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	Stock Options You should know your options In the late 70's, the Microsoft Corporation was just starting out. Founders Bill Gates and Paul Allen couldn't afford to match the salaries being offered to the top computer science graduates from Harvard and Stanford. So to get them to come to work for the new company developing software, they offered these grads a salary plus stock options in their new company. Today, those first Microsoft employees are among the richest people in the world. Recently, a client phoned me all excited that her employer was granting her stock options and she was wondering if she'd have to pay tax on them. So I thought this might make a good topic for a column. The Government of Canada is currently considering changing the way stock options are taxed but I'll give you the condensed version of how stock options are taxed today. A stock option is a contract granted by the issuer (in this case, the employer company) to the holder (in this case, the employee). This contract gives the holder a right to purchase (or sell) an underlying security (in this case, the company's stock) at a specified price (known as the strike price) for a specified period of time. If the option is not exercised within the specified period of time, the option expires. Typically, the employer issues stock options to valuable employees as an incentive to keep them with the company. Options give the employee a chance to purchase the company's stock sometime in the future, when it's hoped the stock's market price is much higher than the strike price. Most employers put restrictions on options; i.e. they can't be excercised for ten years. This was the case with Microsoft, where the original employees were granted options to purchase the company's stock at its 1979 price. A great deal considering Microsoft Corporation stock has increased by more than 10,000% since 1979. In Canada stock options are basically taxed like this: - There is no taxable benefit to the employee in the year that the options are granted. - In the year the employee exercises the option, the difference between the strike price and the actual market price of that stock, on the day the option was exercised, is a taxable benefit to the employee, and they'll be T4'd for that amount. The only good news is the taxable amount gets added to the stock's cost base for tax purposes, thus reducing the taxable capital gain the employee will have when they sell the stock. There are three exceptions to the above: 1) A 25% deduction of the above benefit is allowed if all of the following exist: - the option was granted after February 15, 1984 - The option strike price is NOT less than the market price was on the day the option was granted. 2) The benefit gets deferred until the year the employee sells the stock if: - the option was granted after March 31, 1977, and - the option is exercised after May 22, 1985 If both of these conditions exist AND the employee holds the stock for at least two years before selling it, then the employee will also get the 25% deduction on the deferred taxable benefit. 3) There is NO taxable benefit to the employee if all the following conditions exist: - the option was granted after March 31, 1977 - the option was exercised before May 23, 1985 - the employee held the stock for at least two years before selling it All the above exceptions are based on the assumption the employee is dealing with the employer corporation at arms-length. That means they weren't owners of the company, as well as employees. Stock options are a great way for a small businesses to attract and keep quality employees without bankrupting the company through huge salaries; or giving away the farm to someone whose long term plans are unknown. It worked for Gates and Allen.
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