I see it's the top of the hour. For those of you just joining, welcome to today's webinar, US Taxation of Stock-Based Compensation Received by Nonresident Aliens. We're so glad you're joining us today. My name is Evette Davis and I am a Senior Stakeholder Liaison with the Internal Revenue Service, and I will be your moderator for today's webinar, which is slated for approximately 75 minutes. Now this webinar offers one IRS continuing education credit. Participants earn one IRS CE credit and related certificate of completion by attending the live broadcast for at least 50 minutes after the official start time and by answering at least three polling questions during the live broadcast. Please note, folks, that polling question example that we're going to do to test your pop-up blocker, well, that one does not count towards the polling question response requirement. 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We've included several technical documents that describe how you can disable pop-up blockers based on the browser you are using. We have documents for Chrome, Firefox, Microsoft Edge, and Safari for Mac users. You can access them by clicking on the materials drop down arrow on the left side of your screen. Okay, we're going to take some time now and test the polling feature, and this is your opportunity, folks, to ensure your pop-up blocker is not on so you can receive the polling question throughout today's presentation. Audience, please remember that this is an example polling question and does not count towards the polling question requirement of three to earn those the CE credit. Okay, here's the question. Do you know who your local Stakeholder Liaison is? A, for yes; B, for no; or C, what is Stakeholder Liaison? Take a moment, click the radio button that corresponds to your answer. Do you know your local Stakeholder Liaison? A, for yes; B, for no; or C, what is Stakeholder Liaison? All right, so let me give you a few more seconds to make your selection. Let's go ahead and see. Let's stop the polling now and let's see how the majority of you responded to the question. Okay, it looks like 56% of you respond, no, you do not know your local Stakeholder Liaison. Well, thank you for responding. Hopefully you received the polling question and you were able to submit your answer. If not, now's a good time to check your pop-up blocker to make sure you have it turned off. Side note, we will tell you at the end of this presentation how to find your local Stakeholder Liaison because we want you to know who that is. In reference to your pop-up blockers if you didn't get the polling question, we have included several technical documents that describe how you can disable pop-up blockers based on the browser you are using. Just click on the materials drop down arrow on the left side of your screen to download your browser document. Again, welcome. We're so glad you've joined us for today's webinar, but before we move along with our session, let me just make sure you're in the right place, and I think you are. Today's webinar is US Taxation of Stock-Based Compensation Received by Nonresident Aliens. This webinar is scheduled for approximately 75 minutes from the top of the hour. Today, folks, we are joined by speakers Dora Diaz and Andy Daxon. Dora has a Bachelor of Science degree majoring in accounting from San Francisco State University. She is certified as a public accountant in the State of California and she is currently inactive at this time. She has over 30 years of tax audit experience with 15 years dealing in international tax. Wow! She has worked with withholding and international tax compliance issues dealing with US persons and nonresident aliens. Currently, Dora is a Senior Revenue Agent with the US Business Activity Practice Network. Next, Andy Daxon; Andy is a Senior Revenue Agent with US business activity practice network in the LB&I withholding and international individual compliance practice area. Andy provides assistance to examiners training, facilitates workshops and network events, and develops LB&I campaigns with respect to Chapter 3 Withholding on and the taxation of fixed, determinable annual periodical income and effectively connected income compensation from employment, foreign athletes and entertainers, and income exempt under a tax treaty received by nonresident aliens. He is amazing. And Andy has worked with the IRS for 35 years folks, including 12 years in international practice area, five years in international individual compliance area of the LB&I business operating division, five years in SB/SE International and 13 years in regular exam. Ooh, we have some great folks here today. So without further ado, Dora, I'm going to pass it to you. Take it away. Thank you, Evette. Hello everyone. In this webinar we will discuss us federal income tax implications for nonresident alien individuals who receive stock-based compensation from US companies. We will begin with a brief overview of NRA taxation rules, explain the basics of stock-based compensation, explain when stock compensation is recognized and taxed, show you how to determine the source of stock compensation for nonresident taxpayers with simplified examples, and discuss potential income tax treaty implications. So, for today's webinar agenda, we are going to explain basic US tax rules related to the most common types of stock compensation received by nonresident aliens, demonstrate how nonresident alien’s taxable stock compensation is calculated, identify treaty implications related to stock compensation income, and highlight best practices for tax compliance for taxpayers. Next, we have our acronyms. I'll highlight the common ones we will be using in today's presentation: ECI refers to Effectively Connected Income; FDAP, Fixed, Determinable, Annual or Periodical; ISO, Incentive Stock Option; NSO, Non-qualified Stock Option; RSU, Restricted Stock Units. As most of you may know already, US citizens and resident alien individuals are taxed on their worldwide income regardless of where it is earned or sourced. However, NRAs are taxed differently. They are taxed on a territorial system, meaning only on income that is sourced to the United States and income that is effectively connected with the US Trade or Business. It's important to know the sourcing rules, which can be found in IRC section 861 through 865 and the related regulations to assist you in determining if income is sourced within or outside the US and in determining if the income is taxable in the US. For example, income from personal services is generally sourced to the location of where the services are performed. So, services performed in the US are generally considered US source and services performed outside the US are generally considered foreign source. For capital gain from the sale of personal property such