Granting stock options or shares to employees is an effective tool for improving compensation, retaining employees, and attracting new ones—especially in high-tech and startup companies, but not only. In recent years, more and more companies have been compensating their employees not just with a monthly salary but also by offering stock options and company shares.
Companies use these compensation methods mainly to achieve two key objectives:
- Ensuring continuity and stability for the short, medium, and long term by providing financial benefits and rewarding employees for their efforts.
- Creating a sense of ownership and belonging, as holding shares or stock rights turns the employee de facto into a part of the company, whose profits depend on their work quality.
What is an ESPP?
One type of employee equity compensation is the Employee Stock Purchase Plan (ESPP)—a program that allows employees to purchase shares of the company they work for.
This plan enables employees to buy shares at a discounted price compared to market value (Fair Market Value – FMV). The discount is typically 15% of the lower between the share price at the beginning and end of the purchase period. The benefit's value (15% discount) is subject to marginal income tax.
How Does the Plan Work?
- A fixed percentage of the employee’s monthly net salary is deducted (typically between 1%–15%).
- The deduction is after taxes—there’s no tax benefit at this stage.
- Each purchase cycle lasts 6 months, meaning employees can exercise and purchase shares at least twice a year.
- There is no obligation to sell the shares at the end of each cycle
- At the end of the cycle, the accumulated amount is used to buy shares at 85% of the lower of: 1. The share price at the beginning of the cycle, or 2. The share price at the end of the cycle.
- The 15% discount value is considered taxable income and is reflected in the payslip.
In most cases, employees can change their contribution rate or withdraw from the plan.
Contribution Limitations
- Contributions are typically capped at 15% of monthly salary.
- Annual contribution limit is $25,000.
- Due to the 15% discount, the actual stock value that can be purchased is $21,250 annually.
- Monthly limit: $1,770.83, or approximately ₪6,600 (at exchange rate of ₪3.7/USD). Maximum monthly salary for full 15% contribution: about ₪44,000.
- If contributions exceed the effective limit, the excess is refunded in the payslip after the last ESPP cycle of the year, without profit.
- Small remainders (because fractional shares can't be purchased) are either rolled into the next cycle or refunded.
Example
Gross Salary: ₪30,000
Contribution %: 15%
Monthly Contribution: ₪4,500
Net Salary without ESPP (assuming 2.25 tax credit points): ₪19,079
(Income tax: ₪6,160 Pension (6%): ₪1,800 Social and health taxes: ₪2,961)
Stock Purchase:
- Same salary and contribution: ₪27,000 = $7,297
- Share price at start: $100
- Share price at end: $120
- Purchase price: $85 (15% discount on the lower price, $100)
- Shares bought: 85 = $7,297 ÷ $85
- Remainder: $72 → carried forward
- If shares are sold immediately:
- Profit per share: $35 (120–85)
- Total gain: $2,975 = ₪11,007
- Taxable benefit: ₪5,003 (at top marginal tax rate of 50%) If the employee holds the shares, any increase beyond $120 is taxed as capital gains at 25% (or 28% for high-income earners).
Purchase at a Loss
- Same salary and contribution: ₪27,000 = $7,297
- Share price at start: $100
- Share price at end: $80
- Purchase price: $68 (15% discount on the lower price, $80)
- Shares bought: 107 = $7,297 ÷ $68
- Remainder: $21 → carried forward
- If shares are sold immediately:
- Profit per share: $12 (80–68) Total gain: $1,284 = ₪4,751
Taxable benefit: ₪2,375 (at top marginal tax rate of 50%)
?Keep or Sell
- You are not obligated to sell the shares when received. You can hold them and sell at a later date.
- If held: Any gain/loss beyond the value at purchase is considered capital gain/loss.
- Capital gains tax in Israel: 25% (plus an additional 3% surtax for high earners).
- Advantage: Since shares are purchased at a discount, there’s a cushion for potential loss before investment becomes unprofitable.
- Disadvantages: Riskier: investing in a single stock is inherently less diversified.
- Requires annual tax report if capital gains are realized (although high earners must report regardless).
Risks
- Dollar Exchange Rate
- Fluctuations in the USD/ILS rate can positively or negatively impact profit.
- Since contributions are made gradually over 6 months, the exchange rate risk is somewhat balanced.
- If the dollar drops drastically and the stock doesn't rise, the final shekel amount might be lower than the initial one—but this is unlikely.
- Stock Price Drop After Holding
- If the employee holds shares, they are exposed to a drop in stock price.
Taxation
In Israel:
- Marginal tax on the benefit (15% discount calculated on the lower of the two prices).
- Capital gains tax on any additional gains from the purchase date until the actual sale.
In the U.S.:
- Marginal tax on the 15% discount.
- Capital gains tax on any increase above the base price used to calculate the discount.
Taxation Example
- Starting price: $200
- Ending price: $300
- Purchase price: $170 = 85% of $200
- If the employee holds the stock for an additional year and the price rises to $350:
- U.S. taxes: $30 taxed at marginal rate $150 taxed as capital gain
- Israeli taxes: $130 taxed at marginal rate $50 taxed as capital gain