Many individuals who receive stock options as part of their compensation package ponder the tax implications if they relocate to a state with no income tax. This issue is particularly relevant for those who were California residents when they received their stock options. This newsletter explores whether moving out of California can help you avoid California income tax on these stock options.

The core question is: Can a former California resident avoid California state income tax on stock options received while a resident but exercised after moving to a state with no income tax? 

California's tax regulations stipulate that residents are taxed on worldwide income, while non-residents are taxed on income derived from California sources. For stock options, California uses a source rule, which allocates income based on where the services that earned the options were performed.

In the case of the Appeal of Gene and Joann Clark (2001-SBE-006), the California State Board of Equalization addressed the issue of how to apportion income from stock options for tax purposes. Gene Clark received stock options while he was employed in California. He later exercised these options after moving out of state.

The Board determined that the income from the stock options was subject to California tax based on the proportion of time Clark had worked in California during the vesting period of the options. Specifically, the ruling confirmed that the income should be apportioned according to the period of service performed in California relative to the total period from the grant date to the vesting or exercise date. This meant that only the portion of the stock option income attributable to the time he worked in California would be subject to California income tax.

If you received stock options while a resident of California, these options are considered compensation for services rendered during your employment in the state. Upon moving to a no-income-tax state, you change your residency status to non-resident. However, the income from exercising these stock options will still be subject to California tax based on the proportion of time you were employed in California relative to the total time from the grant date to the vesting or exercise date.

Relocating to a no-income-tax state does not exempt you from California income tax on stock options received while you were a California resident. California will tax the portion of the stock option income that corresponds to services performed in the state. The key determinant is the source of the income, not your residency at the time of exercise.