How Stock Options Are Taxed

by Tax Guy - Burlington Accountant on September 23, 2009 Print This Post Print This Post

This is the final article in my series on stock options. The previous articles provided background on what stock options are and how stock options are used. In this article, I address the tax consequences of using stock options.

Capital Gains or Business Income?

The first step in figuring out how stock options are taxed is to determine whether your gains or losses are capital gains and losses or business gains and losses.

Only 1/2 of capital Gains are taxed while businesses can deduct expenses from income but the net income is taxed at your marginal tax rate.

For more information on capital gains, see Capital Gain or Income?, Calculating Gain or Loss on a Stock Sale, and Superficial Losses: Gains & Loss on Identical Properties.

Buying or Holding Call Options

If you have purchased or hold a call option, you have acquired the right to buy a stock at the stated price on or before the option expires.

You expect the share price to rise before the option expires so that you can either “lock in” the share price or sell the option on the options exchange before it expires.

If the option expires, you will be out of pocket for the price of the option.

  Capital Income
Exercising A Call Option The costs of the option plus brokerage fees is added to the adjusted cost base of the shares. The costs of the option plus brokerage fees are added to the cost of the shares.
Call Option Expires The cost of the option plus brokerage fees become a capital loss in the year the option expires. The cost of the option plus brokerage fees is deducted from income in the year the option expires.
Selling or Closing The Option The adjusted cost base of the option is deducted from the selling price less brokerage fees generate a capital gain or loss. The premium is added to income while the cost is deducted from income.

Buying A Put Option

If you have purchased a put option, you are acquiring the right to sell a stock at a stated price on or before it expires.

You expect the price of the stock to fall before the option expires so that you can “lock in” your gains.

If the option expires, you will be out of pocket for the price of the option.

  Capital Income
Exercising A Put Option The cost of the put plus the brokerage fees is deducted from the proceeds from the sale of the shares. The cost of the put plus the brokerage fees is deducted from the proceeds from the sale of the shares.
Put Option Expires The cost of the option plus brokerage fees become a capital loss in the year the option expires. The cost of the option plus brokerage fees is deducted from income in the year the option expires.
Selling or Closing The Option The adjusted cost base of the option is deducted from the selling price less brokerage fees generate a capital gain or loss. The premium is added to income while the cost is deducted from income.

Selling A Call Option

The seller of a call option has an obligation to sell or deliver shares of a stock at a stated price on or before the option expires.

If you are selling or writing a call option, you believe the price of the stock will not change or will decrease so that you can earn a premium.

Covered Call – If you own the share and the price increases and the option is exercised then you must deliver your shares to the other party.

Naked Call Option – If you do not own the shares and the option is exercised you will have to purchase the shares on the stock market to deliver.

Selling/Writing Covered Call Options*

  Capital Income
Premium The premium less brokerage fees is a capital gain when written. The premium is included in income when the option is exercised.
Exercised Call Option The premium is added to the proceeds of the share sale (If written the in the prior year, you’ll need to amend your tax return for the prior year to remove the gain). The premium is included in income when the option is exercised.
Call Option Expires The premium less brokerage fees is a capital gain when written. The premium is included in income when the option expires.
Selling or Closing The Option The premium less brokerage fees is a capital gain when written and an offsetting position would be deducted from the capital gain. The premium is income and the cost of the offsetting position is a deduction.

* Gains and losses on the writing of naked (non-covered options) are typically considered income.

Selling A Put option

The seller of a put option has an obligation to buy a stock before the option expires.

Selling/Writing Put Options

  Capital Income
Exercising A Put Option The premium is subtracted from the adjusted cost base of the shares. The premium is subtracted from the adjusted of the shares.
Put Option Expires The premium less brokerage fees is a capital gain when written. The premium is included in income when the option expires.
Selling or Closing The Option The premium less brokerage fees is a capital gain when written and an offsetting position would be deducted from the capital gain. The premium is income and the cost of the offsetting position is a deduction.

More Information On Investments

If you are looking for more information on the types of investments available and how they work, take a look at the Investor Education Fund.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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