Stock Options Tax Guide

How Stock Options Work

The Basics

• Right to buy company shares at a fixed price (exercise price)
• Usually vest over time (e.g., 4 years)
• Valuable if stock price rises above exercise price
• No tax when granted

Key Terms

• Grant: When options are given to you
• Vest: When options become exercisable
• Exercise: When you buy shares using options
• Exercise price: Price you pay for shares
• FMV: Fair market value when exercised

When Are Stock Options Taxed?

Timing of Taxation

• Public companies: Taxed at exercise
• CCPCs: Can be deferred until sale
• The "benefit" is the difference between FMV and exercise price

The Stock Option Benefit

• FMV at exercise minus exercise price
• Treated as employment income
• Reported on T4 slip
• Subject to income tax (not CPP/EI)

The 50% Stock Option Deduction

Current Rules (Post-2021)

• $200,000 annual limit on deduction-eligible options
• Limit based on FMV of shares when options vest
• Applies to public companies and large CCPCs
• Small CCPCs often exempt from limit

Qualifying for the Deduction

To claim the 50% deduction:

• Exercise price ≥ FMV when option granted
• Shares are prescribed shares (common shares)
• Arm's length employee-employer relationship
• Within the $200,000 annual limit (if applicable)

Example Calculation

You exercise options to buy 1,000 shares:

• Exercise price: $10/share
• FMV at exercise: $25/share
• Total cost: $10,000
• Total FMV: $25,000
• Stock option benefit: $15,000

With 50% Deduction

• Employment income: $15,000
• Deduction (line 24900): $7,500
• Net taxable: $7,500
• At 40% rate: $3,000 tax

Without Deduction

• Employment income: $15,000
• At 40% rate: $6,000 tax

CCPC Stock Options

Canadian-Controlled Private Corporations have special rules:

Tax Deferral

• Tax deferred until shares are sold
• Not taxed at exercise
• Helps with cash flow
• Must meet qualifying criteria

Exemption from $200K Limit

• Small CCPCs not subject to limit
• Gross revenues under $500M
• All employees qualify for deduction

Subsequent Sale of Shares

Capital Gain or Loss

When you sell shares acquired through options:

• ACB = FMV at exercise (not exercise price)
• Proceeds minus ACB = capital gain/loss
• 50% inclusion rate applies

Example

• FMV at exercise: $25 (your ACB)
• Sell at $35
• Capital gain: $10/share
• Taxable capital gain: $5/share

Alternative Minimum Tax (AMT)

Stock options can trigger AMT:

• 50% deduction is a tax preference item
• Added back for AMT calculation
• May pay more tax in exercise year
• AMT recoverable in future years

Planning for AMT

• Spread exercises over multiple years
• Calculate potential AMT before exercising
• Consider timing with other income

Exercise and Hold vs Exercise and Sell

Exercise and Sell Same Day

• No capital gain (proceeds = FMV)
• Only stock option benefit taxed
• Immediate liquidity
• No market risk

Exercise and Hold

• Need cash to pay exercise price
• Need cash to pay tax on benefit
• Potential for capital gains
• Risk if stock price falls

Tax Planning Strategies

Timing of Exercise

• Consider your marginal tax rate
• Exercise in lower income years
• Spread exercises to manage brackets
• Watch expiration dates

Using the $200,000 Limit

• Limit based on vesting year FMV
• Plan vesting to stay under limit
• Talk to employer about option grants

Donation of Shares

• Donate publicly traded shares directly
• No capital gains tax on donation
• Receive donation receipt for FMV
• Stock option benefit still taxable

Employer Reporting

Your employer reports:

• T4 Box 14: Includes stock option benefit
• T4 Box 38: Stock option benefit amount
• T4 Box 39: Amount eligible for deduction
• T4 Box 41: Security option cash-out

Common Mistakes

• Not setting aside tax: Big tax bill at exercise
• Holding too long: Stock may fall, but tax is owed
• Ignoring AMT: Surprised by minimum tax
• Wrong ACB: Using exercise price instead of FMV
• Missing the deduction: Not claiming eligible 50%

RSUs vs Stock Options

Restricted Stock Units are different:

• No exercise price
• Full value taxable as employment income
• No 50% deduction
• Simpler but higher tax