Do you have shares that you originally acquired using stock options? There is a special tax relief provision expiring at the end of the year that you need to be aware of. If you think this might apply to you, please speak to a tax accountant before making any decisions.
Many of the shares acquired years ago have since tanked and not recovered. This can present a situation where the tax owing if those shares are sold would be higher than the actual cash received. Let’s use an example to simplify:
Back in the tech hay-day, Joe bought 100 shares using stock options. At the time, the market value of the shares was $30 each. He only paid $15 each (his option price – $1,500 total). The shares are still sitting in his portfolio.
Because of the way the tax treatment for these shares worked at the time, Joe didn’t pay any tax related to this acquisition. However, he had a deferred employment benefit equal to the difference between the market value and what he paid: ($30-$15) x 100 shares = $1,500. This deferred benefit is sitting on his form T1212 being carried forward each year, waiting until he eventually sells the shares.
If Joe’s shares went up in value, this would make sense. That benefit would be brought into his income when he actually received the cash for the sale and all would work out ok in tax land.
However, let’s say that Joe’s shares are now worth $1 each (a situation that is unfortunately not far-fetched). If he sells them, Joe would actually get $100 cash ($1 x 100 shares). Effectively, Joe lost money. He shelled out $1,500 for the shares and only got $100 upon re-sale. He lost $1,400.
The regular tax rules don’t mirror the economic reality in this case. The $1,500 deferred employment benefit is added to Joe’s cost base, making it $3,000 (the $1,500 he paid plus the $1,500 benefit). His capital loss on the transaction is $2,900 (the $100 cash he got less the $3,000 cost base).
Capital losses can only be deducted against capital gains. So, Joe is stuck including the $1,500 benefit in his income and paying tax on it. The only good news is that there is a stock option deduction for 50% of that amount, bringing the taxable amount down to $750. If Joe’s tax rate is 50%, he is going to pay about $375 in tax for a transaction that only gave him $100 in cash.
The interim solution
Most people in this situation realized that they were better off holding on to the shares forever to avoid paying tax on money they never got. However, if the company goes bankrupt or is delisted, it’s possible that there could be what is called a deemed disposition. This would mean that Joe would effectively sell his shares even though he never made the decision to do so.
Finance Canada’s solution
There is now a special tax, which is calculated on form RC310. Basically, the election made on this form allows a taxpayer to just remit the proceeds of the sale in this situation. In Joe’s case, that would be $100. Much better than $375 under the usual rules. RC310 clearly states that the shares must be disposed of before 2015, which means that time is running out.
As I mentioned at the beginning, make sure you talk to your accountant before deciding to sell shares that may qualify for this treatment. Some private company shares are not caught by these rules, much to the annoyance of a lot of people. Your accountant can help you figure out the best course of action from a tax perspective.
Personal note from me
I’ve been working on a contract for the last few months while continuing to homeschool my kids, so that has left me very little time for blogging. I miss it, and plan to be back regularly when the contract is finished in a few months. Merry Christmas, Happy Holidays, and Happy New Year!