Foreign Earned Income Exclusion after repatriation

Do you mean NQSOs are normally taxed when exercised?

What I've seen is that NQSO's are normally taxed when exercised.

Also, section (B) says

(B) Attribution to year in which services are performed For purposes of applying subparagraph (A), amounts received shall be considered received in the taxable year in which the services to which the amounts are attributable are performed.

Could they pro-rate the profits? So if he was granted the options in the foreign country and worked there for 2 years, and exercised the shares 3 years after moving back to the states while still working for the same big company, then 2/5 of the profits are foreign earned income. This pro-rate rule applies to stock options between states (ie. you are granted shares in CA, move to TX, what happens -- see "International tax treatment of deferred tax bonus payments").

Where is this two year period mentioned in IRC 911?

My understanding is that nonqualified options are taxed (to the extent the exercise price is below the market price at that time) at the time of receipt. Is that incorrect?

To the extent there is taxable income, yes. But I believe that they are also taxable when received, to the extent the market price exceeds the exercise price when received.

Under §911(b)(1)(B), foreign earned income (e.g. available for the exclusion) does NOT include amounts,

"received after the close of the taxable year following the taxable year in which the services to which the amounts are attributable are performed."

Stu

I've never heard of NQSOs being taxed except at time of exercise, and the board of directors almost always approves an exercise price equal to the FMV at time of grant.

I didn't exactly answer your question, but for practical purposes, NQSOs are set so there's no tax at time of grant.

When Enron or Worldcom executives attempted to backdate Board Minutes to reflect a different grant date, they ended up in jail for a mighty long time (though I think that was for ISOs, but same reasoning.)

Stuart: In the case of my colleague and I, we have NQ options. They are taxed as ordinary income when exercised. The income is calculated as the difference between market price at exercise and the grant (strike) price. This presents an awkward issue in this particular circumstance, as "receipt" of the grant is directly following service, but "recognition" of the income can be several years later (when the options are exercised).

Proration of the income seems like a sensible approach. However, you can also assert that the option had significant value on the day it was granted. Options have value; however one cannot sell employer- granted options, so it is difficult to determine this value. Proration would just allocate the "in the money" value of the option, which is easy to do, but not necessarily economically correct.

That sounds right to me. The stock is recognized in the year received - there just is no value there to tax at that time.

Which, for me, supports the notion that you can't extrapolate and say that profit received on the sale of stock relates back to the services performed for the receipt of the stock. The "income" for the services was received and recognized when rendered. Anything happenning after that time would be solely with respect to the stock.

One issue is, when is the income "received" for purposes of §911? If it's received on exercise of the option, if that's more than two years after the services rendered, then it doesn't quality due to §

If you want to argue that the income was "received" when the stock was transferred, it wouldn't qualify as earned income in the current year in any case.

I haven't researched this issue, so it could be there is some esoteric rule that I'm not aware of.

But it seems to me that income from these stock options was "recognized" in the year the options were granted - they just had no taxable value.

How would you propose to pro-rate this? Assuming you're a cash- basis taxpayer, income is recognized for tax purposes in the year received. If you're an accrual taxpayer it's recognized in the year accrued - which is when the services were performed. I don't see how you can get around that.

If it's worth a lot of money to you, get a tax lawyer to give you a formal opinion - it should cost between $5,000-$10,000 for a complete analysis. Without looking into it more deeply, I'd be skeptical that you'd win.

The latter would be a neat trick: "For work you do in 2009, you'll get paid 3% of the revenue received from that product for the next five years." How much accrues in 2009? Assume you don't do anything for that company after that.

The issue is similar for options: you can't accrue the income when earned, because the amount can't be known until later.

Seth

Thanks to Stuart, Art, Seth, Lanny and others for their views on this issue.

Let's change the facts to get away from the options. Say I am living overseas in 2010 and elect to defer salary in an executive compensation plan (a Rabbi trust). I repatriate and retire in 2011, and take the first distribution from the deferred compensation plan in

Thanks.