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Stock Option Transfers on Death – Why Careful Estate Planning is Critical

18/07/2013


When someone passes away, people are often surprised by the number of financial and legal considerations that must be wrapped up by the deceased’s surviving family, executors and other will beneficiaries. Assumptions that were made during the estate planning process – particularly surrounding relatively unknown subject areas like stock option rules on death – can easily be challenged. Ultimately, the distribution of someone’s estate creates complex tax scenarios for everyone involved, including the person that has died.

Stock Options & Your Spouse

The majority of people leave the bulk of their estate to their surviving spouse, with most property transferable to that person with no income tax consequences. An exception to this rule is stock options held by the deceased that are meant to be transferred to their spouse. In these instances, those options will be taxed on the deceased’s final tax return. The employment benefit of the deceased is equal to the fair market value of the option at the time of death, less any amount paid to acquire that option. If for some reason the stock options aren’t transferrable, the fair market value of the stock option would be nil, so there would be no taxable benefit to the person that’s passed away.

Stock Option Deductions

Another twist on transferring stock options involves a 50% deduction that is typically available to shareholders. Generally when a stock option is exercised or sold from a Canadian Controlled Private Company, you can claim a deduction which is equal to 50% of the stock option benefit, effectively making the option similar to a capital gain. In the case of stock options held at death, that 50% deduction is not available on the deceased’s final return. That being said, the Canada Revenue Agency’s interpretation on this matter has changed over the years.

Not having access to this deduction does impact the estate (or spouse). Essentially, it’s deemed that the beneficiary has acquired the stock option at the fair market value at time of death. The fair market value is then added to the adjusted base cost of the stock option. When the shares are sold there will be a capital gain or a capital loss. If the stock option expires, it means a loss for the beneficiary. In this instance, income tax would only have been paid as a benefit on the deceased’s final return, while a capital loss can only offset a capital gain for the beneficiary. Given the benefit has been taxed at 100% and you can only achieve a deduction of 50%, expect to incur a cost.

A Solution + Planning Ahead

If you’re looking for a way to avoid the above scenario, there is one possibility. If the loss is realized within 12 months of the date of death and you file an election with an amended final income tax return, you may be able to offset the income inclusion by the capital loss.

Of course, the best solution to avoiding this kind of situation is to consider every aspect of your tax situation and carefully plan your estate without making assumptions. If you own options, review your will and ensure you have considered the tax impacts. In addition, make sure your stock option agreements actually are transferable on death.