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Stephen J. Bercovitch
Michael Maglio
Amper, Politziner & Mattia P.C.

One of the concerns we are frequently asked to address is the effective tax planning when an executive changes residency to another state. The issues raised are multiple and overlapping: the state taxability of various distributions and future payments; coordinating the timing of various payouts; and effective change of residency to effectuate a more tax efficient financial plan; and, the questions can come from the employer side, as well as from the employee.

Normally two issues arise in the context of state sourcing of these payments. The first is the nature of the payment and the second is one of timing.

Equity Compensation Plans

Stock Options:

In the case of incentive stock options ("ISOs") and non-qualified stock options ("NSOs"), a departing executive can have a fairly long period of time after retiring (or leaving) a company to continue to exercise outstanding grants. Upon changing residency to another state, the executive needs to be aware that New Jersey, as is the case with many state tax jurisdictions, will source the resulting income based on the location of the working days at the time of the grant of the options. Most companies source this income appropriately for state purposes through payroll, on a Form W-2.

Because of recent New York litigation, a New Jersey resident who may have worked in New York while earning the options may confront an added complexity. The New York Tax Appeals Tribunal in the Stuckless case, decided in August 2006, held that stock option income should be sourced using the ratio of days in the year the stock option income was received. Where the New Jersey employee is retired and provided no services for the employer at all inside New York, then this ratio is zero.

There may be refund opportunities in the situations where the number of days worked in New York divided by the total days worked in the year of receipt of the income is less than the ratio of days worked in New York to total days that were used to report the nonresident's income on his Form IT-203 Allocation.)

Restricted Stock & Other Equity Compensation Related Payouts:

With respect to most all other equity compensation payments, it is more likely that upon termination of employment, for retirement or other event, that there is an acceleration of vesting, and thus triggering of income. Deferred salary, and bonus distributions, severance payments, and payments made in conjunction with non-compete agreement (where the ex-employee cannot compete within New Jersey) will be treated as equivalent to "wages" or ordinary compensation (New Jersey State Tax News, Fall, 2005, p. 12) . Many deferred compensation plans, where an executive has deferred some part of their salary and bonuses for prior years, are required to be sourced back to New Jersey due to the timing of the income as it relates to the executive working in and being a resident of the state at the time of deferral. From a practical standpoint, many employers may not withhold any state taxes from such payments, putting the onus on the recipient.

The greatest leverage for planning pertains to pension plan payouts and timing payments to coincide with state residency changes, particularly where an executive is going to a lower, or no tax, state. In 1996, Congress enacted the Pension Source Act that prohibited all states from imposing an income tax on the pension/retirement benefits received by a former state resident. Therefore, it is imperative, where a change of domicile to a less taxing state is contemplated, that the timing and nature of such payments be considered.

Character of the Income

Income of a nonresident from intangible property, such as corporate securities, is generally not subject to the New Jersey Gross Income Tax. If the requirements of the Internal Revenue Code are met, income from stock acquired on the exercise of ISOs is treated in its entirety for federal tax purposes as capital gain from corporate stock that is intangible property. This presents tax savings opportunities for the employee that worked in New Jersey, but is a resident of a non-income tax state such as Florida or Texas at the time the holder sells the stock.

Practical Issues With Respect to Timing

Since the sale of the underlying stock from an ISO that has previously been exercised is deemed to be an intangible, employees should be advised of the tax advantages of selling the stock after a bona fide change of domicile which, provided that the federal holding and other requirements are met, results in the realization of income that can avoid state taxation.

For NSOs, since the income will be reported in the year of exercise, the proper treatment would be: withhold tax at the time of exercise, but based upon the location of the employee’s services at the time when the options were earned.

Employer Withholding

Practitioners advising employers should be aware of the basic requirement for withholding for an employee changing residence.

Although the Division has not addressed this issue in an across the board Regulation, a generally strict policy is followed. For New Jersey and Pennsylvania, a resident changing residence to the other state must file an Employee's Certificate of Non-residence within 10 days of the change. For other states, the employee would file only Form NJ-W4 where he or she would indicate change of residence. These Forms declare, under penalties of perjury, the new state of residence.

The key question is the degree of reliance that the employer can place in the information provided by the employee as to their residency status. While there is no specific New Jersey regulation, in general there would be a high degree of scrutiny of the employer withholding, particularly if a senior executive of the company were to change residence and the employer had actual knowledge that the statements as to residency were not reliable

Stephen J. Bercovitch, J.D. is the Director of the SALT (State and Local Tax) practice at Amper, Poliziner & Mattia, LLP He has extensive experience with all aspects of state taxes. He can be reached at 212-682-1600. Michael S. Maglio is the Director of Amper's Corporate Executive Services Group and has broad expertise advising senior executives of large public companies. He can be reached at 908-218-5002. The firm renders tax, auditing and accounting advice for business and personal clients. For more information visit www.amper.com.