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How are Options that are Granted in One Country Taxed if They Vest in Another Country?

Arin V., EA , MBA
Arin is an Enrolled Agent (EA), authorized to represent taxpayers in front of the IRS, and holds a BA and MBA (Management) degree from California State University, Northridge.
In recent years, stock options have become a larger part of the pay packages for startup employees and expats. Therefore, it makes sense to take a deeper look at the taxation of options, especially when the options are granted in one country, but the taxpayer moves to another country, such as the U.S., and the options then vest.

But how are options that are granted in one country taxed, if these same options vest in another country? For individuals who are not U.S. persons but are considering a move to the U.S., the first thing to determine is whether the options are statutory or non-statutory. The IRS considers options granted under an employee stock purchase plan (ESPP) or incentive stock option plan (ISO) to be statutory stock options. Such statutory stock options are looked at as employee benefits that allow you to purchase the company’s stock at a discount on the market price. On the other hand, the IRS considers all other options (that is, those not granted under an ESPP or ISO) to be non-statutory options.  

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An individual who receives statutory stock options is not subject to tax in the U.S. when the option is granted or exercised. However, when the U.S. taxpayer sells the shares, he or she will be taxed at long-term capital gain rates on the gain, if the holding period was greater than one year. On the other hand, a U.S. person who holds non-statutory options is taxed in the year the option is exercised. The taxable compensation is an amount equal to the difference between the exercise price and the fair market value of the shares on the date of exercise, which is also called the “spread”. After a non-statutory option is exercised and the stock is acquired, the stock is treated for tax purposes as an investment by the employee. If the stock appreciates after the date of exercise, the employee can sell the stock and will pay tax on the resulting capital gain.

Another thing to consider is the tax residency of the individual, and, in particular, where the income is sourced. If a nonresident of the U.S. is granted or exercises stock options, but does not work in the U.S., then neither the grant nor the exercise of the stock options will result in a taxable scenario for this individual in the U.S., though this may have tax implications in their home country. If this same person worked for part of the year outside of the U.S., but at some point during the year, became a U.S. resident, then he or she could be liable for tax in the U.S. upon exercising the options. Indeed, nonresidents of the U.S. who hold non-statutory options and move to the United States are liable for tax on the full amount of stock option income if the options are exercised while they are U.S. residents. If an individual is a nonresident of the United States at the time of exercise of a non-statutory stock option, the person will be exempt from U.S. tax on the portion of the option income attributable to services performed while physically outside of the United States. Such an individual may, however, be subject to U.S. tax on income attributable to services performed in the United States. 

U.S. residents and citizens are taxed on their worldwide income. There are numerous challenges associated with this. In particular, a U.S. taxpayer who is subject to tax in more than one country (i.e. the U.S. and some other country) or who relocates from the U.S. to another country, could face a double taxation scenario if the two countries’ tax laws do not have tax treaty articles to avoid the double taxation of options. For example, if a U.S. citizen residing and working in a foreign country receives and exercises non-statutory options from a foreign (non-U.S.) company, the IRS would tax the option income. In this scenario, the foreign country the U.S. citizen is living in may very well consider that option income to be sourced in that foreign country, as well. 

Therefore, if you have stock options and you are either an American leaving the U.S. for an overseas position, or a non-resident moving to the U.S., please get in touch today so that we can plan for your impending move. Given the complexities around cross-border transactions and international tax law, you don’t want to be caught in a situation where you incur tax liability you never knew about (and which could have been avoided). 

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