If stock options are granted to UK employees and the gain is subject to payroll taxes, both employee and employer social security will be due on the gain. The amount due will be the difference between the market value at the date of exercise and the exercise price.
At time of writing, the employer’s social security charge would be 13.8 per cent of the gain. This can be a substantial expense for an employer, as well as being difficult to estimate since you have no way of knowing when an employee will exercise nor what the market value will be at that time.
Quite often, employers mitigate the risks and costs associated with the grant of stock options by implementing a national insurance contribution (NIC) election. A NIC election transfers the employer’s social security burden legally to the employee so that, at the time of exercise, there is no social security payable by the employer. Any NIC election must be approved by the UK tax authority in advance.
How mistakes are made
Many employers aren’t aware of the NIC election option and may only learn of it when stock options are already granted. Technically, a NIC election must be in place only before the tax is due but, practically, it would be difficult to ask an employee to sign an election after you’ve granted the stock options. They would be, after all, agreeing to take on a larger tax burden.
So, the key is to put in place a NIC election prior to granting any stock options to employees, and ensure all grants of stock options are conditional upon the employee entering into a NIC election.