The federal government recently announced potential changes to how stock options will be taxed in 2020, but as long as you’re not raking in millions per year, you should be fine. Canadian Finance Minister, Bill Morneau said in June that they’re working towards a “fairer tax system” and that the tax advantages offered by stock options have been abused by high-earning executives at big corporations when they were intended to help start-ups attract talent. However, any potential changes have not yet been submitted to Parliament and may be changed before Parliament considers implementation.
How stock options work
Stock options allow employees the “option” (get it?) to buy shares from their employer at a fixed price during a fixed period. If the shares rise past that fixed price, an employee can “exercise” the option to purchase shares, essentially buying them at a discount. Then, employees can immediately sell those shares, thereby making a profit. If the share price goes down, employees are under no obligation to purchase.
Stock options are often used as a kind of employee benefit to brighten up a salary or as an incentive to stay with a start-up. To add to the sweet deal, any profit made from exercising a qualifying stock option is taxed at half the normal rate of personal income (as employment income with a special deduction) — very similar to the capital gains rate. However, non-qualifying stock options are not granted this special tax deduction.
For example, you get 100 stock options at $50 with the option to exercise them in 2020, 2021 and 2022. The company does well with shares rising to $100 in 2020. You exercise 10 options for $500, with the market value for those shares now being $1000. Your immediate profit is $500, and the CRA collects half your marginal rate for that return. If you sell the shares immediately, you should not be taxed further. If, however, you think the shares will rise even higher and you decide to hold onto them, you may be taxed on any additional profit. (Except for employees of small, private Canadian corporations who hold onto the shares for two years before paying tax when the stock is sold, not when the stock option is exercised.) If the shares decline, you will not be able to offset the loss against a capital gain, because the options are technically classified as an employee benefit.
In short, stock options reduce the risk of investing while maintaining the tax-advantage of a capital gain.
New $200,000 stock options cap per employer
Ottawa is now proposing that employers can only grant stock options worth up to $200,000 annually that will qualify for special tax treatment.
Below that limit, employees will only pay half their marginal tax rate on any profit. Above that amount, employees must pay their full marginal tax rate on any profit — essentially treating the yield like a raise or a salary.
Luckily, this shouldn’t affect too many Canadians —in 2017, only 36,630 Canadians claimed a stock option deduction, and 55% of those earning under $200,000 total, salary and options combined.
Furthermore, there’s a number of strategies to make it possible for someone to pay half the tax even if they’re granted options above $200,000:
That limit is per employer, not employee. Someone could technically get stock options from multiple companies, each worth $200,000
Canadian Controlled Private Corporations are exempt.
Start-ups are also exempt, as long as they meet certain, yet-as-unnamed conditions.
Confused? We don’t blame you! Stock options are a labyrinth of tax rules and each agreement is unique. Before accepting, exercising or selling stock options, you should consult with a qualified Oakville tax professional on the best course of action. Your business tax accountant will help you make a comprehensive financial plan that will consider all aspects of your situation to make sure it’s tax-efficient.