State Tax Compliance for Mobile Employees with Stock Awards

Last year, the California tax authority, known as the Franchise Tax Board (FTB), sent several personal income tax notices to individuals who had not filed a 2020 California tax return. The FTB asked questions of those individuals because they had filed a California tax return either before or after the 2020 tax year. In the cases for Rutlen clients, the lack of filing for 2020 was legitimate. The individuals had either moved out of California with no stock awards granted prior to the move, or they had not yet moved to California, and we were able to satisfactorily close the line of questioning.

It is hardly surprising that such notices were sent, as the increase in state mobility during the COVID-19 pandemic was well publicized. As readers are probably aware, stock awards granted prior to a move leave a trailing tax liability. State authorities tax took note of the relocation and remote work phenomenon. While it was hardly surprising that high-enforcement states such as California and New York published guidance for movers and remote workers, such guidance was also published by states with limited history of mobile tax enforcement. For example, Kentucky’s employer withholding web page now starts with a reminder that withholding is required for resident and nonresident employees.

State Tax Withholding and Reporting for Equity Awards

In general, employers must apply income reporting and tax withholding in each relevant state for both residents and nonresidents, as described below.

Employees resident in the state

For employees who are resident in a state and have a taxable event in their equity awards, depending on the state, the rules may require tax withholding on any of the following:

• the full income with the employee claiming tax credits for other state taxes on the state tax return,
• the full income less credits for taxes paid to another state,
• income not subject to tax withholding in another state, or
• the state-sourced income.

Sourced income means that the income generated from work in that state. For equity compensation, this typically follows where the work is performed but sometimes it can be based on where the employment relationship is based. There is a longer discussion of sourcing of income in the article “State Mobility Issues for Equity Compensation Professionals.”

State nonresidents

State tax withholding may also be required for employees who are nonresidents in a state if they have sourced income from that state. Nonresidents include former residents, employees who commute or travel to that state and, depending on the state, employees whose employment is based in that state.

Payroll Withholding and Reporting for Mobile Employees

Some states exempt employers from payroll withholding and reporting where the company does not have a presence in that state. However, there may ultimately be an employee tax liability. As the rules can vary by state, employers should review each state’s requirements carefully to determine their payroll compliance obligations. While the payroll department may have this under control, it may not have focused on the trailing liability created by long term incentives such as equity compensation.

Key Mobility Scenarios to Watch For

In the post-pandemic era, companies should pay particular attention to a few key situations:

1. Executives who moved out of the headquarters state during the pandemic and, as offices have re-opened, are traveling to the headquarters state for meetings. California-headquartered companies are particularly at risk as the FTB often reviews SEC filings of California-headquartered companies to determine whether the named executives are filing a state return.
2. Individuals who moved out of state during the pandemic and moved back to the prior state or another state where the employer has offices once the offices reopened.
3. Employees who live in one state and work on a hybrid basis in another. For example, employees may have lived in Vermont but worked fulltime in Massachusetts in the past and only Massachusetts tax would have been withheld. Now that they are working hybrid, the income needs to be split between Massachusetts and Vermont. This is especially tricky for equity compensation where the period between grant and vest covers fulltime work in the office in Massachusetts, fulltime work from home in Vermont, and a hybrid split between the two.

The Future of State Tax Compliance

Mobility compliance for states used to be an afterthought to global mobility compliance. Now almost every state has published guidance for such situations. We expect many states will follow the California example and start enforcement actions in the near future. For more information about state mobility taxation, see “State Mobility Issues for Equity Compensation Professionals.”