But how do employee stock options work? And how are stock options taxed in Canada? We take a deeper look into the various implications from a tax perspective.
How do employee stock options work?
Companies often give their employees the option to buy shares at a set price (called the exercise price), during a set period of time. If the company’s shares increase in value, employees can choose to buy shares at that lower exercise price and can then choose to either sell the shares at a profit or to hold onto them in the hope that they continue to increase in value.
When the employee receives the option to buy the shares, there are usually no tax consequences until they exercise the option — that is to say, when they buy the shares at the discounted rate - or when they sell the shares, depending on the situation. How stock options are taxed in Canada will depend on several factors, such as the company the employee works for and whether a stock option deduction may be available.
How are stock options taxed in Canada
If you exercised your stock option to buy your employer’s shares at the exercise price, there is a taxable employment benefit, which is equal to the number of shares bought, multiplied by the difference between the shares’ fair market value on the exercise date, minus the exercise price.
If you work for a Canadian-controlled private corporation (CCPC), you don’t need to pay tax on the stock option employment benefit until the year you sell your shares. To be a CCPC, in addition to other requirements, the company must be a Canadian privately-owned corporation that isn’t controlled by non-residents or public corporations.
If you work for a company other than a CCPC (for example, a public corporation), you would be taxed on the stock option employment benefit in the year that you exercised the stock option. There may be a 50% stock option deduction (generally 25% for Quebec) available to help offset a portion of the employment benefit. The stock option deduction is discussed further below.
If you continue to hold the shares after you exercise your options, there could be a capital gain or loss. Keep in mind that half of capital gains are taxable provided they are held in a non-registered account.
How stock option tax in Canada is calculated
As noted earlier, when it comes to calculating the stock option employment benefit included in your income, there is often a 50% stock option deduction available. There are conditions required to be able to receive the stock option deduction which depend upon whether or not the corporation is a CCPC and are more stringent if the corporation is not a CCPC.
For Quebec, the deduction is generally a quarter of the employee stock option taxable benefit amount. Since February 22, 2017, the deduction could be increased to 50% if the underlying shares are listed on a recognized stock exchange and whose payroll in Quebec is at least $10 million.
Rules were put in place (which are effective for stock options granted after June 30, 2021), to restrict the stock option deduction that is available in certain circumstances. Options that can qualify for the 50% employee stock option deduction are limited to $200,000 vesting annually (based on the value of the shares on the date the option was granted). Quebec has harmonized with this federal tax measure.
The new rules do not apply to CCPC employees or non-CCPC employees whose company’s revenue is $500 million or less.
Here’s an example of an employee stock option purchase:
- An employee is granted an option to purchase 100 shares of their employer (a public company), at an exercise price of $30 per share.
- Two years later, the employee exercises the option when the value of the shares is $50/share.
- The employment income inclusion is $2,000 (($50-$30) x 100).
- If the 50% stock option deduction is available, this would provide a deduction of $1,000 to apply against the employment income inclusion.
The amount of tax that the employee would have to pay would depend on their marginal tax rate. If, for example, their marginal tax rate was 35%, they would pay $700 of tax (or $350 if the 50% stock option deduction was available).
We strongly encourage you to reach out to your tax advisor to determine if the stock option deduction is available in your particular circumstances.
Fitting your employee stock options into your overall financial plan
For many people, exercising an employee stock option can be an easy decision, particularly if the company’s share price has increased significantly since the options were granted. However, you still have to pay for those shares and, like any asset in your portfolio, there are many factors to consider, including whether you plan to sell the shares or hold onto them.
How these shares will affect your portfolio’s diversification is also a key concern. Shares of a single company shouldn’t generally account for a large percentage of your portfolio’s assets. Also, holding shares in your employer can be dangerous if the company hits hard times. You could lose your job at a time when your savings (in the form of your company shares) have lost value.
An IG Advisor can help advise you on how to integrate shares from employee stock options into your portfolio and your overall financial plan. Contact your IG Advisor today to discuss your employee stock options. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Advisor. Trademarks, including IG Wealth Management and IG Private Wealth Management are owned by IGM Financial Inc. and licensed to its subsidiary corporations.
