Canadians generally think of stock options as financial lottery tickets given to CEOs and other company bigwigs to make them rich. There is a lot of truth to this. But during the technology boom in the late 1990s, even working level employees often received a few stock options not realizing their potential for financial harm.
When stocks rise and employee stock options become valuable, we usually say that so-and-so “cashed in his options” and now the jerk is rich. However, this glosses over the fact that it is really a two-step process. For example, a Nortel employee first had to exercise the stock option by paying its strike price. Then the employee received Nortel shares and could sell them in the stock market for a higher price than the option strike price.
This sounds a lot like many scams where you’re promised great riches if you just send in a small fee now. With scams, there are no real great riches to come later. Unfortunately, that’s the way it worked out for some people as we’ll see.
Exercising stock options and selling the resulting shares are often done all on the same day so that it is like a single transaction. But, for various reasons, some employees choose to pay the option strike price but then hold onto the shares, sometimes for years.
The problem comes if the share price is high when the option is exercised, but drops before the shares are sold. Canada Revenue Agency (CRA) expects people to pay taxes on the paper gain from when the shares were high. For employees of Entrust and Nortel, the income tax owing usually far exceeds the pittance they get when they sell their shares. The Nigerian prince didn’t come through with the promised fortune, and CRA still wants their cut of the fortune anyway.
Minister Flaherty has ridden to the rescue with a compromise of sorts. As long as Canadians are willing to forfeit the proceeds from the sale of the shares in the form of a special tax, it appears that they won’t have to pay tax on the huge paper gain. I say “it appears” because I base this on my own (possibly flawed) interpretation of pages 357 and 358 of the 2010 budget document:
“In any year in which a taxpayer is required to include in income a qualifying deferred stock option benefit, the taxpayer may elect to pay a special tax for the year equal to the taxpayer’s proceeds of disposition, if any, from the sale or other disposition of the optioned securities. Where such an election is made:A big area of uncertainty is how taxpayers can make this election to pay the special tax and how they subsequently fill out their tax forms. It appears that this election can be made even if the shares were sold before 2010:
– the taxpayer will be able to claim an offsetting deduction equal to the amount of the stock option benefit; and
– an amount equal to half of the lesser of the stock option benefit and the capital loss on the optioned securities will be included in the taxpayer’s income as a taxable capital gain. That gain may be offset by the allowable capital loss on the optioned securities, provided this loss has not been otherwise used.”
“Individuals who disposed of their optioned securities before 2010 will have to make an election for this special treatment on or before their filing-due date for the 2010 taxation year (generally April 30, 2011).”I’m certainly hoping that I can make this election before filing my 2009 taxes. This provision will save me more than the amount of my first mortgage. I don’t want to have to come up with this money by the end of April and hope to get it back later somehow.