ESOP- Understanding Types & its Tax Impact


“Employee Stock Ownership Plan” commonly known as ESOP is an employee benefit plan that grants employees an ownership stake in the company. Employers choose which employees will benefit from ESOP, how many shares to distribute, and how much to charge.

Employees are then awarded ESOPs, along with a grant date. An organization will provide its staff with stock options as a means of encouraging them. Employees would have the motivation to give it their all since they would stand to gain financially from the company’s rapid share price growth. The Different categories of stock issued under ESOP are specified as follows:


  1. Employee Stock Option Scheme (ESOS)
  2. Employee Stock Purchase Plan (ESPP)
  3. Restricted Stock Units (RSUs)
  4. Restricted Stock Awards (RSAs)
  5. Stock Appreciation Rights (SARs)
  6. Phantom Stock Plan (PSP)

The most prevalent kind of ESOP is this one. Employees have the chance to buy company’s shares at a fixed price, usually less than market value, through an employee stock option scheme (ESOS).

These options are usually awarded subject to certain performance targets over a predetermined vesting time and as part of a compensation package.

The employee will become a shareholder with full ownership rights, voting privileges, and dividend payments if they choose to exercise their option. However, the employee will forfeit any benefits if they decide not to exercise their choice.

  • Taxation Of ESOS

When an ESOP is exercised, the difference between the exercise price and the market price is computed, and that amount is what is subject to taxation. In the eyes of the employee, this difference is considered as perquisite and is subject to tax under the head of Salary Income.


Employee stock purchase plans (ESPPs) are corporate-run initiatives that enable participating staff members to directly acquire company stock at a reduced cost.

Payroll deductions made by employees, which accumulate between the offering and purchase dates, are how they contribute to the plan. On behalf of the participating employees, the corporation uses the employee’s accrued funds to buy company stock on the purchase day. There are two types of ESPPs qualified and non-qualified.

  • What is the difference Between Qualified ESPP and Non-Qualified ESPP?

There are two types of ESPPs: Qualified and Non-Qualified. All plan participants have equal rights under qualified plans, and implementation requires the approval of shareholders. An eligible ESPP’s offering period cannot last more than three years, and there are limitations on the biggest price discount that can be applied. Plans that are not qualified are not bound by the same regulations as qualified plans. On the other hand, qualifying plans enjoy the tax benefits of after-tax deductions, while non-qualified plans do not enjoy the after-tax deductions.

  • Taxation of ESPP:

The tax laws pertaining to ESPPs are intricate. Generally speaking, any stock you buy through an ESPP will be subject to taxes in the year you sell it. It may be treated as a deductible loss or as taxable revenue.

A capital gain or loss is the amount that you receive after selling stock that differs from what you paid for it. The remaining gain is taxed as a long-term capital gain, and any discount to the initial stock price is treated as regular income. If you have not kept the entire gain for the following periods, it will be taxed as regular income one year following the transfer of the shares to you; or Two years following the granting of the option.


A restricted stock unit (RSU) is a stock share award that is typically granted to employees as a kind of pay. Before the restricted stock units are given to the owner, the receiver needs to fulfill a few requirements.

Employees receive restricted stock units through a vesting plan and distribution schedule upon meeting predetermined performance goals or after a predetermined amount of time working for their business.

Employees who own restricted stock units have an interest in their employer’s equity, but they are worthless until they are vested. At the time of vesting, the RSUs are given a fair market value (FMV). Once vested, restricted stock units are treated as income, and a portion of the shares are withheld to cover income taxes. The remaining shares are subsequently given to the employee.

RSU shares are not issued to the recipient until they vest and are settled by the company, and can have multiple vesting conditions. If your RSUs have a single-trigger vesting schedule, or if you have liquid RSUs, then you typically only need to satisfy a time-vesting requirement.

  • Taxation on RSUs:

The taxation of RSU in India is similar to the taxation of any other equity share. The fair market value of the Restricted Stock Units must be considered for taxation purposes. Fair market value refers to the price at which these shares are sold on the stock market at the date of vesting.

Tax on RSU applies to both the vesting and when the company sells his/her holdings. When an employee sells their RSU holdings, any profit resulting from the transaction is categorized as a capital gain. The taxation of this capital gain is determined by the duration for which the shares were held. This tax obligation applies regardless of whether the shares are listed on the Indian stock exchange.

