CANADA: Nortel staff rolled dice with options, income delay may hurt them - 30 May 2009

Nortel staff rolled dice with options

Jamie Golombek,
Financial Post 

Published: Saturday, May 30, 2009

At a roundtable tax discussion I facilitated in an Ottawa boardroom
this past week, it didn't take long for the talk to turn to Nortel
employees, their disappearing pension and their tax predicament.

As
reported this week, Nortel employees who received and exercised
employee stock options face a looming problem called "phantom income."
The company is under court protection from bankruptcy, and should the
shares disappear or be sold, employees could face a massive tax bill
this year.

While many have blamed the problem on a flaw in the tax law, the issue is not so simple.

Here's
an example: Let's say Dick's employer has a stock option plan and he
was granted the option to purchase 1,000 shares of his employer at $50
per share. Dick exercised that option when the market price of the
shares was $80. Rather than sell the shares he decided to hang on to
them. By filing an election in the year of exercise, Dick was able to
defer paying tax on this benefit until he sold the shares.

The
stock-option benefit deferred was $30,000, equal to the difference
between what he paid ($50,000) and what the stock was worth when he
exercised his option ($80,000).

The difference, while not a
capital gain, is taxed at the same rate as a capital gain -- 50% of
your marginal tax rate--but is considered to be employment income.

The
problem arises when Dick decides to sell his shares which, given recent
market conditions, have been pummelled and are now worth a mere $10
each. As a result, Dick will receive proceeds on the sale of $10,000
and realize a loss of $70,000 ($10,000 -$80,000). This loss is
considered to be a capital loss and thus can only be used to offset
other capital gains. This means it cannot be applied against the
deferred employment benefit of $30,000, due in the year of sale, even
though it was taxed at the same rate as a capital gain.

It is
this mismatch of employment income against capital loss that has
created the harsh economic reality for employees who face potentially
massive tax bills on money they never received.

The government remains unsympathetic.

As
the Canada Revenue Agency previously wrote: "The tax system reflects
the result that, at the point of acquisition, those employees who hold
their shares have chosen to accept a market risk as an investor, in the
expectation

http://www.financialpost.com/personal-finance/story.html?id=1645026