Is there a startup stock options tax?

Before we answer whether there is a stock options tax, let’s first talk about what the heck stock options are – and how they work in the context of a startup. 

You’ve probably heard the term stocks and shares loosely thrown around to describe an array of different financial activities. Options are part of that world of financial investment. But there’s an important difference between owning shares and owning stock options. 

How do Employee Stock Options work?

Employee Stock Options are offered to lots of startup employees as a type of equity compensation. They’re often part of the benefit package when you join a company. As someone with ESOs, you have the option to buy the company stock at a set point in the future and for a set price. 

The main benefit of being compensated with an ESO comes if/when the company (and so the stock) grows in value. If this happens, you’re able to buy the stock at a significant discount compared to other investors at that time.  

Do you have to pay tax on exercised stock options?

In short, yes. (Sob.) 

First things first, what does it mean to exercise stock options? The exercise price is basically the discounted price that you’ve agreed with the employer to buy the stock. When you exercise, you buy the stock you optioned at the agreed discounted rate. But you (normally) won’t pay Income Tax or National Insurance on the difference between the exercise price and current value of the stocks. Hurray!

This is because ESOs are often offered through certain tax-efficient schemes. Take a look 👇 

• Share Incentive Plans (SIPs)
• Save As You Earn (SAYE)
• Company Share Option Plans
• Enterprise Management Incentives (EMIs) 

The only tax you may have to pay is Capital Gains Tax, but this is only when you sell up and if your profit is more than the £3,000 CGT allowance. Read more on Capital Gains Tax liabilities via HMRC online.

Do CEOs pay tax on stock options?

Yes. A CEO will pay the same tax on stock options as other employees. 

And what about RSUs – how are they taxed?

A Restricted Stock Option (RSU) is another form of equity compensation. They aren’t the same as stock options but are a very popular way to compensate employees nowadays, especially those working in big tech companies. 

Startups have historically preferred stock options as part of their benefit package, but with the growth of big tech, there’s been a shift towards paying in RSUs instead. 

Unlike stock options, RSUs are not an opportunity to buy at a discounted rate but a promise to give employees shares at a certain event. There are two dates to bear in mind:

1. Grant date – when the shares are promised to you
2. Vest date – when they’re available and can be sold

What’s an example of an RSU in practice?

You work for Google and you’re granted 200 RSUs on starting there. 20% vests every year over a five year total period. This means you can sell and profit from 40 (20% of the 200 total) RSUs every year. If you sell immediately, the value will be added to your salary. 

But if you choose to hold onto the shares after they vest and profit from them – which most people do – your tax situation becomes less favourable. Here’s why 👇

• You pay Income Tax and National Insurance – and your RSU earnings may push you into a higher tax bracket
• You’ll likely owe Capital Gains Tax and have to file a tax return

Check out our CGT calculator to see what you might owe from your profits.