Struggling to report ESOP income correctly? Learn how to fill the ESOP section in ITR-2, including tax deferred, perquisite, and trigger event reporting.
Employee Stock Ownership Plans (ESOPs) have become an integral part of compensation in the startup ecosystem. They provide employees with a stake in the company’s growth and a unique opportunity to benefit financially from the success of their workplace. But along with this benefit comes tax obligations, which can be complex for first-time ESOP holders.
If you work in an eligible startup, you can leverage the tax deferral option introduced under Section 191IA of the Finance Act, 2020, allowing you to postpone perquisite tax payment on ESOPs. It’s important to understand that even though tax payment is deferred, you must report ESOP income correctly in your ITR-2, ensuring transparency and compliance with the Income Tax Department.
This guide breaks it down in a technical yet approachable way, with examples and step-by-step instructions to help you navigate ESOP taxation confidently.
Understanding ESOP Taxation: Perquisites vs. Capital Gains
Before filing your ITR-2, it’s crucial to distinguish between the two main aspects of ESOP taxation:
1. Perquisite Taxation at Exercise: When you exercise your ESOPs, the difference between the Fair Market Value (FMV) on the exercise date and the exercise price is considered a perquisite. This amount is taxable as salary income, even if the actual shares are not sold immediately.
2. Capital Gains on Sale: When you eventually sell your ESOP shares, the profit over the FMV at exercise is considered a capital gain, which can be either short-term or long-term, depending on the holding period.
- Short-term capital gains are taxed at 15% if shares are sold within 24 months.
- Long-term capital gains exceeding ₹1 lakh are taxed at 10% for listed shares.
Understanding these distinctions ensures accurate reporting and avoids double taxation.
Tip: Keep a record of exercise date, FMV, and exercise price, as these details are essential for both perquisite and capital gains calculation.
What is Tax Deferral on ESOPs? Key Mechanism Explained
The tax deferral mechanism is a relief measure for employees of eligible startups, allowing them to postpone perquisite tax liability without impacting compliance.
Eligibility Criteria:
- The company must be recognized as an eligible startup under Startup India guidelines.
- Must have a valid Inter-Ministerial Board (IMB) certificate.
Trigger Events for Deferred Tax Payment:
- Sale of ESOP Shares – tax becomes payable on the perquisite portion at the time of sale.
- Employee Exit – leaving the company triggers payment of deferred tax.
- 48 Months from Exercise – if neither sale nor exit occurs, tax is payable after this period.
Even though payment is postponed, perquisite values must be reported in ITR-2, ensuring the Income Tax Department is aware of the deferred liability. This transparency avoids discrepancies during tax assessment.
Step-by-Step Guide: Reporting Deferred ESOP Tax in ITR-2
Filing ITR-2 with deferred ESOP tax requires careful attention to detail. The process involves reporting perquisites accurately, noting deferred tax, and preparing for future trigger events. Here’s how to do it step by step.
1. Include ESOP Perquisites in Salary Schedule (Schedule S)
Start by reporting the full perquisite value of ESOPs in the Salary Schedule (Schedule S). This information comes directly from Form 16, Part B. It ensures that your gross salary matches TDS records with the Income Tax Department.
Important considerations:
- If you exercised multiple ESOP grants in a financial year, sum all perquisite values for accurate reporting.
- Properly recording these amounts prevents mismatch notices and facilitates smooth filing.
By reporting the total perquisite in Schedule S, you establish a foundation for both current and deferred tax calculations.
2. Enter Deferred Tax in Schedule TDS → Tax Deferred on ESOPs
ITR-2 includes a dedicated field under Schedule TDS for tax deferred on ESOPs. Here, you must enter the exact amount of tax that has been postponed.
Key points:
- Properly recording deferred tax ensures your current year tax liability reflects only the actual payable amount.
- Maintaining separation between deferred and current taxes prevents errors during tax credit reconciliation.
- It signals to the Income Tax Department that the deferred portion is acknowledged and tracked for future payment.
3. Avoid Reporting Deferred Tax as Exempt Income
Deferred ESOP tax is not exempt, even though payment is postponed. Reporting it under the exempt income section is incorrect and may trigger notices.
Guidelines:
- Keep deferred tax separate from exempt income to maintain accuracy in total income reporting.
- Ensure that only actual exemptions like HRA, LTA, or tax-free allowances are reported in this section.
This step is critical for avoiding errors in ITR processing and ensuring compliance.
4. Track Trigger Events for Future Payment
Deferred ESOP tax becomes payable only when certain trigger events occur:
- Sale of ESOP shares
- Employee exit from the company
- 48 months from the date of exercise
Recommendations for compliance:
- Maintain a tracker with exercise dates, FMV, perquisite values, and deferred tax amounts.
- Payment can be made through employer TDS systems or direct challan, depending on your situation.
- Proper tracking ensures timely payment and prevents penalties.
5. Ensure Consistency with Form 16
Accurate reporting requires consistency between Form 16 and ITR-2.
