Thousands of Canadians taxed on 'phantom income'

Kathy Tomlinson, CBC News (excerpts below)

Employees who lost on stock options face bankruptcy over huge tax bills

Thousands of Canadian workers who purchased stock options from their employers before the market downturn are expected to pay millions of dollars in taxes on income they haven't received because the shares have lost their value. "I had to take out over a hundred thousand dollars in loans, plus interest, in order to pay off taxes," said marketing manager Shannon McLeod, a tech-industry worker in Vancouver who faced the same situation several years ago."I was a good little Canadian taxpayer and I paid it off, but it had a huge effect on me."The income tax is applied to stock options, a benefit many Canadian employees are given as part of their remuneration. Employees at various levels of companies in high tech, mining, banking and other industries are allowed to buy stock in their firm at a significantly reduced price. "Companies give out stock options to their employees thinking it is a huge benefit, and it's actually a huge liability," McLeod said.

Because of a little-known loophole in Canada's tax law, people are expected to pay income tax on the market value of the stocks when they are issued — not on their lesser value if they are later sold at a lower price. Those affected call it a tax on "phantom income." Tax experts estimate many Canadians have been hit since the latest stock market downturn. The national group Canadians for Fair and Equitable Taxation says it's hearing about dozens of new cases from people who have just received their assessments for the 2008 tax year.

For example, if an employee bought $100,000 worth of stock for the employee price tag of $25,000 early in 2008, they would be taxed on $75,000 worth of "income" for that year. If the employee held on to their stock, as many do, they would still have to pay tax on the $75,000 — even if the stock's value drops to mere pennies. Employees can defer remitting the tax until they sell the stock or the company is sold, but the tax bill doesn't change.

Thousands of tech-industry employees like McLeod have been hit since 2000. McLeod bought 10,000 shares in Burnaby, B.C.-based digital-imaging company Creo — with money borrowed against the stock — for $17 each. At the time, the stock was trading at $53. She was assessed income tax on $360,000 — the difference between what she paid and the market value of the shares at that time. She was 27 years old and earning a modest salary of less than six figures."On the advice of my financial planner and my accountant, I held on to the shares. And then the market crashed," she said Ottawa taxed McLeod $100,000 on the stock options, even though by the time the tax was assessed, the shares were worth less than she bought them for. Creo stock didn't recover and McLeod said she didn't make a penny. The company was eventually sold, and McLeod had to use a line of credit to pay the $100,000 bill. "If I had again gone into the stock option plan with the company I am with now, right before the 2008 crash, I would again be in the exact same situation," McLeod said.