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moneysense.ca, 26/09/07
Tax Treatment of ESPP Benefits
The tax on Employee Stock Purchase Plans (ESPP) has two components: the difference between the offering price and the fair market value (FMV) of the stock is treated as employment income and the difference between the FMV and the selling price is treated as capital gains or losses.
For example, let’s say that shares in your employer ABC Inc. was offered to you at a price of $10 on September 15th and on that day, the stock closed at $12. The company beat expectations and when the markets opened for trading the next day, you sold the stock at $13. The $2 benefit ($12 – $10) is treated as employment income and typically taxed at your marginal tax rate and the $1 gained when selling the stock is treated as capital gains and only 50% of it is subject to taxes. The portion considered as employment benefit is tracked by the employer and included in Box 40 of your T4 slip. It is your responsibility to track the capital gains portion of ESPP profits and report it in Schedule 3 of your tax return.
The peculiarities of the tax treatment of ESPPs underline the risks inherent in holding on to company stock. If you were offered shares at $2 when the company stock is trading at $20, you are on hook for income tax on the difference, irrespective of what you finally sold the stock for. If the stock tanked and you finally sold at $2, you’ll have capital losses of $18 that can only be used to offset capital gains elsewhere in your portfolio, not the original employment benefit.
moneysense.ca, 26/09/07
“If you were offered shares at $2 when the company stock is trading at $20″
It’s true with a minor variation because you can sell the stock the same day they show up in your account. For example, my company buys ESPP every 6 months and the offer prices is the lowest of (1st day, last day). In the worst case, if you sell the same day, you profit from the employment benefit (-tax). Of course, the danger is that you hold onto the stock and if it drops, the scenario you described occurs: you’re taxed on the benefit on the day of offering.
Just to add an important reminder that you as the employee are responsible for keeping track of your taxes. The employment benefit will be deducted at source, but you may get other forms, especially if your plan is handled by a third party. You must validate the information on those forms.
I used to work for a company that had an ESPP (a large Canadian HR company) and they messed up the paperwork that was sent to the ESPP provider. The result is the tax slips that came from the third party showed a capital gain that included the employment benefit, meaning we were being taxed twice. I only noticed it after my second or third year in the plan, and the company wouldn’t help me figure it out. After talking to many people over at CRA and the ESPP provider I found the real answer (that we had been getting double taxed), filed a tax adjustment and got back around $3,000. Even after all of that the HR department refused to send out an email explaining the problem. They eventually sent out a fairly vague email telling people to consult a tax professional.
@LUC – I had a similar setup except there was a 5 day window from when I received the shares (from my employer) to when they showed up in my account to sell. Any fluctuation in the share price in those 5 days was a capital gain/loss.
Sean
Sean: Thanks for the comment. It happened once to me when the accountants forgot to add the ESPP benefit to the T4 slip. I waited until they sent a new one with the correct information before netfiling but a lot of colleagues went ahead and filed their taxes and had to submit an adjustment later.
Does anyone here have any experience with the tax treatment of Restricted Stock Units?
I have a set amount that vests in November and the taxes on them are ridiculous — 46%?
Is there any way around this?
I noticed in the comment above that you are taxed on the benefit at the time of the offering. Does that mean, for instance, that if your ESPP offered shares at a 10% discount of the closing price of the day of purchase that the purchase would be taxable in the current tax year, no matter when the stocks were actually sold?
So for instance, stock closes at $100, an we buy 10 shares through the ESPP, at $90.00. This will then be included ($10 * 10 shares = $100) on my current year income tax. In 5 years I sell these stocks for $125 a piece. So I have a $250 Capital gain ($100 -> $125 * 10)
Am I following correctly? I used to participate in the ESPP through work, and no one explained this to me.
[...] Canadian Capitalist posted today about how Employee Stock Purchase Plans are taxes. Particularly, he points out that [...]
Traciatim: Yeah. Your math is correct.
Employment benefit = ($100 – $90) * 10 = $100
Capital gains = ($125 – $100) * 10 = $250
The employment benefit will usually automatically be added to your T4 (tax may or may not be deducted at source) and reported in the current year.
The capital gains is declared in the tax return 5 years hence. If you made a mistake in earlier year’s tax returns, you could file an amendment.
Calvin: I have no idea how restricted stock units are taxed. I know many US-based companies don’t offer them in Canada and continue to offer stock options.
CC,
In all cases of stock options, you can defer the benefits from being included in income. Go to the CRA website (www.cra.gc.ca) and get form T1212. You can defer the inclusion of stock option benefits in income until you dispose of the shares.
