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Is there a startup stock options tax?

  • 3 min read
  • 12 Dec 2021
Startups and 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. 

Shares

If you buy shares in a company, you automatically become a shareholder. You own a part of that company.

Options

If you buy options in a company, you have the right to buy a share of that company in the future at a preset time and price.

Derivatives

In the 🌎  of finance, an option is what’s known as a derivative – its value comes from (or is derived by) an underlying asset. Still with us? In the case of a startup, an option’s value comes from the shares of the company’s stock i.e. the value of the company.

And if you work for a startup, you may have been offered what’s known as Employee Stock Options (ESO). These are a little different.

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 👇 

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 £12,300 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. 

Your situation

Outlined number oneOutlined number one
How did you make money?
Profit from capital gains
Annual salary
?
Other income
?

Tax and profit

Outlined number two
  • Your profit from
    shares
    £20,000
    Incl. £12,300 tax-free CGT allowance
    ?
  • Capital Gains Tax to pay
    £1,413
  • Profit after tax
    £18,587

How your capital gains tax is calculated

Your total capital gains tax (CGT) owed depends on two main components:

  1. How much you earn in total
  2. What type of assets you sell

Your overall earnings determine how much of your capital gains are taxed at 10% or 20%.
Our capital gains tax rates guide explains this in more detail.

In your case where capital gains from shares were £20,000 and your total annual earnings were £69,000:

Capital gains tax (CGT) breakdown

You pay no CGT on the first £12,300 that you make

You pay £127 at 10% tax rate for the next £1,270 of your capital gains

You pay £1,286 at 20% tax rate on the remaining £6,430 of your capital gains

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