Why your US ISO/RSU plan won't work as-is in Israel

If you're a US or EU company hiring engineers in Israel, your existing equity plan was almost certainly drafted under US tax code — Sections 422 (ISO), 409A (deferred comp), and 83(b) elections. None of those map onto Israeli tax law.

Here's what happens if you just hand an Israeli employee the same US grant agreement your American hires get:

• The employee is taxed at ordinary income rates on exercise — currently up to 50% marginal income tax, plus Bituach Leumi (National Insurance) and health insurance contributions. Combined, that lands near 62% for a senior engineer.
• The employer owes Israeli social contributions on the same value (because it's classified as compensation income, not capital gain).
• You lose the entire reason equity is supposed to be tax-efficient in the first place.

Section 102 of the Israeli Income Tax Ordinance exists specifically to solve this. It carves out a separate regime for employee equity, and — when used correctly — drops the employee's tax to a flat 25% capital gains rate. But you have to opt in through paperwork filed with the Israel Tax Authority before the grant. Retroactive fixes are not possible.

Section 3(i) vs Section 102(a) vs 102(b) capital gains track

Israeli tax law gives a foreign employer three realistic tracks for granting equity to an Israeli employee. The choice determines the tax rate the employee pays — and the employer's obligations.

For 95% of foreign companies hiring Israeli employees, the Section 102(b) capital gains track is the right answer. The employer gives up the ability to deduct the option expense for Israeli corporate tax purposes — which is irrelevant if you don't have an Israeli entity anyway — and the employee pays a flat 25%. Section 102(a) is mostly used by Israeli-incorporated companies that want the expense deduction.

Section 3(i) is the default that applies automatically if you ignore Section 102. It's also the only track available for contractors. If you're working with someone classified as a contractor in Israel — see our contractor vs employee guide — equity grants will land in Section 3(i) and get taxed as ordinary income.

The trustee requirement

Section 102 makes the trustee non-negotiable. Without an Israeli trustee, the grant does not qualify — full stop. This is the single most common reason foreign companies miss out on the capital gains rate: they assume their US transfer agent or Carta-style cap table tool counts as a trustee. It does not.

An Israeli Section 102 trustee is a regulated role. The trustee must be approved by the Israel Tax Authority and is usually one of a small number of Israeli law firms or trust companies that specialize in employee equity. Their job:

• Hold the granted options and underlying shares in trust for the required holding period (24 months on the capital gains track).
• Track the grant date, vesting schedule, exercise events, and sale events for each individual Israeli employee.
• Withhold and remit the 25% capital gains tax to the ITA when the employee sells.
• File annual reports with the ITA for the plan as a whole.

The trustee fee is typically a setup charge per plan plus a small per-employee annual fee. For a 5-10 person Israeli team it usually lands in the low thousands of dollars per year — trivial compared to the tax delta on a single liquidity event.

The 24-month holding rule

Here's the rule that catches the most companies by surprise: to get the 25% capital gains rate, the trustee must hold the underlying shares for at least 24 months from the date of the grant — not from the date of exercise, and not from the date of vesting.

That distinction matters. In the US, the ISO clock for long-term capital gains starts at exercise. In Israel, the Section 102(b) clock starts at grant. So an Israeli employee who is granted options on Jan 1, 2026, vests them on Jan 1, 2030, and exercises and sells on Jan 1, 2031 — that whole sequence comfortably clears the 24 months and qualifies for 25%.

But an employee granted options on Jan 1, 2026, who exercises and sells within the same 24-month window — say in a quick acquisition in late 2026 — does not qualify. The proceeds get taxed as ordinary income under Section 102(a), even though the plan was filed on the capital gains track. The 24-month rule is hard. The ITA does not bend it.

This is why founders who anticipate an acquisition need to file the Section 102 plan as early as possible — ideally at the company's first Israeli hire, even before there are real shares to grant. The clock can only start once the plan is filed.

Filing the plan with the ITA

Filing a Section 102 plan with the Israel Tax Authority is paperwork, not a discretionary review. There's no approval to wait for — the ITA accepts the filing and the plan becomes effective on a defined date. But the filing must happen at least 30 days before any grant is made under the plan. If you grant options first and try to file the plan afterward, those specific grants fall back to Section 3(i) or 102(a) by default.

The filing package typically includes:

• The equity plan document itself (often the same US plan, with an Israeli appendix attached).
• The trust agreement with the Israeli trustee.
• An election form specifying the chosen track — usually 102(b) capital gains.
• A board resolution adopting the Israeli appendix.
• Form 904 and supporting documents identifying the trustee and the issuing company.

Timeline from kickoff to a filed plan is realistically 4-6 weeks: 1-2 weeks for the Israeli trustee and Israeli employment counsel to draft the appendix, 1 week for board approval, plus the mandatory 30-day waiting period before the first grant. Plan accordingly if you've already promised options to a new hire.

Vesting, acceleration, double-trigger

Standard Silicon Valley vesting terms — 4 years with a 1-year cliff, monthly vesting after that — are fully compatible with Section 102(b). Israeli tax law doesn't care about vesting schedules; it cares about the grant date and the 24-month holding period at the trustee level.

Acceleration provisions also work, with one nuance worth flagging:

• Single-trigger acceleration on change of control — fully compatible. The shares accelerate, the trustee transfers them, and if the 24-month period from grant is met, the gain is taxed at 25%.
• Double-trigger (acceleration on involuntary termination within X months after change of control) — fully compatible. Same outcome.
• Acceleration within the 24-month window — the gain still happens, but it falls into Section 102(a) ordinary income at the employee level (typically 47-50% plus surtax). Not a 102(b) problem per se, but a sequencing reality.

For exit planning, the practical advice is to grant the Israeli team as early as possible so that by the time a real liquidity event happens, the 24-month clock has long since cleared.

How NETO handles Section 102 grants

NETO operates as the Employer of Record (EOR) for foreign companies hiring in Israel — we hold license #1565 from the Israeli Ministry of Labor and we run payroll for the Israeli employee under our entity, so the foreign parent doesn't need to incorporate in Israel.

Section 102 sits adjacent to payroll, not inside it: equity is granted by the foreign parent (the issuer of the shares), not by NETO. But the two pieces have to be coordinated, because the trustee needs to know what's happening at payroll, and the payroll system needs to report option exercise events correctly to Bituach Leumi and the ITA.

Concretely, when a NETO-employed Israeli team member is granted Section 102(b) options by the foreign parent:

1. The foreign parent files the Section 102 plan with the ITA through our trustee partner (an ITA-approved Israeli trustee). Usual timeline: 4-6 weeks.
2. The grant is recorded with the trustee and the 24-month clock starts.
3. NETO's payroll engine flags the employee as having a Section 102 grant so that any exercise event triggers the right reporting (and not double withholding).
4. When the employee sells, the trustee withholds 25% and remits it to the ITA; the employee's payslip shows nothing — the gain is outside payroll.

For a foreign company hiring its first 1-12 Israeli employees, this is usually the cleanest path: NETO under license #1565 handles the employment relationship and payroll compliance, the trustee handles Section 102, and the founder only signs documents.

Related reading: how to hire Israeli employees · mandatory benefits in Israel · Israel payroll for foreign companies.

Granting equity to Israeli engineers?

NETO coordinates Section 102 filings with our trustee partner, so the 25% capital gains track is locked in from day one — not retrofitted after the exit.