMT tax. Regular Form 1116 also does not include this income as foreign sourced (since then foreign income claimed on Form 1116 would exceed foreign earned income reported, which seems weird...). However, on the AMT Form 1116, do include the income as foreign sourced, since in essence it's also treated as regular income for AMT purposes, and the tax paid on it to Switzerland as claimed credit. That requires manually overriding some Form 1116 fields in TurboTax Deluxe offline (e.g. 3d, gross foreign source income, so that it's the higher value which includes the exercise income and not the lower value reported for regular tax purposes, which also seems strange). With this method, most of the AMT is covered by the AMT FTC, resulting in a low AMT reflecting the part of the bargain element which Switzerland did not tax (about 5% of the total) since it's considered US-vested/sourced only. However, it seems like with this method, a future capital gains tax on the full spread would result, not taking into account any basis or credit for taxes paid to Switzerland. (I have read that in less complicated cases not involving foreign residence/tax, when an ISO exercise triggers AMT, there is AMT credit which can be carried over and reduce future tax, thereby offsetting the capital gains tax which would be paid on the same bargain element for a future sale. But in my case, the AMT is almost fully reduced by the AMT FTC, so there is almost nothing to carry over and reduce a future capital gains tax on the stock sale.)
2. Utilize some kind of tax treaty resourcing argument so that only the US-vested portion of the ISO exercise (i.e. the ~5%) is reported as AMT income, and the rest is essentially treated as foreign-sourced regular income/compensation. That seems logically equivalent to foregoing the more preferential tax treatment of ISOs for the larger portion of the ISOs, by treating it as regular income for US tax purposes. No idea if this is allowed, could not find any specific references, even in the US-Swiss treaty for avoidance of double taxation. Later, at stock sale time, there would also need to be a manual adjustment to the cost basis with the argument that for the portion of the stocks resulting from foreign-vested options, the costs basis should be the FMV at exercise rather than the lower grant price. Again, no idea if this is a valid argument or process for the IRS even though it seems logical.