Steps to ensure consistency:
- Verify that Part B of Form 16 correctly reflects the deferred ESOP tax.
- Cross-check perquisite values and deferred tax amounts before submitting ITR-2.
- Confirm that TDS records match with deferred tax entries to avoid processing delays or notices from CPC.
By keeping Form 16 and ITR-2 entries aligned, you create a smooth filing process with minimal discrepancies.
Illustrative Example: How to Fill ITR-2 for Deferred ESOP Tax
To make the process of reporting deferred ESOP tax in ITR-2 completely clear, let’s walk through a detailed, step-by-step example with practical numbers and explanations.
Scenario:
- Perquisite Value of ESOPs Exercised: ₹5,00,000
- Deferred Tax Amount: ₹1,50,000
- Exercise Date: 1st April 2024
- FMV on Exercise: ₹1,000 per share
- Exercise Price: ₹700 per share
- Number of Shares Exercised: 5,000 shares
- Company: Eligible startup with IMB certificate
Step 1: Calculating the Perquisite Value
The perquisite value is calculated as the difference between the Fair Market Value (FMV) on the exercise date and the exercise price, multiplied by the number of shares exercised:
Perquisite Value=(FMV−Exercise Price)×Number of Shares =(1,000−700)×5,000=3,00,000×5=5,00,000= (1,000 - 700) \times 5,000 = 3,00,000 \times 5 = 5,00,000=(1,000−700)×5,000=3,00,000×5=5,00,000This ₹5,00,000 is the salary component attributable to ESOPs and must be included in Schedule S (Salary) of ITR-2. Including this ensures that your gross salary aligns with Form 16 and TDS records, avoiding discrepancies during processing.
Step 2: Recording the Deferred Tax
Under Section 191IA, the employee can defer perquisite tax on eligible startup ESOPs. In this example, the deferred tax is ₹1,50,000, which is recorded in the Schedule TDS → Tax Deferred on ESOPs field.
Entering this separately is crucial because:
- It reduces tax payable for the current financial year, improving cash flow.
- It signals to the Income Tax Department that the liability exists but is postponed.
- It keeps the deferred tax distinct from other TDS and prevents errors in reconciliation with Form 26AS.
Step 3: Filling Schedule S (Salary)
When filling Schedule S:
- Include the entire ₹5,00,000 ESOP perquisite along with your normal salary components (basic, allowances, etc.).
- The total gross salary figure should match Form 16 provided by your employer.
- If you have other perquisites (bonus, HRA, LTA), combine them carefully with ESOP perquisite to avoid mismatches.
By doing this, your ITR-2 correctly reflects all taxable salary components, even though part of the tax is deferred.
Step 4: Understanding Trigger Events
Even after reporting the deferred tax, payment is postponed until one of the trigger events occurs:
- Sale of shares – if you sell your ESOP shares in a later year, the deferred tax becomes payable.
- Employee exit – leaving the company triggers payment of deferred tax.
- 48 months from exercise – if neither sale nor exit occurs, tax becomes payable automatically.
In our example, if the employee sells the shares after 36 months, the ₹1,50,000 deferred tax will be paid in that year along with any applicable capital gains tax on the sale.
Step 5: Ensuring Form 16 Alignment
Most employers mark deferred ESOP tax in Part B of Form 16. Ensure that the ₹1,50,000 deferred tax and ₹5,00,000 perquisite are accurately reflected in your Form 16, as any discrepancies may cause delays or notices from CPC.
Tips for verification:
- Check the salary break-up section in Form 16 against Schedule S in ITR-2.
- Verify that TDS deducted and deferred tax amounts match Form 16 entries.
- Maintain documentation of exercise date, number of shares, FMV, and deferred tax for audit or future reference.
Step 6: Practical Takeaways
- Recording the deferred tax does not exempt it; it only postpones the liability to a future year.
- Correct reporting ensures smooth processing by CPC and prevents notices or penalties.
- Combining detailed tracking with ITR-2 entry helps in future tax planning, especially if multiple ESOP grants exist over the years.
By following these steps, employees can accurately report ESOP income, track deferred tax, and prepare for eventual tax payment, making the ITR-2 filing process straightforward and compliant.
Common Mistakes to Avoid When Reporting ESOP
Reporting ESOPs in ITR-2 can be tricky, and even minor errors can lead to delays or notices from the Income Tax Department. Here’s a detailed look at the most frequent mistakes and how to avoid them:
Reporting Deferred ESOP Tax as Exempt Income
Many employees mistakenly include deferred ESOP tax under exempt income. While the tax is deferred, the perquisite itself is fully taxable in the year of exercise. Reporting it as exempt can trigger notices and require re-submission of the ITR.
Ignoring Trigger Events
The deferred tax becomes payable only upon trigger events: sale of shares, employee exit, or 48 months from exercise. Employees often forget to track these events, which can result in penalties or interest if the tax is not paid timely.
