NSO Tax Rules for NRIs Working in US and India

Non-Qualified Stock Options (NSOs) give you the right to purchase a company's shares at a predetermined exercise price, often called the strike price. Once the options vest and become exercisable under the plan terms, you can generally exercise them by purchasing the shares at that price. These are flexible, as they can be issued to employees and non-employees alike, such as board members and consultants. The difference between the stock's fair market value and the strike price becomes subject to taxation when you exercise the NSOs.

Unlike qualifying Incentive Stock Options (ISOs), NSOs generally do not receive the same preferential U.S. tax treatment. For a typical NSO, the spread recognized on exercise is generally treated as ordinary compensation income. This is a common area of cross-border tax planning that many people get confused about. For U.S. tax purposes, NSO compensation received by a nonresident alien is generally sourced based on where the underlying services were performed during the applicable grant-to-vesting period. However, an applicable tax treaty and the specific facts of the compensation arrangement may affect the final U.S. tax and sourcing analysis. Keep reading further to know more about NSOs for NRIs. 

What are Non-Qualified Stock Options (NSOs)?

Non-qualified stock options (NSOs) are stock options that give the holder the right to purchase company shares at a predetermined exercise price. Depending on the compensation arrangement, they may be granted to employees and certain non-employees such as consultants or directors. 

In simple terms, suppose your employer allows you to buy shares at $10 per share. Later, when you decide to exercise the option, its price becomes $40 per share. So, in this case:

• $40 (market value) - $10 (exercise price) = $30 (spread)

Now, when you exercise the NSO, the $30 spread is generally what gets taxed as compensation. Also, the gains from the exercise will be added directly to your taxable income and taxed at your regular income tax rate, just like your salary.

Unlike Incentive Stock Options (ISOs), which have different U.S. tax rules and may receive special tax treatment, NSOs usually don't come with these benefits. Next, let's discuss more about how NSOs are taxed in the U.S.

How are NSOs Taxed in the U.S. for NRIs?

In the U.S., a non-resident alien is generally taxed on the portion of their NSO income that's associated with work you have actually performed there. Here's how the calculation actually works:

• NSOs are generally taxed when you actually exercise the option based on the spread.
• Spread is the difference between the fair market value and exercise price, which is treated as ordinary income under U.S. tax laws.
• A nonresident alien will only be taxed on the U.S. source portion of that spread. This portion is determined by the number of working days you physically spend in the U.S. during the period between grant and vesting.
• For an employee, the taxable NSO compensation may be included in wages and reported on Form W-2, with withholding determined under the applicable payroll and NRA rules. For nonemployees, the reporting and withholding treatment can differ depending on the nature of the services and applicable U.S. tax rules. 

Now comes the surprising part. Assume that during the vesting period, you didn't perform any service in the U.S., as you were granted options for a U.S. company's Indian subsidiary, entirely from India. In this case, the portion of the spread is usually treated as foreign-source income. If the underlying services were performed entirely outside the U.S., the related NSO compensation will generally be treated as foreign-source compensation for U.S. sourcing purposes, even if the company is U.S.-based. However, the final U.S. tax result should be confirmed based on the compensation arrangement and any applicable treaty provisions.

Moreover, for NRIs, the tax treatment becomes different. That being said, let's understand when NSOs get taxed for NRIs. 

When Are NSOs Taxable for NRIs?

For a typical U.S. NSO, the taxable compensation event generally occurs when the option is exercised, rather than merely when it is granted or vested. Indian ESOP taxation also generally arises in connection with exercise, subject to specific provisions and exceptions under Indian law. This matters a lot for planning:

• If you simply keep vested options sitting there, it won't create any tax bill. It means you can keep them untouched for years. 
• For a typical NSO, the taxable compensation event generally occurs when you exercise the option, with the taxable spread determined by the fair market value of the shares at exercise minus the exercise price. 
• A separate tax event kicks in later when you sell the shares, as a capital gain or loss. It is determined based on the difference between the value when you purchased them and the value when you sold them. 

For an NRA, gain from selling shares is generally not subject to U.S. federal income tax if the individual is present in the United States for fewer than 183 days during the tax year, subject to exceptions such as effectively connected income and certain special categories of gains. The 183-day capital-gain rule is separate from the Substantial Presence Test. 

So, it's clear that NSOs become taxable the moment you exercise them, and simply having vested options will not create any tax bill. Now comes another part: NSO taxation in India for NRIs. 

How Does India Tax NSOs for NRIs?

