Executives: Mid-Summer Tax Planning Will Maximize Stock Option Benefits

For executives who are compensated in part with stock options, mid-summer tax planning will be especially important this year. The Notice of Ways and Means Motion, introducing draft legislation to implement a $200,000 limitation to the stock options deduction will take effect in 2020 for employees of large, mature, public companies. If your client is an executive in one, it’s important to schedule a tax planning discussion.

This is especially so because there are still a number of grey areas, despite the release of the draft legislation. The government has also announced a consultation period ending September 16, 2019 on prescribed conditions that will outline whether a public corporation will be subject to the new rules. CCPCs will be exempt; as will public start-ups.

Under the proposed new rules, the securities option deduction will only be available to the employee for the first $200,000 of stock options that become vested in the year from any one employer.

As under current rules, the taxable benefit will remain equal to the difference between the value of the shares at the time the option is exercised and the amount paid. However, where the value of the options vested exceeds $200,000, the securities option deduction will be limited to one-half of the benefit on the first $200,000 of the options exercised.

This new treatment will apply to options granted after 2019. That means that any options granted prior to January 1, 2020 will continue to be eligible for the securities option deduction regardless of the value of the options. That’s where mid-summer compensation planning may be especially important for companies who want to reward their executives before the new rules kick in.

It’s also important to note that where multiple options that are granted after 2019 are exercised in one year, the limitation on the securities option deduction will be applied based on the year the options are vested, not the year they are granted or exercised.

Finally, where an employee has identical options granted both before and after January 1, 2020, the older options are deemed to be exercised first so the old rules will apply to those options.

Example:

In 2020, Marcus is granted an option to purchase 30,000 shares of his employer who is subject to the new rules. The option price of the shares is $25.00 per share (the market price of the shares at the time the option is granted). 10,000 of these shares become vested in 2022, 2023. and 2024 respectively.

In 2024, Marcus exercises all 30,000 of the options. The value of the shares at that time are $35.00 per share. His securities option taxable benefit in 2024 will be ($35.00 - $25.00) x 30,000 = $300,000. The value of the options vested each year is $25.00 x 10,000 = $250,000.

Under the new rules, only the first $200,000 of shares vested each year is eligible for the securities option deduction so his securities option deduction is one-half of the taxable benefit on the first 8,000 ($200,000/$25.00) shares vested each year. The deduction is therefore [($35.00 - $25.00) x 8000 shares/year x 3 years x 50%] = $120,000.

For employees who donate the shares acquired under a stock option, there will also be consequences if the options fall under these new rules.

Kim Moody, FCA, TEP with Moodys Gartner Tax Law, points out that historically the preferred tax treatment for stock options was put into place for competitive reasons and to discourage a “brain drain” to the U.S. He does a great job of overviewing the historical treatment of Employee Stock Options in his blog of June 24. Kim will be joining an outstanding line-up of thought leaders speaking at the Distinguished Advisor Conference in Puerto Vallarta, Nov. 10-13.

Additional educational resources: help Canadians claim their eligible securities option deductions by obtaining your credentials as a DFA-Tax Services Specialist™ .

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