How Elon Musk pays taxes in Texas and California

Elon Musk had a pretty good 2020.

Tesla has just entered the S&P 500. The electric car maker’s share price is up over 600% this year, causing Musk’s net worth to surge to $ 157 billion and removing Bill Gates as the world’s second richest person. And Musk recently moved to Texas, one of nine states that don’t levy income taxes on their residents.

But this move towards an income tax-free state does not necessarily mean that it is completely off the hook. Because of Musks’ complicated compensation package and the nuances of California tax law, he is likely to continue paying income taxes to the Golden State for years to come.

Musk’s 2018 compensation deal with Tesla is expected to result in a massive payday once it hits ambitious performance targets. Due to the structure of the package, Musk will likely have to pay California taxes on part of that payout.

Additionally, he may still have to pay taxes on work he did in California that year, as well as foreign income taxes on future work he physically does in a California factory.

To get a feel for just how much Musk could still owe California taxes, Insider looked at SEC filings detailing how Tesla is compensating Musk and spoke to a tax professional. Tesla did not immediately respond to the request for comment.

Musk compensation package

To understand what taxes Musk has to pay, we must first look at how he paid.

In 2018, Tesla announced a new compensation plan for Musk. The new plan essentially removed any guaranteed compensation – such as salaries or bonuses – and moved all compensation into a complicated long-term stock incentive plan.

Elon Musk

Musk’s unusual compensation package makes its tax position difficult.

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Musk’s Incentive Plan gives him a variety of stock options that vest or are available to buy Tesla stock at a fixed price if the company has a combination of operational goals – steadily increasing sales and earnings targets – and the market achieves capitalization targets that require Tesla shares to hold a certain price over a certain period of time.

If you’re interested in a more detailed breakdown of the plan, read more here.

The goals set were aggressive, but Musk has already unlocked four of the twelve “tranches” or option blocks in the agreement.

When each tranche is unlocked, Musk will gain access to 8.44 million options, giving him the right to buy Tesla stock for $ 70 per share. According to Insider analysis, the fourth tranche alone would have been worth more than $ 3 billion at the time of its release.

Ultimately, the option award is likely to result in billions of dollars for Musk. Taxing option premiums can be complicated, however, and becomes even greater when calculated in two different states.

Stock options like Musk’s are only taxed when he uses them

Musk’s move to Texas means he won’t have to pay any income taxes as the state doesn’t have an income tax liability. But Musk’s tax position is probably not that simple.

In California, stock bonuses, such as those included in Musk’s compensation package, are taxed as income, Seth Pardee, a partner at Coblentz Patch Duffy & Bass LLP’s law firm in San Francisco, told Insider.

The timing of stock bonus taxation is key to a situation like Musk’s. Option awards that are required to be exercised are taxed in California when the options are used to actually purchase stocks – this is also known as the “exercise” of the option.

In essence, this means that even if Musk controls billions of dollars in options this year, those options will not be taxed until he actually exercises them and uses them to buy the stock to which he is entitled.

There are currently no records with the SEC showing that Musk exercised options in connection with the compensation plan and would not yet owe California income tax on them. This means that Musk will only be taxed by California this year on the salary he received due to minimum wage requirements (which he never accepted).

Elon Musk

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If Musk exercises his options, even now that he has moved out of the state, California will tax Musk on a portion of his resulting income by prorating the options granted while he was in California, Pardee said.

This means that the state will calculate the time between the grant date, January 21, 2018, and the option exercise date, dividing the number of days it worked in California during that period based on the total time between the grant and exercise according to Pardee. That fraction of Musk’s income from exercising his options would then be subject to California income tax.

With just a little over a week left to 2020, Musk is unlikely to exercise its options this year. But the day will very likely come when he will have to pay a lot of money to California.

While Musk’s move to Texas doesn’t exempt him from California income taxes for his time in the Golden State, he is cutting his taxes long-term as he continues to unlock his tranches in a state with no income tax.