Ok, he got the $250k gain but would $500k not become his new cost base, so when Nortel goes bust he can claim a $500k (complete) capital loss? Is it because the gain is considered income while the loss is capital and not claimable against income?

By CanadianInvestor on Jul 25, 2009

I’m in a similar position to Mr. Roy’s except that my amounts are larger, and my options were with Entrust rather than Nortel. Most people I try to explain all this to simply can’t understand it because it seems so crazy. People are used to taxes being some percentage of money actually received rather than a percentage of some paper gain that is long gone. Mr. Roy is getting taxed on money he never received.

To answer Canadian Investor’s question, yes the gain is considered employment income. It attracts a special deduction so that the inclusion rate is 50% (the same as capital gains), but this gain can’t be offset with a capital loss. If Mr. Roy is wealthy enough to have other investments that allow him to use this huge capital loss, then this is of little consequence to him. But, if he is a person of modest means, then he is likely to never be able to make much use of the capital loss.

By Michael James on Jul 25, 2009

I’m in the same position with double the exposure, facing over $100,000 tax bill on imaginary income. To rub some salt in, Flaherty has said that affected taxpayers shouldn’t hold their breath waiting for him to undo this fiasco. And if you thought your MP might be of help, you’re wasting your time. My MP, Gord Brown, either can’t understand this gross injustice or could care less about a constituent. Seems indicative of the Conservatives’ attitude (unless you’re a former PM).

Thanks Mr. MacDonald for giving this some airtime, but I’m afraid that unless the Conservatives get publicly embarrassed by this, they will continue to exact their pound of flesh.

By Shafted by Flaherty on Jul 27, 2009

Two thoughts:
As I understand it, tax laws were changed back in the late ninties/early 2000 so that you didn’t have to pay tax immediately upon exercising your options. From what I understand it’s the same people who had options that lobbied for this change.

From an investment stand point… 50% gain isn’t enough? …or at least cover your liabilities. Perhaps I’m just too conservative and risk-adverse.

By A on Jul 28, 2009

Maybe I do not understand this properly but here are my taught

Mr Roy is just caught like every other investor who lost money in the Nortel saga,
Actually, I feel he is stuck like every other investor who has bought Nortel stocks on margin!
(He owed money to the tax man instead of a bank)

Unless I am mistaken, Mr Roy was allowed to sell his stocks as soon as he exercised his options. If Mr Roy
Would have done the right moves, he would have cash in is options, sell the stocks on the market,
Pay the taxman and kept the rest. At 50% tax rate, he would have had $175,000 left in his bank account
($500K from selling, $250k to buy the stock, $75k tax bill).

Instead Mr Roy taught the stock was going sky high (like everybody else who got fooled) and kept the stock.
Now he has to pay back his debt. He is even better off than someone who would has bought Nortel on margin
At the same time as him; that person has been paying interest since day one, while Mr Roy has not started paying
Interest yet. That person would also be stuck with a capital lost that he could probably not ever use.

By the way, I bought Nortel shares at 108$ in my RRSP, even dough I have had a small tax credit, I still have a capital loss that I cannot use!!

Blame your boss Mr. Roy, not the taxman!

By Foolled Investor on Jul 28, 2009

By exercising the options, Mr. Roy received $250000 in stock from Nortel. He then chose to risk that money by keeping it as stock and not selling it. I too would like to avoid paying taxes on income I lost by choosing to play the stock market, but that’s not the way it works – nor should it be. He received the money, he should pay tax on it. Anyone lucky enough to have drawn a senior manager’s salary at Nortel and be granted stock options on that scale has nothing to complain about. We certainly shouldn’t change the tax laws just because those people didn’t bother to find out the rules when they received such generous grants.

By Bill on Jul 28, 2009

He took a chance, he lost. Why should all the rules be changed to suit him or her. Next time sell to cover taxes, keep the rest.

By tookachance on Jul 29, 2009

Bill:- I beg to disagree with your scenerio.
I know Mr Roy personally and he did not receive “money”. All he received for his options purchase was a piece of paper that momentarily had a “deemed” Fair Market Value of $250,000. But that piece of paper was not sold so he didn’t actually receive any cash at all for that investment.

How would you like to be taxed on equities you held past their peak value but actually lost money on. A loss your taxman won’t even allow you to apply against the unjust taxes levied on a “phantom” gain on those very same equities?

