How Does California Tax My Stock Options?

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If you work in tech in California, chances are stock options are a significant part of your compensation. But with this valuable benefit comes a key question: How does California tax my stock options?

The answer depends on the type of stock options you have, when you exercise them, and whether you sell the shares. Since California has some of the highest income tax rates in the country, understanding how stock options are taxed can help you plan ahead and avoid unexpected tax bills.

If you are a tech professional interested in learning how we can help you claim your financial independence by investing wisely, minimizing taxes, and maximizing your equity compensation, please book a no-obligation call here.

In our insightful video below, we break down the tax implications of Non-Qualified Stock Options (NQSOs) and Incentive Stock Options (ISOs), covering everything from exercising options to selling shares. It explains how income tax and capital gains tax impact your finances and helps you discover essential strategies to maximize your savings.

Types of Stock Options and Their Taxation in California

1. Incentive Stock Options (ISOs)

ISOs are typically offered to employees as part of a company’s compensation package. They come with tax advantages at the federal level, but California doesn’t always align with those benefits.

When You Exercise ISOs

Federal Tax: Exercising ISOs doesn’t trigger regular income tax but can trigger the Alternative Minimum Tax (AMT).

California Tax: Unlike the federal system, California does not recognize AMT adjustments. However, exercising ISOs does not create a state tax event unless you sell the shares.

When You Sell ISO Shares

Holding for Over a Year After Exercise and Two Years After Grant (Qualifying Disposition)

Federal: You pay long-term capital gains tax on the difference between the sale price and the grant price.

Example: If you exercise at $6, hold for over a year, and sell at $10, your $9 profit is taxed at lower long-term capital gains rates federally (15%-23.8%).

California: You pay California capital gains tax, which is the same rate as ordinary income tax (up to 13.3%). Unlike federal tax rules, California does not have lower capital gains rates.

Selling Before Meeting the Holding Requirements (Disqualifying Disposition)

Federal: The bargain element (difference between exercise price and fair market value at exercise) is taxed as ordinary income.

California: The same bargain element is taxed as ordinary income, subject to the highest state tax rates.

For more insights on maximizing your equity compensation, check out this blog.

2. Non-Qualified Stock Options (NSOs)

NSOs are more common than ISOs and are often given to employees, consultants, and board members. They do not receive favorable tax treatment at the federal level or in California.

When You Exercise NSOs

Federal Tax: The difference between the strike price and the fair market value at exercise is taxed as ordinary income.

California Tax: The same bargain element is taxed as ordinary income at California’s progressive tax rates (which can be as high as 13.3%).

Example: If your strike price is $1 and the stock is worth $6, that $5 difference is taxable income.

Since this counts as income, you’ll pay:

Federal and state income taxes

Payroll taxes (Social Security & Medicare)

Your company will withhold 22% for federal taxes, but if you’re in a high tax bracket, you may owe more when you file next year.

When You Sell NSO Shares

If you sell your shares after holding them for more than a year, you’ll pay long-term capital gains tax federally.

However, California taxes all capital gains at ordinary income tax rates, so the benefit of holding long-term is reduced.

Example: If you sell for $10 and the stock was worth $6 at exercise, the $4 gain is taxed at capital gains rates (15%-23.8% federal, plus California state tax up to 13.3%).

Tip: If you sell within a year of exercising, you’ll owe higher short-term capital gains tax, which is the same as income tax. Holding for over a year means lower federal capital gains tax—but California still taxes it as regular income.

3. Restricted Stock Units (RSUs)

While not technically “options,” RSUs are a major part of equity compensation in tech. They are taxed differently than ISOs and NSOs.

When RSUs Vest

Federal Tax: The value of the shares at vesting is treated as ordinary income.

California Tax: The full fair market value at vesting is taxed as ordinary income.

When You Sell RSU Shares

Federal: If you hold for more than a year, you pay long-term capital gains tax.

California: Regardless of how long you hold, all capital gains are taxed at ordinary rates.

California Residency and Stock Option Taxes

One challenge with stock option taxation in California is state residency rules. Even if you move out of California, the state may still tax part of your stock option income if it was earned while you were a resident.

If you exercise ISOs or NSOs after moving out of state, but earned them while living in California, California can still tax a portion of the income. The same applies to RSUs—if they vest while you are a non-resident but were granted while you lived in California, you may owe state taxes on a prorated portion.

Tax Strategies to Reduce Your California Tax Bill

1. Time Your ISO Sales Strategically

If you exercise ISOs, holding the shares for at least one year after exercise and two years after grant can help you avoid ordinary income tax at the federal level. However, since California taxes capital gains at ordinary rates, the benefit of this strategy is limited for state tax purposes.

2. Plan for RSU Taxation

Since RSUs are taxed as ordinary income at vesting, some employees sell a portion of their shares immediately to cover taxes. If your RSUs vest in a high-income year, consider other tax strategies to offset the impact, such as maximizing 401(k) and HSA contributions.

3. Consider Moving Before Exercising or Vesting

If you plan to relocate, exercising options or allowing RSUs to vest after leaving California could reduce or eliminate state tax liability. However, California has aggressive tax rules, so consult a tax advisor before making a move.

4. Use Charitable Giving to Offset Tax Burden

Donating appreciated stock to a donor-advised fund (DAF) or directly to charity can help reduce taxable income while supporting causes you care about.

5. Work with a Financial Advisor

California’s tax system is complex, and mistakes can be costly. Working with a financial advisor who understands stock options and California tax laws can help you make the most of your equity compensation.

Next Steps For You

If you’re wondering how to minimize your stock option taxes, a financial advisor can help you create a strategy tailored to your situation. Want to chat about your equity compensation and tax strategy? Reach out today.

How Does California Tax My Stock Options?

Types of Stock Options and Their Taxation in California