Mismatched Form 16 and ITR-2 Entries
Form 16 provided by the employer usually reflects the ESOP perquisite and deferred tax in Part B. Errors happen when employees manually enter different values in ITR-2, causing mismatches with TDS credits in Form 26AS. Always cross-check your Form 16 with ITR entries.
Poor Record-Keeping
Without maintaining detailed records of exercise dates, number of shares, FMV, and deferred tax, reconciliation becomes difficult. This is particularly important if multiple ESOP grants were exercised in a single financial year.
Misunderstanding Capital Gains Implications
Some employees report only perquisite tax but ignore the capital gains tax that arises on selling ESOP shares. Both short-term and long-term capital gains must be calculated correctly and reported in the appropriate schedules.
Confusing ITR Forms
While most ESOP holders should use ITR-2, some may mistakenly attempt ITR-1 or ITR-3. Using the wrong form can result in rejection of the return.
Practical Tip: Maintain an Excel tracker or a digital tool listing each ESOP grant, perquisite value, deferred tax, and potential trigger events. This ensures no detail is missed during filing.
Special Cases in ESOP Taxation
ESOP taxation isn’t always straightforward. Certain scenarios require additional attention:
Non-Resident Employees (NRIs): For NRIs, ESOP taxation depends on the residency status and the source of income. Both perquisite tax at exercise and capital gains on sale are applicable, and proper TDS and Form 26AS reporting is critical. Currency conversion and declaration of foreign shares in ITR can complicate matters if not done correctly.
Unlisted Companies: ESOPs in unlisted companies require accurate valuation of FMV, which may differ from market perception. Using incorrect FMV can result in under-reporting of income and future penalties. Employers usually provide a certificate of FMV, which should be used for ITR-2 reporting.
Foreign ESOPs: Employees with ESOPs from foreign companies must report them under Schedule FA. Exchange rates, timing of vesting, and double taxation avoidance agreements (DTAA) must be considered. Proper reporting ensures compliance with both Indian tax laws and applicable foreign regulations.
Multiple ESOP Grants: When employees receive multiple grants over different years, tracking exercise dates, FMV, and deferred taxes individually is crucial. Consolidating values incorrectly can lead to errors in Schedule S and Schedule TDS.
Short-term vs. Long-term Capital Gains: Understanding this distinction helps in planning the trigger event payment alongside capital gains tax.
- Short-term capital gains (STCG) arise if shares are sold within 24 months of exercise and are taxed at 15% for listed shares.
- Long-term capital gains (LTCG) apply for shares held beyond 24 months, with a 10% tax on gains exceeding ₹1 lakh.
Expert Tips for Employees and Startups
Successfully managing ESOP taxation requires strategic planning and proactive compliance. Here are some actionable tips:
Cross-Verify Form 16 with ITR
Always check that Form 16 reflects the correct perquisite value and deferred tax. Any discrepancy can lead to notice from the CPC and delays in refund processing.
Maintain Comprehensive Records
Track each ESOP grant with details like exercise date, FMV, exercise price, perquisite value, and deferred tax. Include potential trigger events and projected tax liabilities. Digital spreadsheets or specialized apps can help automate this process.
Plan for Trigger Events
Be proactive about future payment of deferred tax. Anticipate sales or exits and plan liquidity to ensure timely payment. This prevents penalties and interest charges for delayed tax settlement.
Seek Professional Guidance
Complex scenarios like foreign ESOPs, multiple grants, or unlisted company ESOPs often require guidance from a qualified tax consultant. Professional advice can prevent errors and optimize tax planning.
Understand FMV and Valuation Certificates
Always rely on official FMV certificates provided by your employer for unlisted or startup shares. Do not estimate FMV yourself, as discrepancies can trigger audits.
Combine Tax Planning with Retirement or Investment Goals
ESOPs are both a compensation tool and an investment opportunity. Consider tax deferral, capital gains, and liquidity requirements when planning sales or exits. Aligning ESOP exercise strategies with broader financial goals ensures maximum benefit.
Conclusion: Navigating ESOP Tax Deferral Successfully
Reporting tax deferred on ESOPs in ITR-2 may seem technical, but with the right approach, it becomes manageable. Key takeaways:
- Always report perquisite values in Schedule S.
- Enter deferred tax in the correct field to reflect postponed liability.
- Track trigger events to pay tax timely.
- Maintain consistency with Form 16 and keep records for audit readiness.
By following these steps, employees in eligible startups can enjoy ESOP benefits while staying compliant and minimizing tax stress.
Useful Resources:
Income Tax Department’s Official Guide: This manual provides a clear, step-by-step guide for filing ITR-2 and reporting tax-deferred ESOPs in the “Tax Deferred on ESOP” schedule.
Taxation of ESOPs – Income Tax India: This document explains how ESOPs are taxed, including perquisite tax and the deferment mechanism for eligible startup employees.
Visit Our Post Page: Blog Page