Taxation of Options

What does taxation of options mean?

Taxation of options (Besteuerung von Mitarbeiteroptionen) is the tax treatment of the benefits that employees and managing directors derive from a stake in their employer. Three forms are to be distinguished. Options are the right to buy shares later at a fixed price. In addition, there are shares that are acquired below their value, and virtual shares, which grant only a payment claim on a sale of the company. In Germany these benefits are generally employment income under Section 19 of the German Income Tax Act (EStG). They are taxed at the point at which they accrue (Zufluss), that is, when they actually reach the beneficiary.

Taxation helps determine which form of participation programme (ESOP) a company chooses and how much reaches the beneficiaries. It affects the employees, who owe personal income tax (Einkommensteuer), and the company, which must withhold wage tax and is liable for it under Section 42d EStG. Acquirers therefore check in due diligence whether wage tax was withheld correctly, and protect themselves against the liability risk in the purchase agreement.

Principle: employment income at the time of receipt

Benefits from an employee stake are income from employment if they have their cause in the employment relationship. Wage tax arises under Section 38(2) EStG as soon as the employment income is received. The employer withholds it as other remuneration (sonstiger Bezug), that is, like a one-off payment alongside the regular salary, and remits it. Anyone who wants legal certainty on the treatment of a programme can obtain a binding ruling on wage tax withholding (Anrufungsauskunft) from the tax office responsible for the employer's place of business under Section 42e EStG.

The amount of the benefit depends on the fair market value (gemeiner Wert) of the shares, that is, the price that could be achieved on a sale in the ordinary course of business. For unlisted companies, it is derived under Section 11(2) of the German Valuation Act (BewG) primarily from sales between independent third parties that took place less than a year ago. Otherwise it is determined taking account of earnings prospects. In practice, the prices of the last financing round are often used. Whether and with what discount they can be transferred to ordinary shares without preferential rights is a question for the individual case.

Taxation of genuine options and direct holdings

Options: taxation on exercise

For non-tradable options, such as growth companies issue, no employment income accrues either on the grant or on vesting. Only the exercise is taxed.

Formula: taxable benefit = fair market value of the shares acquired at exercise minus exercise price; this amount is employment income.

Because the shares usually cannot be sold at that point, a tax arises without any money flowing in. Later increases in value are taxed on disposal no longer as employment income but as a capital gain from the holding. The price paid and the benefit already taxed count as acquisition cost.

Direct acquisition of shares

If employees acquire shares below fair market value, the difference is employment income at the time of acquisition. If they acquire at full value, no employment income arises. The Federal Fiscal Court (Bundesfinanzhof) has in principle classified gains from management holdings acquired at market price not as employment income but as income from the holding. This also applies where leaver clauses are linked to the employment relationship. What matters is whether the gain rests on the holding itself or is consideration for work. Share classes that participate in proceeds only above a proceeds threshold (hurdle shares) use this idea. At issue they are worth little and can therefore be acquired at a low price that nevertheless corresponds to their full value. Whether the tax authorities accept this low value is, however, the most important question on review.

For the later disposal, the following applies: for a holding below 1%, the gain is subject to the flat-rate withholding tax (Abgeltungsteuer), a fixed rate of 25% plus solidarity surcharge. If the holding was at least 1% at some point within the last five years, Section 17 EStG applies with the partial income method (Teileinkünfteverfahren). Then 60% of the gain is taxed at the personal tax rate, and 40% remains tax-free. There is no holding period after which gains from shares would be tax-free for shares acquired after 2008.

Section 19a EStG and the tax-free allowance under Section 3 no. 39 EStG

Section 19a EStG defers the taxation of the benefit where employees are transferred equity holdings in the employer's company free of charge or at a discount. Equity holdings (Vermögensbeteiligungen) are genuine holdings, such as shares in a GmbH (German limited liability company) or shares in a stock corporation. Virtual shares do not belong here, because they grant only a payment claim. Under the version applicable since 2024, the deferred amount is taxed as employment income as soon as one of the following events occurs:

• the holding is sold or given away,
• 15 years have passed since the transfer,
• the employment relationship ends.

In the last two cases, taxation does not take place if the employer irrevocably assumes liability for the wage tax; taxation then occurs only on sale.

Under the version in force since 2024, employers with fewer than 1,000 employees and at most EUR 100 million in annual revenue or EUR 86 million in total assets are eligible. It is sufficient if these limits were met in the year of transfer or in one of the six preceding years. The company may have been founded at most 20 years ago.

Besides this, the benefit from the transfer of equity holdings is tax-free up to EUR 2,000 per calendar year under Section 3 no. 39 EStG (since 2024, previously EUR 1,440). A condition, among others, is that the offer is open to all employees who have been continuously employed for at least one year when it is announced. Programmes that cover only selected key people generally do not meet this.

Taxation of virtual shares (VSOP)

With virtual shares, nothing accrues before payout; the grant and vesting remain without tax consequences. The payment on exit is employment income in full and is subject to the personal tax rate, even if it is paid only after leaving a former employment relationship. There is no portion that would be taxed as capital income here. Relief can come from the one-fifth rule (Fünftelregelung) under Section 34(1) in conjunction with Section 34(2) no. 4 EStG, which spreads income from an activity lasting several years, for calculation purposes, across five years. Its advantage is the smaller, the higher the other income already is.

