Stock options — how employee options are taxed
Employee stock options
Section 7 governs the taxation of employee stock options. The employment benefit is generally recognized when the option is exercised (not when granted), and qualifying options on CCPC shares may defer tax further until the shares are sold.
Plain-language explanation
Section 7 is the primary provision for employee stock option taxation. The rules differ significantly between options in public companies and Canadian-controlled private corporations (CCPCs).
When is the benefit taxed? - Public company options: The benefit arises when you *exercise* the option (buy the share below FMV). The benefit = FMV of share at exercise − exercise price. It is included in employment income. - CCPC options: If you are an employee of a CCPC and the options are on CCPC shares, you can *defer* the benefit until you *sell* the shares. This is a significant advantage — you don't need cash to pay tax before selling.
The s.110(1)(d) deduction: If certain conditions are met (exercise price ≥ FMV at grant date; option granted in ordinary course; shares are prescribed shares), the employee can deduct 50% of the benefit under s.110(1)(d), making the effective inclusion rate 50% — the same as a capital gain. This deduction is available for options on public company shares.
The $200,000 annual limit (since 2021): The s.110(1)(d) deduction is capped at options on shares worth $200,000 (based on grant-date FMV) per year. Options above $200,000/year give the employer a deduction but deny the employee the 50% deduction — the full amount is employment income.
Example
Alex has options to buy 10,000 shares of his public employer at $10/share. At exercise, the shares trade at $25. Benefit: $15 × 10,000 = $150,000 employment income. If the options qualify for the s.110(1)(d) deduction, Alex deducts $75,000, bringing the taxable amount to $75,000 — same rate as a capital gain.
Amendment history
Significant changes to this provision. Older versions help you understand rules that applied in prior tax years.
2021 budget capped the stock option deduction at options on shares worth $200,000 per year (based on grant-date FMV). Options above the cap are fully taxable as employment income; the employer gets a deduction instead. This cap applies to large employers (CCPCs and startups below revenue thresholds are exempt).
Before
No annual cap on stock option deduction; unlimited 50% deduction available if conditions met
After
$200,000/year cap on options eligible for 50% deduction (applies to large employers); options above cap are 100% employment income
Common questions
When is a stock option benefit taxed? +
For public company options: when you exercise (buy) the option, you include the difference between FMV and exercise price in employment income in that year. For CCPC options: the benefit is deferred until you sell the shares — you recognize income in the year of sale.
What is the stock option deduction? +
If your options qualify under s.110(1)(d), you can deduct 50% of the employment benefit, reducing your effective tax rate to match capital gains. Conditions include: exercise price ≥ FMV at grant date, the shares are "prescribed shares", and the grant was made at arm's length.
Are start-up employee options treated differently? +
Yes. The $200,000/year cap does not apply to CCPCs (which have their own deferral rule) or companies with less than $500M in gross revenue. Early-stage employees at these companies retain unlimited access to the 50% stock option deduction.
Key terms
Related sections
Source: Income Tax Act, RSC 1985, c. 1 (5th Supp.), section 7. — Read the official text on Justice Canada
These summaries are for educational purposes only and do not constitute legal or tax advice. Speak with a CPA for advice on your specific situation.