as stock, the source generally is based on the residence of the recipient. Furthermore, there are generally two categories of income NRAs are subject to US tax. First, there is fixed or determinable annual or periodical or commonly referred to as FDAP income that is not effectively connected with a US Trade or Business. And the second category of income is effectively connected with a US Trade or Business, otherwise known as ECI income. Under section 871(a), non-ECI or FDAP income that is sourced within the US is taxed on a gross basis, meaning no deductions are allowed and income is taxed at a flat 30% rate or at a lower treaty rate or exempt from tax pursuant to an income tax treaty. This type of income generally refers to passive income such as interest, dividends, rental, royalty, gambling income, et cetera. For ECI, NRAs are taxed under IRC section 871(b) at graduated tax rates on their net taxable income, just like a US citizen or resident alien. When I refer to ECI, I'm referring to the wages paid as an employee while working in the US, income from a US sole proprietorship, flow through income from a partnership operating in the US, and so forth. Since ECI is taxed on its net taxable income. It means that deductions can be taken against that income as long as they are properly allocated and apportioned and a true and accurate tax return is timely filed. This is in contrast with the taxation of non-ECI income, FDAP income, which is taxed on the gross basis, meaning no deductions are allowed. Before we move on to discuss tax compliance with stock compensation, Evette, I think it's time for our first polling question. You've got it, Ms. Dora. I believe you are correct. Okay, audience, here we go with our first polling question, and this is a true or false question. True or False, Nonresident aliens are generally only subject to US tax on US source FDAP income and income effectively connected with a US Trade or Business. Select A for true or select B for false. Take a moment, think about what Dora just told us, and click the radio button that best answers the question. Now, folks, if you do not receive the polling question, just don't worry about that. It's okay. Please enter only the letter A or B that corresponds with your response using the ask question text box. You need to respond, your response is time stamped. Remember that you need to answer at least three polling questions while you're participating in the live broadcast from the official start time for at least 50 minutes to earn one IRS CE credit. That polling question example that we did at the beginning of the presentation does not count towards the requirement of three questions answered. I want to give you just a few more seconds to make your selection and if it didn't pop-up, submit your answer in the ask question text box. Use that feature to give us a response. Okay, right. Let's go ahead and let's stop the polling now and let's share the correct answer on the next slide. Okay and the correct response is a true. And this is amazing. This is good start. Looks like 86% of you responded correctly. I think that is awesome. So, Dora, you've got their attention. I'm going to turn it back over to you. Okay, thank you. Now let's review the basics of stock-based compensation. Many companies provide stock-based compensation, also referred to as equity compensation plans, share-based compensation to employees and others such as directors, consultants and contractors to be paid and reward them in stock or stock options in lieu of cash. And it's very common for US companies to include key nonresident alien employees, directors and executives in their stock compensation plans as more and more companies are using stock-based compensation as part of compensation package to attract and retain talent. By granting equity employees’ financial interests are aligned with those of shareholders, motivating them to work towards increasing the company's value. When dealing with stock compensation, it's often subject to a vesting period or conditions before it can be collected and sold by an employee. We will get into more details on what vesting means later. Next, let's take a closer look at the various types of equity compensation. Compensation that is based on the equity of a business can take several forms. This slide shows the common ones that many companies use. For today's session, we are going to focus on the two most relevant types that apply to nonresident alien individual recipients, which are Restricted Stock Units, RSUs, and Non-qualified Stock Options, NSOs. So what should an NRA consider if they receive stock-based compensation? When an NRA receives a stock compensation, they will need to identify the types of stock compensation received, when the income is recognized, what type of income it is, and how to determine if it is US source income or foreign source income. Let's review these factors more closely. Here are the key factors to consider regarding NRA US tax compliance related to stock compensation. As we mentioned earlier, an NRA is only taxed on compensation that is attributable to their personal services performed in the US under IRC section 861(a)(3). If the NRA did not perform services in the US to earn that income, the income is considered foreign source and likely exempt from US taxation. If the NRA performs services both inside and outside of the US, compensation would need to be allocated between the US and the foreign country on the basis that most correctly reflects the proper source of income under the facts and circumstances of the case. Commonly, allocation is done on a time basis between the US and non-US workdays to determine the portion of income that is US sourced. We will discuss the allocation rule in a later slide. Different types of stock compensation are subject to different tax treatments. The type of stock compensation will determine how much the income is recognized, when it is recognized, and how much is subject to US tax. Tax treaty consideration is an important step regarding the taxation of an NRA. An applicable income tax treaty may identify certain types of income that may be exempt from taxes or subject to a reduced rate of taxes based on a specific provision in a treaty. And whenever we deal with NRAs, depending on the type of stock-based compensation entered, withholding will need to be considered. Now that we understand what factors an NRA needs to consider, let's focus on the issuance of Restricted Stock Units, RSUs. As mentioned earlier, Restricted Stock Units, RSUs, is not an immediate transfer of stock but rather a promise to receive stock or cash in the future, deferred compensation. The employee typically pays nothing to acquire the stock since it is part of compensation. The company will specify what amount of stock each RSU is worth once it vests. The