Employee Stock Options - Post June 24, 2024

In our last article on this subject, current tax rules on ESOPs were covered.  In the absence of proposed legislation that enables the federal government’s proposed increase in the Capital Gains Inclusion Rate (CGIR), recall that it is anticipated that if the individual’s total gains for the year exceed $250,000, two-thirds of gains over the $250,000 threshold would be included in income if they were generated after June 24, 2024.  Here’s a synopsis of the effect of this change on ESOPs to initiate discussions with business owners, key employees and tax advisors:

Anticipated Outcomes.  The method used for calculating the capital gains on employee stock options should not fundamentally change from the current rules, which are complex, but the taxes payable, may increase, when an employee exercises the options and a resulting taxable benefit occurs and is recorded on the 2024 T4 slip.  There are two rules to be aware of:

• The stock option deduction an employee will claim, will be 50% of the taxable benefit up to $250,000 plus one-third of the taxable benefit over $250,000.
• The stock option benefit will be added to any capital gains for the year to determine if the $250,000 threshold was reached and whether the 2/3 inclusion rate applies to any additional capital gains reported.

Here’s an example:

Stock Options Acquired before 2024.  Company A granted their employee, Helen, the right to purchase 100,000 shares of Company A on February 1, 2021.  The market value of the shares at that time was $1.00 per share.  Helen could exercise the option at any time after February 1, 2023. On February 1, 2023, the market value of the shares was $5.00 per share.  Helen exercised her option and purchased the full 100,000 shares for $100,000.  The value of the shares when she exercised the option was $500,000.

On November 1, 2023, Helen sold the shares for $5.50 per share ($550,000). Helen’s T4 slip for 2023 showed a taxable benefit of $400,000 ($500,000 - $100,000). It also showed a securities option deduction of $200,000.  Helen’s employment income related to the stock option was $400,000 - $200,000 = $200,000.  She also reported the capital gain of $550,000 - $500,000 = $50,000, of which 50% was included in her income.

Stock options were acquired in 2024.  The exercise date is November 1, 2024.  The T4 slip for 2024 will show a taxable benefit of $400,000 ($500,000 - $100,000). It will also show a securities option deduction.  However, because the benefit exceeds the $250,000 threshold, the securities option deduction will be $250,000 x 50% + ($400,000 - $250,000) x 1/3 = $175,000.  Helen’s employment income related to the stock option was thus $400,000 - $175,000 = $225,000.  This is $25,000 more than under the old rules.

Calculation of the Capital Gain:   She will also report the capital gain of $550,000 - $500,000 (ACB of $100,000 exercise price + $400,000 taxable benefit) = $50,000.  Because her total gain for the year is over $250,000 ($550,000 disposition of shares she acquired  - $100,000 exercise price),  2/3 of her $50,000 gain on the sale will be included in her income.  Under previous rules this would have been 50% of her $50,000 gain.

Some Alternatives.  If Helen waits until the following year to sell her shares and realizes a capital gain, the $50,000 would qualify at the 50% inclusion rate. (assuming she had less than $200,000 of other capital gains)  because she would qualify again for the $250,000 threshold to report Capital Gains at 50%.

Make a Difference.  Business owners, executives and their advisors need to have conversations before June 20, 2024, to enable adequate time to take action before the June 25, 2024 changes to the Capital Gains Inclusion Rates.

Excerpted from the Advanced Retirement and Estate Planning Course, now available!