Surprisingly, the number one reason why employees hold off on selling stock options is not because they expect the company's value to appreciate immensely, not even because they see a massive liquidation event in the near future, but instead because of the tax implications that an equity sale might have. Employee confusion around taxation on equity sales had become a leading force that has inhibited them from taking the full step to sell their shares.
Detailed information on the tax implications of stock options in both Israeli and U.S. jurisdictions has been provided, offering valuable insights for individuals employed by Israeli startup companies.
In Israel, Section 102 of the Income Tax Ordinance is significant for employees and executives, granting a reduced tax benefit of 25% under capital gains tax instead of the standard income tax rate, given specific conditions are met. To qualify, options must be entrusted to a trustee for 24 months, with the taxable event occurring upon liquidation, subject to a reduced flat Capital Gains tax rate of 25%.
Advisors and external service providers fall under Section 9.3, facing taxation at two points: upon exercise and again during liquidation. The initial taxable event is based on the gap between Fair Market Value and the exercise price, taxed as ordinary income. The subsequent event levies a 25% tax on the difference between the previous Fair Market Value at exercise and the selling price.
Dividend tax in Israel varies based on factors such as shareholder type, company structure, and residency. The "Wealth Tax," a 3% surtax, applies to individuals with annual income exceeding 651,600 NIS.
Under U.S. law, employees of Israeli startup companies are subject to U.S. tax if their options vested while working in the U.S. Two paths exist: Incentive Stock Options (ISO) and Non-qualified Stock Options (NSO).
ISOs offer tax advantages if held for at least two years post-grant and one year post-exercise. Taxes are incurred on the gain between the exercise cost and returns from selling shares after filing taxes for the sale year.
NSOs face taxation at two points, similar to Israel's Section 9.3. The first event taxes the gap between FMV and the exercise price as ordinary income, while the second event imposes a 25% tax on the difference between FMV at exercise and the selling price.
Navigating stock option taxation requires careful consideration of jurisdiction-specific laws and individual circumstances. Seeking professional advice is crucial to ensure compliance and optimize tax outcomes.
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