Since when does making an error, in shares trading, justify being taxed on the profit you might of had? Roy had no actual income with which to pay those taxes so he is faced with paying the tax levied out his retirement savings

If that sounds reasonable and fair to you then I would like to handle your investment account.

Ken

By Ken Thompson on Jul 29, 2009

I urge all Canadians to visit http://www.cfet.ca and understand this issue. This is a most cruel, vindictive and unfair tax situation with real human consequence ruining and bankrupting hard working families and filling their lives with fear and foreboding. Read the victim impact statements. The USA has seen fit to change this! Why can our current Government not see the damage that is being done

By Gary L. Hawe on Jul 30, 2009

Ken:
Mr. Roy received the money in the form of stock, but the form is irrelevant. The stock had a real value gain of $250000 which he could have realized by selling it, but he chose instead to risk it in hopes of making more money. Despite your use of passive voice, he was an active participant in this process. He had to initiate the transaction for it to happen, so painting him as a hapless victim just isn’t accurate.

I have paid tax on equities I held past their peak and lost money on, but I paid tax before I received the money (as salary) – like most people do. I don’t like this at all, but those are the rules. With stock options the rule is you pay taxes later, but you still have to pay. Paying later is an advantage of this system, but you suggest we add another advantage by asking people to pay only if their gamble in the stock market pays off? Ridiculous.

This is a tough situation for Mr. Roy, but ignorance of or indifference to the tax laws doesn’t excuse him from his responsibility. Taxes will be paid on this money, either by him or by you and me. I don’t feel like paying Mr. Roy’s taxes. Do you?

By Bill on Jul 30, 2009

Ken, I totally agree with Bill. If Mr.Roy would have saw the futur, he would have sold his piece of paper right away and made money. Instead he did the equivalent of investing “before tax dollars” in a stock that went down, but he is still liable for the tax.

The only situation where the legislation might need to be changed is if the owner of the stock options is locked in for a certain amount of time after exercising them.

Options are a two edge sword, make the right moves and you will make a bundle, make the wrong move and it will cost you. Mr. Roy just taught he would have more money later and that he did not have to pay taxes right away if he kept the paper. It turned out to be the wrong move

I do not feel sorry that he has to cash in his RRSP or sell his house, everybody that had Nortel in their portfolio got some financial impact; lost of capital, lost in RRSP value, and some had to pay back loans or margins.

By Fooled Investor on Jul 31, 2009

Bill:-

This is supposed to be “INCOME TAX” not a gamblers tax. If Roy did not actually receive real dollars as income the government has no right to collect real dollars in tax period.

By Ken Thompson on Jul 31, 2009

My take-away message from stories like these and like Michael James’s is: don’t exercise your options unless you plan to sell the resulting shares immediately.

More importantly, I agree that this system is patently unfair and should be fixed.

By Patrick on Jul 31, 2009

Bill, Mr Roy DID receive real dollars value ($250K of it), but he opted to buy Nortel stocks with it!

By Fooled Investor on Jul 31, 2009

Bill:-
I can see that you and I can only agree to disadree. Fortunately I feel justified in my view as the U.S. Congress voted to end the U.S. taxing of pretend income so I feel more people agree with me. Have a look at http://www.reformAMT.org

Ken

By Ken Thompson on Jul 31, 2009

Ken:-

it is not because the U.S Congress voted to end the U.S taxing of pretend income that more people agree with you, it just means that they have a better lobby group!

And it is not because the U.S. have done it, that we have to do it too! Nor does it means that it is the right thing to do

I’m am wondering what the real ratio would be if this question was brought to “The People”!

By Fooled Investor on Aug 2, 2009

If Nortel had paid Mr. Roy with ice cubes and he failed to put them in the freezer, nobody would be crying about “Phantom Ice” when they turned into water and evaporated. There wouldn’t be websites springing up and rallying to defend him, and no Canadian taxpayer could be misled into believing they should foot the bill for him.

The point is that what happened to the money was one of the possible outcomes of the risk he took with what he’d been given. He gambled and he lost, but the rules were in place when he took that risk and he either ignored them or assumed the risk was worth it because he thought he was going to get much richer. Even if he didn’t know the rules, it was his responsibility to learn them. Anyone who signs up to buy stock options assumes the risk of losing and agrees to play by the rules, there are no surprises here.

