Stock Tax Obligations for International Workers in the U.S. Regarding Equity Compensation
Foreign folks working in the US often receive stock options as a perk by their employers. But things get tricky when these foreign nationals leave the US and become nonresident aliens for tax purposes. This article explores the U.S. taxation of international workers on stock options earned in America and the pesky tax issues they encounter after departing the US.
Getting the Stock Options - No Immediate Tax
We're talking about non-statutory stock options, a common choice because they involve fewer restrictions and are easier to manage. Usually, when a taxpayer working in the US is given NSOs, there's no immediate tax liability. NSOs aren't taxed at grant because they often lack a readily ascertainable fair market value. Taxation is delayed until the options are exercised.
However, watch out for trouble if the option strike price is set beneath the fair market value of the shares at the time of grant or if the plan violates Internal Revenue Code Section 409A, which governs deferred compensation. In such cases, the employee may owe tax and penalties right away, even without exercising the options, so it's essential to review the compensation package with a tax pro.
U.S. Tax When Exercising the Stock Option
Options generally vest over time, usually with a four-year schedule that includes a one-year cliff, meaning no options vest until the employee has completed a year of employment. After that, 25% of the options vest, with the remainder vesting monthly or quarterly over the next three years.
Exercise your options once they're vested, and boom! You're taxed on the difference between the fair market value of the shares at the time of exercise and the option strike price. This difference is treated as ordinary compensation income. For example, if an individual pays $30 per share to exercise the option and the FMV at that time is $100, they must report $70 per share as ordinary compensation income.
Taxation of Foreign Nationals at Option Exercise
The main question here is whether the US still has taxing rights if the individual is no longer a tax resident when the option is exercised. In general, compensation for services performed in the US remains U.S.-sourced income. Since stock options are considered deferred compensation, the IRS applies specific income sourcing rules to determine how much of the income is taxable in the US even if the individual is living abroad at the time of exercise.
The "grant-to-vesting" sourcing rule" compares days worked in the US and outside the US during the period between the date the options were granted and the date the stock options became exercisable (the vesting date). If half of the vesting period occurred while the individual was working in America, then half of the income would be treated as having a U.S. source and would be taxable by the US, even though the option was exercised after the individual became a nonresident alien.
So, even after leaving the US, foreign nationals may owe tax on stock option income tied to services performed while they were in the US. Income treated as U.S.-sourced would be subject to withholding by the U.S. employer, typically at a flat 30% rate, unless a tax treaty applied providing a reduced rate or exemption.
Double Taxation Possible
A foreign country might also tax the stock option income. This means when the taxpayer leaves the US and resides abroad, there's a risk of double taxation. Some countries tax stock options at exercise in the same manner as the US, while others impose tax only when the stock is sold. Using foreign tax credits or treaty benefits can reduce the tax impact, but when U.S. law and foreign law are involved, it gets complicated, and it's best to consult an international U.S. tax professional.
U.S. Tax Upon Later Sale of the Stock
Once the taxpayer buys the stock by exercising the option, any future gain upon a later sale will be treated as capital gain. It's no longer taxed as ordinary income. If the stock is sold while the foreign individual is still a U.S. tax resident, the gain is taxed as either short- or long-term capital gain. If the stock was held for over one year, it is long-term gain and taxed at preferential rates of 15% or 20%. The holding period starts on the day after the stock was acquired by exercising the option.
If an individual is an NRA when selling the stock, the gain is generally not taxed by the US, pursuant to a special tax rule for foreign investors without significant physical presence. This difference in tax treatment makes it crucial to know one's U.S. tax residency status at the time of sale. For those with green cards, it is critical to properly sever U.S. tax resident status. Taxation on worldwide income will continue until U.S. tax residency is severed according to specific and detailed tax rules. Many green card holders don't realize it's possible to have lost the right to live in the US under immigration rules, but still be subject to U.S. taxation under the tax laws.
Example of Tax Savings
A foreign national living and working in America was given 10,000 NSOs in January 2022 with a strike price of $10 per share, matching the fair market value of the shares at the time. The options vested over four years, 25% vested in January 2023, and the rest vested monthly thereafter. In 2025, while she was still a U.S. resident, she exercised 7,500 of her vested options when the shares were valued at $30. This resulted in a $150,000 spread between the price at which the shares were trading at the time of exercise and the strike price (7,500 x $30 = $225,000 MINUS 7,500 x $10 = $75,000). This amount is treated as ordinary compensation income on which she will pay US tax at her marginal tax rate.
Later that year, assume she leaves America and becomes an NRA. In 2026, assume she exercises her remaining 2,500 options at a time when the fair market value had gone up to $35 per share. Under the "grant-to-vesting" source rule, the portion of income attributable to her services performed while in the US remains taxable. If half of the vesting occurred during her performance of services in the US, then half of the $62,500 gain is treated as U.S.-sourced compensation. As an NRA, she will be subject to 30% withholding on that portion, unless a tax treaty applies to reduce it.
By exercising her remaining options after she became an NRA, she avoided U.S. taxation on the portion of the income tied to her non-U.S. service. This results in significant tax savings that would not have been available had she exercised everything while still living in the US.
Stock Options and State Taxation
State taxation is a crucial consideration when employees receive stock options, especially if they have lived or worked in multiple states before exercising the options. Many US states allocate stock option income based on where the employee performed services during the vesting period. Even if an individual moves to another state or becomes an NRA, they may still owe state taxes on the portion of the income tied to the work performed in that state.
The Tax Rules Are Complex
Stock options certainly offer the potential for huge returns and can motivate an employee. But when stock options are granted to foreign nationals who work in the US, they present unique tax challenges.
The US retains taxing rights over income derived from US employment, even after a person leaves America and becomes an NRA. Simply leaving the US doesn't make the tax issues disappear. To minimize tax, the taxpayer must understand how the US sources stock option income, the potential double taxation risks, and whether any tax treaty provisions can apply.
Proper planning such as using foreign tax credit strategies and treaty benefits, can help reduce the tax burdens and avoid compliance problems. Given the complexity, an experienced U.S. tax professional should be consulted.
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- The tax liability for foreign workers receiving non-statutory stock options in the US is often delayed until the options are exercised, as they often lack a readily ascertainable fair market value at the time of grant.
- Foreign nationals may encounter tax issues upon departure from the US, as stock option income can still be treated as U.S.-sourced income for tax purposes, even if they become nonresident aliens.
- When a foreign national exercises their vested stock options, they will be taxed on the difference between the fair market value of the shares at the time of exercise and the option strike price, with this difference treated as ordinary compensation income.
- Double taxation is a possible risk for foreign nationals when selling stock acquired through exercised options, as both the US and their home country may impose taxes on the gain from the sale. This can be mitigated through the use of foreign tax credits or treaty benefits, but it requires the guidance of an international U.S. tax professional to navigate the complexities involved.
