Employee Options & RSUs: How Taxation Works Under Section 102

Category: Hi-Tech & Equity | Reading time: approx. 5 minutes

Section 102 of the Income Tax Ordinance is one of the most significant tax provisions for hi-tech employees in Israel. It is what allows an employee who received options or shares from an employer to pay 25% capital-gains tax on the profit — instead of marginal rates reaching 47% (and up to 50% with surtax). But the benefit is conditional on a series of requirements, and any deviation can double the tax. Let's bring order.

The Three Allocation Tracks

• The capital track with a trustee — the common and most advantageous track: the options/shares are deposited with a trustee, and subject to the holding period, the gain on sale is taxed as a capital gain — 25%. No tax event at allocation, and none at exercise for options — only on actual sale;
• The work-income track with a trustee — the entire gain is taxed as employment income (marginal rates). Rarely chosen;
• Allocation without a trustee — different, less favorable rules; relevant mainly in special cases.

Important: the track is chosen by the company (for the entire allocation), and it requires procedural compliance — filing the plan with the Tax Authority in advance, timely deposit with the trustee, and ongoing reporting. A company's procedural failure can cost employees dearly.

The Holding Period: 24 Months

The golden condition of the capital track: at least 24 months must pass from allocation to sale, with the securities held by the trustee. Selling before the end of the period ("breaking the blocking") means the entire gain is taxed as employment income — full marginal rates, plus National Insurance liabilities. Note: the count runs from the allocation date, not the vesting date — a common point of confusion.

Private vs. Public Company

• In a private company (a typical startup) — under the capital track, the entire gain on sale is taxed at 25%;
• In a public company (or approaching an IPO) — part of the benefit, equal to the share value at allocation, is taxed as employment income at marginal rates, and only the appreciation beyond that enjoys 25%. This is a material point for employees joining a listed company or receiving RSUs.

RSUs — Restricted Stock Units

RSUs have become the standard equity instrument in large companies. They too fall within Section 102, but given their nature (no exercise price — the employee receives the full share value), a significant component of the proceeds is generally taxed as employment income, with the capital component applying to appreciation beyond it. The practical result: a higher effective tax than classic options — making sale-timing planning especially important.

Life Events That Change the Picture

• Leaving the job — unvested options are usually forfeited, and vested ones carry a limited exercise window. Important: the exercise itself does not break the 102 track — the shares remain with the trustee until sale;
• An exit or merger — a forced sale of the shares is a tax event. Deals with deferred consideration or share swaps require special tax arrangements (a ruling) — the company should handle it, but employees should understand what is being signed in their name;
• Relocation — a risky combination: an employee with options who leaves Israel meets both the exit tax and the residency rules, and questions of allocating the tax between countries by work periods. Plan before the move;
• Staged selling — after an exit or IPO, spreading sales over years can save surtax and make use of brackets — another decision worth planning.

And for Service Providers: Section 3(i)

Consultants, directors and freelancers who receive options do not enjoy Section 102 — Section 3(i) applies to them, taxing the benefit as ordinary income (marginal rates) at exercise. Anyone working with startups as a contractor who received options should know this dramatic difference in advance — and sometimes the engagement can be structured differently.

The above article is provided for general information only and does not constitute professional advice or a substitute for specific consultation. For any question, you are welcome to contact us.

Sincerely,
Hager-Alperowitz & Co. — Certified Public Accountants