A Taxing Situation...

Recently I consulted with a tax professional about the consequences of changing the state I reside in.  Most likely we will be moving to Idaho when I retire, but we have to build a home there so the residency situation was murky to me.  We'll probably have a home in California for a while, but at the same time have a rented home in Idaho while we're building our “real” home.  For tax purposes, I wondered, which state do I reside in?  Idaho taxes are lower, so it would be better for me to be an Idaho resident.

The tax professional told me something about the stock obtained through exercising my Incentive Stock Options (ISOs) that surprised me: California would claim the proceeds as taxable income no matter what state I lived in, no matter when I sold them.  Furthermore, the state I moved to (she didn't know for sure about Idaho) might also claim the proceeds as taxable income.  I could be taxed on the same income by two different states!  WTF?

Here's the explanation, but the really interesting part is what that explanation implies.  California claims the right to tax the proceeds of stock obtained through ISOs based on when those ISOs vested.  For me, and for virtually everybody else with ISOs, that means the first “n” years of their employment (four years, for me).  In those years I was clearly a California resident, ergo, California claims those proceeds as taxable income.  California is the only state to make this claim, and they only started doing this in the past few years.  All other states claim the proceeds as taxable income based on what state you reside in when the stock was sold.  So someone like me could be taxed by California (because my ISOs vested while I lived here) and again by Idaho (if I lived there when I sold the stock) – for the same income.

Think about what California's behavior implies.  They would only be pursuing such a path if the situation were a common one.  California's high tax rates make moving out-of-state attractive to people who suddenly make a lot of money through ISOs – so California comes up with a way to ensure they collect those taxes anyway!  When this becomes broadly known (it doesn't seem to be as yet), you can bet your sweet bippie that startups are going to think twice about establishing themselves in California – because for a startup, it's all about those ISOs.

What a frickin' stupid government California has!