India follows a different approach for NSO taxation for NRIs. In India, an employee’s eligible NSO/ESOP benefit is generally taxable as a salary perquisite under Section 17(1)(d) of the Income-tax Act, 2025, based on the prescribed valuation rules. For tax years governed by the Income-tax Act, 1961, the corresponding provision was Section 17(2)(vi). For an NRI, however, the benefit is not automatically taxable merely because the option is exercised while the individual is in India. Indian taxability depends on residential status, where the underlying employment services were performed, whether the salary income was received, accrued, or deemed to accrue in India, and any applicable DTAA provisions.

However, there is an important point to keep in mind. For Indian tax purposes, an employee’s NSO/ESOP benefit may be taxable as a salary perquisite when the option is exercised. For an NRI, Indian taxability must be determined based on residential status, the source of the salary income, where the underlying employment services were performed, and any applicable DTAA provisions. The Indian analysis should not automatically be assumed to follow the U.S. grant-to-vesting allocation formula.

If the underlying employment services were performed entirely outside India, the NSO benefit may be outside the Indian tax net for some non-resident taxpayers. However, this cannot be determined solely from the vesting-period work location. The taxpayer’s Indian residential status, where the underlying services were performed, whether the income was received, accrued, or deemed to accrue in India, and any applicable DTAA provisions must also be considered. Where the NSO/ESOP perquisite is taxable in India and the payer has an applicable TDS obligation, tax may be withheld through payroll or by the person responsible for deducting tax, depending on the employment and compensation arrangement.

Apart from the tax event that occurs while exercising the options, a separate tax event generally arises when the shares are sold. The capital gain or loss is generally measured using the value of the shares at exercise as the starting tax basis, with the subsequent increase or decrease generally treated separately under the applicable capital-gains rules. For an NRI, Indian taxability depends on residential status, the source of the gain, the nature of the shares, the holding period, and any applicable DTAA provisions.

Moreover, if you sell the shares immediately after purchase, the second tax will typically be small. This happens because the sale price will usually be close to the value used to compute the first tax.

But the best thing here is that various tax treaties are designed to help prevent double taxation and may allow you to claim credit for eligible taxes already paid. That being said, let’s look at how these treaties help.

How Does the India-US Tax Treaty Help?

Article 16 of the India–U.S. tax treaty deals with dependent personal services. Where NSO income is treated as employment compensation, the treaty may affect which country can tax the income and whether treaty-based relief is available. The exact result depends on the taxpayer’s residence, where the employment was exercised, the employer, and other treaty conditions. Here is how it works:

• The U.S. may tax the portion of NSO compensation attributable to services performed in the U.S., while India may tax the portion that is taxable under its domestic source rules and applicable DTAA provisions. Therefore, when you worked in both countries during the vesting period, the two countries’ tax rules may overlap and require a detailed allocation and foreign tax credit analysis.
• For U.S. sourcing purposes, NSO compensation may be allocated based on the services performed in the U.S. and outside the U.S. during the applicable grant-to-vesting period. However, you should not automatically apply the same workday percentage to Indian taxation; Indian domestic rules and the India–U.S. DTAA must be analyzed separately.
• If you are eligible to claim a foreign tax credit in India for U.S. tax paid on income that is also taxable in India, you must submit the prescribed foreign tax credit statement within the applicable timeline. For tax years governed by the Income-tax Act, 2025, Form 44 is the prescribed statement for claiming foreign tax credit under Rule 76 of the Income-tax Rules, 2026. Form 67 applied under the earlier Income-tax Rules, 1962.
• For tax years governed by the Income-tax Act, 2025, an eligible resident assessee claiming foreign tax credit must furnish Form 44 under Rule 76 of the Income-tax Rules, 2026 within the prescribed timeline. The current rules generally require Form 44 to be furnished within 12 months from the end of the relevant tax year in which the corresponding foreign income was offered to tax in India, subject to the applicable conditions and special rules.
• You may need to provide details such as the amount of foreign income, the country where you earned it, how much tax you paid there, and supporting documents such as your W-2 or a foreign tax certificate.

Keeping proper records can also be helpful here, including travel dates, calendar notes, and details of the places where you worked. If either country’s tax department asks questions, this evidence can help establish the allocation and support your foreign tax credit claim. Without these records, it may become difficult to defend the claim.

There’s a very common situation that many people encounter and find confusing: moving between countries during the vesting period. Let’s understand what happens in such situations.

What Happens If You Move Between India and the US Mid-Vesting?

