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Business Donations and Their Tax Implications

Business Donations and Their Tax Implications
Stock options are common employee compensation and retention tools at public companies that can be used to fund tax-effective donations to charity. When a stock option is exercised it triggers an employment benefit which is included as income in the year of the transaction and taxed at 50% of the normal rate (depending on certain qualifications).

If you decide to donate the proceeds of the exercise – either the shares themselves or net cash proceeds – there is no taxation on the amount donated as long as the gift is made to a registered charity within 30 days. In addition, you will also receive a tax credit for the fair market value.

There are two ways to make a donation of stock option proceeds:

  1. Donate Shares
    You may exercise the options and donate all or a portion of the shares in kind. The charity needs to receive shares within 30 days of exercise. The value of the donation is based on market value on day of receipt by the charity. There are two factors to consider with in-kind donations funded by stock options. First, due to a processing time lag, the value of the receipt may be different than the value of the stock at the time of exercise. This makes it difficult to “lock in” a specific stock price for donation purposes. Furthermore, you will need to finance the purchase of the option exercise, and a donation will leave you out of pocket, especially if the exercise requires borrowing.
  2. Donate Net Cash Proceeds
    You may exercise the options, sell the shares, and donate all or a portion of the net cash proceeds within the 30-day window. At the time of the exercise, you must direct an employer-approved dealer or broker to pay the gift to the charity. Donations of cash proceeds enable you to more accurately determine the value of the gift by making the exercise and the sale of the security simultaneous. In addition, you are less likely to be out of pocket when financing the options.

Taxation

Only the proceeds of the stock option exercise that are donated to charity are eligible for nil taxation of the employment benefit. The amount retained for personal use is taxable. When cash proceeds of a stock option exercise are donated, there will always be a portion of the total amount triggered by the stock option exercise that will be taxed. For example, even if 100% of the net proceeds are donated, a portion of the cost of the option – the amount up to the exercise price – is taxable on a pro-rated basis. However, there would be sufficient tax savings from the gift to offset this amount.

Claiming the Benefit
To eliminate the employment benefit after donating employee option securities, the gift is reported on line 249 of the T1 tax return by the taxpayer. The charity is not required to annotate the tax receipt to document the source of funds.

Applicability
The elimination of the employment benefit tax when donating employee option securities does not apply in two cases: stock unit plans and stock options owned by nonarm’s length shareholders. Stock unit plans track the value of the employment benefit against the company’s stock, but the employee will receive a fully taxable cash payout at the end of the period. Types of stock unit plans include: restricted stock units (RSUs), performance stock units (PSUs) and deferred stock units (DSUs). Non-arm’s length shareholders who are typically controlling shareholders can receive stock options. Options issued to non-arm’s length shareholders are taxed as income even when a donation is made.

Special thanks to Malcolm Burrows, Head of Philanthropic Advisory Services for Scotia McLeod, for authoring this article. See the LedgersOnline Accounting and Tax Services page for more information relating to the financial services offered by our team.

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Posted in tax tips