Understanding ESOPs: How they work and how they are taxed

Employee Stock Ownership Plans (ESOPs) are a way for companies to reward employees with shares. You don’t buy them right away. First, the company grants you the option to buy shares at a fixed price, usually lower than market value. After a waiting period (called vesting), you can “exercise” the option buy the shares.

There are two times when tax is involved. First, when you exercise the ESOP, the difference between the market price and the exercise price is taxed as a perquisite under your salary. This is added to your income and taxed as per your slab rate. Second, when you sell the shares, the profit (sale price minus the market price on the exercise date) is taxed as capital gains.

If you sell the shares within 24 months, it’s considered short-term capital gain and taxed at 15%. If you hold them longer, it’s long-term capital gain, taxed at 10% if gains exceed ₹1 lakh.

Startups get special tax relief employees can defer tax payment on ESOPs for up to five years or until they leave the company or sell shares.

ESOPs are a great way to build wealth, but smart planning is key to avoid high taxes and make the most of your benefits.