Tax implications of employee share schemes

Many global corporations utilise employee share schemes as workplace incentives. They are an effective way to encourage retention and motivate employees to do their best for the organisation. If an employee has a financial interest in the company, they are more likely to invest extra time and energy in its success.

Here in Australia, these schemes were first used in the 1950s and were legislated in 1974. They have become more popular in recent years as organisations look for ways to encourage employee loyalty and provide additional reward for hard work.

But it’s important to understand the tax implications of employee share schemes… there are both income tax obligations and possible capital gains tax liabilities that you should consider. First Financial Principal James Wrigley discusses employee share schemes and the potential tax implications you need to know about.

What is an employee share scheme?

What is an employee share scheme?

Essentially, an employee share scheme (ESS) allows employees to own shares in the company they work for. In some instances, employees buy the shares at a discounted price, but they may also receive them as a bonus. James explains:

“Employee share schemes used to be most commonly used by banks, but they are becoming more prevalent through lots of different industries, especially tech companies… like Google, Salesforce or Kogan. There are a lot of thirty- and forty-year-olds who have made quite a lot of money from their schemes.

They are often awarded to people who hold senior roles within the company and so they are already earning pretty decent incomes… then as an incentive to stay with the company, they are given their share schemes.

As an example, they might be earning $250,000 and receive $50,000 worth of shares as a bonus in an ESS.”

An ESS usually has a time frame attached to the plan. A specific number of years must pass before the employee has access to the capital within the shares; this is known as the vesting period. The standard time frame is from three to five years.

Understanding the tax implications

Understanding the tax implications

Receiving an ESS can be extremely beneficial, but there are several tax implications that are sometimes overlooked. James continues:

“If you receive an ESS today, there’s no immediate taxable event… you don’t receive any money, so you don’t pay any tax. While it might be considered a bonus, it’s not like your salary where your employer takes the appropriate income tax out for you.

During the preparation at the start of the scheme, you need to be aware of the future tax implications and think about how you are going to pay.

When the shares vest, it’s likely that you will have to pay a tax bill. Some people are well prepared and have the cash available – whether offset in their mortgage or as savings in their bank account. Other people end up selling a portion of their shares to cover the tax costs. Either way, this is one of the tax elements you need to be prepared for.

You also need to think about capital gains tax (CGT) liabilities because if you sell your shares when they vest, this is recognised as a capital gain.

There’s usually a small window of time – around 30 days – when your ESS vests that you can sell shares without any CGT liability. You will have an income tax liability… but not CGT. But if you leave it for more than the 30 days, and you choose to sell, then you might have CGT obligations.”

Speak to your financial adviser

Speak to your financial adviser

We know that navigating income tax and capital gains tax can be complicated. There are several options available to you, so if you currently have, or are considering, an employee share scheme, we recommend that you speak with your financial adviser for personalised guidance.

If you have any questions or would like to find out how we can help you, please contact our friendly team today.

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