For the company, the payment is personnel expense and deductible as a business expense. If genuine options are instead satisfied out of a capital increase, the company generally incurs no deductible expense; the shareholders bear the cost through dilution.

Social security on employee stakes

Benefits and payouts from participation programmes are remuneration subject to contributions. Contributions are, however, due only up to the contribution assessment ceilings (Beitragsbemessungsgrenzen), the income limits above which no further contributions are levied. For one-off payments, they are allocated pro rata to the year. For high salaries, therefore, often only small additional contributions arise, whereas for employees below the ceilings noticeable contributions arise, also for the employer. How deferred benefits under Section 19a EStG are to be treated for contribution purposes must be examined separately. For managing directors, the obligation to pay contributions depends on their status under social security law.

Worked example: tax on virtual shares and on a direct holding

An employee has an economic stake of 1,000 out of 200,000 shares, that is, 0.5%. On exit, EUR 150 is attributable to each share. A marginal tax rate, that is, the tax rate on each additional euro, of 42% and flat-rate withholding tax of 25% are assumed, in each case plus a solidarity surcharge of 5.5% of the tax. This gives 42% × 1.055 = 44.31% and 25% × 1.055 = 26.375%. Church tax and social security are disregarded.

• Virtual shares with a base price of EUR 20: payout (150 minus 20) × 1,000 = EUR 130,000; tax 44.31% × EUR 130,000 = EUR 57,603; net EUR 72,397
• Direct acquisition at EUR 20 per share at a fair market value of EUR 60: benefit 40 × 1,000 = EUR 40,000, tax on acquisition 44.31% × EUR 40,000 = EUR 17,724; funds needed on acquisition EUR 20,000 plus EUR 17,724 = EUR 37,724
• Disposal on exit: gain EUR 150,000 minus acquisition cost of EUR 20,000 plus EUR 40,000 = EUR 90,000; flat-rate withholding tax 26.375% × EUR 90,000 = EUR 23,737.50
• Net on direct acquisition: EUR 150,000 minus EUR 20,000 minus EUR 17,724 minus EUR 23,737.50 = EUR 88,538.50
• Same case with deferral under Section 19a EStG: the same tax amounts, but the EUR 17,724 falls due only on disposal; on acquisition only EUR 20,000 has to be raised

Before tax, the employee receives EUR 130,000 in all variants. The direct acquisition leads to a higher net amount because part of the gain is taxed as capital income. In return, the employee bears the purchase price, the tax risk and the risk that no exit takes place.

Cross-border cases: change of country of work and emigration

If an employee changes the country of activity between the grant and vesting, the double taxation treaties generally apportion the benefit among the states concerned on a time-proportionate basis. For privately held stakes of 1% or more, emigration abroad can trigger tax on unrealised gains under Section 6 of the German Foreign Tax Act (AStG). If employees are also subject to tax in the USA, separate rules apply there, which depend heavily on the type of option.

Distinctions: taxation of options, income tax, ESOP and retention bonuses

• Income tax: the tax within which the benefits are captured as employment income or as a gain from the holding. Wage tax is its form of collection for employment income.
• ESOP: the programme itself. Its design determines which of the rules described here apply.
• Retention bonuses: payments for staying after a company sale. They are always employment income, with no connection to a holding.

Common mistakes

• Shares below value without tax review. The discounted acquisition triggers wage tax without liquidity, and the company is liable if it does not withhold.
• Valuation without a basis. Without a documented derivation of the fair market value, it remains open whether the taxed benefit will withstand a tax audit.
• Outdated allowance. Anyone who plans with the former amount of EUR 1,440 or overlooks the condition of an open offer calculates wrongly.
• Social security not planned for. Employer contributions on payouts raise the cost of a programme, above all for employees below the contribution assessment ceilings.
• Payouts outside payroll. Payments to former employees are also subject to wage tax withholding.

Frequently asked questions

When do employees pay tax on virtual shares?

On payout. Before that nothing accrues; the employer withholds the wage tax from the payment, so no tax arises without liquidity.

Does the one-fifth rule apply to payouts from virtual shares?

It can apply if the shares were earned over more than twelve months and at least two calendar years and the payment is received in one year. Since 2025, the relief takes effect only through the income tax return; wage tax withholding no longer takes it into account.

Is there an allowance for employee stakes?

Yes, under Section 3 no. 39 EStG up to EUR 2,000 per calendar year (since 2024) for genuine equity holdings if the offer is open to all employees employed for more than a year. It does not apply to virtual shares.

Are gains from employee shares tax-free after a holding period?

No. There is no such period for shares in corporations. Depending on the size of the holding, the flat-rate withholding tax or the partial income method under Section 17 EStG applies.

Does Section 19a EStG also apply to virtual shares?

No. The provision covers only genuine equity holdings. Virtual shares are in any case taxed only on payout and need no deferral.

The Roemer Capital view

Tax questions are decided by the company's tax adviser, not by Roemer Capital. Roemer Capital's contribution comes before that: for founders and team, it calculates what net amount arrives with virtual shares, with a direct holding and with a deferral under Section 19a EStG in different exit scenarios. This includes the liquidity needed in between. This calculation is the basis on which the tax adviser reviews the structure.

Before a company sale, Roemer Capital compiles all grants, share transfers and payouts with their wage tax treatment. Acquirers regularly ask for this because the company is liable for wage tax not withheld.