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Employment Income, Lesson 3 - Employment Income Lesson...

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Employment Income Lesson Three
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Summary of Employee Benefits Taxable* Room & Board Provincial Health Care Wage Loss Plans Use of Employer’s Vehicle Low or No Interest Loans Travel Benefits Tuition Cost of Tools Gifts from Employer Prizes or Awards Counselling Fees *ssec.6(7) Cost includes GST, PST Non Taxable Housing in Remote Locations Private Health Care Group Accident, Sickness and Life insurance Plans Moving Expense Reimbursement Schools in Remote Locations Uniforms Subsidized Meals Merchandise Discounts Job Transportation Transportation Passes (airline, bus, or rail employees)
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Conceptually Benefits that create inequity between taxpayers are generally taxable (tax re- establishes some equity) Benefits related to personal pleasure or enjoyment are taxable (Trips, vehicle availability, expenses for spousal accompaniment on trips, etc.) A benefit deductible by the employer is generally taxable to the employee (with few exceptions)
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Stock Options Section 7
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Stock Options A stock option is an agreement which grants the employee the right to invest in the company’s shares at a given price before a specified date Stock options are intended to provide management with incentives to maximize firm value (aligns management’s and shareholders’ interests by making management a shareholder) Employers like the scheme because it does not involve before or after-tax cash outflows – many small companies just don’t have the cash
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How Options Work
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$$ Time Value of Shares on Grant Date $7.00 Exercise Price $10.00 (Option Purchase Price per [email protected]) FMV @Purchase $15.00 Taxable Stock Option Benefit [email protected] $25.00 Taxable Capital Gain
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Example of A Stock Option Calculation On January 1, 2004, Ms. Smith was given an option to purchase 10,000 shares of XYZ Corporation for $8.00 per share. This option extends for three years. The value of the shares at particular dates are as follows: January 1, 2004 $ 8.00 January 1, 2006 $ 9.50 January 1, 2008 $11.00 Determine the impact when Ms. Smith exercises her option on Jan. 1/06 and sells on Jan. 1/08.
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Solution: When Ms. Smith Exercises her Option Taxable Benefit: FMV of shares on exercise date: $9.50 X 10,000 shares $95,000 Cost of Shares: $8.00 X 10,000 shares $80,000 Taxable Benefit [ssec.7(1)] $15,000 Because Ms. Smith paid $80,000 cash and is taxed on the $15,000, the tax authorities consider her cost of those 10,000 shares to be $95,000 or $9.50 per share.
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Tax Impact When Ms. Smith Sells her Stock Option Shares Proceeds of disposition: $11.00 X 10,000 shares $110,000 Adjusted Cost Base: $9.50 X 10,000 shares 95,000 Capital Gain $ 15,000 Taxable Capital Gain $15,000 X 1/2 $ 7,500
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Rules Regarding Stock Options The option must be received as as a result of employment When stocks are purchased under the option, the difference between the option price (the purchase price agreed to in the employment contract) and the FMV is a taxable employment benefit Inclusion of this stock option benefit in income has the potential to create inequity between employees who purchase the shares through their employment contract versus individuals who purchase shares from a broker
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How Does This Inequity Arise?
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