Employee stock options are one of the most powerful — and most misunderstood — components of startup compensation. The tax falls in two stages.
Stage 1 — perquisite at exercise
When you exercise, the difference between the fair market value (FMV) of the share and your exercise price is taxed as a salary perquisite. Your employer withholds tax on this amount.
Stage 2 — capital gains at sale
When you sell, the difference between the sale price and the FMV-at-exercise is a capital gain, taxed at short- or long-term rates depending on the holding period and whether the shares are listed.
The startup deferral
Employees of DPIIT-recognised eligible startups can defer the perquisite tax to the earliest of five years from exercise, the date of sale, or the date of leaving the company — easing the cash-flow pain of taxing an illiquid benefit.
Worked example
Try the numbers yourself with our ESOP Taxation Calculator, which models both stages and the total liability.
Sample article for template demonstration; confirm current rates before relying on the figures.