Stock Option Tax Deferral Election

Volume No. 10-10

“The 2010 Federal Budget proposes to repeal the employee stock option tax deferral election.”

Employee stock options can provide a tax-effective way to compensate key employees. There is no tax cost to an employee when a stock option is issued. Once the employee exercises an option to acquire shares of their employer, the difference between the fair market value of the shares at that time and the price the employee pays for the shares is treated as a taxable employment benefit. An employee of a publicly-traded company is required to include this benefit in income for the year during which the option is exercised unless certain conditions are met, in which case the employee can elect to defer the inclusion of up to $100,000 of benefits vesting in a particular year until the year in which the employee disposes of the shares. This “tax deferral election” is not of any practical use if the employee sells the shares immediately after exercising the stock option.

The 2010 Federal Budget proposes to repeal the tax deferral election for stock options exercised after 4:00 p.m. Eastern Standard Time on March 4, 2010. Tax deferral elections made before March 4 will continue to be effective until the shares are sold. However, the ability to make such elections in the future will be eliminated. As a result, the taxable employment benefits for employees of publicly-traded companies will be included in income for the year in which the option is exercised. This change can create a tax liability before the stock option shares are sold.

Furthermore, the Budget clarifies the payroll withholding requirement for the tax on the employment benefit at the time the shares are issued (i.e., when the option is exercised). Tax must be withheld from the employee’s pay and remitted for the pay period that includes the date on which the shares are issued. With certain limited exceptions, this rule will apply for shares issued after 2010 to provide time for employers to put procedures in place to provide for these withholding requirements.

The stock option proposals were not included in Bill C-9, the Budget bill, which is currently before Parliament and is expected to be enacted this spring. The Department of Finance is drafting the amendments to the Income Tax Act for these changes, and it is expected to introduce draft legislation that will include the stock option changes in the summer or fall. Retroactive enactment will likely be late this year or in 2011. It is wise, therefore to assume that these provisions are in force.


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