Taxation Changes of Employee Stock Options
In his fiscal update of November 20, Finance Minister Bill Morneau clarified that these changes to the tax treatment of employee stock options will be grandfathered in and will only effect options issued after the date of the change. “Any stock options that have been issued prior to that date will be under that taxation regime that was in effect prior to that date,” said Morneau.
In the short term, employers should consider issuing any employee stock options prior to the changes being made.
However, employers may wish to begin re-evaluating their long-term incentive plans to ensure employee compensation is structured in a tax-efficient manner.
As discussed in a previous article posted by Shea Nerland, employees receiving stock options from an employer are, in many cases, entitled to claim a deduction equal to one-half the difference between the exercise price of the option and the fair market value of the shares on the exercise date.
When an employee receives stock options from an employer there is no income inclusion to the employee. However, when the employee exercises the option, there will be a taxable option benefit equal to the difference between the exercise price and the fair market price of the shares on the exercise date.
In many cases, the employee will be entitled to claim a deduction equal to one-half of the option benefit that results from the exercise of the stock options. Also, in certain circumstances the tax payable on the exercise of the option can be deferred until the shares are sold.
The Liberal government has proposed to limit the one-half deduction to annual option benefits below $100,000. Given that the exercise of stock options and sale of private company shares by an employee often occurs as a result of a liquidity event such as the sale of the business, gains accruing from employee stock options are frequently concentrated in a single taxation year. As such, the proposed ceiling of $100,000 in annual stock option gains may not necessarily be limited to a select group of c-suite executives.
Removing the ability of employees to claim a deduction in respect of the taxable benefit that accrues upon the exercise of an employee stock option will significantly limit the tax efficiency of option-based compensation.
Going forward, employers may wish to restructure their long-term employee incentive programs to improve tax efficiency. Shea Nerland LLP works with corporations and their employees to structure both the tax and commercial aspects of employee incentive programs.
Invitation for Discussion:
If you would like to discuss this blog in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Tax + Estate Planning group at Shea Nerland LLP.
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.