Employee Options and Relocation

In high-tech, options are often a central part of the compensation package – and sometimes even the reason for joining a start-up or a growing technology company. The idea is familiar: employees work hard today, and if an exit or IPO happens, they benefit from the increase in value. At the same time, more and more Israeli employees are relocating – to the United States, Europe, and other destinations.

The problem begins when the two meet. Exercising options after moving abroad may create exposure to tax in two places: both in Israel and in the destination country. Instead of enjoying the gain you have accumulated, you may discover that a significant part of it is eroded by double taxation or by different tax classifications in the two countries.

How Are Employee Options Taxed in Israel?

To understand where the problem arises, it is important to start with the rules in Israel. Section 102 of the Israeli Income Tax Ordinance [New Version] creates a beneficial tax route for employee options, designed to encourage the high-tech industry. Under the capital gains route, and subject to the conditions of the section, the gain from the sale of the shares is taxed at a rate of only 25%, plus surtax where applicable, instead of marginal tax rates that can be much higher.

As long as the employee remains an Israeli tax resident, there is no tax at the time of grant, and the main tax event occurs upon exercise or sale, depending on the route determined under Section 102.

For further reading on the taxation of employee options in Israel, click here.

What Changes When You Move Abroad?

Once an employee moves to another country, a new tax system is added – and sometimes a more aggressive one. Each country determines for itself how to tax options, when the income is deemed to arise, and how to classify it. Therefore, after relocation, the same options may be subject both to Israeli rules and to the tax rules of the destination country. This is exactly where the problems begin.

One of the main gaps concerns the timing of when the income is considered to have “arisen.” From Israel’s perspective, part of the gain was accumulated during the period in which the employee worked in Israel, and therefore Israel has the right to tax it. The destination country, on the other hand, may view the gain as income that arose while the employee was already its tax resident – and may seek to tax it as well. In practice, this can lead to withholding tax in Israel, full reporting abroad, and actual double taxation.

Another gap concerns the nature of the income. In Israel, a gain from options under the Section 102 route may be considered a capital gain and benefit from a reduced tax rate. In other countries, the exact same gain may be treated as ordinary employment income and taxed at higher progressive tax rates. In the United States, for example, many options granted under an Israeli framework will in practice be classified in a way that leads to employment taxation rather than capital gains taxation. The result is a conflict between two completely different tax systems.

Think a Tax Treaty Solves the Problem? Not Necessarily

Tax treaties are intended to reduce cases of double taxation, but in the world of employee options they do not always provide a complete solution. The main reason is that a treaty does not always bridge material differences between countries regarding what exactly is being taxed – and when.

For example, if Israel views the gain as a capital gain and the destination country views it as employment income, the treaty’s credit mechanism may provide only a partial solution. In such a case, even if a certain credit is granted, the employee may still be left with an excess tax liability.

In some cases, the situation is even more complex – for example, when relocating to a country that does not have a tax treaty with Israel. In such situations, there may be no effective mechanism to prevent double taxation, and the employee may be exposed to full taxation in both countries.

There Are More Pitfalls Along the Way: Vesting, Timing, and the Type of Compensation

The classification of the income is only part of the story. Questions such as when the options vested, where you worked during the vesting period, and what type of compensation you received may also significantly affect the tax outcome.

One of the key issues is vesting. In Israel, the position of the Israel Tax Authority with respect to employees who relocate is generally to allocate the tax liability on a linear basis according to the place of work during the vesting period. In other words, Israel will seek to tax the relative portion that was accumulated while the employee worked or was a tax resident in Israel. The destination country, however, may apply a completely different rule – for example, taxing the full gain upon exercise, without considering where the employee was located during the vesting period. This gap is one of the most common sources of relocation tax accidents.

The type of compensation also matters. Options, Restricted Stock Units (RSUs), and other equity-based instruments are not always treated in the same way. In Israel, RSUs will generally be taxed as employment income at certain points in time, while in other countries – such as the United States – the timing of taxation and the way the income is classified may be different. Therefore, it is not enough to know that you have “equity compensation” – you need to understand exactly what instrument you received and how each country treats it.

The Good News: Early Planning Can Save Significant Tax

Despite the complexity, there are quite a few cases in which tax exposure can be reduced – sometimes significantly. The key is not to wait until the exercise or the first tax filing, but to review the situation in advance.

In appropriate cases, it may be possible to consider exercising or selling before the move abroad, so that taxation is carried out only under the Israeli rules. This is not always possible – especially in a private company or when the employee does not want to give up the potential increase in value – but it is certainly an option worth examining. In other cases, it may be worth checking with the employer whether there is a possibility to accelerate the vesting before the relocation. Here too, this will not always be practically feasible, but sometimes a small change in timing can create a major tax difference.

When such solutions are not available, it is still possible, and sometimes necessary, to carry out individualized tax planning. This includes analyzing the tax laws of the destination country, reviewing the application of the tax treaty, examining the vesting and exercise dates, and properly planning the timing of the relocation itself. Sometimes, even moving the relocation forward or delaying it by a few weeks can materially change the economic outcome.

The bottom line is simple: if you hold options and are considering relocation, do not assume that the tax treatment will “sort itself out.” With options and equity compensation, timing mistakes can cost a lot of money – and proper planning in advance can prevent them.

Nimrod Yaron & Co. specializes in Israeli and international taxation and advises employees, executives, and companies on cross-border tax matters. With a combination of legal and tax experience, and hands-on involvement in complex cases, we help clients understand their exposure, review alternatives, and build the right plan before and after the move.

If you hold options and are considering relocation, it is advisable to review the tax implications in advance – based on the option route, vesting dates, destination country, and your personal circumstances. An early review may save significant costs and prevent unpleasant surprises.

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