The federal government announced new rules governing the tax treatment of employee stock options in this year’s budget to prevent certain tax-planning practices known as a “double deduction.” These practices allow stock-based employment benefits to escape taxation both at the corporate and personal level.
When an employee acquires shares of his or her employer under a stock option agreement, the difference between the fair market value of the security at the time of the option being exercised and the amount paid by the employee to acquire the shares is treated as a taxable employment benefit, in which the employee is entitled to a deduction equal to 50% of the benefit.
The Income Tax Act ensures that when an employee acquires securities under a stock option agreement only the employee is able to claim a deduction. Employers are, in this context, prevented from claiming a tax deduction for the issuance of a security.
However, it is possible to structure employee stock option agreements so that, if employees “cash out” their stock option rights for a cash payment from the employer (or other in-kind benefit), the employment benefit is eligible for the stock option deduction while the cash payment is fully deductible by the employer. This represents, in effect, a double deduction – one by the employer and the employee.
In this year’s budget, the government is introducing rules to prevent the double-deduction practice. Under the new rules, the stock option deduction would be available to the employee only in those situations in which the employee exercises his or her option to acquire the shares.
The employer may allow an employee to cash out their stock option rights and still get their stock option deduction only if the employer makes an election to forgo the deduction of the cash payment. If the employer does not make the election to forgo the deduction in a cash-out scenario, the stock option deduction would not be available to the employee.
The new rules are effective immediately.
Golombek on Budget 2010: Stock option changes
Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management, discusses changes to stock options as described in the 2010 federal budget. He spoke at the Government Conference Centre in Ottawa on March 4, 2010.
WATCH