Read Also ….ESOPs V/s SWEAT EQUITY – The Need and Differences


One kind of equity compensation known as restricted stock awards. The shares are normally still subject to vesting rules, but you will own them on the day you accept the award and fulfill any purchase price obligations. Because the shares of RSAs cannot be easily transferred or traded, they are referred to as “restricted” stock. This permits the corporation to maintain compliance with securities rules.

RSAs are generally issued by very early-stage companies when the fair market value (FMV) of common stock is very low—this way, employees don’t need to pay a lot to have ownership in the company, and they won’t get hit with a significant tax burden if they receive the shares as compensation instead of purchasing them outright.

RSAs also have some advantages over certain types of options. Unlike options, RSAs don’t have to be exercised, and you start the long-term capital gains holding period when you acquire them. In addition, they don’t have to satisfy the additional ISO (Incentive Stock Options) holding periods. RSAs help startups compete for talent against larger companies that can pay higher salaries by allowing the companies to offer equity with high upside potential.

  • Taxation on RSAs

If your RSA calls for vesting, you must submit an 83(b) election to the IRS.

You would be required to pay ordinary income tax at each vesting event (for example, at the cliff and each month after for a regular four-year monthly vesting schedule with a one-year cliff) if you did not make an 83(b) election. The difference between the original purchase price and the FMV at the time of vesting would be used to compute the taxes. Future substantial tax costs may result from the company’s increasing value. You can opt to pay all of your ordinary income tax on an RSA upfront at a point when the FMV matches the strike price by filing an 83(b) election with the IRS.


One kind of employee remuneration that is based on the company’s stock price over a set period is called stock appreciation rights, or SARs. Similar to employee stock options (ESO’s), SARs are advantageous for staff members when the company’s stock price increases. With SARs, employees are exempt from paying the exercise price, nevertheless. Rather, they get the total of the cash or stock rise.

The primary benefit of stock appreciation rights is that employees can receive proceeds from stock price increases without having to buy stock.

The right to the cash equivalent of a stock’s price increases over a predefined time is provided by stock appreciation rights. This kind of compensation is nearly always paid by employers in cash. The employee incentive may, however, be paid by the corporation in shares. Employees can often exercise SARs following vesting.

  • Taxation of SARs

Generally speaking, SARs and non-qualified stock options (NSO’s) have the same tax treatment.

However, grantees of just stock options have several drawbacks, such as having to find the money to exercise the option, having to pay stock broker commissions on transactions, having to pay taxes on employee gains and benefits, and having to worry about the underlying stock’s market price declining. If SAR is granted in addition to stock options, the corporation can potentially mitigate any cash shortage.  The money required to pay for the various outflows will come from these rights.


An employee benefit plan called a “phantom stock plan” allows senior management and other chosen staff members to enjoy many of the advantages of stock ownership without actually granting them any company stock. Shadow stock is another term for this kind of arrangement. The employee receives faux stock instead of actual shares. The phantom stock pays out any earnings that arise from following the real stock’s price movement, even if it isn’t real.

Both types of plans resemble traditional nonqualified plans in many respects, as they can be discriminatory in nature and are also typically subject to a substantial risk of forfeiture that ends when the benefit is actually paid to the employee, at which time the employee recognizes income for the amount paid and the employer can take a deduction.

  • Taxation of Phantom Stock Plans

Payments from phantom stock plans are subject to typical income taxes, not capital gains taxes. In turn, companies can deduct phantom plan payouts the year the employee reports the income. Employers must ensure their plans follow federal laws in section 409A of the Internal Revenue Code (IRC). In addition, employers can subtract taxes from payouts on the employees’ behalf, streamlining tax calculations for everyone involved.

Disclaimer: This article provides general information existing at the time of preparation and we take no responsibility to update it with the subsequent changes in the law. The article is intended as a news update and Affluence Advisory neither assumes nor accepts any responsibility for any loss arising to any person acting or refraining from acting as a result of any material contained in this article. It is recommended that professional advice be taken based on specific facts and circumstances. This article does not substitute the need to refer to the original pronouncement