Many companies, especially in the technology and startup sectors, choose incentive plans for their employees. The most well-known and common means of incentivizing company employees is by granting options convertible into company stock. In recent years, companies seeking to incentivize their employees have begun to utilize another tool that has become increasingly common over time – Restricted Stock Units (RSUs).
What are RSU (Restricted Stock Units)?
RSUs are stocks that the company commits to grant to an employee after the vesting period, upon the signing of the agreement between the parties. The vesting period is a period during which the employee has no access to the allocated stocks, and only upon the end of the period is entitled to receive them. In other words, during the vesting period, the employee has only the right to the stocks, while after the vesting period, the employee actually owns the stocks. After the vesting period, the stocks are automatically issued, and there is no cost to the employee for exercising them. The stocks belong to the employee, and they are free to hold onto them for a period of their choosing and sell them when they see fit. Since the stocks are issued to the employee at no cost, the profit, or at least the absence of loss, is assured. So even if the value of the stock drops to zero, they won’t lose money.
| Options | RSU |
Employee cost | When exercising the options, the employee is required to pay an “exercise cost”, which is actually the discounted share price that the employee can convert the option into a share within the framework of the options agreement granted to him. | No cost on the part of the employee. |
Profit potential | If during the sale of the share, the actual price of the share is higher than the exercise price of the share, then there will be a profit for the employee. | No loss is certain because the stock is issued to the employee at no cost on his part. |
Date of realization | As long as the redemption option is valid, the employee may send a redemption request to the company plus the redemption cost, and it will issue or sell him a share. | The share is issued automatically according to the date agreed upon (the end of the blocking period). |
Expiry date | Options have an expiration date from the moment they mature if they have not been converted into shares. In addition, the employee has the right to exercise the options for a short period after the end of his employment (usually 90 days). | There is no expiration date because it is a share that belongs to the employee (there is only a blocking period, as mentioned). |
Therefore, some view the RSU compensation method as the preferred compensation method over other options. It’s important to note that the choice of compensation method for the employee is in the hands of the company, and it is the company that determines the compensation policy for the employee.
RSU Taxation
The Income Tax Ordinance considers the granting of RSUs a taxable event in every respect, and the applicable rules depend on how the incentive plan was implemented. In this article, we will discuss the taxation for an RSU stock plan that meets the requirements of Section 102 of the ordinance.
Section 102 stipulates that the tax liability will occur not at the time of the grant or allocation of the share but at the time of exercise. The exercise date is extended under Section 102 under two possible alternatives:
- In the allocation of shares on a trustee track – the date of transferring the shares from the trustee to the employee or the date of the shares’ sale by the trustee, whichever is earlier.
- In the allocation of shares on a non-trustee track – the date of the share’s sale by the employee.
The ordinance allows every company to choose between two allocation tracks through a trustee – the ’employment income track’ and the ‘capital gain track’. The ‘capital gain track’ or ‘capital track’ is considered more favorable by employees because the tax imposed on them in this track is the lowest. In this track (capital gain track), there are two options:
- An employee who exercises the shares granted to him/her within less than 24 months (‘violation’) – all the profit from the sale will be classified as employment income according to the marginal tax rate on income. In case of a violation, the company is not allowed a deduction.
- An employee who waits 24 months from the date of grant until the exercise date –
- if it concerns a share that is not traded on the stock exchange in Israel or abroad – the tax on the profit will be capital gains tax at a rate of 25% (before additional tax).
- If it concerns a share traded on the stock exchange in Israel or abroad or that was listed for trading within 90 days from the date of the grant –
- The income equal to the share price in the 30 days preceding or following the grant date will be classified as employment income for tax purposes and will be subject to the employee’s marginal tax rate.
- The rest of the profit will be classified as capital gain, and the tax rate on the remainder will be only 25% (before additional tax).
As mentioned, there are additional tracks for allocating shares under Section 102 of the ordinance, such as the employment income track and also allocations in the non-trustee track. Unfortunately, this article does not have the scope to cover all the differences between the various tracks, but attention must be paid to the tax implications that will vary with each track. For more information on this topic, click here.
In summary, there are many considerations and calculations when you come to exercise shares granted to you by the company. It is important to be familiar with the track chosen by the employing company and to ensure that the timing of the exercise is optimal both in terms of the time elapsed since their grant and in terms of the share value at that time.
It is recommended and advisable to conduct tax planning through professionals specialized in taxation to ensure that the tax liability on the exercise of the shares is minimized.
Feel free to contact us and arrange an introductory meeting.
