Offering stock option rewards is a method companies use to attract and retain the best talent, and are often popular among start-ups that may not yet have the resources to pay top salaries. Employees are invested in the company and are motivated to work hard to ensure its success.
Employee stock options allow staff to purchase company stock, subject to restrictions, at a specific price called the grant price, strike price or exercise price. As long as the market price of the stock continues to increase, they can then sell the stock at the market price – the difference between the grant and market prices is the profit they earn.
When a stock option contract is issued, it includes a vesting date or schedule which indicates when an employee can exercise their stock options. In some cases, the company will specify a vesting schedule that can cover different time periods and follow a variety of structures.1
For example, if an employee received a stock option of 100,000 shares, the schedule could be set up to allow them to exercise 25,000 shares on the one year anniversary of the grant, with another 25,000 shares on each of the second, third and fourth anniversaries. If the employee were to resign three years after receiving the grant, they would have to exercise any outstanding vested options within a specified period after leaving, and would lose access to the last 25,000 options. Depending on the potential earnings, stock options could be a factor in an employee’s decision to stay with the company.
The plan will also indicate an expiration date which is the date by which the employee must exercise their options or they will expire. While they may want to wait to see if the stock price increases, if they wait too long they may be forced to exercise their options at a lower price or the options become underwater (a situation where the share price is lower than the grant price).
Paying taxes
Stock options allow employees to increase their earnings, but as compensation, are taxable. How much tax is paid and when depends on a number of factors.
In a Canadian Controlled Private Corporation (CCPC) the employee does not pay tax until the shares are sold; the difference between the grant price and the market value of the shares is the amount that is taxable. In public corporations, the benefit is taxed in the year the employee exercises the stock option and acquires the shares.2
Under the current Income Tax Act, employees receive preferential personal income tax treatment in the form of a stock option deduction, which is 50% of regular tax rates. The 2019 Federal Budget brought down in March, has proposed changes to this taxation structure. This would cap the amount eligible for tax preferred treatment at $200,000 CAD, with amounts above this being taxed at the regular rate.3
In addition, this change would impact employees of "large, long-established, mature firms" only, with start-ups and other growing businesses maintaining the current tax structure. The other point to note is that this would not apply to stock options granted prior to the announcement – the changes would apply on a go-forward basis.4
The federal government has stated that more details will be forthcoming before summer 2019, and we will continue to monitor and report on the proposal.
Sources:
1, 2 What should I do with my employee stock options? Globe and Mail
3, 4 2019 Federal Budget Highlights
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