Taxation of Nonqualified stock options


F

Frank S. Duke, Jr.

I have clients who have retired from the Procter & Gamble
Company in Cincinnati, Ohio who are starting to cashless
exercise nonqualified stock options. The company issues the
previous employ a W-2 and withholds Federal, Ohio and local
income tax as well as Social Security and Medicare on the
difference between the grant price and the exercise price.

Many of these retirees moved away from Ohio long ago and
many live in Florida, where there is no state income tax.
Now, they are subject to income tax on a state an local
jurisdiction where they have not lived in years. Is this
income considered to have been earned at the last place of
employment?

In many cases, the options were under water when the
taxpayer left Ohio so the income clearly appeared in the
post Ohio period.

Since the withholding has already been done, the taxpayer is
faced with asking for a refund from a jurisdiction reluctant
to give up the cash.

Does anybody have any experience with successfully obtaining
a refund?

All freely provided advice guarantee correct or double your
money back

Frank S. Duke, Jr. CPA
Cincinnati, OH USA
 
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H

Harlan Lunsford

Frank said:
I have clients who have retired from the Procter & Gamble
Company in Cincinnati, Ohio who are starting to cashless
exercise nonqualified stock options. The company issues the
previous employ a W-2 and withholds Federal, Ohio and local
income tax as well as Social Security and Medicare on the
difference between the grant price and the exercise price.

Many of these retirees moved away from Ohio long ago and
many live in Florida, where there is no state income tax.
Now, they are subject to income tax on a state an local
jurisdiction where they have not lived in years. Is this
income considered to have been earned at the last place of
employment?

In many cases, the options were under water when the
taxpayer left Ohio so the income clearly appeared in the
post Ohio period.

Since the withholding has already been done, the taxpayer is
faced with asking for a refund from a jurisdiction reluctant
to give up the cash.

Does anybody have any experience with successfully obtaining
a refund?
Any time I've run across such a case (not stock options for
a non-resident however, I've simply filed a non-resident
return, with a zero on whatever taxable block is concerned.
A letter of explanation might help, then it might not.
Probably best to make it zero with no explanation on the
hopes it will not be questioned, but then if so, then
explain.

P&G "should" have prepared a propert W-2 form with zero in
Ohio taxable block and that amount in the retiree's state .

ChEAr$,
Harlan Lunsford
 
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A

Arthur Kamlet

Frank S. Duke said:
I have clients who have retired from the Procter & Gamble
Company in Cincinnati, Ohio who are starting to cashless
exercise nonqualified stock options. The company issues the
previous employ a W-2 and withholds Federal, Ohio and local
income tax as well as Social Security and Medicare on the
difference between the grant price and the exercise price.

Many of these retirees moved away from Ohio long ago and
many live in Florida, where there is no state income tax.
Now, they are subject to income tax on a state an local
jurisdiction where they have not lived in years. Is this
income considered to have been earned at the last place of
employment?

In many cases, the options were under water when the
taxpayer left Ohio so the income clearly appeared in the
post Ohio period.

Since the withholding has already been done, the taxpayer is
faced with asking for a refund from a jurisdiction reluctant
to give up the cash.

Does anybody have any experience with successfully obtaining
a refund?
I had a client in a similar position recently and treated it
as income earned when the option was exercised, in the state
of residence at that time -- not Ohio. And I did not
prepare a city return either. Of course, the SOL is still
running, but ....

__
Art Kamlet ArtKamlet @ AOL.com Columbus OH K2PZH
 
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A

A.G. Kalman

Frank said:
I have clients who have retired from the Procter & Gamble
Company in Cincinnati, Ohio who are starting to cashless
exercise nonqualified stock options. The company issues the
previous employ a W-2 and withholds Federal, Ohio and local
income tax as well as Social Security and Medicare on the
difference between the grant price and the exercise price.

Many of these retirees moved away from Ohio long ago and
many live in Florida, where there is no state income tax.
Now, they are subject to income tax on a state an local
jurisdiction where they have not lived in years. Is this
income considered to have been earned at the last place of
employment?

In many cases, the options were under water when the
taxpayer left Ohio so the income clearly appeared in the
post Ohio period.

Since the withholding has already been done, the taxpayer is
faced with asking for a refund from a jurisdiction reluctant
to give up the cash.

Does anybody have any experience with successfully obtaining
a refund?
I believe Ohio follows the same general rule that we have
here in CA. Compensation income earned on NQSOs or
disqualified ISO transactions have as their source the state
in which the employee was working at the time of the grant.
Here's how CA taxes that compensation:

CA will tax 100% of the compensation if the taxpayer left CA
after terminating employment. If the taxpayer left CA and
continued to work for that employer, then the taxpayer has
to allocate the compensation between CA and the other
state(s) using a reasonable method. CA identifies one
reasonable method as time. CA workdays divided by total
workdays from date of grant to date of exercise times the
income. Note that any appreciation in value while still a
CA employee is not in the time method.