Calvin – Restricted Stock Units aren’t recognized in Canada the same way they are in the States. In Canada, the stocks are taxed the same way an ESPP is….the taxable benefit is included in income (as employment income) in the year the Units are granted and the capital gains are included in income when they are realized.
With Restricted Stock Units, you have a vesting period (thus the term restricted stock units). You need to hold the stocks for a period of time OR until they reach a certain value….this depends on the terms set out in the agreement with your employer. This is where you need to be careful. If you don’t fulfil the requirements of the vesting period, you can’t claim anything against your employment income. With Restricted Stock Units, you have no choice but to hold onto them until they vest.
An example is best. In November 2005 you received 100 Restricted Stock Units for $8.00/share and a FMV of $10.00. The vesting period is 2 years. You would’ve reported $200 ($2X100) as taxable income on your 2005 tax return at line 101.
If you quit your job in 2006, or don’t meet the vesting requirements, you’re out of luck. The $200 is included in income in 2005 and there’s no corresponding deduction you can claim in 2006.
If you do make it through the vesting period, in November 2007 you can sell the stock. If you sell it at a gain, you claim capital gains on the stock…if not, you claim a loss.
Thanks for your help everyone.
It was my understanding that with restricted stock units, all the shares that vest are considered a capital gain (different from stock options where the gain is the difference between the strike price and sell price).
Here’s my situation:
At the end of November, 125 shares will vest and the current market value is $50/share.
I’m guessing the full amount will be considered capital gain and I will be taxed accordingly?
Calvin
Calvin, I definitely hope you are right. I always thought with Restricted Stock Unit, all the amounts on the vesting day is considered as your income. I hope I was wrong. Anyway, if they are considered as income, they should show up in T4 slip, right?
I participate in a one-for-one ESPP. The shares that are released to me by the company are considered as a taxable benefit and included as income. The shares I purchase (on a quarterly basis) are not discounted but valued according to the weighted average price of the last five business days of the quarter.
I sell all my shares as soon as the company releases its holdings to me, but I have no idea how I’m supposed to claim this. Say I have 2000 shares. 1000 shares purchased by me and 1000 shares purchased by my company on my behalf (as a taxable benefit).
Do I have to calculate capital gains on the company shares ?
What is the cost of the company shares?
Do I only claim a capital gain on my own purchases?
crete: Your company should tell you the Fair Market Value (FMV) of the matched shares. Just ask someone at accounting. They already know this because they probably already include the value of the matched shares in your T4 (best to check that’s the case).
Yes, when you sell, you have to calculate the capital gains on the company shares as well. Just use the FMV from accounting as the cost of the shares.
I participate in a ESPP for a US stock company, but I work in a Canadian branch. Does the 2 year holding time for it to be taxed as capital gain apply to me? Am I subject to US taxes, Canadian taxes, or both?
Thanks in advance.
Leo: Can you explain a little bit more? I’m not sure what 2-year holding period you are referring to. Are you referring to US tax treatment of short-term and long-term capital gains? Under Canadian tax rules, there is no distinction between the two.
50% of your capital gains are taxed in Canada. There is no US tax as long as you are classified as a Canadian resident.
Hi Canadian Capitalist,
Yes, I was referring to the US tax treatment of short-term and long-term capital gains.
Thanks for your response, that was helpful. So if I am not mistaken, selling my stocks immediately after the purchase date, as opposed to selling my stocks 2 years after the purchase date has no taxation benefit.
Leo: Actually, there may be capital gains or losses to report even if you sell immediately. Let’s say the stock closed at $15 which your company shares were trading at when they were given to you (the company provides this information for you). Next day, when you sold the shares it was trading at $15.25. You’ll have to report the difference as capital gains. Usually, the difference will be very small if you sell immediately. Still, you have to keep track of any gains / losses and report them at tax time.
I have a question related to what Philip wrote in a post above:
“In all cases of stock options, you can defer the benefits from being included in income.”
I understand this rule from a stock option perspective but does this rule apply also for ESPP, for the Employment benefits/income part?
EX: I got the stock at 8$ and the FMV is 10$, thus I make a profit of 2$ per share as an employment income. Can I defer to a later year this 2$ per share? Is this any different if I sold the stock versus if I still own it?
Thanks
Richard: No. ESPP benefits are employment income and taxes on it cannot be deferred.
What about the ESPP/ESOP Tax Remission Order (TRO) revoking the taxes imposed on money the empoyees never saw, for 37 former SDL Optics/JDSU employees in Saanich Gulf-Islands B.C. ?
Has anyone else had their ESPP/ESO tax, on money they never saw, levy revoked?
Newbie question(s) here:
I, like Leo above, work at the Canadian branch of a US stock company. My ESPP does the payroll deductions in $Cdn. and then makes the purchases in $US.