So now the wealthy in the U.S. have passed another law to shield themselves from paying tax. Like little children do, they have changed the rules of the game now that they’re losing. “Ignorance” of the law now isn’t an excuse to break it, unless you’re rich. And yes, no matter a person’s lack of planning or irresponsibility with it, if they’ve been given $250000 by their employer, regardless of the form, they’re rich. If they can afford to pay out the initial $250000 to buy the shares, they’re rich, far richer than the majority of people who never receive stock options but must now pay the tax bill for those who do.

I know that the same thing is likely to happen in Canada, but don’t for a minute think that that’s because it’s the right thing to do. It’s because of politics. How else could we be fooled into paying taxes for a guy who was paid a quarter million dollars but lost it in the stock market before paying the taxes he owed on it?

By Bill on Aug 6, 2009

Bill:

The rules around the time of Mr. Roy’s tax dealings were in flux. Mr. Roy might even have gone to a tax advisor and been told “well, the rules are changing right now, and we’re still waiting for them to settle.”

Mr. Roy probably assumed (like I did) that whatever the rules would be, they would boil down to taxing you fairly on income you received (like the clever system of capital gains / losses). The inconsistent way the tax law turned out to be probably caught him by surprise.

Yes, Mr. Roy was taking a risk with his money.
All stock trades are risks, as is driving a car.
The question is: how BIG a risk was he taking?
It turns out he wasn’t just risking the stock he was given. He was risking 1.3x of the stock he was given. He was trading on margin (thanks to this silly tax rule) and not even knowing it! How can we blame someone for taking risks that they didn’t even know existed? … risks that were in fact hidden from them?

For all other taxes, your employer is expected to deduct them from your pay when they are incurred. The tax law was inconsistent because it charged employees for taxable benefits but didn’t require employers to deduct that tax. That seems to have been fixed since, but the damage is done. Mr. Roy was tricked.

By Jurgen Hissen on Aug 11, 2009

Bill, your figures are incorrect. Mr. Roy did not have to pay $250,000 to buy his shares. Option gains at that time were around 30:1, so he would only need to collect about $10,000, which most working people could manage. That makes a $30,000 (my estimate) resulting tax bill all the more painful.

We toss around numbers like “$250,000″ and sound like we’re talking about rich people. But you have to remember that in early 2000, everyone working in high-tech was “rich” – at least on paper. Most of them aren’t anymore.. they’re regular Joes again… but with rich-guy tax bills.

Also, please tell us how you would recognize a bad tax law and how that differs from this situation.

By Jurgen Hissen on Aug 11, 2009

I (and my family) was significantly impacted by the unfair tax law. My occurrence was during the tech bubble – in my situation I needed to exercise stock or lose them as I left the company – but I could not sell the stock as I was in an IPO lockout trading period… Needless to say, I had “paper income” in excess of my normal income and was taxed heavily. And at this time, it was not a 50% reduction but rather a 25% reduction…

I knew about the death, company dissolved or sold, etc. causing the tax to become due…not a burden I wanted to leave for my family – so I decided to pay it off. To do so, I needed to de-register significant amount of RRSP, sold my house at a loss and got a loan.

So I watch this issue really close, hoping one day the Canadian Government decides to correct this wrong and make it retro-active. If it happens, I can only hope they also consider the hardship that those of us that elected to pay the taxes in full went through….like interest on the loan I took out – allowing me to put back in the RRSP funds without taking from my contribution amount…. I do not know how they are going to compensate though for the house – selling at a loss for just under 500k when the Calgary market was in a slump… THEN the new owners selling just over two years later at 1Million plus!!!

By M.E.L. from Calgary on Aug 11, 2009

I’ve read all your comments trying to come to my own position on this. Those who think he should pay the tax sometimes come across as mean-spirited but those who think this should be changed are asking for him to be given a tax holiday at the expense of the rest of us.

While I hate to see someone lose their shirt, if someone made a mistake on this on $25K, not $250K, I think we would all say, you made a mistake and you have to live with the consequences. It’s much sadder and more serious when it’s 250K.

However, I work in the high-tech sector and remember those days. I remember kicking myself for not investing in Nortel in the early days, as I was in the industry. I should have known better and got in early!! But I looked at the price ($200 or so) and thought, what are the odds of this stock even doubling from this point? Compared to the risks of it going down? I never bought. Never rode the train up and never rode it down.