employee does not grant, does not gain any rights or stock ownership such as voting rights, or receive dividend payments until the shares are earned and issued. While the company has discretion, the standard vesting period for RSUs is three to five years. Stock settled RSUs result in the transfer of shares to the employee or non-employee by the employer. The employee does not receive any shares upon grant of the RSU. When the RSU vests, then the shares are paid or transferred to the employee. Cash settled RSUs result in a cash payment equal to the value of the underlying shares. The cash payment is made after the RSU vest and is includable in the employee’s gross income. Before we discuss the taxability of RSUs issued to NRAs, let's review the terminology of stock-based compensation. The terms and dates you need to understand for stock-settled RSUs are Grant Date, the Vesting Date, the Payment Date also known as the Transfer Date. The Grant Date is the date the company promises restricted shares of stock to employees or others. The Vesting Date is the date when the set schedule and restricted conditions are satisfied and the stock is eligible for the individual to take full control. The Transfer Date represents when the employer initiates payment of the shares or cash equivalent is paid out. At this time, the number of shares of stock to be transferred and the Fair Market Value of the stock become fixed and determinable. The stock is considered transferred for purposes of IRC section 83 and the Fair Market Value of the stock is includable in the employee's gross income as of this date. Next, let's discuss how RSUs are taxed. Generally, RSUs are not taxable at the Grant Date and generally are exempt from IRC section 451 and 409. At Grant RSUs are not considered property for purposes of IRC section 83 since no actual property has been transferred, therefore, no IRC section 83(b) election can be made with respect to the grant of an RSU. Typically, the value of the stock transferred is includable in the income of the employee upon vesting of the RSU and it is taxed as ordinary income, at federal and state tax rates with tax due once the RSU becomes vested and are assigned a value. Upon vesting, the Fair Market Value of the RSU is includable on the W-2 form. Next, let's discuss Non-qualified Stock Options, NSOs. The other common form of equity compensation offered by large companies as well as many startup companies is stock options. A stock option gives the recipient the right to buy a specific number of shares of company stock at a pre-set price, also known as the exercise price or strike price, that hopefully is lower than the current share price. Before it can become exercisable by the recipient, the stock option is generally subject to a vesting period. There are two types of stock options: Options granted under an employee stock purchase plan, or an incentive stock option (ISO) plan, which are statutory stock options. The other type is a non-qualified option, an NSO, which is a type of option that does not qualify for special favorable tax treatments; non-qualified referring to the tax treatment. The tax benefit for statutory stock options, such as an ISO plan, is that on the exercise, the individual does not pay ordinary income tax and FICA tax on the difference between the strike price at the exercise date and the market value. But it could trigger an AMT tax if it's not sold in the same year later. The taxpayer will pay capital gain tax on a later, on a later date. An NSO plan is basically a legal agreement between the employer and the employee. It spells out the terms under which the employer is willing to sell the stock options to the employee, the recipient. When the employee is granted an option, they receive the rights to purchase a certain amount of stock at a certain price, which is known as the exercise price, the option price, or the strike price, on or after a future date. The strike price is typically the same as the market value of the shares when the company makes such options available, also known as the grant date. The stock option is generally subject to a vesting period before it can become exercisable by the recipient. The vesting period is the period the employee must wait to own the stock options outright. When dealing with NSOs, the terms you need to be familiar with are the Grant Date, and the grant date is the date a company grants the stock option to an employee or contractor. When the employee can first buy and keep the underlying stock at the agreed price, the stock option is said to be vested or exercisable. Usually, the option holder must continue to work for the employer until the option vests. After the options are vested, the employee holds it unconditionally. He or she can exercise it even if they're retired, fired, or working for another employer. After the option vests, it becomes exercisable. They may only be for a limited period, after which the option expires and the employee loses the right to buy the stock at the option price. The exercise date is the date on which the employee elects to exercise their right to purchase the stock option at a predetermined price. And the spread is the difference between the Fair Market Value of the stock share at the date of exercise and the original exercise price, also referred to as the option price or strike price. Now let's move how NSOs are taxed. The tax treatment of NSOs is generally governed by IRC section 83 unless section 409A applies. A company's 409A valuation or Fair Market Value determines the strike price of an option. However, in the rare circumstances where the NSO has a readily ascertainable Fair Market Value on the date of grant, such as where the options are actively traded on an established market, they are taxed upon grant, and the recipient has ordinary income equal to the Fair Market Value on the date of grant of the option received less the exercise price paid. Because most compensatory NSOs do not have a readily ascertainable Fair Market Value on the grant date, they are not considered property on the date of grant under IRC section 83 and are not eligible for an 83(b) election. Therefore, the taxable event generally occurs when the NSO is exercised. The taxpayer would include in gross income the spread, the excess of the Fair Market Value of the option over the exercise price. As code section 83 treats the spread as compensation. The spread is characterized as ordinary income. The exercise of the NSO is income in the year of exercise and reported on the form W-2 for employees or Form 1099 for consultants. The new IRC section 83(i), enacted as part of TCJA, allows employees of certain privately held companies to elect and to defer payments of income taxes for up to five years. Evette, I think it's time for another polling question. Sounds like a great