Many companies, especially start-ups, often make extensive use of stock-option plans to attract, retain and reward key employees. Depending on the type of stock-option plan you offer, your firm, and perhaps your employees, could be negatively affected by recent changes announced in the March 2010 federal budget.
If an employee purchases a share of his or her employer under an employee stock-option plan, the difference between the fair market value of the shares at the time the option is exercised and the exercise price is treated as a taxable employment benefit. In most cases, the employee is then entitled to the "stock-option deduction," which is equal to 50% of the employment benefit.
The net result of the deduction is that stock-option benefits get taxed at capital gains tax rates and thus provides businesses with a valuable tool to attract and retain highly-skilled employees.
From the employer's perspective, when shares are issued from treasury to satisfy employee exercises under a stock-option plan, no tax deduction is available for the issuance of shares.
Some employers, however, have structured their stock-option plans to permit employees to "cash out" their stock-option rights for a cash payment from their employer. This makes the payment from the employer tax deductible, while still allowing employees to claim the stock-option deduction.
The recent federal budget proposes to prevent this "double deduction." Under the new proposed rules, the stock-option deduction will now only be available to employees in situations where they exercise their options by actually acquiring shares of their employer.
If, however, an employer chooses to continue to permit employees to cash out their stock-option rights instead of actually acquiring shares, the employer must make an election to forgo its deduction for the cash payment in order for the employee to retain his or her entitlement to the 50% stock-option deduction. Absent such an election by the employer, the employee will face 100% taxation on the stock option employment benefit when he or she chooses to cash out their rights.
As a result of these changes, employers who continue to offer "cash-out" option plans to employees now need to consider whether they would be willing to forgo the tax deduction so as to not negatively impact the staff they are trying so hard to reward.
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