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How to use stock options to help others (and yourself)

How would like to have stock options valued at the GDP of a small country – say, Belize? When William McGuire, former CEO of UnitedHealth Group, left his position in 2006, that's precisely what he had: Stock options worth $1.6-billion (U.S.). Notwithstanding that Mr. McGuire ended up with a little less than this amount due to a settlement with the Securities and Exchange Commission over an accusation of "options backdating", Mr. McGuire and his wife have been very generous with their wealth, largely accumulated through Mr. McGuire's stock options.

As we head into autumn, there will be a flurry of activity as far as the exercise of stock options is concerned. It's a common occurrence at this time of year, since many executives of large publicly traded companies have certain windows during which they are entitled to exercise their options. And options can expire if they're not exercised within a certain period of time.

If you're one of the fortunate ones to own stock options that are "in the money," and you have charitable intentions, now is a great time to consider how you can turn your stock options into significant tax savings and help others at the same time.

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The rules

If you own stock options and exercise them, you'll face a taxable benefit if the value of the underlying shares is higher than your exercise price (the price which you must pay for the shares). If, for example, the shares have a value of $50 each and your exercise price is $30, you'll face tax on the $20 difference as a taxable employment benefit when you exercise the options. If you have options to acquire, say, 1,000 shares, then the total value of the shares you could acquire would be $50,000. The cost to you would be $30,000, and you'd have a $20,000 taxable employment benefit in this example.

Now, you may also be entitled to a tax deduction for 50 per cent of this benefit if certain conditions are met (most stock options in publicly traded companies meet the conditions for this deduction; stock options issued by private companies may also qualify but the rules are a little different, so speak to a tax pro). So, the taxable benefit could be reduced from $20,000 in my example to just $10,000. The tax owing on a $10,000 benefit would depend on your province of residence and income level, but would amount to about $4,641 for someone in the highest tax bracket (but under $500,000) in Ontario.

The gift

Now, suppose you want to help your favourite charity and are thinking of using some of the proceeds from your stock options to do this. Our tax law will provide some exceptional relief in this case. You could simply exercise your stock options and acquire the underlying shares, then immediately sell the shares on the open market. You'd then have cash that you could donate to charity.

If you donate the proceeds from the sale of your shares within 30 days of acquiring the shares under your stock option plan then the taxman will give you an additional deduction equal to 50 per cent of the taxable stock option benefit – on top of the other 50-per-cent deduction I spoke about earlier. Further, you'd be entitled to a donation tax credit for the value of the cash that you donate to the charity.

Did you catch all that? The end result of donating the proceeds within 30 days of exercising your stock options could be: (1) the usual deduction for 50 per cent of the stock option benefit, (2) an additional deduction for the other 50 per cent of the benefit (so that the benefit now becomes tax free), and (3) a donation tax credit for the value you donate to charity to boot.

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Rather than selling the shares that you acquire under the stock option and then donating the cash, you could also exercise your stock options and direct your broker to donate to charity the shares acquired under the plan.

But there are a couple of drawbacks to this approach: (1) If the securities decline in value between the date of exercise and the date of the donation to charity, the 50-per-cent deduction for the gift that I spoke about would be reduced, and (2) the employment benefit from exercising the options is subject to a withholding tax (much like a bonus would be), which can be avoided if the shares are sold for cash and the proceeds are donated instead.

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.

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