idea, Dora. Okay, audience, here we go with our second polling question. For recipients of NSO compensation, which of the following would usually trigger a taxable event in most cases? A, at grant date; B, at vested date; C, at exercise date; or D, at expiration date. Take a moment, think about what we just heard from Dora, and click the radio button that best answers the question. And remember, if you do not receive the polling question, please enter only the letter A, B, C, or D that corresponds with your response using the ask question text box. Your response again is time stamped. Audience, please remember you need to answer at least three polling questions and participate in the live broadcast from the official start time for at least 50 minutes to earn one IRS CE credit. That polling question example that we did at the beginning of the presentation does not count towards the requirement of three. I'll give you just a few more seconds. Read the question again, make your selection, or if you need to submit your answer in the ask question text box so you can use that feature if you didn't get the pop-up. Okay, I want to give you a few more seconds to make your selection. Okay, we're going to stop the polling now and let's share the correct answer on the next slide. And the correct response is C at exercise date. Now, let me see what percentage of you responded correctly. Okay, Dora, it looks like we have a correct response rate of 74%, so we need a little more clarification from you. Can you help us out with that? Why is C the correct response, Dora? Sure, Evette. You know, when you're dealing with NSOs, the vesting occurs at the exercise date. It's not -- if anyone chose the grant date, it's only -- that only applies if it's the Fair Market Value is ascertainable, otherwise, it's the exercise date; and the vesting date would only apply if it's an RSU. So hopefully that helps. Okay, awesome. Thank you so much, Dora. Hopefully that cleared up some confusion there, folks. All right, thank you, Dora. Andy, the floor is yours. Thank you, Evette. Hello, everyone. We're going to continue talking about the general tax rules on Restricted Stock Units and Non-qualified Stock Options. I am starting with the question of how are nonresident aliens taxed on the income from vesting in Restricted Stock Units and exercising Non-qualified Stock Options. Well, there are a few issues that we really need to determine and to know how much of the option income is taxable, the manner of taxation, and the rate of taxation. First, the character of the income needs to be identified to determine the manner it is taxed and at the rate it's taxed. If the character of the income is non-effectively connected FDAP income, it is taxed at a flat 30% rate under section 871(a)(1) of the code. If the character of the income is effectively connected income with a taxpayer's US Trade or Business, it's taxed under section 871(b)(1) at graduated rates described in sections 1 and 55. Second, the source of the income needs to be determined. The performance of personal services within the United States constitutes a trade or business within the United States, and the income received for such services is considered US source income. Therefore, if a nonresident alien's option income arises from personal services performed in the United States, the income should be treated as effectively connected income and taxed at graduated rates under section 871(b). Now, let's talk about how to allocate Restricted Stock Units and Non-qualified Stock Option compensation income. As Dora provided earlier, when employees exercise Non-qualified Stock Options, they recognize ordinary income on the option spread, which again is the difference between the market price of the stock at the date of exercise from the option price that was granted. As this option income is considered compensation for personal services for tax purposes, the treatment of the income depends on where employees perform their services. As Dora provided earlier, services performed in the United States are United States source income, which is effectively connected income. Services performed outside of the United States is foreign source income, which is not taxable to nonresident aliens. Therefore, nonresident alien employees are only taxed on the income attributable to services performed in the United States. So this rule seems simple, but it's a little difficult with respect to stock options, and this is due to several factors, including one, usually several years elapsed between the grant date of the option and the vesting date of the option; two, additional time may occur between the vesting date of the option and the actual exercise date of the option; three, during the time period between the grant date and the vesting date, a nonresident alien employee may work for the employer only in the United States, only outside of the United States, or both in and outside of the United States; and finally, fourth, after the vesting date, the employee may or may not remain an employee of the employer that granted the actual option. The regulations under section 861 provide a sourcing rule for such scenarios and whereby income received in one tax year is attributable to services provided in two or more other tax years. These are called multi-year compensation arrangements or deferred compensation arrangements. The percentage of time for which the employee worked in the United States during the applicable period determines the percentage of income that is United States source. The regulations provide that for stock options, the applicable period is the period between the grant date and the vesting date. Therefore, when an employee works both in and outside of the United States during the vesting period, the option spread for Non-qualified Stock Options and the Fair Market Value of stock at vesting for Restricted Stock Units is sourced based on the percentage of time spent working in each location. Although the exercise of the option constitutes a realization event and triggers this analysis, the applicable period ends on the vesting date, not the exercise date. Nonresident alien employees can defer the realization of income attributable to stock options by delaying the exercise of the option, but that cannot alter the way the income will be sourced. The percentage sourced to the United States is fixed from the day on which the option vests. As personal services are sourced to where they are performed, if personal services are performed both inside and outside of the United States during the vesting period of Non-qualified Stock Options, an apportionment must be made. Now, this apportionment is based on a time basis and it can be seen in Treasury Reg. 1.861-4(b)(2)(i), such as the number of days if the individual is an employee. As provided here on the