I realize I’ll get dinged on the exchange when purchasing, but am I going to get dinged on the exchange again when I sell?
Also: should I keep these shares in the account they set up for me? Is it wiser to transfer to a brokerage account RRSP before I sell (since I plan on putting it into an RRSP anyway)? I was thinking the Questrade RRSP that can hold $US might be a good idea.
JC NewGrad
If the ESPP shares you purchased are held in a US Broker Account you will be required when you sell those shares to sell them on the same market they were purchased on. then “yes” you will receive the benefit of the $ exchange rate at that time.
If, however, your shares were paid for in U.S. $ but on a Canadian exchange, you should be able to sell them in Canada and not incur an exchange problem.
As to putting them into your RRSP account before selling them is something outside my area of experience. I expect you should be able to make that move if their is no problem with the percent of your income that is allowed to be applied to your RRSP account.
As gains made within an RRSP account are not taxed, as they occur, you might be better off with the shares in an RRSP allowing the economy recovers while the shares are still in the RRSP.
If you haven’t run into the following booby-trap then be aware that equities acquired by way of an Emloyer’s Shares Purchase Plan (ESPP) or Employee Share Option (ESO) plan can result in the employee being levied devatating taxes on phantom income.
This tax attrocity happens when the shares vested, (purchased) increase in value by the time they are delivered (exercised) and are taxed on the Fair Market Value (FMV) of the equities whether or not they are actually sold.
The bust in the hi-tech stock market of the year 2000 set a series of events in motion whereby thousands of Canadian taxpayers were levied horrendous taxes on ESPP/ESO equities that they did not sell at time of exercise and which crashed in value shortly after.
The economic recession of 2008 is another situation where the same thing is happening.
For details visit http://www.cfet.ca, and http://www.fair-iso.org and http://www.reformAMT.org
@JC: When you sell your ESPP shares you can keep the proceeds in USD or convert the USD into CAD. If you convert to CAD, of course, there will be a foreign exchange charge.
If you are planning on contributing in-kind to your RRSP, you may want to consider opening a RRSP account with the broker your ESPP shares are deposited. Otherwise, you have two options and both will cost you money. You could do a partial transfer of the ESPP shares into the investment account you have with your RRSP broker and then transfer it in kind to your RRSP. Or, you could sell the ESPP shares, withdraw the cash, buy the same stock with your RRSP broker and contribute in-kind to your RRSP. Both should cost roughly the same.
Search the blog for in-kind transfers because there are certain rules you should be aware of. Also, think carefully before you decide to load up on company stock — it is usually not a good idea to have your investments in the same place you get a paycheck.
For the record, I almost always sell my ESPP shares immediately and invest the proceeds elsewhere. Also, I always cash in ESOPs and don’t sell and hold them because of problems that Ken outlined in his comments.
Thanks KT and CC.
For the record, if I do join the ESPP (which I haven’t yet, and might not at all since the ESPP has some other unattractive features that I won’t get into), I plan on selling the shares immediately.
If I receive ESPP at a discounted rate, but do not sell the stocks, hence making no profit, do I need to claim them on my Canadian taxes? Or do I only claim this income once I sell?
Stocknewb.
Prior to the introduction of the 2010 Federal Budget (Mar 4 2010) when you took possession of ESPP stock (exercise date) and the Fair Market Value (FMV) of the shares, on that date, exceeds the Adjusted Cost Base (ACB) of those shares you were deemed to have received a taxable benefit equal to the exercise date equity FMV minus the ACB. regardless of whether, or not you actually sold them later at a loss.
When the Hi-Tech Stock market BOOM went BUST in July 2000 thousands of honest, hard-working Canadian taxpayers were caught in this obscure tax trap and were levied taxes on paper profits that never actually materialized, i.e. phantom income..
This problem is addressed in the 2010 federal budget and changes are in the works but just exactly how the budget will treat the various types of victims of tax on phantom income wont be known until the budget is passed and becomes law.
The Canadian Federal Budget is outlined in the following document: http://www.budget.gc.ca/2010/pdf/budget-planbudgetaire-eng.pdf
On my computer this document displays two types of page references, i.e. (1) Each page of the document has a number (in blue) that can be seen at the bottom of the page AND the On-Screen (bottom of screen) displays a pdf page number that runs from 1 to 424.
To give you the best directions I will quote both numbers.
The reference to Tax regulations on ESO’s (ESPP’s?) begins on document page No. 353 and continues through document page No. 358. (blue numbers)
The PDF page display at the bottom of my computer screen indicates pages 328 of 424 through page 333 of 424. for those same pages.
Just how those proposed new tax regulations will look after the budget has gone through the Review and Approval process is anyones guess.
