What Are Employee Stock Options and How Are They Taxed?

Employee stock options can significantly boost your earnings — but only if you understand the tax treatment. In the UK, EMI schemes, CSOP, and unapproved options all work differently. Here's what you need to know before you exercise them.

What Are Employee Stock Options?

An employee stock option is the right to buy shares in your company at a fixed price (the "grant price" or "exercise price") at some point in the future. If the company's share price rises above that grant price, you have an instant gain. If it stays flat or falls, you can walk away — you're not forced to exercise.

The appeal is clear: you're betting on your own company's success, and if it pays off, you keep the upside. But the tax authority is betting alongside you, and the rate it takes depends on which scheme your company uses.

EMI (Enterprise Management Incentives)

EMI is the most tax-efficient employee share scheme in the UK. It's designed for smaller, higher-growth companies, and the tax treatment is generous.

How it works:

Your company grants you the right to buy shares at fair market value when the option is granted
You wait (usually 3–10 years) for the share price to grow
You exercise (buy) the shares at the original grant price
The gain between grant price and exercise price is treated as capital gains, not income

Tax on exercise: When you exercise an EMI option, there's no immediate income tax bill — none of the gain is taxed as earnings. Instead, you only pay tax when you later sell the shares. That tax is capital gains tax (CGT), which is currently 20% (or 10% if you're a basic rate taxpayer and the gain falls within your annual exemption of £3,000).

Real-world example: You're granted 1,000 EMI options at £2/share (grant price £2,000). Three years later, the company's share price is £8. You exercise and buy 1,000 shares for £2,000. Your gain so far is £6,000, but no tax is due yet. Two years after that, you sell at £12/share (proceeds £12,000). Your total gain is £10,000, and you owe capital gains tax on it — roughly £2,000 depending on your other gains that year. Compare that to the income tax you'd pay on the same gain in an unapproved scheme, and you can see why EMI is the gold standard.

Conditions:

Your company must be a qualifying small/medium company (roughly <£30m turnover, <250 employees)
You can't be granted more than £250,000 worth of options per year
The grant price must be at or above the share price when granted

CSOP (Company Share Option Plans)

CSOP is the larger sibling to EMI — available to companies of any size. It's still tax-efficient, but slightly less generous than EMI.

How it works:

Your company grants you options at fair market value
After a holding period (typically 3 years), you can exercise
Gains are treated as capital gains, not income — but with a catch

Tax on exercise: When you exercise, up to £30,000 of gain is treated as capital gains (currently 20% tax). Any gain above £30,000 is treated as income tax at your marginal rate (20%, 40%, or 45% depending on your salary).

Real example: Same scenario as above: you're granted options at £2, and the share price is now £8. Your gain is £6,000. You exercise and later sell — all of that £6,000 gain gets capital gains treatment (20% tax, so roughly £1,200). But if your gain had been £40,000, you'd pay income tax (20%) on the first £30,000 (£6,000) and capital gains tax (20%) on the remaining £10,000 (£2,000) — total £8,000 instead of £8,000 flat. In this case it's the same, but at higher income tax rates, CSOP becomes less efficient than EMI.

Conditions:

Available to all employees (not just directors)
You can be granted up to £30,000 worth of options per year
Options must be held for at least 3 years before exercise (and 10 years before sale to avoid income tax)

Unapproved Share Schemes

If your company doesn't use an approved scheme, any gain on your options is taxed as income — at your marginal rate — the moment you exercise.

How it works:

Your company grants you options at whatever price it chooses (often below fair market value, which is why this matters)
You exercise at some future date
The gain between the grant price and the exercise price is treated as salary/income, taxed immediately

Tax on exercise: If your grant price is £2 and the exercise price is £8, you owe income tax on the £6 gain immediately. If you're a basic rate taxpayer, that's £1.20 in tax on every £6 of gain (20%). If you're higher rate (40%), it's £2.40. And you've not even sold the shares yet — that's just the tax on taking the option.

Why companies use this: Unapproved schemes are simpler and more flexible — companies can pitch options at whatever price they choose without meeting regulatory conditions. For employees, the trade-off is clear: you pay more tax, sooner.

What Happens When You Sell

Once you've exercised an option (in any scheme), you own the shares. What happens when you sell them?

If you exercise an EMI or CSOP option and hold the shares for at least 12 months, gains from exercise to sale are usually capital gains (20% tax). You get the benefit of the upside.

