Gifts of
Shares Acquired with Employee Stock Options
by
Kathy Faber, CA, CFP, CFA
This article focuses on gifts of shares acquired with employee stock
options. It does not apply to put and call options.
This article covers the following points:
• Treating gifts of shares acquired with employee
stock options similar to gifts of securities
• What are the new rules?
• How are employee stock options taxed?
• Example
• What about the ability to defer taxes on the stock
option benefit?
• What about donating to private foundations?
• Beware of the Alternative Minimum Tax (AMT)
Treating “Gifts of
Shares Acquired with Employee Stock Options” Similar to “Gifts of
Securities”
When an individual contributes a listed security
to a registered charity, the amount of capital gain that is taxable is
reduced by 50%, thus reducing the amount of tax payable on the capital
gain by 50%. However, under the old rules, if an individual was exercising
employee stock options in order to donate these shares to a charity, the
employment inclusion (i.e., the amount of income that would appear on the
donor’s tax return when they exercised the options) did not receive the
same beneficial tax treatment.
The 2000 Federal Budget addressed this anomaly so that the donor would now
only be taxed on 25% of the employment benefit if the shares acquired upon
exercise were donated to a registered charity after October 17, 2000. In
other words, this would put the donor in the same position as someone who
had purchased the stocks on the open market and then donated them to the
charity.
What are the New
Rules?
To
be eligible, the shares acquired by exercising stock options must be
acquired after February 27, 2000 and must be donated:
• In the same calendar year that the stock option was exercised, and
• Within 30 days of exercising the stock option.
How are the
Employee Stock Options Taxed?
Next, the employee may be able to deduct 50% of the taxable employment
benefit relating to the employee stock options. The intent of this
deduction is to treat the taxable employment benefit, related to the
employee stock options, in a manner similar to a regular taxable capital
gain. The shares must “qualify” in order to receive this preferential
treatment. This rule applies to employee stock options granted by Canadian
Controlled Private Corporations (CCPCs) as well as public corporations.
An
employee stock option will be considered to “qualify” for the 50%
deduction, if they meet the following criteria:
• The exercise price is not less than the price of the shares when the
options are granted (there are different rules for CCPCs);
• The employee must be dealing at arm’s length with their employer
(other than the employer-employee relationship); and
• The employee stock options are in respect of common shares
Example
If
the above conditions are met, here is how the employee stock options and
related donation would appear on the donor’s tax return vs. selling the
stock and donating the cash.
Let’s assume that:
• The stock options have an exercise price of $10/share
• The stock options were issued when the stock was trading at $10/share
• The stock is now trading at $45/share
• The employee has options on 1,000 shares (i.e., they are now worth
$45,000)
What About the Ability to Defer Taxes on the Stock
Option Benefit?
The
Federal Budget announced on February 27, 2000 introduced some significant
changes to the taxation of public corporation employee stock options.
These included the ability of some employees (there are some restrictions)
to defer including the taxable benefit from exercising their employee
stock options until the year in which they sell their shares.
Since donating shares to a charity is considered to be a deemed
disposition, the Canada Revenue Agency (CRA) considers this to be the same
as “selling” the shares to the charity at no cost. In other words, the
“Deferred Option Benefit” does not apply to this situation.
What About Donating To Private Foundations?
Unfortunately, donations of stocks that were purchased by exercising stock
options do not benefit from this preferential tax treatment. In this
situation, there would not be any tax advantage to donating the shares as
compared with donating the cash proceeds from the sale of the shares.
Beware of Alternative Minimum Tax (AMT)
Donors that have large taxable employee stock option benefits should be
cognizant of the possibility of paying AMT. The alternative minimum tax
is the government’s attempt to ensure that high-income earners (that take
specific deductions to reduce their taxes payable) actually pay a minimum
amount of taxes each year.
One
of these specific deductions that reduce taxes payable is the qualifying
shares 50% deduction (see above), if certain conditions apply. This
deduction may put the taxpayer in a lower tax bracket, but they may be
still be subject to the AMT that will impose a higher level of taxation.
We recommend that you speak with your tax professional in order to
determine whether or not AMT will apply in your situation.
Speak to your Planned Giving Professional
If
you are considering a gift to a charity that is somewhat complex, it is
always best to discuss your thoughts with the receiving charity. Most
will have either a planned giving professional, or at least a fundraising
professional that can walk you through the steps in order to ensure that
your wishes are met in the most effective manner.
Kathy Faber is a Portfolio Manager with The Faber
Wealth Management Group at RBC Dominion Securities. She has over 15 years
experience advising both charities and individuals on tax planning and
investment management issues. This gives her a unique perspective on gift
planning, as she is able to work with donations from either side of the
gift. Kathy manages investment portfolios on both a discretionary or
non-discretionary basis for private clients, charities, foundations,
estates and trusts.
