Taxation Of Stock Options For Foreign Nationals Working In The U.S.

Forbes

07-05-2025

Stock options can be a lucrative form of compensation, but for foreign nationals who work in the ... More U.S., they present unique tax challenges. The U.S. retains taxing rights over income derived from U.S. employment, even after a person becomes an NRA. Understanding how the U.S. sources stock option income, potential double taxation risks, foreign tax credits and tax treaty possibilities are all critical for minimizing tax liability. getty
Many foreign persons are employed in America and are given stock options as an incentive by the companies for which they work. When a foreign national works in the U.S. and is granted stock options, the taxation of these options can become complex, especially if the individual later leaves the U.S. and becomes a nonresident alien for tax purposes. This article examines how the U.S. taxes foreign individuals on stock options received for work carried out in America and the tax issues they face after leaving the U.S. and becoming NRAs.
This article discusses non-statutory stock options , which are more commonly granted since they involve fewer restrictions and are easier to administer. When a taxpayer working in the U.S. is granted NSOs, there is typically no immediate tax liability. NSOs are not taxed at grant because these options generally lack a "readily ascertainable fair market value." As a result, taxation is deferred until the options are exercised.
It is worth noting that problems can arise if the option strike price is set below the fair market value of the shares at the time of grant or if the plan otherwise runs afoul of Internal Revenue Code Section 409A, which governs deferred compensation. In those cases, the employee might owe tax and penalties immediately, even without having exercised the options. This is why it is important that the compensation package be reviewed by a tax professional.
Options generally vest over time. A common schedule is four years with a one-year cliff. This means that no options vest until the employee has completed one year of employment. After that, 25% of the options vest, with the remainder vesting monthly or quarterly over the next three years.
The right to exercise the options is tied to this vesting schedule. Once vested, exercising the options triggers taxation on the difference between the fair market value of the shares at the time of exercise and the option strike price. The 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.
For the foreign national, the key issue is whether the U.S. still has the right to tax this income if the individual is no longer a tax resident when the option is exercised. The general rule is that compensation for services performed in the U.S. 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 U.S. regardless of where the individual is living at the time of exercise.
This 'grant-to-vesting' sourcing rule determines how much of the income should be treated as having a U.S. source. This sourcing rule compares days worked in the U.S. and outside the U.S. during the period between the date the options were granted and the date the stock options became exercisable (the vesting date). If, for instance, half of the vesting period occurred while the individual was working in America Youtube, then half of the income would be treated as having a U.S.-source and would be taxable by the U.S., even though the option was exercised after the individual became a nonresident alien.
Thus, even after leaving the U.S., foreign nationals may owe tax on stock option income tied to services performed while they were in the U.S. 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 Is Possible
A foreign country may also tax the stock option income. This means when the taxpayer leaves the U.S. and resides abroad, there is a risk of double taxation. Some countries tax stock options at exercise (in the same manner as the U.S.), 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 becomes complex and is best examined with an international U.S. tax professional. U.S. Tax Upon Later Sale Of The Stock
Once the taxpayer has purchased the stock by exercising the option, any future gain upon a later sale will be treated as capital gain. It is 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 1 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 U.S. 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 do not realize that it is possible to have lost the right to live in the U.S. under the immigration rules, but still be subject to U.S. taxation under the tax laws.
Example of Tax Savings
Elena, a foreign national living and working in America was granted 10,000 NSOs in January 2022 with a strike price of $10 per share, which matched 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, Elena 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 (7500 x $30 = $225,000 MINUS 7500 x $10 = $75,000). This amount is treated as ordinary compensation income on which Elena will pay U.S. tax at her marginal tax rate.
Later that year, assume Elena 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 Elena's services performed while in the U.S. remains taxable. If half of the vesting occurred during her performance of services in the U.S., then half of the $62,500 gain is treated as U.S.-sourced compensation. As an NRA, Elena 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, Elena 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 U.S. Stock Options And State Taxation
State taxation is a crucial consideration when employees receive stock options, particularly if they have lived or worked in multiple states before exercising the options. Many U.S. 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 possibility of great returns and can incentivize an employee. When stock options are granted to foreign nationals who work in the U.S., they present unique tax challenges.
The U.S. retains taxing rights over income derived from U.S. employment, even after a person leaves America and becomes an NRA. Simply leaving the U.S. does not make the tax issues disappear. In order to minimize tax, the taxpayer must understand how the U.S. sources stock option income, the potential double taxation risks, and whether any tax treaty provisions can apply.
Proper planning such as use of 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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This communication is for general informational purposes only. It is not intended to constitute tax advice or a recommended course of action. Professional tax advice should be sought as the information here is not intended to be, and should not be, relied upon by the reader in making a decision.