Tax Pitfalls for US Stock Options
James Schofield - May 17, 2023
Stock compensation can turn employees into millionaires, but on the flipside huge amounts can be lost to taxes if one does not understand how their employer stock works. Here we delve into one of such complexities with US stock paying dividends.
Stock options can be an extremely lucrative form of compensation. You may have heard stories of early employees at Google who were granted multiple thousands of options in the early 2000s when Google went public, who are now multimillionaires. Many companies outside of the tech industry also use stock-based compensation to reward employees, as it is a great way to ensure everyone is working toward the same goals. Unlike owning shares of a stock where tax implication of receiving dividends are fairly clear; options, RSUs, and other forms of stock compensation are complex structures, and if not managed carefully, they can lead to some nasty surprises at tax time.
One common problem, particularly for companies based outside of Canada, is dividend reporting. Often, stock-compensation plans are sponsored by US-based companies, held at a brokerage outside of Canada. Most investors expect their investment manager to make them aware of any actions that would give rise to an additional tax, but in the case of US stocks held at a US brokerage, Morgan Stanley, UBS, or whoever administers the account, the brokerage is not responsible for providing T-Slips to the employee. They will, however, provide a statement of dividends paid during the year and state the amount of tax withheld by the US or other countries, in some cases. Canadians who have had taxes withheld by other countries will often receive a credit, which basically tells the Canadian government not to take as much tax as they otherwise would have. These arrangements between countries are called tax treaties, and they are a way for different countries to ensure they collect some tax from income that they made possible.
A common mistake made by employees with stocks paying dividends is when they see that taxes have been withheld by another country at source, they incorrectly assume they are paid-up with the CRA, but any income earned by Canadian residents is also subject to Canadian tax. Tax treaties ensure that taxpayers are not fully taxed by both countries, but do not make the mistake of assuming that because foreign taxes have been withheld, that you are square with the CRA. In Canada, investors are accustomed to receiving a T5 to report dividends, which makes it much easier to file your own taxes online, as it is an exercise in simple data entry, match the boxes on the T5 to the fields in the tax software, and you are ready to file! Because you will not receive the T5 from foreign brokerage, you will have to find the dividends paid and taxes withheld on the statements, which you should be able to download from the brokerage portal. From there, the do-it-yourself tax filer will have to find the correct fields to enter foreign dividends and foreign taxes withheld.
Cross border taxation is one of the most complicated facets of taxes because it involves understanding not only the rules and implications of two different tax systems but how they function when they meet. There are sometimes gaps in a tax treaty, whereby one country will take more than its fair share of tax, but it is eligible for a rebate, which puts the onus back on the tax payer to apply for the rebate. It is at this point that you may want to seek the help of an experienced CPA.
You do not have to be a tax professional to deal with your stock compensation, and depending on the complexity of your situation, you may still be able to file on your own taxes using a software like TurboTax. A few things you should do, at the very least are:
- Familiarize yourself with the brokerage portal your company uses to learn the different statements you can download. Everyone who receives stock-based compensation needs to understand where they can see an updated adjusted cost base for the shares they hold before selling any shares. There are several tax planning strategies that can be utilized with stock options.
- Hire an accountant. Even if you are comfortable tracking the dividend income and taxes withheld on the statements, an accountant may alert you to a tax rebate and can help you apply for it.
Stock-based compensation has changed lives and created generational wealth for many families, but employees have also lost large sums to taxes by not fully understanding how their employer stock works. In an economic environment where pensions are becoming extinct, stock-based compensation plans may be the only source of a nest egg for you in retirement. For that reason, it is important to make the best decisions you can and bring in professionals when necessary.