I found one piece of Ohio information (a footnote to an
information release) that says Ohio only taxes the Ohio
appreciation. It is a 1996 release discussing federal law
that prevents a state from taxing pension distributions to
taxpayers who are no longer residents. The link is below,
but here is the footnote:
*************Begin Text*************
2. Now that the U. S. Congress has specifically addressed
retirement income attributable to retirement plans, the
Department of Taxation's position is that nonresidents and
nondomiciliaries who exercise stock options received on
account of employment in Ohio must pay Ohio individual
income tax on the Ohio-related appreciation. For purposes of
determining the Ohio-related appreciation, the nonresident
will treat as Ohio income the value of the unexercised stock
option at the time the individual left Ohio minus the value
of the unexercised stock option at the time the individual
received the option. In those cases where an individual
receives a stock option prior to either moving to or working
in Ohio, then the Ohio-related appreciation will be based
upon the value of the unexercised stock option when the
individual leaves Ohio minus the value of the unexercised
stock option at the time the individual first became a
resident of Ohio or first began working in Ohio.
*************End Text*****************

Assuming that this rule is still in place, it would seem
that Ohio only taxes the appreciation that occurred prior to
departing the state. As you said the options were under
water when the taxpayer left Ohio, it would appear that no
tax is owed to Ohio and the taxpayer should file for a
refund of any taxes withheld.

http://tax.ohio.gov/divisions/communications/information_releases/info_it031196.stm
 
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F

Frank S. Duke, Jr.

I had a client in a similar position recently and treated it
as income earned when the option was exercised, in the state
of residence at that time -- not Ohio. And I did not
prepare a city return either. Of course, the SOL is still
running, but ...
Thanks Art. I asked the question of the Ohio Department of
Taxation and they gave me a very good explanation. Funny
place to get tax advice, isn't it?

This is a reply I got from an inquiry to the Ohio Department
of taxation. It looks like their position is that the option
will be OH taxed at the fair market value at the time they
left Ohio minus the grant price. When P&G does withholding,
it is most likely based on the exercise price. As a result,
a Florida resident who exercises an option with a grant
price of $20 that was worth $30 when he or she left Ohio and
was exercised at $55 would pay federal tax on $55 - $20 =
$35 but Ohio tax only on $30 - $20. In fact if the option
was under water when they left Ohio, they would file a
non-resident return asking for all their withholding back.

OH Department of Taxation's position is that nonresidents
and nondomiciliaries who exercise stock options received on
account of employment in Ohio must pay Ohio individual
income tax on the Ohio-related appreciation. For purposes of
determining the Ohio-related appreciation, the nonresident
will treat as Ohio income the value of the unexercised stock
option at the time the individual left Ohio minus the value
of the unexercised stock option at the time the individual
received the option.

We have an information release on our website dated March
11, 1996 explaining this position. The section of the code
is 5747.01.

Conclusions:
1. P&G will withhold State and local tax from your option
proceeds based on the last place you worked, whether you owe
any tax or not.

2. You will have to file a non-resident tax return for that
state if you no longer live there. That state could pursue
you for failure to file if they think you owe them more
money. If not, they will keep your withholding and it will
be forfeit at some time in the future to the State Treasury.

3. If most of the value in your options accrued after you
left the state where you worked, you should file a
non-resident state tax return to get your withholding back.
This will be to your advantage if you live in a state with
no income tax or one with a tax lower than Ohio. If you
live in a higher tax state, they will tax your option and
most likely give you credit for the tax you paid to Ohio so
the Ohio refund will gain you nothing.

4. Ohio is not doing this out of the goodness of their
hearts. There is a federal prohibition against states
taxing retirement income for people who no longer live
there.

All freely provided advice guarantee correct or double your
money back

Frank S. Duke, Jr. CPA
Cincinnati, OH USA
 
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V

Victor Roberts

[snip]
4. Ohio is not doing this out of the goodness of their
hearts. There is a federal prohibition against states
taxing retirement income for people who no longer live
there.
This is news to me. I worked in NY for may years, retired
from the company I worked for and still live here. But it
was my understanding that NY would continue to expect income
taxes for my entire pension even if moved to a state that
has no income tax since it was all "earned" while I lived in
NY.

I also do not understand why you classify stock options as
"retirement" income since they are often cashed while you
are still employed.
 
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F

Frank S. Duke, Jr.

Victor said:
4. Ohio is not doing this out of the goodness of their
hearts. There is a federal prohibition against states
taxing retirement income for people who no longer live
there.
This is news to me. I worked in NY for may years, retired
from the company I worked for and still live here. But it
was my understanding that NY would continue to expect income
taxes for my entire pension even if moved to a state that
has no income tax since it was all "earned" while I lived in
NY.
Many states including CA have tried to get away with this.
An act of January 10, 1996 (H.R. 394) limits state income
taxation of pension income.  The following applies to
amounts received after December 31, 1995.