slide, the US sourced compensation for employees from Non-qualified Stock Options are generally computed by multiplying the option spread by a fraction that contains the total days of services that were performed in the US as a numerator and the total days of services provided anywhere as the denominator during the vesting period. Note that if the nonresident aliens are not employees, the apportionment of the spread is based upon the facts and circumstances of each case. After nonresident aliens exercise their Non-qualified Stock Options, they own the stock or securities which are considered personal property for characterization purposes. Any subsequent disposition of the stock or securities by the nonresident aliens is characterized capital gain or loss from the disposition of personal property and is generally considered foreign source income under section 865 and not taxable to nonresident aliens unless the disposition of the stock is considered to be effectively connected income with the United States trade or business and you can see again section 871(b). As just mentioned, generally capital gain from the sale of securities by nonresident aliens is foreign source income. However, section 871(a)(2) provides that if a nonresident alien is in the US for 183 days or more in the same year, they dispose of capital assets, any gain from the disposition of the capital assets will be taxed at a rate of 30%, as they are considered to have a tax home in the United States. In this case, capital assets include stocks and securities. So, the question is, how can a foreign person be considered a nonresident alien if they are present in the US for 183 days or more in a year, as it would appear they meet the substantial presence test again, which is defined in section 7701(b)(3). Well, section 7701(b)(5) provides for the situation where foreign persons present in the United States for 183 days or more in a specific year are not considered resident aliens. This section provides that certain categories of foreign persons are considered exempt individuals for the purposes of the substantial presence test, and therefore their days in the United States do not count as days in the United States for purposes of the substantial presence test. These individuals mostly include foreign government related individuals, teachers, trainees, and foreign students, but may also include foreign athletes in the United States for charitable events. Therefore, this law would generally affect nonresident aliens who are employees of foreign governments, who are teachers, who are trainees, or who are students who are in the United States for 183 days or more in a specific year who are considered to be exempt individuals for purposes of the substantial presence test and who have capital gain income from the disposition of stocks or securities which may or may not have been obtained through a non-qualified stock option. And therefore, if nonresident aliens realize capital gain when they sell stock from exercising a stock option, the capital gain is foreign source income and not taxable. For comparison and a quick reference, here is a table that summarizes the key characteristics of Restricted Stock Units and Non-qualified Stock Options that we have been reviewing. I hope this will help clarify any confusion for some of you who have limited exposure to stock compensation issues related to nonresident aliens. Now, the table covers such issues as what is granted action required by the grantee, vesting, what is the exercise price, the taxation issues, and finally, the look back rule for sourcing. With that Evette, I think it's a good time to pause for another polling question. Thanks Andy. I totally agree. Okay audience, here we go with our third polling question. This is another true or false question. So, true or false, the allocation of employee stock compensation income subject to US tax is generally based on the days worked in the US during the vesting period over all workdays in the same period. Select A for true or select B for false. Take a moment. Review the question. Click the radio button that best answers the question. If you do not receive the polling question, please enter the letter A or B that corresponds with your response using the ask question text box. Remember, folks, your response is time stamped, so please remember that you need to respond to at least three polling questions and participate in this live broadcast for at least 50 minutes to earn one IRS CE credit. Again, remember also the polling question example we did at the beginning of this presentation, you've got it by now, does not count toward the requirement of three polling questions answered. I want to give you just a few more seconds so that you can make your selection or if you need to submit your response using the ask question feature, remember to enter your response using that ask question feature, letter A or letter B. Okay, let's stop the polling now, and let's share the correct answer on the next slide. And the correct response is a true, and I see that 88% of you responded correctly. Okay, I think we're on the right track, Andy. I'll turn it back over to you. Thank you, Evette. So, as with any tax-related issue dealing with foreign individuals, income tax treaty issues may arise. In the case of stock options, treaties between the United States and other countries may have provisions that impact the United States’ taxation of stock option compensation income, as treaties generally try to reconcile the difference between the two countries tax laws and provide equitable solutions to the taxpayers. One of the few treaties that specifically address stock compensation issues is the United Kingdom-United States Income tax Treaty. Under Article 14, which is titled Income from Employment, the look back period for purposes of sourcing stock option income, when exercised, is defined as being from the grant date to the exercise date. This is different from what we just reviewed. The Internal Revenue Code provides that the look back period is from the grant date to the vesting date. The difference in the definition of the look back period could mean a large difference in the United States taxation of stock option and compensation income if a nonresident alien worked outside of the United States after the vesting date. So, as you see in this situation, when dealing with nonresident alien taxation, it is important to determine if there are any treaty implications. So, to help bring all of these concepts together, we have two simplified examples: one for stock, -- excuse me, unqualified stock options, and one for restricted stock options. The first example here is where a non-qualified stock option compensation income allocation, where we're assuming that all of the options granted are vested on the same date, which is January 