Connecticut’s Highest Court Upholds Tax on Nonresident Stock Options

In December 2016, the Connecticut Supreme Court issued a decision (Allen v. Commissioner) that may have far-reaching implications for the taxation of out-of-state residents. The court affirmed the taxation of all of the stock option income of an individual who earned compensation solely in, and as a resident of, Connecticut—despite the fact that the nonqualified stock options were exercised after moving to another state. The plaintiff had originally paid the taxes, but later sought a refund citing state and federal law.

The Case

Jefferson Allen, the plaintiff, was a Connecticut oil company executive at Tosco from 1990 to 2001—living and working solely in Connecticut. In 2002, Allen, then a resident of another state, exercised nonqualified stock options resulting in $7,633,027 in income. Allen filed a Connecticut nonresident tax return reporting this income and paid the applicable tax.

In 2005, Allen moved back to Connecticut to take a positon with Premcor Inc., where he also received nonqualified stock options.  With the company only 8 months, Allen again moved out of state and exercised stock options in 2006 totaling $43,360,812 in income and in 2007 totaling $2,247,745 in income. The plaintiff then filed a tax return and paid the applicable tax for 2006 and 2007.

In 2009, Allen filed an amended return claiming refunds for the income tax paid to Connecticut in 2002, 2006 and 2007. The refund claims were denied.

Federal Treatment

Federal tax law states that no tax is due when non-statutory options without readily ascertainable fair market value are granted. Most non-statutory options do not have readily ascertainable fair market value. However, the fair market value of the stock received on exercise, less the amount paid, is reported as ordinary income when the options are exercised. Subsequent appreciation (or loss) is generally treated as capital gain (or loss) when the stock is sold. That gain or loss is long-term if the stock is held for more than one year from the exercise date.

Taxpayer’s Position

Allen argued that the stock options income was only taxable if he was working in Connecticut when the options were both granted and exercised. However, the court held that the taxpayer need only perform the work in the state while the options were granted.

What This Means

Because states use a variety of allocation rules, and are looking for new ways to expand income streams to decrease budget shortfalls, it is imperative when dealing with potentially complex issues (such as deferred compensation, residency and nexus) that you develop a strategic plan with a qualified tax advisor in order to avoid surprises and potential pitfalls.