Introduction
Stock options and RSUs are powerful wealth-building tools for tech employees and professionals. But they're also tax nightmares if not planned properly.
A tech worker who receives $100,000 in stock options faces complex tax decisions: When to exercise? How much to exercise? Should you hold the stock or sell immediately?
Get these decisions wrong, and you could owe $20,000-$50,000 in unexpected taxes. Get them right, and you optimize thousands in tax savings.
This guide covers everything employees need to know about stock options, RSUs, and tax-efficient strategies.
Understanding Stock Options
Stock Option Basics
Your company grants you the right to buy company stock at a fixed price (the grant price or strike price).
Example:
- Grant date: January 2024
- Grant price: $100/share
- Grant size: 1,000 shares
- Vesting: 4 years (250 shares vest each year)
On January 2025:
- 250 shares vest (you can now exercise)
- Current stock price: $150
- You can buy 250 shares at $100
Decision: Exercise and buy 250 shares at $100 = $25,000 cost?
The Employment Benefit
When you exercise, you trigger an "employment benefit":
Employment benefit = (Current Stock Price – Grant Price) × Number of Shares
Example:
- Exercise 250 shares at $100 grant price
- Current stock price: $150
- Benefit = ($150 – $100) × 250 = $12,500
This $12,500 is treated as employment income (added to your W-2 wages).
The Stock Option Deduction
But Canada offers a deduction for stock option benefits:
50% of employment benefit is deductible
- Employment benefit: $12,500
- Deductible amount: $6,250
- Taxable amount: $6,250
- Tax owing (at 43.4%): $2,709
This is one of the best tax breaks in Canada. Only 50% of your option benefit is taxable (vs. 100% for regular employment income).
RSUs vs. Stock Options: Tax Comparison
Stock Options
- Granted at exercise price
- Only taxable when you EXERCISE (choose to buy)
- Benefit = (stock price at exercise – grant price) × shares
- 50% of benefit deductible (taxed at 50% inclusion)
RSUs (Restricted Stock Units)
- Granted as "virtual" shares
- Taxable when RSUs VEST (automatically given to you)
- Benefit = fair market value at vesting date × shares
- NO deduction (fully taxable)
Tax comparison:
1,000 RSUs vesting at $100/share:
- Taxable benefit: $100,000
- Tax owing (43.4%): $43,400
1,000 stock options at $80 grant price, exercised at $100 current price:
- Benefit: ($100 – $80) × 1,000 = $20,000
- Deductible (50%): $10,000 taxable
- Tax owing (43.4%): $4,340
Tax difference: $39,060
Stock options are FAR more tax-efficient than RSUs.
Strategic Exercise Timing
Strategy 1: Exercise in Low-Income Year
If you can take time off work:
Normal year scenario:
- Employment income: $150,000
- Marginal tax rate: 43.4%
- Exercise 1,000 options at $50/share benefit = $50,000 benefit
- Taxable (50%): $25,000
- Tax owing: $10,850
Sabbatical year scenario:
- Employment income: $0
- Take $50,000 benefit from option exercise
- Marginal tax rate: 30%
- Taxable (50%): $25,000
- Tax owing: $7,500
- Savings: $3,350 on one exercise
Over multiple exercises: $10,000-$20,000 in tax savings.
Strategy 2: Exercise Before Stock Price Drops
Your options are only valuable if stock price is above grant price.
Risk: Company struggles, stock price drops below grant price.
If stock price drops below grant price:
- Options become worthless (underwater options)
- You can still exercise but get no tax benefit (paying above market price)
Strategy: Exercise options as they vest if:
- You're unsure about company future
- Stock price has appreciated significantly
- You want to lock in gains
Don't wait for maximum gain if there's risk of decline.
Strategy 3: Sell Immediately After Exercise (Avoid Capital Gains)
Two approaches after exercising:
Approach 1: Hold the stock
- Exercise at $100/share (stock price $150)
- Hold the stock as it appreciates to $200
- Later sell at $200
- Gain from $150 to $200 = $50/share capital gain
- Capital gain taxable at 50% inclusion rate
Approach 2: Sell immediately
- Exercise at $100/share (stock price $150)
- Sell immediately at $150
- Locked-in gain of $50/share
- Zero capital gains (sold at current market price)
- Only employment benefit tax applies (already dealt with)
Tax result: Approach 2 avoids future capital gains tax. You capture the employment benefit tax (which has the 50% deduction), and avoid additional capital gains taxes.
This is an important timing decision with significant tax implications.
RSU Tax Planning Strategies
Strategy 1: Diversify at Vesting
Many employees hold all their RSU proceeds in company stock (dangerous concentration risk).
Tax-efficient approach:
- RSUs vest, automatically sell (net settlement)
- Receive cash
- Immediately diversify into index funds
- Minimal tax consequence (no capital gains yet)
This removes concentration risk without tax complexity.
Strategy 2: Use eSTOCK or Direct Stock Purchase
Some companies let employees purchase stock directly through ESPP (Employee Stock Purchase Plan):
- Discounted price (usually 10-15% below market)
- Pre-tax contributions
- Tax-efficient way to accumulate company stock
Tax benefit:
- ESPP contribution: $5,000 at 15% discount = $750 value
- Tax benefit (43.4%): $325
- Net cost: $4,675 (instead of $5,000)
Strategy 3: Offset RSU Taxes with RRSP
When RSUs vest, you get large employment income.