1, 2022, and all of the options are exercised by the nonresident alien on the same date, February 1, 2023. So, in this example, on January 1, 2019, Company B granted its employee nonresident Alien A Non-qualified Stock Options to acquire 1,000 shares of Company B stock for $5 a share and the options are exercisable any time after three years of service. So, on January 1, 2022, nonresident Alien A became vested in the options. During the vesting period, which is from January 1, 2019 through January 1, 2022, nonresident Alien A worked for Company B and performed 25% of his services within the United States and 75% of his services outside of the United States. For the 2022 and 2023 years, nonresident Alien A performed 100% of his services outside of the US and was not in the US for 183 days or more during those two years. So, on February 1, 2023, nonresident Alien A exercised all of the options at a Fair Market Value of $15 per share. On May 1, 2023, nonresident Alien A disposed of all of his shares in the stock of Company B that were exercised on February 1. So where do we begin to determine the taxability of these events or facts? First, we calculate any taxable income from nonresident Alien A exercising the Non-qualified Stock Options. To do this, we need to know the number of shares exercised, the spread and the source of the services provided during the vesting period. In this example, a total of 1000 shares were exercised. The spread, which again is the difference between the offer price per share, which is $5, and the Fair Market Value per share at the time of exercise, which is $15. Therefore, the spread is $10 per share in this example. The sourcing of nonresident Alien A’s services during the vesting period is 25% US sourced and 75% foreign sourced. Therefore, of the total spread of $10,000, which is the $10 per share spread multiplied by the 1,000 shares exercised, only $2,500 is taxable, as only 25% of the $10,000 spread is considered US source based upon the services performed by nonresident alien A during the vesting period. The $2,500 of compensation is considered effectively connected income and taxed at graduated rates. Second, we calculate the taxable gain or loss on the disposition of the 1,000 shares of Company B stock which were disposed of on May 1, 2023. Since nonresident alien A is a nonresident alien for tax purposes for the 2023 year and was not in the US for 183 days or more during 2023, the capital gain of $5,000, which is the difference between the $20,000 sales price and the nonresident alien’s basis of 15,000, is considered foreign source income and therefore not taxable. So hopefully this example helps clear up any questions on this issue. Now, using the same fact pattern from the example we just reviewed, the same allocation process is used to determine nonresident alien’s United States source income from investing in Restricted Stock Units. So here we have the same basic fact pattern again as the prior example, except it's a restricted stock unit example. The option was granted on January 1, 2019. The option included 1000 shares of Restricted Stock Units. The vesting period is three years, so the vest of or payment date is January 1, 2022 and the Fair Market Value of the stock is $15 per share on that date. During the vesting period from January 1, 2019 to January 1, 2022, nonresident Alien A performed 25% of his services for Company B in the United States and 75% of his services for Company B in other countries. In 2022 and 2023, nonresident alien worked entirely outside of the United States and again was not in the United States for more than 183 days or more. On May 1, 2023, nonresident Alien A sold 1000 shares of Company B stock for $20 a share. As this example deals with Restricted Stock Units, you must first calculate any taxable income from nonresident Alien A vesting and the Restricted Stock Units, and then whether there's any taxable gain on the disposition of the stock. In this example, nonresident Alien A vested in 1,000 shares of Restricted Stock Units on January 1, 2022, when the Fair Market Value per share of stock was $15. Therefore, the total value of compensation received from the shares vested in is $15,000. As with the Non-qualified Stock Options, the compensation has to be sourced. In this example, just like the other example, only 25% of the services were performed in the US during the vesting period, which was from the grant date of January 1, 2019 through the vesting date of January 1, 2022, therefore, only 25% of the 15,000 total compensation, or $3,750, is taxable to nonresident Alien A as effectively connected compensation income for 2022. Next, we have to calculate the taxable gain or loss on the disposition of 1,000 shares of Company B stock, which was disposed of on May 1, 2023. Since nonresident Alien A, again is a nonresident alien for tax purposes for the 2023 year and was not in the US for 183 days or more during 2023, the capital gain of $5,000, again, the difference between a $20,000 sales price and a $15,000 basis is considered foreign source income and therefore not taxable. So again, hopefully this example clears up any questions with Restricted Stock Units. So, as far as reporting of income from Restricted Stock Units and Non-qualified Stock Options, here are the general rules that are followed. For Restricted Stock Units income, employers generally will file a Form W-2 for the nonresident alien and include an income on the Form W-2 at the Fair Market Value of the Restricted Stock Units as of the date they vested. This Fair Market Value will be shown in boxes 1, 3 and 5 on the Form W-2. Additionally, employers often include in box 14 of the Form W-2 the letters RSU, and the value of the stock is included in Box 1, which is wage income. For Non-qualified Stock Options, employers generally will file a Form W-2 as well for the nonresident alien in the year the non-qualified stock option is exercised to report the taxable portion of the spread which is included as wage income on the Form W-2 in boxes 1, 3 and 5. The spread will also be shown in Box 12 with the code V for victor. As we mentioned earlier, nonresident aliens perform services both within the US and outside of the US during the vesting period may not see the correct amount of taxable income reported on the Form W-2 filed by their employer. This may be due to the employer not having sufficient information to calculate and report to the US source only income and instead reported the whole amount of the spread on the Form W-2 as income. Nonresident aliens may contact their employers to see if a corrected Form W-2 can be filed or the nonresident aliens will be required to report the taxable portion of the spread on their individual income tax returns and most likely attach a statement detailing why only a portion of the amount on