The Startup Employee’s Guide to State Residency and Resulting Tax Implications
Many startup workers unknowingly overlook a key influence on their tax responsibilities: their location.
Throughout the United States, there are currently states without income tax, states with income tax rates over 10%, and everything in between.
Clearly, the tax rules and regulations that you’ll follow when you exercise your stock options can change drastically depending on where you live, but it can also be impacted by your status as a remote worker or an out-of-state employee.
As it’s highly impractical to capture all of the tax nuances for all fifty states in a single blog post, we’re focused on introducing you to specific questions and terminology.
These will be useful when you meet with your company’s HR department or your personal financial advisor and plan the exercising of your stock options.
Am I a Full- Or Part-Time Resident of My State?
One effect of the COVID-19 pandemic is the ongoing increase in remote positions, especially for startup workers. According to research from McKinsey & Company [1], 80% of employees enjoy the ability to work from home and 41% report being more productive when working remotely.
Statistics like these are making many people think that the prevalence of remote work will only continue to grow.
Especially if you’ve transitioned into a remote role or recently moved to a new state, you need to consider the tax implications of what’s called your “domicile” or the legal, permanent residence that you return to after traveling.
For most states, your domicile depends on whether or not you’ve spent more than 183 days residing in that state [2].
If you’ve passed this 183-day threshold in multiple states, you may be classified as a dual resident and may be subject to dual taxation, but you also may receive a tax credit from one of the two jurisdictions.
Consulting with a tax professional will ensure your residency is handled correctly.
Do I Have to File and Pay Income Tax in Multiple States?
As a general rule of thumb, you should file for personal income taxes in the state where you reside [3], even if your employer is headquartered in another state.
But, as we’ve already discussed, this filing can be especially complicated for employees who regularly cross state lines for work.
In addition to the 183-day threshold, figuring out what state(s) you need to file in will depend on numerous other factors. These factors include [4]:
- Whether you stayed at the same job or you started a new one;
- How long you resided in another state and whether this length of time makes you a part-year resident or a nonresident;
- Whether or not the two states have a reciprocity agreement with each other; and
- If a state is listed on the W-2 you receive from your employer.
As you sort through your residency situation, be sure to look into the specific rules for the state(s) of which you are a resident; as with the income tax rates themselves, these regulations can vary wildly for each state.
Wait. What’s a Reciprocal Agreement?
A reciprocal agreement, also referred to as “reciprocity,” is an agreement between two states which (nearly always) are neighboring states. These agreements are intended to positively impact workers who regularly travel across state lines from their homes to their workplaces.
They allow residents of one state to request exemption [5] from tax withholding in the other state, which ultimately saves you the trouble of filing in multiple states.
Make sure you don’t mix up reciprocity with the “convenience of the employer” rule. If your resident state follows this rule, then they can only tax income that you earned in that state [6].
Currently, the states of Connecticut, Delaware, Nebraska, New Jersey, New York, Pennsylvania, and Massachusetts abide by this rule; however, some states (like Massachusetts) are only temporarily following convenience of the employer rules due to the COVID-19 pandemic, so definitely follow up with a tax professional for this one.
What About AMT? Does It Change at a State Level?
While the alternative minimum tax (AMT) – which we discussed in an earlier blog post – is a part of federal income taxes, some states also have their own individual AMT that you definitely don’t want to overlook. Currently, the states of California, Colorado, Connecticut, Iowa, and Minnesota have individual AMT rates in addition to the federal AMT.
Under the individual AMT, you may need to calculate your income tax liability in two different systems and, ultimately, pay the higher amount [7]. If you are a resident of the above states – especially if you are planning to exercise your stock options in the near future – be sure to bring this up with a tax professional.
What Happens if I’m Holding Qualified Small Business Stocks?
As we covered in our glossary, there are many specific rules related to QSBS. These must be stocks acquired from qualified small businesses that are domestic C corporations with assets totaling less than $50 million, among other regulations.
If you do have QSBS and you hold onto these stocks for more than one year after exercising – and two years after your grant date – you will be subject to pay only a portion of federal taxes, or you may be exempt from paying taxes altogether!
Tax exemptions for QSBS can change, depending on your domicile. Some states don’t allow QSBS exemptions at all (Alabama, California, Mississippi, New Jersey, and Pennsylvania) while other states only have partial conformity (Hawaii and Massachusetts).
Due to the intricacies of QSBS, it is essential that you consult with a tax professional when navigating this at the federal or state level.
This is a Lot to Keep Track Of. Are There Any States That Don’t Have Income Tax at All?
Yep! If you work and live in Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, or Wyoming, then you do not have to pay any income tax on wages [8]. Still, you are likely required to file a tax return so don’t assume that your home state lets you off the hook for both income taxes and paperwork!
Okay, I Get It. My Location Can Have a Huge Impact on My Taxes.
We know that this is a lot to take in! We recommend that you bookmark this blog post so it’s readily available to you in the future.
When you next meet with your tax advisor or your company’s HR department – especially if you’re working out the details of exercising your stock options – return to this page, impress the tax professional with your knowledge of state-by-state tax terminology, and then ask all of your nuanced follow-up questions.
[3] https://www.summitcpa.net/blog/remote-tax-filing
[5] https://ttlc.intuit.com/community/state-taxes/help/what-is-a-state-reciprocal-agreement/00/25612
[6] https://www.taxwarriors.com/blog/state-tax-implications-for-individuals-working-remotely
[7] https://taxfoundation.org/state-individual-alternative-minimum-tax-2021/