If you exercise an unapproved option, you've already paid income tax on the gain at exercise. Any further movement in share price between exercise and sale is capital gains tax. So you pay twice — once as income, once as capital gains.

Timing matters. If you exercise in December and sell in January (13 months later), the entire gain from exercise to sale is capital gains. If you sell the next day, you're stuck with the unapproved scheme's income tax hit.

Share Price Volatility and Risk

One thing to remember: an option is a bet. If the share price falls below your grant price, your option is "out of the money" and worthless. You lose nothing (you're not forced to exercise), but your compensation bet didn't pay off.

Real-world caveat: when comparing job offers, never count options as guaranteed income. Treat them as an upside scenario. The base salary and pension are what you can count on.

For a company in early stage, options might be the bulk of your upside. For a mature company with a stable share price, they're a modest benefit on top of salary and bonuses. Know which you're signing up for.

Tax Planning and Strategy

Hold for the long term. The longer you hold an option before exercising, and the longer you hold the shares afterward, the better your tax treatment. EMI and CSOP reward patience — exercise after a cliff (typically 3 years) and hold shares for 12+ months to maximize capital gains treatment.

Watch your income tax band. If you're near the higher rate threshold (£50,270), a large unapproved option exercise could push you into 40% tax. In that year, a salary sacrifice into a pension can bring you back below the threshold and save 20% on the option gain.

CSOP £30k limit. If your company offers CSOP, the first £30,000 of gain gets capital gains treatment. If you're offered a bigger option, ask whether EMI is available — it has no cap.

Sell in tranches. If your option is large and your share price has appreciated significantly, selling all shares in one tax year can create a large CGT liability. Consider selling over multiple years to stay within your annual CGT exemption (£3,000 per year) and spread your tax bill.

Dividend considerations. Once you own shares, you're entitled to dividends (if the company pays them). Dividends are taxed at 8.75% (basic rate) or 39.35% (higher rate) — better than income tax, but still worth planning for.

Frequently Asked Questions

Q: Do I pay income tax when I'm granted options? A: No. You only owe tax when you exercise (in unapproved schemes) or sell (in EMI/CSOP). Receiving an option grant is not a taxable event.

Q: Can I exercise options if I leave the company? A: It depends on the scheme rules and your employment contract. EMI and CSOP typically have "leaver" provisions — often, you have 30–90 days to exercise after leaving. Unapproved schemes vary widely. Check your option agreement.

Q: What if the share price is below my grant price? A: Your option is "underwater." You're not forced to exercise — you simply don't. You lose the opportunity, but you owe no tax. This is why options are a bet, not a guaranteed bonus.

Q: Can I gift my options to someone else? A: Generally, no. Share options are personal to you and tied to your employment (or the employment that granted them). Some schemes allow you to exercise and then gift the shares themselves, but not the option.

Q: How does national insurance work on options? A: This is complex. On EMI options, there's no NI on exercise (a major advantage). On CSOP and unapproved schemes, NI is sometimes charged on the gain at exercise — ask your payroll team. On dividend income once you own shares, no NI applies.

Q: Should I exercise all my options at once or spread them over time? A: It depends on your personal circumstances and share-price outlook. A financial adviser can model tax scenarios for you. Generally, spreading is better for tax planning — it prevents a single-year spike in income or gains.

Q: What happens to my options if the company is sold? A: Again, it depends on the scheme rules. Some option agreements have acceleration clauses (you can exercise immediately before a sale). Others have "good leaver" and "bad leaver" provisions. Read your option agreement — this is often buried in the details, and it matters hugely.

Q: Are employee stock options the same as restricted stock or RSUs? A: No. Options give you the right to buy at a fixed price. Restricted stock and RSUs (restricted stock units) are direct share grants that vest over time and are taxed when they vest (as income), not when you sell. Different scheme, different tax treatment.

Next Steps

Employee stock options can be a substantial part of your compensation — but only if you understand the tax consequences and plan accordingly. Before you exercise a large option, consider running the numbers with a tax adviser. The cost of an hour's advice usually pays for itself in tax savings.

If you're evaluating a job offer that includes stock options, factor in the tax treatment. A £5,000 EMI option gain taxed at capital gains rates (20%) costs less than a £5,000 unapproved option gain taxed as income (20%, but no deferral benefit). And if you're on a high salary and facing the 40% or 45% tax bracket, the planning becomes even more important.

Most importantly: don't leave tax efficiency on the table. The difference between an EMI scheme and an unapproved scheme on a £50,000 gain can be £5,000+ in tax. That's worth understanding.