TLDR
Moving to a location with favorable tax treatment can be lucrative at any stage of the vesting, exercise, and liquidity cycle.
The decision to relocate to a lower state tax jurisdiction can have a significant impact on reducing tax liabilities for employees, especially those dealing with stock options. Whether you hold ISOs or NSOs, understanding the tax consequences upon vesting, exercise, and final sale is crucial. Recall that stock options and RSUs are taxed at two points in their lifespan; when they are exercised and when they are sold. Your taxation upon exercise is significantly impacted on the state you were in when vesting your equity. ISOs incur Alternative Minimum Tax (AMT) upon exercise, while the taxable gain of NSOs add to ordinary income.
By moving to states with lower or no income tax, such as Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming, employees can potentially minimize the tax burden associated with exercising their options. Moving to these states while vesting options is especially powerful if you have NSOs since the bargain element (the spread between your strike price and the 409A) is taxed at ordinary income tax rates. New Hampshire is another appealing jurisdiction for the specific cases of RSU settlement and NSO exercises as they have no ordinary income tax.
If you have ISOs you can minimize your taxes by moving to any of the 45 states without an additional state AMT surcharge (which is every state except for CA, CO, CT, IA, and MN). Keep in mind that the long arm of the California Franchise Tax Board is entitled to its portion if you vested equity while you were living or working in the state, so if you want to maximize your tax savings and can take advantage of WFH or remote work you should do so early in your vesting period.
Capital gains tax are the logical next considerations once the options are exercised, and relocating to a state or territory with favorable capital gains tax rates can further optimize tax outcomes. Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming have no capital gains in addition to no income taxes. North Dakota, Pennsylvania, and Indiana’s low capital gains rates also deserve attention. With remote work flexibility on the rise, exploring tax-efficient jurisdictions becomes increasingly relevant for startup employees looking to maximize the value of their equity compensation. CA provides no benefit for long term capital gains and treats all gains as ordinary income so moving to any other state will comparatively reduce your liability upon final sale even if the respective states’ capital gains rate is not zero. Your capital gains at liquidity will be subject to the taxes of the state of residency at that moment providing opportunity to lower your taxes later on in the holding period of the equity.
Puerto Rico provides one of the most friendly environments and exempts interest, dividends, accruals, and capital gains from both foreign and Puerto Rico taxes for gains accrued since becoming a resident of Puerto Rico via two tax acts enacted in the last decade. The incentives have proven so enticing the IRS created an enforcement program in 2021 to prosecute tax evaders simply claiming residency. The bar for qualifying as a bona fide resident is high however these tax benefits can be worth it when considering the potential of early startup equity.
For help funding exercise related taxes, check out how ESO Fund can cover your taxes risk-free.
