How to spread, for income tax purposes, income arising from the exercise of shares or options granted as part of a compensation package
Employee options and shares are no longer relevant only to early-stage startups. For many companies, particularly in the technology sector, they are an integral part of the compensation structure – a tool designed to create a connection between employees and the company’s success, and to give employees a real share in its growth potential.
A significant tax question in this context is whether the income generated can be spread, rather than treated as income that accrued entirely in a single year.
This is precisely the issue addressed in the new position paper published by the Israel Tax Authority on 30.07.2026. The paper explains how income spreading should be treated in cases involving equity compensation, and emphasizes the distinction between grants that fall under Section 102 of the Income Tax Ordinance [New Version] and grants taxed under Section 3(i).
To understand the practical significance of the position paper, it is important to start with the basics. Income spreading is not a tax deferral, and it does not mean that the money is received in several installments. It is purely a computational mechanism: the tax is calculated as if the income accrued in equal annual portions over a number of tax years. The rationale behind the mechanism is straightforward – if the economic value of the benefit was built up over several years, there may be circumstances in which it is appropriate not to examine it as if it was all “created” on a single day.
Not all equity compensation is taxed in the same way. Where a grant is made to an employee under Section 102, the Israel Tax Authority states that the spreading mechanism under Section 91(e) may be applied only to the portion of the benefit classified as a capital gain. It is important to understand how the income is classified, since if it is a capital component, spreading may be available. If it is ordinary income, such as employment income, the outcome may be entirely different. The nature of the spreading under Section 102 is limited to up to four tax years back, or the shorter holding period, with the spreading period ending in the year of exercise.
Spreading under Section 102 does not allow the use of personal exemptions or offsets from prior years. In addition, according to the Authority’s position, the surtax on high income is examined on the full amount in the year of exercise itself. Therefore, anyone who assumed that spreading necessarily provides a broad “package of reliefs” is likely to find that it is a more limited mechanism, intended mainly to affect the calculation of tax rates and nothing beyond that.
The Israel Tax Authority also seeks to clarify what does not fall within this framework. Where the benefit is taxed as employment income or business income, and not as a capital gain, the position paper states that the spreading mechanism under Section 8(c) cannot be applied to it.
On the other side is the route under Section 3(i), which generally applies to persons who are not considered “employees” for purposes of Section 102 – for example, consultants, controlling shareholders and others. Here, the Israel Tax Authority describes a different mechanism. The income is examined at the time of exercise or sale of the right, and is measured according to the difference between the market value and the amounts actually paid. This is the basis for calculating the tax, and it is also where the possibility of spreading under Section 3(i)(2) arises.
Under this route, spreading may extend over up to six tax years, from the date the right was granted until its exercise, in equal annual portions. While Section 102 leads to technical spreading, Section 3(i)(2) allows substantive spreading. Under substantive spreading, personal exemptions or relevant offsets from the spreading years may also be taken into account, and the issue of surtax on high income is examined with respect to each relevant year.
Comparison between the two routes:
Comparison item | Section 102 – Employee equity compensation | Section 3(i) – Consultants, controlling shareholders and others |
Who the route applies to | Employees as defined for purposes of Section 102 | Persons who do not fall within the definition of “employee” for purposes of Section 102, such as consultants and controlling shareholders |
Type of income relevant for spreading | Only the portion classified as a capital gain | Income under the Section 3(i) mechanism at the time of exercise or sale of the right |
Source of spreading | Section 91(e) of the Ordinance | Section 3(i)(2) of the Ordinance |
Spreading period | Up to 4 tax years, or the shorter holding period, ending in the year of exercise | Up to 6 tax years, from the date the right was granted until its exercise, ending in the year of exercise |
Nature of spreading | Technical spreading | Substantive spreading |
What may be taken into account in the spreading years | Tax rates and credit points only | Personal exemptions and relevant offsets as well |
Surtax on high income | According to the Authority’s position, on the full amount in the year of exercise | Examined according to each relevant tax year within the spreading period |
Employees, consultants, controlling shareholders and companies that operate equity compensation plans cannot rely on a general review of an “options route”. It is necessary to examine who the recipient of the grant is, which section applies, how the income is classified, when the exercise occurred, and what the possible spreading period is. In some cases, the difference between early planning and an assessment made too late may have significant financial implications.
Nimrod Yaron & Co. specializes in Israeli and international taxation. Our team is composed of professionals with years of experience at the Israel Tax Authority, alongside experience at leading firms and law offices, bringing together legal and economic perspectives. We advise private and public companies, Israeli and foreign companies, global venture capital funds, and clients seeking focused advice in clear and practical language. We also work with a professional network of accounting firms and law firms around the world, in order to provide comprehensive support in cross-border matters.
If you are considering exercising options, managing an employee equity compensation plan, or seeking to understand whether there is a real possibility of tax spreading in a specific case – it is advisable to examine these matters in advance, before the exercise, with a full view of the classification, route and possible tax implications.
FAQ
Can every employee who exercises options request tax spreading?
Not necessarily. The possibility depends on the tax route that applies to the grant and on whether the relevant portion is classified as a capital gain or as employment income.
Over how many years can the income be spread?
Under the route relevant to Section 102 – up to four tax years, subject to the holding period. Under the Section 3(i) route – up to six tax years, according to the period from the date the right was granted until exercise and subject to the wording of the Ordinance.
Can personal exemptions or offsets also be used as part of the spreading?
It depends on the route. According to the Israel Tax Authority’s position, in spreading under Section 102, personal exemptions or offsets from prior years cannot be taken into account, whereas under spreading pursuant to Section 3(i), this is possible.
Does the position paper change the law?
No. The position paper does not replace the provisions of the Ordinance, but it reflects the Israel Tax Authority’s position regarding the implementation of the rules on this issue, and therefore has significant practical importance.
