How to apply tax treaty to stock option income on 1040NR

WomanOnTheMove · Post by **WomanOnTheMove** » Mon Feb 27, 2012 9:09 pm

My husband was granted non-qualified stock options as a U.S. resident alien working for a U.S. company. He subsequently transferred employment to the companyâ€™s Canadian affiliate and exercised the options as a Canadian resident (and U.S. nonresident alien).

Based on the fact that the entire vesting period happened during U.S. residency, the company reported 100% of the income generated to the IRS and withheld U.S. taxes. 100% was also reported to the CRA, and he received both a W-2 and a T-4 for the option income.

I understand that he is required to report only U.S. source income in the U.S. and worldwide income in Canada. I also understand that the Fifth Protocol of the tax treaty dictates that the option income should be sourced proportionally according principal place of employment.

My question is how he correctly reports the income and applies the treaty on the U.S. side. How does he remove the Canadian sourced income on the 1040NR from the W-2 income that he reports on line 8? Should he be using line 22 of the 1040NR? Is he required to attach Form 8833? Any tips would be greatly appreciated!

Example:

Suppose that he had $3000 option income. The company reports $3000 to the IRS, withholds taxes, and issues a W-2, so (at least to start) he would report $3000 on line 8 of the 1040NR.

However, if the grant date was 1 year before the move from the U.S. to Canada and the exercise date was 2 years after the move, the tax treaty says that he owes U.S. tax only on $1000 of the income because of the portion of the income that is sourced in the U.S. How would the terms of the tax treaty play out on the 1040NR and related forms?

nelsona · Post by **nelsona** » Mon Feb 27, 2012 9:46 pm

Seems to me the options are indeed 100% US-sourced. So he reports them on a 1040NR, pays the US tax, and then reports the income on his Cdn return, along with the tax as a credit.

WomanOnTheMove · Post by **WomanOnTheMove** » Mon Feb 27, 2012 10:47 pm

Thanks very much for your reply. What you write is quite interesting. Could you elaborate a bit on what drew you to this conclusion?

The reason I had been thinking that the income may not be 100% U.S.-sourced is the Fifth Protocol. The CRA website explains it this way:

"The income in question (the stock option benefit) will generally be considered to have been derived in a country to the extent that the individual's principal place of employment was in that country during the time between the granting of the option and its exercise (or the disposition of the share)."

Since his options were granted while his principal place of employment was in the U.S. and then his principal place of employment changed to Canada and after that he exercised the options, it seemed that under the Fifth Protocol the income would not be 100% U.S. sourced.

What am I missing?

nelsona · Post by **nelsona** » Tue Feb 28, 2012 10:58 am

No. You are correct.

You would report the US potion on 1040NR, with an 8833 to expalin why only a portion is being included.

All would be reported in canada, with any US tax (now lessened) as a credit.

No over-all savings.

WomanOnTheMove · Post by **WomanOnTheMove** » Wed Feb 29, 2012 12:15 am

OK. Thanks for the input!

playaz · Post by **playaz** » Thu Apr 05, 2012 2:46 pm

Anyone know how to input this into Turbotax? Since the income is on both the T-4 and W-2, I don't want to input the W-2 income since that would cause it to be added twice. But now, since I don't input the foreign income, then the foreign tax credit worksheet won't give me credit for tax paid.

Do I have to manually override the tax credit form?