Employee Stock Option Plans (ESOPs) is a beneficial plan given to the employees of a company to buy the company shares at a pre-decided price and it forms part of taxable income. Most senior employees working with bluechip companies get ESOPs regularly and they have to pay tax on their ESOPs. When an Indian employee moves to the US to work there, he has to pay tax on his India ESOPs in US too, In this article we will explain how ESOPs are taxed in the US vis-s-vis India.
ESOPs can be taxed on two occasions:
- 1. on exercising the option.
2. on selling of exercised shares.
Taxation in India on exercising the option
The ESOP taxation in India would be easier to understand with a case study.
Example: Amit Verma is a 34 year old software engineer with one of India’s biggest software companies. Being a senior employee, he receives his ESOPs regularly in the form of company’s shares listed on the Indian stock exchange.
At the beginning of the next financial year, his ESOP of 50 shares got vested and he exercised the shares at a price of Rs 200 per share. The fair market value(EMV) at the exercise time was Rs 500 per share. Hence his perquisite value for ESOP taxation in India of one share stood at Rs 300, that is (FMV-Exercise price), Rs 15,000. As he was in the highest income bracket, he had to pay tax for exercising ESOP at the rate of 30%, that is, Rs 4,500.
The exercise tax on ESOP in India will be deducted from your salary through TDS by your employer itself.
Example of ESOP tax calculation with formula is given below for better understanding.
How to calculate ESOP tax in India on exercising
Taxable amount (or) Perquisite value = Number of Share × (FMV per share on exercised date – Exercised price per share)
- Taxable amount = 50 × (500 – 200) = 50 × 300
= 15,000 Rs
Tax = Taxable amount × Tax rate applicable to you
Tax = 15,000 × 30%
= 4,500 Rs
Taxation in India on selling the exercised shares
When you sell your ESOPs the income generated is calculated as Capital Gains. In India, the difference between the sale value and the market value at the time of exercising the option determines the capital gain on ESOPs.
Example, if Amit sold his shares at Rs 700 per share, his capital gain per share would be Rs 100. The rationale behind this is that he has already paid the difference between the exercise value and market value, so now he must pay tax on excess only.
In India, long term capital gains (LTCG > 1 year) tax is NIL if a share is sold after one year of purchase, on the contrary short term capital gain (STCG < 1 year) tax is levied at 15% if the share is sold within a year.Example of ESOP tax calculation with formula is given below for better understanding.
How to calculate Capital gains on ESOP tax in India on sale
Taxable amount = Number of shares × (Sale price per share on Date of sale – FMV per share on exercised date)
- Taxable amount = 50 × (700 – 500) = 50 × 200
= 10,000 Rs
Short Term Capital Gains Tax = Taxable amount × 15%
= 10,000 × 15%
= 1,500 Rs
Long Term Capital Gains Tax = NIL
Taxation in the US on exercising the option
It is mandated by the US IRS tax law that a person who is a citizen or resident of the US must pay taxes on his global income. As is the case with India, in the US too, the value of the ESOPs awarded is taxed right away when the employee exercises the ESOP option.
Example: If Amit moved to the company’s US office in 2019. Now being a US resident, he is bound to pay taxes on his global income in the US, which includes the perquisite value of his India ESOPs. As per the prescribed exchange rate by the IRS, the ESOP perquisite value of Rs 15,000 would be USD 211. Amit is entitled to claim a tax credit in his US tax return since he has paid tax in India on his income through ESOP exercise. Using form 1116 he can claim a tax credit of USD 63.36 in lieu of the 4,500 Rs tax which he paid in India (Conversion rate may vary).
But there are certain limitations on the amount of credit you can claim. For example, the India tax credit you claim should not exceed the tax payable in the US on your Indian income. You could seek a financial expert to sort it out for you.
Taxation in the US on selling the exercised shares
In the US, the same method is applied to calculate capital gains tax of ESOP as how it is done in India. The only difference is that there is no tax-exempt on long term capital gains in the US.
Example: In the case of Amit, as an NRI he is not entitled to pay taxes in India if he sells his ESOP shares after one year, but he has to pay taxes on those gains in the US. With reference to short term capital gains (< 1year) tax, he can claim a tax credit in his US tax return which is paid in India.So as a US based NRI, when you exercise Indian ESOPs or sell Indian ESOPs, your taxation will not complete if you adhere to the Indian Taxation Rules. In addition to the Indian Taxation rules, you also need to comply with the US taxation rules.
The only good news is you will get a tax credit in US tax return for the LTCG taxes you paid in India with reference to these ESOPs.
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