You've hit the jackpot with your company stock. Here’s how to keep more of what you’ve earned.
So you've hit the jackpot with your company stock. CONGRATULATIONS! Unfortunately, a lot of this money ISN’T actually yours – it belongs to the CRA! This is where one of Canada's best-kept tax secrets comes into play. But it isn't for everyone, and that’s where the experts in tech compensation plans and advanced tax strategies at Novel Wealth come in.
Key Takeaways
- When stock appreciates in value, investors have to pay tax on those gains.
- Traditional options of holding or selling stock and paying tax can be costly (i.e. Concentration risk vs Pay Tax).
- Most people don’t realize there is a 3rd option where you do not trigger any taxable gains, yet you are able to diversify.
- The process is relatively straightforward and inexpensive, however, it requires a good deal of expertise and infrastructure to complete properly (can’t be done DIY)
So you've hit the jackpot with your company stock. CONGRATULATIONS! Unfortunately, a lot of this money ISN’T actually yours – it belongs to the CRA!
The good news is - the CRA will LET YOU KEEP ALL of the money, for now - until you initiate a ‘deemed disposition’ and trigger the capital gain.
The bad news is – you’re officially in the ‘Capital Gains Trap,’ AKA the ‘Tech Pro’s Dilemma’. You don’t want to sell and pay the tax. However, if you don’t diversify, there is a chance the stock will go down, and you will lose even more money than you would have paid in taxes.
What's a savvy investor to do?
If you're like most Canadians, you probably think you have two options:
- Keep all your eggs in one basket (HOLD on to the stock) or
- Sell and pay the tax man (SELL the stock)
But what if I told you there's a THIRD option that lets you diversify and keep the taxman waiting?
The strategy is called the Section 85 Rollover. This is a strategy that most Canadians (even many accountants) are not aware of. However – it’s one of the best ways to save tax and build wealth if you find yourself in the Capital Gains Trap.
The Tech Pro’s Dilemma
Picture this scenario: You've faithfully participated in your company's share purchase plan for years. Your loyalty and financial savvy have paid off as your company's stock has skyrocketed.
Let's put some numbers to it:
- Your original investment: $500,000
- Current value: $1,000,000
- Potential capital gain: $500,000
- Estimated tax bill if you sell: $125,000 (ouch!)
You know that keeping most of your wealth tied to one company's fortunes is risky business. But cashing out means saying goodbye to $125,000 that could be working for you. You have officially found yourself in the Capital Gains Trap aka the Tech Pro’s Dilemma!
Enter the Section 85 Rollover
This is where one of Canada's best-kept tax secrets comes into play. Hidden in the labyrinth of the Income Tax Act is Section 85 – a provision that allows for tax-deferred transfers of property between individuals and Canadian corporations.
In plain English? You can take those highly appreciated company shares - and swap them for shares in a diversified S&P 500 ETF-Type investment - without triggering immediate capital gains taxes.
Yes, you read that right. You CAN diversify WITHOUT paying taxes!
How It Works (Without the Tax Jargon)
Instead of selling your company shares on the open market (which would trigger taxes), you essentially "roll them over" into a corporate structure that holds a more diversified portfolio.
The magic happens because:
- You're not technically selling your shares
- You're exchanging them for shares in another entity (Diversified among ~500 companies, instead of one)
- Your original cost base transfers with you
- Your tax liability gets deferred until you eventually sell the new diversified holdings (likely in retirement, or a lower-income year)
The best part? That $125,000 you would have paid in taxes keeps working for you as an investment in the market. Over time, that difference can significantly boost your long-term returns.
Not a DIY Project
Before you rush to your online brokerage account, this isn't something you can easily DIY. The Section 85 rollover requires:
- Specific forms filed with the CRA
- Precise valuation of the assets being transferred
- Proper structuring of the receiving corporation
- Coordination between your investment and tax professionals
This is complex stuff happening in the back offices of financial institutions that specialize in these transactions. It's definitely not a "click a few buttons and you're done" kind of deal.
You next best move
If you're sitting on significant gains in your company stock, the Section 85 rollover could be your ticket to better diversification without the immediate tax hit. After all, what's better than having your cake and eating it too? Having your diversification and deferring your taxes!
That said, this strategy isn't for everyone, and it's absolutely critical to work with both an expert in tech compensation plans and advanced tax strategies.
If you’d like to talk about whether this strategy is right for you, reach out.
