US Tax Obligations on Stock Options for Non-American Workers
Working abroad in America and receiving stock options can come with a surprising level of tax complexity when you later become a nonresident alien for tax purposes. Let's break it down:
Stock Options Ain't Taxed Immediately
When you're working in the U.S. and granted stock options, there's usually no immediate tax bill because these options often lack a "readily ascertainable fair market value." The taxation kicks in when you exercise the options. But beware, if the option strike price is set below the fair market value or the plan runs afoul of Internal Revenue Code Section 409A, you could owe tax and penalties even before exercising the options. Always consult a tax pro to avoid trouble.
Exercising Those Options Triggers Taxes
Options usually vest over time, let's say 4 years with a one-year cliff. When vested, exercising the options triggers tax on the difference between the fair market value of the shares at the time of exercise and the option strike price. This difference counts as ordinary compensation income, kicking off Uncle Sam's tax claims.
Foreigners Don't Escape U.S. Taxes That Easy
The U.S. continues to claim the right to tax this income even when you're no longer a resident. That's right, your green card might not be enough to escape those taxes. A "grant-to-vesting" sourcing rule determines how much of the income should be treated as having a U.S. source. This rule calculates the portion of time spent working in America during the period between the grant date and the vesting date, and tax is applied accordingly. So, even if you leave the land of opportunity, you might still owe taxes on income generated while you were here.
Double Trouble: Double Taxation Possible
Another country may also claim the right to tax the stock option income. Depending on the rules of the country, this could lead to double taxation. A skilled international U.S. tax pro can help sort out the mess and minimize the impact of taxation on both the U.S. and foreign fronts.
Selling the Stock Means New Tax Troubles
Once you've purchased the stock by exercising the option, any future gain upon a later sale will be treated as capital gain, not ordinary income. If you're still a U.S. tax resident when selling the stock, the gain will be taxed as either short or long-term capital gain. If the stock was held for over a year, preferential tax rates of 15% or 20% apply. However, if you're an NRA when selling, the gain might not be taxed by the U.S. unless you have significant physical presence.
Green Card Holders Beware
Green card holders should take care to properly sever U.S. tax resident status to avoid being subject to U.S. taxation under the tax laws after losing the right to live in the U.S. I've seen many green card holders who don't realize this, so make sure you're in the know.
Example of Tax Savings
Here's an example of how proper timing can lead to tax savings. A foreign national working in the U.S. was granted 10,000 NSOs with a $10 strike price. Half of the vesting occurred while she was in the U.S., and the remaining half happened after she became an NRA. By exercising her options while no longer a U.S. resident, she avoided U.S. taxation on the portion of the income tied to her non-U.S. service, resulting in significant tax savings.
Don't Forget State Taxes
State taxation is a crucial consideration when it comes to stock options, especially if you've lived or worked in multiple states before exercising the options. It's important to note that even after leaving America and becoming an NRA, you may still owe state taxes on the portion of the income tied to the work performed in that state.
The Bottom Line
Stock options can be a ticket to financial success, but they also present unique tax challenges for foreign nationals working in the U.S. To minimize tax and avoid compliance problems, proper planning, use of foreign tax credit strategies, and treaty benefits, and the counsel of an experienced U.S. tax pro are essential.
Stay on top of tax matters around the globe. Reach me at [email protected], and don't forget to check out my U.S. tax blog at www.us-tax.org.
[2]: https://www.goulet norton.com/resource_library/business-tax-resources/understanding-409a-stock-options
- A foreign worker who receives and later exercises nonresident alien taxable nonstatutory stock options (NSO) from a U.S. business should be aware that the sale of the stock could potentially be subject to both U.S. and foreign taxation, resulting in double taxation.
- In the realm of personal-finance, understanding the complex tax implications of foreign-earned stock options under U.S. tax law, such as deferred compensation from a nonstatutory stock option (NSO), can help a nonresident alien minimize tax liability and comply with the intricacies of their financial portfolio.
