Stock Option Benefit Source Deduction and Reporting

Administering stock options can be challenging for payroll, particularly where the persons concerned are no longer employees and there are no other earnings from which to make source deductions. These challenges increased after the related income tax source deduction requirements changed in 2010. Now that a couple of years have passed, it would be interesting to discover how compliant employers are with the new rules.

First, let’s clarify that by “stock options” we do not mean benefit plans structured as a cash bonus based on the value of the company’s stock, without either stock options being granted or shares being issued. Cash payments made under such a “phantom stock option” plan are bonuses, pure and simple, and are subject to the same source deduction and reporting as regular salary or wages.

An “option” is a legally binding, employee right to purchase shares at a fixed price, whether or not that right is ultimately exercised. For example, the taxable benefit consequences of surrendering options back to an employer, for a cash payment, are the same as if such options had actually been converted into shares. “Stock option” plans also include those under which employees purchase shares outright, without the intermediary step of an option.

Note, the CRA now uses the term “security option” to describe stock options, where the term “security” is meant as a replacement for the more common terms “share”, “stock” or “equity”.

The main challenge in administering stock options is the gap – which may be measured in years – between the events that must be managed:

  • Granting employees options to acquire a specific number of shares at a particular price;
  • Such options being exercised or shares being directly acquired; and
  • Employees disposing of their options or stock to either the employer or a 3rd party.

Simply creating a plan under which employees may either be granted options or acquire shares is not something that triggers a taxable benefit. Similarly, granting actual options for the future purchase of shares does not itself trigger a taxable benefit. Instead, the general rule is that a taxable benefit occurs when employees either acquire shares or dispose of stock options. When the employer is a Canadian-Controlled Private Corporation (a CCPC), this rule changes for issued shares – a taxable benefit is only recognized when employees sell or otherwise dispose of shares. The distinction between CCPC and non-CCPC benefits is well described in T4130, the CRA’s Taxable Benefits and Allowances guide, so we won’t repeat that description here.

The potential gap between the time options are granted and the time share are acquired or disposed of, if the employer was a CCPC, means that persons might no longer be employees. How does this affect the required source deductions and reporting?

For income tax purposes, the source deduction rules changed in the 2010 federal budget. As of that budget, stock option taxable benefits are deemed to be cash payments to employees. The government’s explicit intentions, as stated in the 2010 budget documents, were that employers be required to remit the related income tax when employees incurred a taxable benefit related to stock options and shares purchases. In other words, even if no other earnings or cash are involved, employers must remit income tax source deductions calculated on employee stock option benefits. Presumably employers who honour this obligation are not just out of pocket and have the right to recover any such remittance from the former employees concerned.

However, there are exceptions to this remittance requirement. First, this requirement does not apply when the employers is a CCPC, where shares are only taxed in the year of disposal or sale. Second, employers are not required to treat stock option benefits as a cash payment:

  • For the taxable benefit related to stock options held at the time of an employee’s death;
  • For the amount of any deduction available to the employee, for non-CCPC shares;
  • For the amount of any deduction available when employees donate part or all of their stock options to a charity.

For the last two bullets, employers are only required to remit on the net income tax owing after applying the available deduction amounts. For example, if the gross taxable benefit was $50,000 and the corresponding deduction was $25,000, employers would only be required to remit the income tax owing on the remaining $25,000. However, the full $50,000 must be included in T4 Box 14.

For CPP purposes, the gross taxable benefit amount is a pensionable earning. This status does not change, if at the time the taxable benefit is recognized, the person is no longer in an employment relationship to the employer concerned. Further, it’s the gross taxable benefit that is pensionable. None of the deductions above that reduce taxable income are taken into account for CPP purposes. In other words, for the $50,000 benefit above, CPP contributions are owing on the full amount (up to the applicable YTD maximums), not the net $25,000.

For EI purposes, since they are non-cash, stock option benefits are not insurable earnings and no ROE reporting is required.

In practice, it’s not clear what the CRA expects when stock option benefits are provided to former employees and there are no other earnings from which to make the necessary source deductions. Prior to the 2010 budget change, the CRA accepted that employers were not required to withhold and remit when the only employment income were taxable benefits. It’s not clear how this 2010 budget change affected that CRA administrative position.

Stock option taxable benefits are T4 reportable, even for benefits that are income taxable in years where otherwise there is no employment relationship. This means the gross amount of any stock option benefits must always be reported in T4 Boxes 14 and 26, even for former employees. If no CPP source deductions are taken, and no corresponding employer contributions are reported on the T4 Summary, presumably a PIER report would show both sides of these CPP contributions as owing.

Alan McEwen is a Vancouver Island-based HRIS/Payroll consultant and freelance writer with over 20 years’ experience in all aspects of the industry. He can be reached at armcewen@shaw.ca, (250) 228-5280 or visit www.alanrmcewen.com for more information. This article was first posted to Canadian HR Reporter and Canadian Payroll Reporter on May 14, 2013.

About Alan R. McEwen

HRIS/Payroll consultant and freelance writer
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