Use RRSP to offset:
RSU vesting year:
- RSU benefit: $100,000 (fully taxable)
- Contribute to RRSP: $30,000
- RRSP deduction: $30,000
- Net taxable income from RSUs: $70,000
- Tax savings: $13,000
This effectively reduces RSU tax burden.
Real-World Example: Tech Worker Stock Compensation Planning
Situation: Software engineer at Ottawa tech company
- Salary: $120,000/year
- Stock options grant: 2,000 shares at $50/share grant price
- Vesting: 4 years (500 shares/year)
- Current stock price: $80/share
- Expected appreciation: 10% annually
Suboptimal strategy (no planning):
- Year 1: Exercise 500 shares at $80 (benefit $15,000)
– Tax (43.4% rate): $3,258
- Year 2: Exercise 500 shares at $90 (benefit $20,000)
– Tax: $4,340
- Year 3: Exercise 500 shares at $100 (benefit $25,000)
– Tax: $5,423
- Year 4: Exercise 500 shares at $110 (benefit $30,000)
– Tax: $6,511
- Total tax over 4 years: $19,532
Optimized strategy:
- Year 2: Sabbatical from work (take unpaid leave)
– Income: $0
– Exercise all 1,000 vested shares at average $90 (benefit $40,000)
– Taxable (50%): $20,000
– Tax rate: 30% (low income year)
– Tax owing: $6,000
– Regular 4 years of exercise: $19,532
– Savings: $13,532 (vs. no sabbatical strategy)
- Alternatively: Spread exercises across years at lower income levels
– Years with bonus dips, exercise more options
– Years with bonus peaks, exercise fewer options
– Optimize tax rate on each exercise
Dealing with Underwater Options
What Are Underwater Options?
Options become "underwater" when stock price drops below grant price.
Example:
- Grant price: $100/share
- Current stock price: $60/share
- Options are "underwater" (out of the money)
Tax consequence: No tax benefit to exercising (you'd be paying $100 to buy stock worth $60).
Should You Exercise Underwater Options?
Generally NO, unless:
1. Company turnaround expected (stock likely to rebound)
2. You have other capital losses (can offset employment benefit)
3. Options expire soon (use it or lose it)
4. You want to own the company (strategic reason, not tax reason)
Tax-Loss Harvesting with Underwater Options
If you have capital losses elsewhere:
- Exercise underwater options
- Create employment benefit (trigger tax)
- Offset with capital losses
- Net tax impact: reduced or zero
Example:
- Exercise 500 underwater options at $100 (stock price $60)
- Employment benefit: $0 (no benefit since exercise price = grant price)
- Buy 500 shares at $60 = $30,000
- If you sell immediately at $60 = $0 capital gain
No tax benefit from this exercise (not useful unless stock rebounds).
Documentation & Compliance
Track Exercise Details
For each option exercise, document:
- Grant date and grant price
- Exercise date and exercise price
- Stock price on exercise date (determines employment benefit)
- Number of shares exercised
- Cost to acquire shares
Why: CRA will ask for this if they audit stock option reporting.
Report on Tax Return
Stock option benefits reported as:
- Employment income on T4 (if Canadian company granting options)
- May be reported separately as "stock option benefit"
- Deduction shown (50% of benefit deductible)
If working for US company:
- Reported on Form W-2 (if US employee)
- Must report on Canadian tax return
- Foreign tax credit may apply
Employer Reporting
Company should provide:
- Statement of stock option benefits (Form T4 Box 14)
- Exercise prices and dates
- Number of shares exercised
If company doesn't report properly → You must report accurately, even if company doesn't.
International Considerations
US Employer Stock Options
If you work for US company exercising options:
- Treat as employment income (reported on W-2)
- Report on Canadian tax return
- Potential foreign tax credit if US taxes withheld
Incentive Stock Options (ISOs) – US Only
US companies offer two types:
- ISO (Incentive Stock Options): Special tax treatment in US
- NSO (Non-Qualified Stock Options): Regular employment income in US
Canada doesn't distinguish—both treated as employment income.
ESPP Plans (Employee Stock Purchase Plans)
US plans let employees buy stock at discount.
Tax treatment:
- Discount is employment income
- Difference between discount price and FMV is taxable when purchased
Conclusion
Stock options and RSUs are valuable compensation, but tax planning is critical to maximize their value.
Key strategies:
1. Understand option vs. RSU tax differences
2. Time exercises strategically (low-income years)
3. Consider sell-immediately approach to avoid capital gains
4. Use RRSP to offset RSU taxes
5. Document everything for CRA
The difference between optimized and unoptimized strategy: $10,000-$30,000+ in tax savings over your career.
Related Articles
- Article 2: RRSP Strategies for Tech Workers in Ottawa
- Article 13: Build a Million Dollar Portfolio the Right Way
- Article 14: Corporate vs Self-Employed Tax Strategy Guide
Sources & References
- CRA Stock Option Deduction
- CRA Employment Benefit
- CRA Capital Gains Rules
- IRS Stock Options
- US Treasury Incentive Stock Options
- CPA Canada Stock Options Guide
- Canadian Couch Potato – Stock Options
- Wealthsimple – Stock Options Explained
- BDC Employee Equity
- Global Relocation Services – Stock Options Tax