the Form W-2 and not all of it, is taxable. Now, on the other hand, the employer may not report the spread at all on the Form W-2 if the employer was aware that the nonresident alien employee worked 100% of his or her time outside of the United States during the vesting period. It is essential to verify whether a foreign individual is a nonresident alien for federal tax purposes because nonresident aliens are generally only taxed on the US sourced income. If nonresident aliens perform personal services partly within the United States and partly in other countries, correctly applying source of income rules will require nonresident aliens to maintain proper travel and work records to compute the portion of income that is attributable to US source over the vesting period. For various reasons, employers may over report or under report or not report at all, all of the compensation element of United States source income generated from Restricted Stock Units or Non-qualified Stock Options. In these situations, income recognized in the current year has to be traced to prior years which are within the vesting periods. Therefore, nonresident aliens need to carefully review the Form W-2 received and if material errors are found, they may want to contact their employer to request an amended Form W-2 with supporting documentations. Again, as mentioned earlier, when dealing with foreign individuals, treaties may be a factor. Treaty benefits may be available to nonresident aliens who are residents of treaty countries with applicable treaty provisions that could exclude or reduce tax related to exercising stock options. Now, Evette, I think it's time for our last polling question. Okay, thank you so much, Andy. And we are close, Andy, to our last polling question. So here we go with our fourth polling question. Folks, you will need to select the answer that completes the following statement. The amount reported on Form W-2, Box 12, Code V represents: A, income from the vesting of RSUs included on W-2 Box 1 wage income; B, income from the exercise of NSOs included on W-2 Box 1 wages; C, income from vesting of RSUs not included on W-2, Box 1 wages; or D, income from exercise of NSOs not included on W-2 Box 1 wages. Okay, we've got some great information that we just heard from Andy. Hopefully you printed out the materials and you can go back and look at the information shared. Take a moment, think about what Andy said, think about what the materials, the PowerPoint that you probably printed out, look at that information and then click the radio button that best answers the question. If you do not receive the polling question, please respond using the ask question text box. And remember, enter only the letter A, B, C, or D that corresponds with your response. Folks, again, your response is time stamped. Please also remember, folks, that you will need to answer at least three polling questions and participate in the live broadcast for at least 50 minutes to earn one IRS CE credit. I want to give you a little bit more time to kind of mull this one over and reread it. The polling question example, let me remind you of that, the one that we did at the beginning of this presentation, it does not count towards the requirement of three credits or three questions answered. Okay, so look at the question and click the response that best answers this question. All right, let's close the polling now and see what the correct response is on the next slide. So, the correct response is B income from the exercise of NSO included on W-2 box one wages. And I see that 57% of you responded correctly. I figured this one might be a little bit tricky for us, so, Andy, can you shed some light on this? If you got some resources that you can share with us to help us out? Sure, I will try. So, if we remember back a couple slides, the slide was titled W-2 information reporting on Restricted Stock Units and Non-qualified Stock Options. For Non-qualified Stock Options, employers general will file a Form W-2 for the nonresident alien in the year the non-qualified stock option is exercised to report the taxable portion of the spread, which they include on the Form W-2 in the wage income box as well as – Box 1 as well as Box 3 and 5. And then this spread will also be shown in Box 12 with the code V for Victor. So that's where you'll see the in Box 12, the code V is for Non-qualified Stock Options. Okay. That is awesome. Thank you, Andy. Thank you so much. And I do believe you've got some additional information to share with us, Andy. Yes. So here you see some additional resources, including some IRS publications, the Pub. 519, 515, and 525. Also, the instructions for the Form 1040-NR, as well as the Form 1040 have some additional information. Also, on the IRS.gov website, in addition to the international pages. Also, there's a practice unit out there, titled Deferred Compensation Received by Nonresident Aliens that's pretty helpful, as well as some additional information on the slide. With that, Evette, I'll turn it back over to you. Thank you, Andy. I appreciate you and Dora. Okay, folks, it's me again, Evette Davis. And I'll be moderating the Q&A session. But before we get started with that session, I do want to thank everyone for attending today's presentation, US Taxation of Stock-Based Compensation Received by Nonresident Aliens. Earlier, folks, I mentioned that we want to know what questions you have for our presenters and here's your opportunity. If you haven't input your questions, there is still time, so go ahead and click that drop down arrow next to the ask question field. Type in your question and click send. Dora and Andy are staying on with us to answer your questions. Those questions will be selected by subject matter expert Henry Dong. Henry works alongside Dora and Andy as a Senior Revenue Agent. He graduated from the University of Michigan Law School and has been working for the IRS for more than 20 years with extensive knowledge and experience in international tax compliance issues related to nonresident alien individuals. He's been graciously working behind the scenes getting your questions, and he wants so that we can ensure that questions are directly answered and pertaining to today's presentation. I want to make sure those questions are addressed. One thing before we get started, folks, unfortunately, we may not have time to answer all the questions submitted, and I do see you've submitted some great ones, but we'll answer as many as we can possibly get to. So let's go ahead and get started with the first question. And Dora, I'll come over to you. Just looking at the questions, can you briefly explain the difference between ISO, NSO, and RSU just very briefly? Okay, Evette, you know, we really didn't talk much about ISOs, but ISOs are statutory stock options, and they have certain criteria