ESOP - Employee Stock Option Plan Taxation In India (2024)

FAQs

How is ESOP taxed in India? ›

The period of holding begins from the exercise date and ends on the date of sale. In this case, short-term gains are taxed at income-tax slab rates, and long-term gains are taxed at 20% after indexation of cost.

If you receive a distribution from an ESOP before you are age 59 ½, the distribution will be subject to a 10% early distribution penalty tax (unless the distribution is due to disability, medical expenses, child support, or a few other exceptions).

In-Service Distributions for Diversification

If the fair market value of the participant's account balance is less than $500, the ESOP is not required to offer the opportunity to diversify. Qualified employees can elect to diversify up to 25% of the shares in their account each year, and up to 50% at age 60.

In general, you will be taxed on any stock you purchase through an ESPP during the year you sell it. It can be counted either as taxable income or as a deductible loss. The difference between what you paid for the stock and what you received when you sell it is considered a capital gain or loss.

ESOP accounting involves recording and disclosing the financial transactions related to ESOPs in a company's financial statements. The accounting treatment of ESOPs depends on various factors, including the type of ESOP, the vesting period, and the fair value of the shares.

They can only report the unadjusted basis, or what the employee paid for the stock. To avoid double taxation, the employee must make an adjustment on Form 8949. Warning: Do not use the box labeled “1g Adjustments” on Form 1099-B to make this adjustment; that is for something else entirely.

Thus, a 100% ESOP-owned S corporation does not pay federal income taxes, and in most states, it would not pay state income taxes. In essence, an S corporation owned 100% by an ESOP operates a for-profit business as a tax-exempt entity, which can provide a competitive advantage.

Tax Advantages

ESOP are taxed upon an employee taking distributions. Distributions taken by the employees under age 59½ are considered early withdrawals and would be subject to IRS mandated taxes, along with an early penalty tax of 10%.

The IRS has a concise explainer of vesting in retirement plans (like an ESOP). If you are not 100% vested in employer contributions to your account when you quit, you will only lose (forfeit) the percentage you have not vested in. So if you are 50% vested, you will lose 50%.

Cliff vesting describes a vesting schedule in which employees have no vesting until, after a minimum term of service (federal minimum requirement is 3 years, but ESOP company plans can vary), they become 100% vested.

Who benefits from ESOPs the most? ›

As an exit strategy, an ESOP provides business owners — and their employees — with several distinct advantages. ESOPs can reward long-time employees, provide business continuity, retain a role for the owner and provide liquidity to the owner — potentially with tax advantages for all parties.

How to Cash Out of an ESOP. Being vested doesn't necessarily mean you can cash out of your ESOP. Generally, it's only possible to redeem these shares if you terminate employment, retire, die, or become disabled. Some ESOPs may distribute dividend payments to employees who are still at the company.

In case shares are traded, the long-term capital gains will be taxed under section 112A at 10 per cent over Rs. 1 lakh of capital gain. Similarly, if it is short-term capital gains, then the same will be taxed at a flat rate of 15% under Section 111A of the Act.

What is the India-US DTAA? The Double Taxation Avoidance Agreement (DTAA) plays a crucial role in promoting trade and investment between India and the United States. It provides a framework to prevent double taxation of income, fostering economic cooperation.

Financial award

ESPPs offer an easy, cost-efficient way to pursue a disciplined savings plan. Since you're buying stock for a discount, you have the potential to earn money with this 'buy low, sell high' approach. Based on the same survey, 71% of qualified ESPP plans offer a 15% discount.

However, if the employee is a non-resident or a resident but not ordinarily resident, RSU vests relating to their overseas employment will not be taxable in India. Similarly, sale of RSUs outside India will not be taxable unless the sale consideration is received directly (first instance) in a bank account in India.

If you paid taxes at vesting by selling shares, those shares wouldn't be mentioned in FAS. While selling your RSU holdings, you pay tax only on the profit made and not the entire value of the shares. This also helps in avoiding double taxation.

ESOP is often included as part of the CTC, or Cost to Company, package offered to employees. In a CTC package, ESOPs are considered a non-monetary component, as they do not directly add to an employee's cash salary but contribute to their overall compensation by providing ownership in the company.

No, it is not mandatory for the company to issue and allot only fresh shares under ESOP scheme, but it may choose either option: 1.