Your best strategy would be to wait until the budget has been passed into law and the tax regulations are out in the 2010, T1 General tax guide.
I, too, like Leo and JC Newgrad, participate in an ESPP in US stock for a Canadian company that is a wholly owned subsidiary of the US company. As a Canadian resident & US Citizen, I understand that I have to file a US tax return. My question is, how do I treat the employee benefit that was added in my T4 in my US return? I haven’t sold any of my stocks and when I do, will I get double taxed on the same employee benefit on the US tax return?
Since the benefit was included in my gross income, I did not subtract the benefit amount from my income when I claimed the exclusion for foreign income. Did I do the wrong thing in this year’s US return?
To zad886
There are two U.S. groups that co-operated with each other and lobbied the U.S.governemnt ro amend their defective “Alternative Minimum Tax” (AMT) legislation to stop taxing U.S. citizens on phantom income plus providing fair compensation retroactively to those that had already paid such taxes/penalties.
Try contacting http://WWW.reformamt.org and http://www.fair-iso.org. One of them should be able to answer your question.
So far Canadians are not getting the same, or similar, tax treatment of taxes levied on their phantom income.
Thanks Ken…much appreciated!!!
For example, let’s say that shares in your employer ABC Inc. was offered to you at a price of $10 on September 15th and on that day, the stock closed at $12. The company beat expectations and when the markets opened for trading the next day, you sold the stock at $13. The $2 benefit ($12 – $10) is treated as employment income and typically taxed at your marginal tax rate
For the example you above, if the $2 benefit is consider as employment income (Canada BC), what tax rate I should use to calculate the Fed and Provincial taxes and what kind of the tax calculation method I should use? Is the employment income also subject to CPP and EI ?
Thanks
@Genesis: You are right. The $2 benefit is treated as employment income. Since last year, your employer will withhold taxes based on your ESPP benefit and remit the taxes to CRA. The ESPP benefit is added to Line 101 of your T4. For 2011, the taxes remitted to CRA will be reflected in Box 22 of your T4 (at least, it should and you might want to make sure. Accounting departments are known to make mistakes sometimes). I’m not sure about CPP/EI.
I was Hi-Tech employee in the year 2000 unfortunately I exercised options and I triggered taxable benefit. I was able to defer tax payment submitting T1212. I was participating ESPP plan as well and again bad luck I never sold my shares. I had to pay large tax on ESPP Taxable benefit there was no deferral possibility on ESPP.
Now by budget 2010 I can elect form RC310 (Tax relief on deferral Election) and I am selling shares. All proceeding belongs to government.
How will I differentiate “deferred” shares vs. ESPP if I sell at once? I have my records but Form RC310 is asking to declare all proceedings from Schedule 3 Column 2 to be on the last line but that is not right, I should include just “deferred share proceedings” that is less than my total proceedings. I paid taxes on ESPP (phantom gain) once, than now is just loss. To simplify I am selling all my shares and how to properly report “Deferred” vs. ESPP
Is the ESOP and ESPP part of the same ACB calculation ?
Hi,
How is the tax calculation different based on the date of the offering price, 1st day vs day 180?
The ESPP offered at my company is for a 6 months period. The lowest price of the 1st day or of the last day is used.
Example:
November 1st (1st day): market price is 10$
April 30th (last day): market price is 20$
The offering price will be 85% of 10$= 8.50$.
I sell the stock on May 5th for 25$
What is the correct scenario in Canada for tax report, A or B?
A-
Employement income= 20$ – 8.50$= 11.50$
Capital gain: 25$ – 20$ = 5$
or
B-
Employement income= 10$ – 8.50$= 1.50$
Capital gain: 25$ – 10$ = 15$
I would prefer scenario B but I think in Canada this would be A, am I right?
Thank you
Richard
@Richard: Option A is the correct one. In fact, you probably shouldn’t have to worry about the Employment income part. Your employer will calculate it for you. And starting in 2011, your employer will be withholding taxes and remitting to CRA immediately after your ESPP shares appear in your account. The employment income benefit from ESPP shares and taxes withheld will then be added to your T4 numbers.
Thank you for the prompt answer, much appreciated.
I needed the explanation to adequately calculate the capital gain on my ESPP.
You are right to say that my employer added the employment income directly on my T4 and since 2011 they also withhold taxes at selling. This is true for both Stock options, RSU but they have not done it yet for my ESPP in 2011. I’m not worry though, the governement will catch me in the corner when they will review my tax report
Richard
@ Canadian Capitalist Do you have any suggestion for my question earlier ? ESPP vs ESO ?
Can you provide me information of RSU and how it will be taxed?
@Genesis: I’ll answer you question in tomorrow’s post. I don’t think I’ve covered this topic before.