It's one of the most commonly confusing questions and the most stressful situation. There can be two situations; let's understand both:

Situation 1: If you got your options while working in India, then moved to the US before they vested. 

• In the US, you will be taxed on the part of the profit connected to the days you worked there during the vesting period.
• If you are an Indian tax resident when you exercise the options, the Indian tax treatment depends on your residential category, the source of the NSO income, the services underlying the compensation, and any applicable treaty provisions. An ROR, RNOR and NR can have different Indian tax outcomes. 
• Make sure the NSO income is allocated correctly and then determine whether foreign tax credit or treaty relief is available in the country where the same income is also taxed. The amount and availability of credit depend on the applicable domestic law, treaty provisions and eligibility conditions.

Situation 2: If you got your options while working in the US, then moved back to India before vesting or exercising.

• Any portion connected to US workdays will be taxed in the US, even after you leave the country. It's because you earned that income while you were physically working there.
• Conversely, in India, your residency at that point will be considered for tax purposes. Now, this will create overlap again, but it can be addressed through proper divisions and tax credits. 

Even with careful preparation and smart planning, NRIs often make common mistakes with NSOs. Therefore, we will next learn about these common mistakes.

Common Mistakes NRIs Make with NSOs

Here are some common mistakes that NRIs make with Non-qualified stock options (NSOs):

• Assuming that only your residency at exercise matters: For a U.S. nonresident alien, the U.S. sourcing analysis generally looks at where the underlying services were performed during the applicable grant-to-vesting period. However, if you become a U.S. tax resident, worldwide-income rules and any applicable treaty provisions must also be considered. 
• Not Keeping Track of Your Workdays By Country: It's important to keep a clear record of everything. Without it, properly dividing your income between the US and India and claiming the appropriate tax credit becomes very difficult to prove.
• Mixing Up NSOs With Incentive Stock Options: There are various stock options with completely different rules that may include additional taxes and may vary in holding requirements. So, don't simply assume that NSO rules apply if your grant is the other type.
• Neglecting the Second Tax Event That Occurs When You Sell: Apart from the tax when purchasing the shares, selling them triggers its own separate capital gains calculations in both countries.
• Employer withholding mistakes: If U.S. withholding does not reflect the correct taxable U.S.-source portion of your NSO compensation, review the payroll reporting and withholding with your employer. Where appropriate, a corrected Form W-2 or a refund claim through the U.S. tax return may be necessary. 
• Not filing the prescribed foreign tax credit statement: For tax years governed by the Income-tax Act, 2025, eligible resident assessees claiming foreign tax credit should comply with Rule 76 and furnish Form 44 within the prescribed timeline. Form 67 applied under the earlier rules. 

Tax Planning Tips for NRIs with NSOs

Here are a few tips that will help NRIs with NSOs:

• Keep day-by-day records of exactly which country you were physically working in during the entire vesting period.
• Ensure you plan the timing of your option purchases around any bigger change in your tax residency. Your overall tax bill may be significantly affected if you exercise in a year when you expect a change in your residency.
• If you take a treaty-based position that overrides or modifies U.S. tax law in connection with your NSO income, Form 8833 may be required to disclose that position, subject to the applicable exceptions. The filing requirement should be confirmed based on the specific treaty position being claimed.
• Rather than reviewing separately, get both your US and Indian tax situations reviewed together. If you get your US situation reviewed by someone who understands India's rules, and vice versa, each will give advice for their own country. But, when you consider their advice together, it will still add up to the wrong result entirely. Hence, get it reviewed together. 

Lastly, to recall and clearly understand everything at once, let's look at an example of someone who moved from India to the US during vesting.

Conclusion

NSO taxes for NRIs may seem confusing as both India and the US follow completely different approaches to decide who gets to tax your income. The US counts your workdays while India looks at your residency. To get it right, you mainly need to keep proper records of everything and know exactly where you were physically working during the vesting period. 

Also, you must have your US and India tax situations reviewed together if you are holding NSOs and expect a change in your residency before exercising, or have already had a change mid-vesting. Do not simply assume that you can get the correct result by assuming the standard default treatment. Moreover, if all of this feels stressful to handle on your own, contact an expert at Savetaxs. 

At Savetaxs, we have a team of experts who can help you correctly divide your income and claim the benefits available to you under the treaty. Our team will help you ensure that both sides of your tax returns align accurately from the start. Reach out to Savetaxs before you file and ensure accuracy at every step of the way.