Changes in Tax Treatment of Employee Stock Options
Hello. My name is Andrew Feldstein, managing partner of Feldstein Family Law Group. Today I am speaking to you about the recent changes to the tax treatment of employee stock options and how that will affect equalization and support.
Employee stock options give employees the right to acquire shares of their employer at a designated price as an alternative form of compensation. Under current legislation, a corporation can grant stock options to an employee at fair market value. When an employee exercises the stock option, the difference between the exercise price and the price at which the stock option was granted will be considered income. The Income Tax Act then provides a stock option deduction and only half of the benefit received from exercising the stock option will be taxed at the employee’s marginal rate.
The amendments to the Income Tax Act limits the stock option deduction to an annual cap of $200,000 for employees at large, long-established and mature firms. What this means is that the employee stock option will be valued at the fair market value of the shares on the date they were granted. If the shares are worth more than $200,000 in total, then the first $200,000 worth of shares will receive preferential tax treatment, which means that only half of those shares will be taxed at the employee’s marginal rate when the stock option is exercised. However, the benefit derived from the rest of the shares will be included in income and fully taxed at the marginal rate.
The new amendments will not affect employees who work at start-ups or rapidly expanding Canadian businesses and will not apply to employee stock options granted prior to the amendments.
You might think the new amendments will increase the total income on your tax return and therefore your support payments. However, this is not the case. In fact, your child support payments will likely be lowered due to a reduction in the amount of capital gains you receive. Income from capital gains are “grossed up” whereas income fully taxed at the marginal rate are not. “Grossing up” is a means of calculating a person’s income if they receive income taxed at a lower marginal rate than normal. The grossed-up income represents the amount of “taxed income” they have to earn in order to have a net income equivalent to their present income. As the new amendments place an annual cap of $200,000 on the value of shares which will receive preferential tax treatment, a person who exercises their employee stock options will likely only have a portion of the benefit treated as capital gains, subject to a “gross-up”, and the rest as regular taxable income. In other words, having fewer capital gains that are subject to a “gross-up” reduces one’s income for child support purposes and will therefore lower the support payments as well. If you do not dispose of your employee stock options prior to the date of separation, then the value of your stock options on the date of separation will be included in your net family property when performing an equalization calculation. In valuing your employee stock options on the date of separation, the tax liability that you would incur in the future upon exercising those stock options is taken into account. This means that the new amendments will in fact increase the estimated future tax lability of employee stock options. As a result of this increase in future tax liability, the employee stock options will be valued at a lower rate, which decreases your net family property for equalization purposes.
However, if your employee stock options have not been disposed of at the time of separation, they may reappear as income on a future tax return. Accordingly, your income may reflect assets that have already been equalized. Luckily, the recurring assets are usually removed from spousal support calculations to avoid “double-dipping”, but they will remain included for child support purposes.
Before you make a decision on how to deal with complex financial assets like an employee stock option, use the articles and videos on our website at www.separation.ca to learn more about the division of marital property. When you are ready to move forward, call us at 905-581-7222 to schedule a free initial consultation. Thank you for watching.