Hi,

I'm a German national who worked for a U.S. company from 1993 to 2003. During this time I received non-statutory stock options. I left the company in 2003 and moved back to Germany. In 2006 I exercised the stock options. Federal and state income taxes on the bargain element were withheld at the time of the exercise and I received a W-2 from my former company. I will file form 1040-NR, but I'm not sure on which line to report the proceeds from the option exercise.

Is the income considered "effectively connected with a U.S. trade/business", even though I was a non-resident for all of 2006 and did not work for the company during the year? If so, should the proceeds be entered on line 8?

Or, is this "income not effectively connected with a U.S. trade or business"? Would line 85 be the correct place to enter the amount in this case? What would be the appropriate rate of tax, i.e. which column of line 85 should be used?

Many thanks in advance!
Matt

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Originally Posted by matmei

Hi,

I'm a German national who worked for a U.S. company from 1993 to 2003. During this time I received non-statutory stock options. I left the company in 2003 and moved back to Germany. In 2006 I exercised the stock options. Federal and state income taxes on the bargain element were withheld at the time of the exercise and I received a W-2 from my former company. I will file form 1040-NR, but I'm not sure on which line to report the proceeds from the option exercise.

Is the income considered "effectively connected with a U.S. trade/business", even though I was a non-resident for all of 2006 and did not work for the company during the year? If so, should the proceeds be entered on line 8?

Or, is this "income not effectively connected with a U.S. trade or business"? Would line 85 be the correct place to enter the amount in this case? What would be the appropriate rate of tax, i.e. which column of line 85 should be used?

Many thanks in advance!
Matt

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You should have salary/compensation income. It is US source income.

I concur; the W-2 properly denotes the "bargain" element as salary and it should be reported as such on Form 1040NR.

However, if you sold the stock after exercising the stock options, you also need to account for that sale on Schedule D. It will probably show little gain, and may even show a loss after transactions costs are considered, but the IRS will notice if the stock sale is not accounted for on Schedule D.

I agree with Atlanta about the potential capital gain. But if you are a non-resident now, the capital gain component will be foreign sourced and you need not include it for US tax. I'm assuming that you were here on a visa and left and are now non-resident.

TaxSearcher:

Good point about the foreign-sourced capital gain. I was thinking like I do when I deal with stock option with everyday clients.

So what is the final answer ?

He should pay German capital gain tax and get all the withheld tax back ?

How does that work for state tax, if you are not a US resident what state tax do you pay ?

The final answer is that he does NOT have to file a U.S. return if no money was withheld.

He probably DOES have to pay German capital gain tax.

If money was withheld, he would have to file a return to get the withheld tax back, and wold probably have to show the IRS that he filed and paid German taxes on these capital gains.

I don't fully agree with ATE. There are two different parts in non-qualified options. You will have income on the exercise and this is US source income. You will have capital gain on the sale and this is foreign source income.

The initial difference between the exercise price and the strike price is considered compensation and was taxed when the option was exercised to get the stock. That part IS subject to U.S. and state income taxes PLUS FICA taxes (Social Security and Medicare). That's the first part that is U.S.-sourced income.

The second part is the capital gain, which I assume is on the stock that was received when the option was exercised and sold later at a capital gain. That, In my opinion, is foreign-sourced income IF the sale of the stock occurred after the owner returned to Germany.