Tax Notes

Given the recent news of Elon Musk exercising over 21 million Tesla shares, worth roughly $22 billion,1 coupled with his departure from California at the end of 2020,2 it is a good time to examine California’s complex income sourcing rules for nonresidents, particularly its treatment of equity-based compensation. California’s sourcing rules for compensation such as incentive stock options (ISOs), nonqualifying stock options (also known as nonstatutory options) (NSOs), and restricted stock units (RSUs) highlight the longrange reach of California’s taxing authority. Further, the decision of the Office of Tax Appeal (OTA) in Appeal of Prince3 provides additional insight on California’s ambiguous nonresident sourcing rules for equity-based compensation.

This article will discuss the basic mechanics of California’s taxation of nonresidents, specifically related to equity-based compensation. It will analyze Musk’s situation — based on publicly available information — as a case study of how the ambiguity in California’s sourcing rules can shift hundreds of millions of dollars in tax revenue in and out of the state. Finally, given that the ambiguity will likely lead Musk and countless other taxpayers to battle the Franchise Tax Board on how much, if any, income should be sourced to California, this article will highlight the state’s controversy process.

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