CRA just made life easier for executors administering estates that include unexercised stock options.
Katy Pitch, an associate with Stikeman Elliott’s Tax Group in Toronto, says a recent technical interpretation issued by the agency (in response to a practitioner query) allows executors to approach tax reporting of unexercised options as they would have prior to rule changes introduced in 2010.
To illustrate, take the case of a client who dies with 100,000 unexercised stock options. Fortunately, her employer plan says the options vest upon death. The option price is $25 per share; the fair market value immediately after death is $30.
Here’s how it worked prior to 2010:
First, the executor calculates the deemed employment benefit for the purpose of the deceased’s terminal return. In our example it would look like this:
$3,000,000 (100,000 × $30) — $2,500,000 (100,000 × $25) = $500,000
The executor then applies what tax experts call the 110(1)(d) deduction, which essentially says income tax is owing only on half of that $500,000. The options aren’t actually exercised—there is a deemed employment benefit for tax reporting purposes only. The options then fall into the estate and the executor exercises them within the timeframe specified by the employer’s plan. Once the options are exercised, the shares have the same status as any other stock in the estate.
Rule changes in 2010, says Pitch, put a question mark around whether an executor could apply the 110(1)(d) deduction on the deceased’s terminal return. If he couldn’t, it would be necessary to pay tax on the entire deemed employment benefit of $500,000. The executor would subsequently exercise the stock options and apply the 110(1)(d) deduction at that time.
CRA’s recent ruling affirms executors can now use the 110(1)(d) deduction on the terminal return.
Pitch notes a crucial precondition: For executors to take advantage of CRA’s ruling, the deceased’s employer must file a 110(1.1) election. So, advise executors in these situations to verify with employers that they’ve done so, otherwise CRA could dispute the executor’s use of the 110(1)(d) deduction on the terminal return.