and requirements and limitations and they're taxed when the stock is sold and they're going to be subject to the AMT calculation on the spread between the Fair Market Value and the strike price. NSOs we covered; those are the stock options that don't qualify for your ISOs. So you know, they're over the limitations or over the requirements that would fall under the ISO. And those are taxed again at exercise and those are going to be on the spread and it's taxed as ordinary income. And the spread, as we've been mentioning, is the difference between the Fair Market Value and the strike price. And RSUs, again, those are a promise that are granted to employees for specific number of shares and those are taxed when they vest. So, it's going to be on the value of the stock transferred and again, it's going to have the ordinary income character, it's going to be reflected on the W-2. Back to you, Evette. Thank you, Dora. Okay, Andy, I want to get to you quickly. So this question, this is a good one. If the foreign person never works in the US, will he or she still owe tax on stock compensation paid by a US employer? Sure. Let me aid the foreign person. So if the foreign person is a nonresident alien, and again, a nonresident alien is a foreign citizen that does not have a green card, does not meet the substantial presence test and hasn't made the first year election. It's all under section 7701. So, if this individual is a nonresident alien and has never worked in the US, either during the vesting period or any point in time, then the answer would be no. And again, the taxability of stock compensation is based on where the employee performed their services between the grant date and the vesting date. So, again, if they're never in the US, including between the grant date and the vesting date, then none of the compensation would be considered US source, it would be considered foreign source and would not be taxable to that nonresident alien. I hope that helps. Okay, sounds good, Andy. Thank you so very much. Okay, Dora, let me come over to you with this question. If capital gains from the sale of US stock are taxable, where will those gains be reported? That's a great question, Evette. So nonresident aliens typically are not subject to the capital gains tax because the sourcing is based on where the recipient resides. So, in this situation, if they are subject to the capital gains, then they're falling within the exceptions for the substantial presence test, as Andy mentioned. So, it's going to be reflected on the Schedule NEC. It's going to be subject to the 30% tax rate unless a lower treaty rate applies. And the other exception with regards to capital gains is if the income is related to effectively connected income. And if it is, then it would be reported on Schedule D, which would roll up to the Form 1040-NR. So I hope that helps. Excellent. All right. All right. Thank you. Thank you, Dora. Okay, folks, we're going to get to one more question. Andy, let me come to you very quickly. I have to get this one in. A nonresident individual sold stock two years after exercise of stock options through a US brokerage firm and received a 1099-B. Is the capital gain taxable to the US? That depends. So, capital gains and losses from the sale of stock are generally sourced to the residents of the seller. So, in general, if the nonresident alien does not reside in the US, then the capital gain or loss is foreign source and there would not be taxable. However, as I mentioned earlier, if the individual, the nonresident alien is one of those exempt individuals and is in the US for 183 days or more in the specific year where the stock is sold, then the nonresident aliens gain would be taxable under section 871(a)(2). So I hope that helps as well on that question. Thank you. Thank you, Andy. I appreciate you. Okay, audience, I know the time has flown by so quickly, but that's all the time we have for questions. And I do want to thank Dora and Andy for answering so many of your questions and for sharing their knowledge and expertise. Also, a virtual round of applause, please, to Henry for the support dedicated to today's webinar and for the selection of your questions. Before I turn it over to Andy, folks, we do have one final polling question and this is an attendance check, so please click the radio button that you see on the screen. And remember, if you do not receive the polling question, use that ask question text box to time stamp your response and just enter letter A. Remember, you have to have answer at least three polling questions while participating in this live broadcast from the official start time to get at least -- to get 50 minutes so that you can qualify for that one IRS CE credit. That polling question example we did at the beginning, you've got it folks, does not count. So please go ahead and click your response or enter the letter A. Thank you so much for responding. Let's stop the polling now. Thank you again for responding and participating with all our polling questions. Now I'll turn the mic over to Andy to quickly share some key points from today's webinar, a quick brief. Thank you, Andy. I shall go fast. So before we end this presentation, we'd like to provide you with a brief recap of the points, key points and takeaways. First, for nonresident aliens, the tax implication of stock-based compensation is complicated, as you heard. Generally Restricted Stock Units are taxable upon their transfer to the nonresident alien, which may occur on or after the vesting date, and Non-qualified Stock Options are taxable as compensation for personal services when they are exercised. Additionally, the income from the transfer Restricted Stock Units or from the exercise of Non-qualified Stock Options is sourced according to the multi-year compensation arrangement sourcing rules. Additionally, a compensation recognized under Restricted Stock Units or Non-qualified Stock Options is treated as a multi-year arrangement and should be sourced based on where the nonresident alien performs services between the date the options are granted and the date the options were vested. Nonresident aliens are generally not subject to taxes on capital gains from the sale of securities because the capital gains are considered foreign source income as they are based on residency unless the nonresident aliens meet the 183-day test in 871(a)(2). And while not common for treaty provisions, some treaties do have provisions that may offer tax benefits to nonresident aliens who are residents of treaty countries. Well with that, I think that wraps up the key points and the takeaways, Evette. Great job, Andy. Thanks so much to you and to Dora. We appreciate you our Senior Revenue Agents with LB&I Withholding Practice Network. We appreciate you. 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