June 30, 2021

Global Tax Compliance with Incentive Stock Options (ISOs)

Incentive Stock Options (ISOs) can help motivate employees to drive company success. While ISOs can be a complex component of international tax, the benefits may still outweigh the costs associated.

We recommend conducting strategic planning and analysis whenever you have an employee working abroad. Contact us to discuss your company’s ISOs strategy. Below are just a few things to plan for regarding ISOs.

US Tax Treatment of ISOs

Like traditional stock options (or Non-Qualified Stock Options), ISOs do not get taxed when granted or vested. The US treats the spread between the exercise price and the stock market price as tax-deferred gain until the options are exercised.

To receive a favorable tax treatment, an individual must hold the stock for at least two years from the grant date and one year from the date of exercise. Favorable tax treatment consists of a long-term capital gain tax rate for all appreciation over the exercise price. Capital gain rates are lower than ordinary tax rates (at 0%, 15%, or 20%). This can present significant savings compared to Non-Qualified Stock Options (NSQOs) since those receive ordinary tax rates. 

An individual is not liable for Social Security and Medicare tax on ISO income, even with a same-day sale or any later disqualifying dispositions. Federal or state taxes do not get withheld on ISO exercises. Individuals should put money aside to pay their income taxes later on and evaluate whether to pay estimated taxes. 

Non-US Tax Treatment of ISOs

In most non-US Countries, ISOs are treated like non-qualified stock options (NQSOs). Meaning the spread between the exercise price and stock option price would be taxed at the date of exercise.  This may affect foreign tax credits, so we advise employees to begin ISO planning before the exercise and sell date.

Non-US Trailing Tax Liabilities from ISOs

Many non-US countries assess tax if the employee worked in the host country between the grant date and the vesting date.  This assessment may trigger a trailing tax liability, even if the individual is no longer in the country during the exercise or sell date. 

In this example, Samantha, a US citizen, was on a work assignment in China from 2018-2020.  After her return to the US in 2021, Samantha exercised ISOs granted in 2017 and vested in 2019.  China may assess a prorated trailing tax liability here because of her working in China between those dates.  A tax professional can ensure taxes are correctly paid in China and that she avoids paying twice in the US.

About Alternative Minimum Tax

One thing easy to overlook is Alternative Minimum Tax (AMT). AMT may still be a factor in the year of exercise after holding periods have been met. This is assuming the stock’s fair market value at exercise is larger than the option price.

If the stocks are sold the same year they were exercised, there will be no AMT adjustment. Tax basis for regular tax and AMT will differ when the exercise date and sale date take place in separate years.

For regular tax, the stock’s basis is the amount paid for exercising the option plus any compensation from a disqualifying disposition. For AMT, the basis is the stock’s fair market value on the date of the exercise. Therefore, when the stock sells, the amount of capital income will not be the same.  If AMT is assessed a year before the sale, a tax credit may lower the tax in the year of sale.  Some states, such as California, allow for an AMT credit for AMT state tax paid for in a previous year.

Conclusion

Incentive Stock Options (ISOs) have a special and complicated tax treatment worldwide.  Understanding the implications of holding periods and acting accordingly can create significant tax savings for a global employee. 

When working abroad with ISOs individuals should always evaluate for global tax planning and compliance. At Glomotax Consulting, we have tax experts in the employee home and host countries and can coordinate employee tax consultations. A tax consultation can lower employee stress, increase international tax compliance, and lower the employee’s worldwide tax liability.