Sec. 114. *Limitation on state income taxation of certain pension income.-

(a) No state may impose an income tax of any retirement
income of an individual who is not a resident or domiciliary
of such state (as determined under the laws of such state).

(b) For purposes of this section-

(1) The term 'retirement income' means any income from-

(A) a qualified trust under section 401(a) of the Internal
Revenue Code of 1986 that is exempt under section 501(a)
from taxation;

(B) a simplified employee pension as defined in section
408(k) of such Code;

(C) an annuity plan described in section 403(a) of such Code;

(D) an annuity contract described in section 403(b) of such Code;

(E) an individual retirement plan described in section
7701(a)(37) of such Code;

(F) an eligible deferred compensation plan (as defined in
section 457 of such Code);

(G) a governmental plan (as defined in section 414(d) of
such Code);

(H) a trust described in section 501(c)(18) of such Code; or

(I) any plan, program, or arrangement described in section
3121(v)(2)(C) of such Code.  If such income-

(i) is part of a series of substantially equal periodic
payments (not less frequently than annually) made for

(I) The life or life expectancy of the recipient (or the
joint lives or joint life expectancies of the recipient and
the designated beneficiary of the recipient), or

(II) a period of not less than 10 years, or

(ii) is a payment received after termination of employment
and under a plan, program or arrangement (to which such
employment relates) maintained solely for the purpose of
providing retirement benefits for employees in excess of the
limitations imposed by 1 or more sections 401(a)(17),
401(k), 401(m), 402(g), 403(b), 408(k), or 415 of such Code
or any other limitation on contributions or benefits in such
code on plans to any of such sections apply.

Such term includes any retired or retainer pay of a member
or former member of a uniform service computed under chapter
71 of title 10, United States Code.

(2) The term 'income tax' has the meaning given such term by
section 110(c).

(3) The term 'state' includes any political subdivision of a
state, the District of Columbia, and the possessions of the
United States.

(c) Nothing in this section shall be construed as having any
effect on the application of section 514 of the Employee
Retirement Income Security Act of 1974.
I also do not understand why you classify stock options as
"retirement" income since they are often cashed while you
are still employed.
If you are still working, they are taxed by the state where
you are, right or wrong. If you have moved away, OH wants a
piece of them equal to the appreciation that happened before
you left. Whether that is practical is another story but if
an ex-employer withholds Ohio tax for a FL resident, the FL
resident is going to have to file an OH tax return to get it
back. At that point, Ohio holds your money and you have to
convince them why they should not keep it.

All freely provided advice guarantee correct or double your money back

Frank S. Duke, Jr. CPA
Cincinnati, OH USA
 
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V

Victor Roberts

Frank S. Duke said:
Many states including CA have tried to get away with this.
An act of January 10, 1996 (H.R. 394) limits state income
taxation of pension income.  The following applies to
amounts received after December 31, 1995.

Sec. 114. *Limitation on state income taxation of certain
pension income.-

(a) No state may impose an income tax of any retirement
income of an individual who is not a resident or domiciliary
of such state (as determined under the laws of such state).
[snip]

Thanks. I had this discussion with someone before 1/96 and
never knew about H.R. 394. Now I can move to New Hampshire
or Florida :)

--
Vic Roberts
http://www.RobertsResearchInc.com
To reply via e-mail:
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This information is provided for educational purposes only.
It may not be used in any publication or posted on any Web
site without written permission.
 
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K

Katie

[snip]

Thanks. I had this discussion with someone before 1/96 and
never knew about H.R. 394. Now I can move to New Hampshire
or Florida :)
Notice that stock options are not included in the HR 394
list of types of retirement income that are protected from
source-based taxation of nonresidents.

The general sourcing rule is that income from personal
services has its source where the services were performed.
Until the enactment of HR 394, states were entirely
justified in taxing pensions and other retirement income to
nonresidents on a source basis. To the extent that you
earned the income by performing services in the state, that
state had the power to tax the income. It still has the
power to tax all such income from sources not listed in HR
394, including stock options.

Katie in San Diego
 
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H

HW \Skip\ Weldon

Frank S. Duke said:
Many states including CA have tried to get away with this.
An act of January 10, 1996 (H.R. 394) limits state income
taxation of pension income.=A0 The following applies to
amounts received after December 31, 1995.

Sec. 114. *Limitation on state income taxation of certain
pension income.

(a) No state may impose an income tax of any retirement
income of an individual who is not a resident or domiciliary
of such state (as determined under the laws of such state).
Assume same applies to city income tax?

-HW "Skip" Weldon
Columbia, SC
 
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F

Frank S. Duke, Jr.

Assume same applies to city income tax?
The problem seems to be withholding. Once cities have the
money, it is very hard to get them to give it back.
Generally, it is not enough to warrant legal action and they
know it.

All freely provided advice guarantee correct or double your
money back

Frank S. Duke, Jr. CPA
Cincinnati, OH USA
 
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