So Mr Roy got greedy and blinded but 250K in one stock? That’s really taking a risk. Adding in your job in the same company leverages the risk even further. He had all his eggs in one basket.

He obviously has done very well salary-wise at Nortel over the years – how many among us would be eligible for 5000 shares and how many would keep 250K in one stock? So he’s taken a lot out of this company. How many Canadians even have 250K in their RRSPs? Why wouldn’t you sell enough to cover the taxes – what do they say, sell half and let the rest ride? But our Mr Roy was greedy. It would be interesting to see if his wife wanted to sell back then and he refused.

Like I said, if it was 25K, we wouldn’t even talk about it. But because it’s 250K, maybe the tax payable should be lessened. Don’t make someone lose more than half their net worth might be a reasonable saw-off.

But there’s little doubt in my mind that the Nortel employees – who among all were close and should have known better – were drinking the company kool-aid and they got caught. Sorry.

Maybe the rule should be changed from here on in but that was the rule back then and these people should have known.

I guess that puts me in the hard ass camp.

By Steve on Aug 11, 2009

I don’t think the hard-ass case is so clear-cut. You want to count the options as income when they are exercised; why not count them as income when they were granted, at the going market value for options? I can’t see how you could consider the income to be realized when the options are exercised, but not when they were granted.

By Patrick on Aug 12, 2009

Bill, fooled investor, and others don’t seem to understand how employee stock options work and therefore draw the erroneous conclusion that Mr Roy was given $250K in profit which he chose to invest in Nortel. Nothing is further from the truth

Mr Roy was granted some options to purchase Nortel stock at a set price. A fictitious ordinary Canadian, Mr Jones, could have purchased very similar leap options at a very modest cost.

Mr Roy and Mr Jones both use their hard-earned after-tax dollars to exercise the options (Nortel did not give Mr Roy the stock, just the options. He had to pay the exercise price to get the stock). They both choose to keep the shares vs getting cash. Mr Roy is zinged on $250K paper profit treated as employment income. Mr Jones has no tax liability at this point. Why the difference?

A little later, the stock tanks so that most of the $250K paper profit is lost (ie profit is now $50K). They both sell. Mr Roy gets a $200K capital loss which he cannot use against the previously attributed employment gain on the same shares. Mr Jones can use his $200K capital loss and is taxed on the correct $50K he actually received. Why the difference?

Mr Roy and Mr Jones both have an additional $50K of capital losses. Mr Roy cannot use these losses against the shares. Mr Jones can reduce his overall taxable capital gain by a further $50K to zero. Why the difference?

Nortel did not give Mr Roy $250K in cash to invest as he will and he chose to gamble it on Nortel. They gave him stock options which others could have acquired on the open market for a modest fee. Yet, the consequences are dire. He owes tax on $250K he never saw whereas his counterpart Mr Jones owes nothing because he made nothing.

If someone says that Mr Roy should have had an employment benefit at the time the stock options were granted equal to the modest amount Mr Jones paid for his options, that is arguably fair.

To suggest that Mr Roy gets penalized out of home and retirement funds because the tax act (erroneously) chose to tax him at exercise (vs sale) and as employment benefit (vs capital gain) is blatantly unfair as the above example amply demonstrates

By blamecanada on Aug 13, 2009

In using your example and to be fair for everybody and the go with our society mentality that every revenue should be taxed, here is what I believe should happen:

You are right when you say that Mr Roy should have had an employment benefit at the time the stock options were granted and this amount could be used has a costs basis for the options. This way, both Mr Roy and Mr Jones have the same costs basis. I also believe that Mr Jones should be “zinged” with a $250k (less the modest fee he paid for the options) tax liability that Mr. Roy gets the day he is exercising them. On that day, Mr Jones is buying something that is worth $500k for $250k and somebody somewhere is dishing out the $250k that he is missing, and since that $250k is not a lottery winning, it should be considered revenue and be taxed.

So I agree with you that Mr Roy and Mr. Jones should be treated equally, but instead of thinking that everybody gets a break, I lean more towards thinking that everybody should be taxed and everybody should get a $500k capital lost to apply to other or future capital gains.

By Fooled Investor on Aug 24, 2009