The pandemic accelerated the trends in working remotely which also prompted people to move to tax-free states. It is no secret that CA state levies high income tax. The highest tax personal income tax rate can be as high as 12.3% if one earns more than $625,370 (tax bracket in 2021-2022). Many people think they don’t have to pay tax to CA state anymore after they move out of the CA state and establish a new residency in another state, but this is not always correct. If you have equity compensation such as RSU, ESPP, ISO and NSO, you may have to pay tax to CA state even if you are a WA or TX resident.
If you have RSUs vesting, you may notice that the company is still withholding CA state tax for the RSU income after you move. This is not a mistake. If you are a CA resident when you were granted the RSUs, you may be still liable for CA state tax. Here is an example.
In this example, you were a CA resident when the RSUs were granted to you. When RSUs vest, you need to allocate income to CA state based on the allocation ratio.
Allocation Ratio= (total workdays in CA between the grant date and vest date)/ (total workdays between the grant date and vest date)
So in this case, the allocation ratio is 88.77% (166/187) which means that you need to allocate 88.7% of the RSU income to CA state and pay taxes.
Same allocation ratio applies to ISO and NSO. The only difference is that you need to use the date of exercise instead of vesting date to calculate the ratio.
The formula is different for ESPPs. In the case you have ESPPs, you should count the days between the beginning of the buying period and the end of the buy period.
If the income is not allocated appropriately, it is possible that you will be double taxed. If you move from CA to a tax-free state like TX or WA, you won’t be taxed by both states. However, if you move from CA to a state with income tax like MA, it is likely that you will be double taxed by both states for the same amount of income. To protect yourself from the double taxation, you need to make sure your employer is doing the right allocations on your equity compensation and report the right amount on the tax documents such as W2s and 1099s. If you realize the error, you should contact your employer and have them issue a corrected tax document as soon as possible. There are also other ways to manually allocate the income on the tax returns, but it may trigger an audit in the future.
Please contact Dimov Associates directly if you have any questions on this topic. We are specialized in this issue and will be happy to help.