Proposed Changes to the Taxation of Stock Options in Canada
The 2019 Canadian federal budget proposed an important change to the way stock options are taxed. With the Liberals now re-elected, and with “closing the tax loophole” being a popular platform stance during the election campaign, it’s more certain than ever that the Liberals will proceed to implement their recently proposed stock option changes.
Proposed Change to Canadian Tax Treatment of Stock Option Benefits
The proposed rules aim to limit the stock option deduction to only $200,000 for large and mature companies for stock options granted after 2019.
Currently, stock option benefits are recognized as 100% taxable income with a possible 50% stock option benefit deduction available provided certain conditions are met. The net 50% taxable income treatment makes for a very attractive compensation strategy for upper-level management as well as executives of large firms.
The suggested constraint of a $200,000 deduction aims to limit current preferential tax treatment; however, this proposed change is limited only to large and mature companies and does not affect Canadian-controlled private corporations. Also, the denied portion of the stock option benefit deduction can be deductible by the employer provided certain conditions are met.
US Tax Treatment of Stock Option Benefits
The US does not provide a stock option benefit deduction, which means that, south of the border, such income is 100% taxable. Note that while differences exist between the treatment of non-qualified stock options and incentive stock options in the US, this blog considers only the former since incentive stock options are rarely seen in practice these days.
The different tax treatment of stock options in Canada and the US creates an income mismatch for taxpayers of both countries. For US expats and US persons who are, or will be, employed by a Canadian corporation, this income mismatch makes it critical to plan for the timing of a change in residency as well as the date that stock options should be exercised.
One common planning strategy to address the income mismatch between the two countries involves using foreign tax credits. Another strategy invokes the Canada-US Tax Treaty to allocate the income benefit to each country based on the number of days worked on either side of the border.
However, if a US person is employed in Canada by a US corporation, no foreign tax credit is granted since the income is sourced to the US. If stock options are present and the taxpayer is affected by taxes on both sides of the border, without careful planning, unresolved income mismatches between the two countries can result in double-taxation.
While the proposed Canadian tax change to stock option benefits potentially reduces the impact of the income mismatch, it serves as a reminder that stock options are, and will remain, a powerful compensation tool for employers and employees alike. Since stocks options are often a large component of high net worth individuals’ compensation packages, these benefits demand careful planning to ensure they remain fiscally justified.